The managers of Lysander-Canso Corporate Value Bond look to add value through corporate credit selection and will invest in a concentrated mix of investment-grade and high-yield bonds. The fund technically fits in the Global Fixed Income category because of its large weighting outside of Canada (39% as of March 31, 2016), but management follows an unconstrained approach, investing wherever the best risk-reward trade-off can be found. This go-anywhere approach, coupled with a large, experienced team that is willing and able to examine out-of-favour and deeply depressed credits, results in a Morningstar Analyst Rating of Gold.
Canso's team of 28 investment professionals is led by CIO John Carswell, a 30-year veteran of fixed-income investing who has specialized in corporate debt for most of this time. With its size and focus on the credit analysis of companies, the Canso team delves deep and gets to know companies and their debt instruments better than most. Because of this, management will take on credit opportunities that other firms generally won't touch, which is a distinct advantage versus peers.
The team sources ideas in a number of ways, some of which are more unique than others. For instance, team members will look at credits that have been recently downgraded or look at companies in the news and out of favour. They are also proactive; they attempt to anticipate the funding needs of companies and then participate in the structuring of debt issues to acquire favourable terms.
The credit research at Canso is thorough. The team assesses a company's financial capacity to service current and future debt and projects company cash flows to evaluate if debt can be repaid. The team thinks in terms of probabilistic outcomes, seeking to answer the question of what could go wrong. Next, the team analyzes the debt security and its covenants to figure out a bondholder's rights. This results in an internal credit rating as well as a "max loss score"--Canso's estimate of the maximum loss potential of a security relative to its trading value. Using these metrics, Canso focuses on buying bonds trading near or below their recovery values while limiting exposure to bonds that trade expensively relative to potential losses. The team also uses the max-loss score to control portfolio risk--limiting securities with a high score to a lower weighting than those with a low score.
While the default is to hedge foreign currency back to Canadian dollars, at times, the team takes a view on the Canadian-U.S. dollar exchange rate and may leave a portion of the portfolio unhedged to the U.S. dollar.
Focusing on its highest-conviction ideas, management builds a concentrated portfolio. As of March 2016, the top 10 positions represented 40% of the fund. Sector concentration is also significant as the fund had 43% in the financial sector and 27% in the communication sector. The team focuses on issuer-specific risk, and this can lead to heavier weightings in certain sectors, especially if value arises because of an issue affecting multiple companies in a given sector.
The Canso team views interest-rate risk within its max-loss framework and, with yields currently at low levels, believes the max loss on long-term bonds is high. As such, the portfolio's duration as of March 2016 was 2.5 years--considerably less than the 6.2 years for the FTSE TMX Canada All Corporate Bond Index. The team has achieved the fund's duration profile by allocating close to one third of assets to floating-rate notes, which carry durations close to zero. Despite the lower duration, the fund's yield, at 5.7%, carries a three-percentage-point advantage over the benchmark.
At the end March 2016, Canso held close to two thirds of its portfolio in below-investment-grade bonds, with the rest held in investment-grade. If the opportunities were available, management would have the whole fund in high-yield bonds, but prudence often dictates otherwise. Over 2015 and into 2016, the fund's management team had become cautious on credit conditions and stashed a portion of the portfolio in higher-quality bonds like the AAA-rated RBC floating-rate notes, which account for 5.1% of the fund. Management views the allocation to these high-quality bonds as "dry powder" and would sell them to buy higher-yielding opportunities that may arise.
The magnitude of the fund's exposure to credit risk will mainly depend on the stage of the credit cycle. When the spread between corporate-bond and government-bond yields is small, as was the case in 2007, management tends to focus on high-quality, safer corporate bonds or even government securities. When spreads widen, such as in 2008 and early 2009, management will become aggressive and buy bonds with more credit risk but at attractive prices.
This approach has served them well. Since inception in December 2011 to June 2016, the fund has returned 6.2% annualized and has outperformed both its benchmark--the FTSE TMX Canada All Corporate Bond Index--and the Global Fixed Income category average by 1.4 percentage points. Canso Corporate Value Bond Class C (an institutional share class) has a record dating back to December 2001 and has trounced the competition over this time, ranking first in the category while returning 9.6% annualized gross of fees.
Before jumping in, be aware that this fund achieves its strong returns by taking higher risk. Canso invests for the long term and in bonds typically shunned by others. While management takes pride in being different than the masses, performance won't look like the masses either. Investors have been amply rewarded over the long term but need to be comfortable with periods where the fund could significantly underperform peers and the benchmark.
The majority of assets in the fund are in the fee-based F Class, which sports a management-expense ratio of 0.95%. That's good enough to rank in the second quintile within the Global Fixed Income category. Similarly, the version sold through commission-based advisors carries an MER of 1.52% and ranks favourably against the category median of 1.85%.
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