In his quest for higher yields without taking excessive risks, portfolio manager Dhruv Mallick is holding more than half of the assets of Leith Wheeler Multi Credit in U.S. senior loans. And he may very well boost that weighting over the coming months. This is consistent with his tactical mandate to generate more income than what the mainstream bond markets can offer, while striving to preserve unitholders' capital.
The fund is designed to be a high-yield strategy "but it's a little more flexible," says Mallick, who joined Vancouver-based Leith Wheeler in January 2015 from CQS in London, where he managed high-yield and investment-grade corporate securities.
Launched on Sept. 30, the Leith Wheeler fund differs from those that specialize in any one of investment-grade, high-yield or bank-loan securities. Instead, the portfolio will normally hold all three, in varying proportions at the manager's discretion. (See table.)
The fund is expected to have a portfolio turnover rate of more than 70%, resulting in higher trading costs than those incurred by buy-and-hold portfolios. But management believes that active trading will enhance risk-adjusted returns after fees. The management fee, which includes operating expenses, is 0.95% for the direct-sales Series B, and 0.80% for Series F, which is for fee-based advisory accounts.
The fund's target return, measured over a full credit cycle, is CDOR (the Canadian Dollar Offered Rate) plus 3% to 4%. Calculated and published by Thomson Reuters, CDOR was 1.4% as of Nov. 14. It's a market benchmark for bankers' acceptances with maturities of one year or less. Bankers' acceptances are short-term loans by banks to companies.
Mallick believes the credit cycle is currently in the later stage of its expansion phase. This follows the recovery phase, which in turn followed the recession phase that dates back to the 2008 financial crisis.
While the early stage of the expansion phase is favourable for high-yield securities, says Mallick, the later stage calls for emphasizing exposure to senior loans. Right now, the 55% that the fund holds in senior loans is right in line with its neutral target weighting.
| Asset-mix ranges for Leith Wheeler Multi Credit | ||||
| Asset class | Range | Neutral weight | Current weight | |
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| U.S. senior loans | 0%-75% | 55% | 55% | |
| Global high yield | 0%-75% | 40% | 42% | |
| Global investment grade | 0%-25% | 5% | 3% | |
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| Source: Leith Wheeler Investment Counsel Ltd. | ||||
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Senior loans offer greater creditor protection because they are secured, with the debtholder typically having a claim on the issuer's assets that ranks ahead of bondholders. Also, though the terms of senior loans may be five years or longer, their vulnerability to interest-rate hikes is low because these loans typically have provisions for interest-rate resets every 90 days, Leith Wheeler notes in a presentation to financial advisors.
Leith Wheeler cited estimates of the size of the U.S. senior-loan market, the world's largest, at US$960 billion. That compares with an aggregate market capitalization of US$1.6 trillion for high-yield bonds in the U.S., also the dominant market for this asset class, defined as bonds that are below investment grade.
The fourth phase of the credit cycle is the slowdown phase. The market isn't there yet, according to Mallick. But as that time nears, he'll be dialling down the credit risk of the portfolio in two ways. He'll shift assets into securities that are in the highest tier of the capital structure, namely senior loans. And he'll raise the average credit quality of the portfolio. "As we get later in the credit cycle, we'll be maximizing the loan component to 75% and maximizing the investment grade to 25%."
During all phases of the credit cycle, Mallick will avoid making currency bets, since foreign-exchange losses could wipe out any returns from interest yields. He says the fund will always be close to 100% hedged back to the Canadian dollar. As noted in the prospectus, this will be accomplished through forward currency contracts that substitute the exposure to U.S. currency and other non-Canadian- denominated assets with Canadian currency.
Though the fund is not restricted by country or industry sector, it currently holds an estimated 90% of its portfolio in U.S.-dollar-denominated assets. Except for a couple of European issues, the foreign issuers held in the fund are mostly American companies. The remaining 10% is held in Canadian-dollar issues. The fund expects to hold at least 30 issuers, with no more than 10% of the assets invested in any one.
Depending on market conditions, one asset class may temporarily be taken down to a zero weighting. The current holdings will depend on Mallick's analysis of the credit cycle and where he believes the market is headed.
In exceptional market circumstances, management may make even bolder tactical moves, deviating from the fund's fundamental objectives to increase its cash holdings beyond their normal minimal level.
At the best of times, a multi-credit strategy like Leith Wheeler's is intended to play only a supporting role in an individual investor's portfolio. "Let's be honest," says Mallick. "This is still a risky product. But it provides a solution that will complement your existing fixed-income products."
