‘Cream puffs’ of­fer tasty yield for this top Cana­dian bond fund

The Globe and Mail (BC Edition) - - GLOBE INVESTOR - MACIEJ ONOSZKO

Ge­off Cas­tle’s formula for beat­ing his peers in the bond mar­ket starts with “cream puffs” – his term for un­rated cor­po­rate bonds whose yields are of­ten too sweet for other in­vestors.

Bets on com­pa­nies such as Just En­ergy Group Inc. and W&T Off­shore Inc. led to a re­turn of 23 per cent last year for the cor­po­rate bond fund Mr. Cas­tle man­ages at Van­cou­ver-based Pen­der­fund Cap­i­tal Man­age­ment Ltd. That beat 98 per cent of its peers, ac­cord­ing to data com­piled by Bloomberg. This year, the fund has gained 5.4 per cent, out­per­form­ing three-quar­ters of its peers. Pen­der­fund man­ages about $645-mil­lion in to­tal, with about $160-mil­lion in credit.

The cream puffs of credit are of­ten bonds with­out rat­ings that slip un­der the radar of ex­change­traded funds and a lot of ac­tive ones, too. The com­mon de­nom­i­na­tor is a high yield, along with a lot of as­sets that can be put to good use in case things turn sour.

Ge­off Cas­tle

Fund man­ager at Pen­der­fund Cap­i­tal Man­age­ment Ltd.

“We’ll eat cream puffs all day along and the ETF hold­ers will have to get by with stew and pota­toes,” Mr. Cas­tle said in an in­ter­view. “It’s a sit­u­a­tion where there’s enor­mous col­lat­eral and busi­ness value com­pared to the de­gree of debt the com­pany has taken on, yet we find a yield much, much higher than com­pa­ra­bly in­debted, rated com­pa­nies.”

One ex­am­ple is Mis­sis­saugabased Just En­ergy, a Cana­dian retail en­ergy provider with se­cu­ri­ties in the do­mes­tic mar­ket and U.S. dol­lar. Cas­tle holds its 6.5per-cent U.S. dol­lar con­vert­ible bonds due July, 2019. In his view, the com­pany’s as­sets suf­fi­ciently un­der­pin its bonds and the yield is higher than com­pa­ra­ble-rated com­pa­nies such as Tran­sAlta Corp.

An­other one is W&T Off­shore, with the fund hold­ing the com­pany’s 9-per-cent U.S. dol­lar bonds ma­tur­ing in May, 2020. In the fund man­ager’s view, the yield they of­fer is at­trac­tive given the cov­er­age the bonds get from the value of the com­pany’s as­sets and its cash. Cash re­serves

The same goes for Aimia Inc., the loy­alty pro­gram op­er­a­tor that has been in trou­ble since May, when Air Canada said it would with­draw from a points agree­ment with the com­pany in 2020. Mr. Cas­tle holds Aimia’s Cana­dian-dol­lar bonds due in 2019, as he says the com­pany has shown it can raise cash, in­clud­ing the sale of Air Miles trade­marks for as much as $67.5-mil­lion while of­fer­ing a juicy yield af­ter rat­ing com­pa­nies down­graded it in the wake of the Air Canada an­nounce­ment.

The yield on the bonds has dropped to about 7.9 per cent from al­most 20 per cent af­ter S&P Global Rat­ings cut the com­pany’s credit grade to junk.

Two con­sec­u­tive in­ter­est-rate in­creases from the Bank of Canada will cre­ate more “cracks in the sys­tem,” which won’t be good for credit and eco­nomic growth but will re­sult in more pock­ets of op­por­tu­nity for funds spe­cial­iz­ing in dis­tressed debt, Mr. Cas­tle said.

“In our world, you’re not nec­es­sar­ily de­pen­dent on what hap­pens to the broader econ­omy,” he said.

“You’re typ­i­cally deal­ing with a con­tract be­tween a bor­rower and some lenders re­lat­ing to some spe­cific col­lat­eral for a cer­tain pe­riod of time – there’s ways to make money even in the worst cir­cum­stances,” he added.

In our world, you’re not nec­es­sar­ily de­pen­dent on what hap­pens to the broader econ­omy.

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