Views at a Glance / Income Report; 4 Income Opportunities (ALF,CMA)

By Market Matters 06 December 17

Income Report; 4 Income Opportunities (ALF,CMA)

Market Matters Income Update 6th December 2017

A few interesting trends playing out this week that are relevant to our income portfolio. Firstly, and I wrote about this yesterday afternoon/this morning, Amazon has finally opened on our shores yet the Aussie retail sector had a very strong day yesterday (less so today), with both Harvey Norman and Nick Scali finishing higher. This was partially a result of better than expected retail sales data, but also a good reflection of the old adage of sell the rumour / buy the fact. While we are not calling the end of the bear market for the retail sector just yet, we do feel the easy money for the “shorters” has gone with share movements to become more about actual performance than pure speculation and scaremongering.

Our target for Harvey Norman sits around $4.60, while we’re looking for $7.20 from Nick Scali.

The other obvious trend is around some of the more expensive stocks being sold, profit taking coming in, while we’re yet to see a meaningful / sustained move into the ‘cheaper’ end of the market, I think this is likely, and the Income Portfolio is positioned for this.

In terms of the MM Income Portfolio over the past week, it added +0.385% versus a market which was down -0.21%. Overall, the portfolio has gained 6.97% since inception (5th July 17)  while our cash levels now sit at 7.50%, before today’s purchase.

1.      Short dated hybrids

Obviously an interesting proposition given cash rates are so low, with the RBA remaining on the sidelines for the past 15 meetings – a record period of ‘doing nothing’. Futures are pricing little chance of a rate increase before December 2018 and the median estimate of economists is for tightening to begin in the fourth quarter of next year – rates lower for longer is the key message here.

Hybrids have often been promoted as a replacement for cash. Firstly, they’re not and the higher returns are reflective of higher risk, however it’s important to think about the three things that play into that risk proposition. 1. Credit quality of the issuer 2. Duration 3. Structure.

The banks are the main issuer of hybrid securities, and clearly the credit quality of the Australian banks is very high, so looking for a security that on a risk adjusted basis stacks up, we still think the bank hybrids make sense. The recently  announced Royal Commission is also likely to improve the outlook for bank debt / hybrids given the banks will end up being ‘safer’, an outcome that is good for debt holders, but in aggregate, less so for equity holders.  In terms of structure, there are some variances here, however the tier 1 securities are now fairly well standardised, although I won’t delve into the detail for now. The main point in today’s note is around opportunities in shorter dated notes – the shorter the duration to call, the lower the volatility, the safer and the more ‘cash like’ the note is, all else being equal. By holding the shorter dated note, it also provides a holder a seat at the table to roll into any new issue, which can (at the moment) be hard to get.

Preferred Short Dated Major Bank Hybrid

WBCPC – trading at $101.34 offers 3.72% annualised and grossed for franking with a first call date on the 31 March 2018 – so the risk is limited to the timeframe between now and March 2018, the holder receives $100 back, takes a capital loss of $1.34 however picks up the dividend in March of $1.80 plus franked = $2.57 benefit, minus $1.34 capital loss = net result of $1.23. A low risk approach to a) increasing income and b) getting a full allocation in any new issue which given current scarcity of these issues may open at a premium (SUNPG the latest example here which opened at $101.47 (and traded to a high of $101.75).

Preferred Short Dated Regional Bank Hybrid

BOQPD – trading at $101.90  offers 4.26% annualised and grossed for franking with a first call date of 14th April 2018

At this stage, we are comfortable with our hybrid allocation however clearly, opportunities can be found within the sector.  

2.    Australian Leaders Fund (ALF) managed by Watermark Funds

This is a fund manager that acts more like a hedge fund, has 3 listed funds and performance has been weak in all recently if measured relative to the market. Two of the three have reasonable performance over the longer term and they offer a market neutral strategy with an absolute return objective – or in other words, they target a positive return in all market conditions  (6-8% after fees) By that we mean they go both long and short to hedge overall market risk. A strategy like that struggles in a strong market, which we clearly have had, however it works well in a more choppy market which could be more reflective of the future than the recent past. While we’re not yet of the opinion that market conditions are ripe for ALF, there is clear value here. The Australian Leaders Fund has most history, going back to 2004 – returns are ok and a strong dividend over time (or return of capital if warranted).   

Looking at performance above, the ALF portfolio has underperformed the All Ords Index over 1-3 years however it has outperformed over longer periods. This re-emphasises that different strategies work at different times while period of strong underperformance are often followed by periods of strong outperformance. They have clearly experienced a reasonable period of underperformance and just maybe, the markets are about to start being kind to their strategy!  From mid-2013 to late 2016 this listed investment Company traded at a large premium to NTA (at times more than a 20%), on the back of strong performance and a high dividend. Now, following a period of weak performance and capital returns, they trade at a 13% discount to the NTA after tax and after the return of capital as at October. November NTA will be released on the 14th December, however in an announcement today, they estimate the portfolio is up by 1.41% in November.

We are allocating 5% of the MM Income Portfolio to ALF around $1.05. The likely yield is not set in stone given recent poor performance, however history shows a strong trend of dividends when performance permits - something around 10c pa, an attractive level based on today’s price of $1.05. This is a value play with income upside.

Australian Leaders Fund – weekly chart

3.    CMA Placement

We recently sold out of Centuria (CNI) booking a very strong 20% profit on the position. One of their stable of funds, the Centuria Metropolitan REIT (CMA) which has office and industrial assets is raising around $60m through a retail entitlement offer and an institutional placement. The placement to institutions was completed and the bidding was strong – shares being allotted at $2.39. This is an interesting REIT that offers a huge yield of 7.8% (unfranked)  and is reasonable value  trading on 12x forward. They also do a very good job of improving assets, and manufacturing returns which will become increasingly important as property comes off the boil. Although we remain cautious on property overall, we like this exposure and may be buyers into weakness below $2.40

Centuria Weekly Chart

Conclusion (s)

We are allocating 5% of the MM Income Portfolio into ALF

We are keen on CMA however cash levels are low

We are looking to reduce our large SUN nearer $15

Disclosure

Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Wednesday, or after the session when positions are traded.

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