July 13, 2021 – One of the most common questions I hear these days is, “How can I generate yield for clients?”
With short-term T-Bills yielding 0.05% and 2-year Treasurys yielding just 0.25%, I am not surprised to hear this question often.
What does surprise me is the record low yields in corporate credit. Specifically, investment grades bonds yield 2.3%, while junk bonds yield just 3.8%. With inflation printing 5.0%, this is the first time on record in which junk bond investors are willing to take on non-investment grade credit risk for a negative real yield (adjusted for inflation). The term “high yield bond” is a misnomer indeed.
Given the unattractive yields offered by traditional fixed income, which are even riskier in an environment of surging inflation, investors need to look elsewhere for yield.
In search of yield, some have taken the plunge into private debt, a highly risky asset class. I believe private debt, given its high risk and illiquidity, is inappropriate for most investors. In fact, given some impropriety that has occurred in the space, I have advised that investors “run, don’t walk away from” private debt.
Another problematic asset class that investors have allocated to in search of yield is preferred shares. There are a couple of reasons why investors should be cautious when considering investing in preferred shares:
- The preferred share index suffered a worse decline than the equity index in March 2020.
- The preferred share index is down approximately -25% since launching in 2012. Including dividends, the preferred share index has rewarded investors with total returns of only 1.6% annualized over nearly a decade timeframe.
I often say that the label “preferred shares” means you should prefer not to own them.
With government and corporate bonds both resoundingly unappealing and private debt and preferred shares too risky, what is a yield-seeking investor to do?
The first place to look is Warren Buffett and Charlie Munger’s favourite investment strategy: merger arbitrage.
Before the Covid pandemic, merger arbitrage had average yields comparable to junk bonds.
Now, highlighting the attractiveness of the asset class, the current average merger arbitrage yield of 8.6% is virtually twice its pre-pandemic level and almost 500 basis points more than junk bonds.
Fifteen months ago, merger arbitrage yields were equivalent to junk bond yields. Now, merger arbitrage offers yields more than double that of junk bonds.
Source: Accelerate, Bloomberg
Another asset class that has seen yields increase is merger arbitrage’s brother, SPAC arbitrage.
During the great SPAC bull run in the first quarter, SPAC arbitrage yields went deeply negative amidst a speculative frenzy, given the equity upside embedded in SPACs.
Now, SPAC arbitrage yields of 1.4% are at a 110 basis point premium to 2-year Treasurys, the most attractive since May 2020. The 1.4% yield offered by SPAC arbitrage only considers the SPACs’ discount to net asset value and excludes the equity upside attainable from an attractive SPAC business combination. Nonetheless, a low-risk 1.4% yield plus equity upside appears to be appealing in the current market environment, especially given the alternatives.
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Source: Accelerate, Bloomberg
The oft-spoken colloquialism TINA, meaning there is no alternative, does not have to force investors into unattractive investments in search of yield.
Two fixed income alternatives that offer attractive yields for investors include merger arbitrage and SPAC arbitrage, both of which are core strategies of the Accelerate Arbitrage Fund (TSX: ARB).
The new term is TAA – there are alternatives – one needs to know where to look.
Accelerate manages four alternative ETFs, each with a specific mandate:
- Accelerate Arbitrage Fund (TSX: ARB): SPAC and merger arbitrage
- Accelerate Absolute Return Hedge Fund (TSX: HDGE): Long-short equity
- Accelerate OneChoice Alternative Portfolio ETF (TSX; ONEC): Alternatives portfolio solution
- Accelerate Enhanced Canadian Benchmark Alternative Fund (TSX: ATSX): Buffered index
Even though SPAC and merger arbitrage spreads have widened recently, as evidenced by rising arbitrage yields, the Accelerate Arbitrage Fund (TSX: ARB) managed to gain 0.5% in June.
This positive performance, despite widening spreads, occurred due to several ARB positions maturing during the month, crystalizing gains for the strategy.
The ARB strategy is relatively short duration, with the weighted average duration of the portfolio currently sitting at 9.1 months. The low duration of the Fund’s arbitrage positions provides two primary benefits to investors:
- The timely maturity of arbitrage investments allows the Fund to crystalize positive returns as investments mature, investing the proceeds at attractive expected returns as spreads have widened.
- A weighted average maturity of 9.1 months allows the portfolio to turnover at an elevated pace, minimizing exposure to rising interest rates that can hurt traditional fixed income strategies, while allowing the strategy to perform in a rising rate environment.
With elevated market sentiment and a return to a more speculative investing environment, evidence-based long-short multi-factor investing suffered in June.
Specifically, U.S. factor performance was deeply negative last month, with the drop led by negative returns for the value and price momentum factors.
The recovery in the value factor was put to an abrupt stop in June, as the long value portfolio fell -3.0% while the short glamour portfolio (betting against the most highly-valued securities) rallied 4.9%, leading to a -7.9% loss for the value factor.
The price momentum factor was not much better, given it lost -5.4% as the long momentum portfolio fell -0.7% and the short momentum portfolio gained 4.7%. In addition, the trend factor dropped -3.1%, while the quality factor declined -2.0%.
Although none of the long-short factors tracked attained positive returns in a difficult month for factor investors, the Accelerate Absolute Return Hedge Fund (TSX: HDGE) barely eked out positive performance in June given its approximate 50% short position, limiting some of the negative attributions from the short hedge portfolio.
The Accelerate OneChoice Alternative Portfolio ETF (TSX: ONEC) crossed a significant milestone last month – the commencement of its quarterly distribution.
The goal of ONEC is to diversify portfolios by providing a one-ticket solution to a diversified alternatives allocation. In addition, we want to reward investors with a quarterly distribution that now equates to a yield of approximately 2%.
In terms of performance attribution, the real asset allocation was the main driver of ONEC’s 1.1% gain in June. Real estate gained 5.5% while infrastructure rose 4.5%. The additional positive performance was driven by risk parity’s 1.5% increase, buffered equity’s 1.2% gain and bitcoin’s 1.1% uptick.
Negative attribution was mainly from gold’s -7.2% drop during the month.
Beta gains continue to power the Accelerate Enhanced Canadian Benchmark Alternative Fund (TSX: ATSX).
In stark contrast to the poor performance of U.S. factors during the month, the Canadian multi-factor long-short portfolio produced a slightly positive performance of 0.9%. This contrasting factor performance between markets is largely due to elevated speculative market activity south of the border.
Nearly all Canadian factors generated a positive result last month, led by the trend factor’s 10.3% surge and the price momentum factor’s 8.7% gain. The only Canadian long-short factor portfolio that was down during the month was value, which dropped -0.2%, as the long value portfolio fell -1.9% while the short glamour portfolio declined -1.7%.
Have questions about Accelerate’s investment strategies? Book a call with me.
-Julian
Disclaimer: This distribution does not constitute investment, legal or tax advice. Data provided in this distribution should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this distribution is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate Financial Technologies Inc. (“Accelerate”) as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Past performance is not indicative of future results. Visit www.AccelerateShares.com for more information.
