Market takes interest rates out of the bond equation
Expectations for an interest rate hike by the Federal Reserve have fallen since Janet Yellen’s late-August speech in Jackson Hole, Wyo., but the spike in bets on monetary tightening by the U.S. central bank that preceded her speech reminded at least one fund manager of an earlier episode: The so-called Taper Tantrum of 2013.
When then-Fed chairman Ben Bernanke suggested rates needed to go higher in the spring of that year, virtually all fixed-income markets made a sharp move lower in the second quarter.
For Matt Shandro, president at Vancouver-based Fulcra Asset Management, the pain wasn’t nearly as bad.
In fact, the Fulcra Credit Opportunities Fund was up 60 basis points, in large part because its duration was short, as it continues to be.
“I think the market is good at calling the Fed’s bluff and realizing that they are clearly going to operate based on the data,” the portfolio manager said.
Shandro isn’t suggesting yields are going to spike as dramatically as they did then, but he feels it is important to point out that even riskfree securities can have periods of very negative volatility.
In other words, there is a price for everything.
Back in Q2 2013, the U.S. 10-year treasury bond fell 4.7 per cent.
The U.S. high-yield (HY) market, an area Shandro is active in, was down 1.4 per cent — and it was the best performing index.
The Canadian corporate investment grade (IG) market dipped 2.1 per cent, and a blended (HY and IG) emerging market corporate index fell 5.5 per cent. Following Yellen’s comments at Jackson Hole, concerns grew to a level that Shandro thinks were comparable to 2013.
The portfolio manager admits that trying to parse the Fed minutes has done investors no good this year, but these types of dramatic market movements linked to comments on policy, demonstrate the importance of his efforts to eliminate the risks associated with interest rate movements in fixed income investing.
“We want to get comfortable with a bond based on the value of the assets or the cash flow, and don’t want to have interest rates influence our performance,” Shandro said.
His bottom-up focus makes him much like a stock picker at the end of the day.
One area where Shandro has found opportunities is the oil and gas sector.
Specifically, he bought bonds in a private natural gas producer at between 10 and 15 cents on the dollar, and is now poised to own (along with other bond holders) nearly 100 per cent of the equity of the business.
“I think there are some opportunities in natural gas,” Shandro said. “There are lots of good companies, but some of them have bad balance sheets.”
In this case, the company’s bonds were driven lower by technical selling, something that isn’t uncommon in the Canadian market.
Since a handful of investors may own well over 50 per cent of an given bond issue, whenever concerns about a company’s performance emerge, there can be a lot of negative price volatility.
That can be a great opportunity for smaller, more nimble funds like Shandro’s.
Another name the portfolio manager got involved with was Canadian publicly listed health-care services provider Centric Health Corp.
Shandro noted that its previous management team made some fairly aggressive debt-financed acquisitions. Some bondholders eventually forced the company to de-lever because it wasn’t performing as expected, and Centric sold one of its businesses early in 2016 to achieve that goal.
Confident this was a solid business, and given the relative value of the bonds versus public comparables, he bought some of these high yield bonds in the fall of 2015 in the low-80s.
They were taken out at par just four or five months later, and Shandro used this positive event for the company’s balance sheet to jump into Centric’s convertible bonds.
The fund also has a position in Sherritt International Corp. bonds.
The nickel and energy producer has historically had a lot of cash on its balance sheet, and the sale of its coal assets added nearly another $1 billion.
Sherritt ended up taking out some of its debt with the proceeds.
“Nickel prices have dropped, but they have effectively extended the maturity of their balance sheets in the past couple of months by offering bondholders like us a cash or equity incentive,” Shandro said.
“We also think the optionality for nickel is interesting, and like Sherritt’s expertise in laterites.”
He noted that big nickel players like Norilsk and Glencore forecast a supply deficit for the metal in 2017, and Sherritt’s presence in Cuba means most American investors cannot participate, leaving its bonds very inefficiently priced.
The company also receives intercompany loan repayments from its Cuban subsidiaries.
While they come in the form of cash, they don’t show up as such on the balance sheet.
As a result, Shandro noted that Sherritt’s organic liquidity is higher than what is reflected in analysts’ estimates.
I think the market is good at calling the Fed’s bluff and realizing that they are clearly going to operate based on the data.