Demand for tax-advantaged cash returns is high

Horizons found a niche in a corporate-class ETF fund, namely HSAV (TSX: HSAV). Last year (February 3, 2022) because it reached a subscription of $2 billion, the fund had to curtail the creation of new units. This had the effect of raising the NAV of the fund well above the market value. Right now, the market value is approximately CAD$104.80 versus a NAV of $103.82, which means investors are willing to pay an approximate 1% premium or about 2.6 months of interest to get into the fund.

Now the US fund, HSUV.u, made the same decision to close the fund to new unit creation.

The current assets under management (“AUM”) of HSUV.U are approximately US$775 million, which is equivalent to more than $1 billion Canadian dollars. At this AUM threshold, it is the Manager’s view that this suspension will help manage potential tax implications and ensure that HSUV.U can continue to reinvest its distributions, consistent with HSUV.U’s current investment objectives.

As noted in HSUV.U’s prospectus, if the ETF experiences a significant increase in total NAV, the Manager may, in its sole discretion and if determined to be in the best interests of shareholders, decide to suspend subscriptions for new ETF shares if considered necessary or desirable in order to manage potential tax implications and/or to permit HSUV.U to achieve, or continue to achieve, its investment objectives. It is the Manager’s view that the suspension will help manage potential tax implications and ensure that HSUV.U can continue to reinvest distributions.

The advantage of a corporate-class ETF such as this one is that gains accrued within the fund can effectively be liquidated as capital gains, avoiding half the tax that otherwise would be payable upon disposition.

The NAV at the close of today was $102.38, while the closing market price was $102.50. If the parallel to HSAV exists, HSUV.u’s premium to NAV should extend further.

This should also be a sign that in Canada there is a huge demand for high interest cash products – the flight to safety is obvious.

Canaccord – Going Private?

Canaccord (TSX: CF) put forward a management-led buyout proposal of the company at CAD$11.25/share. The total price is expected to be $1.127 billion, which also includes a consortium of people, including management, of 21.3% of the company.

The balance sheet of CF is not the cleanest:

The significant amount of minority interest stems from the roughly 2/3rds ownership CF has in its UK and Australia subsidiaries (which are consolidated on the statements) – and 55% of the Goodwill stems from these divisions.

I remember looking at CF last year (when it was still around $8/share) and decided against it given where I thought the economic climate was going (2021 was a banner year for public offerings, while subsequent to this things are going to be quite dry, relatively speaking). This doom-and-gloom did appear to be baked into the stock price, but as to what degree, I could not say. Dividend investors would have been happy considering they have found a new appreciation for giving out their cash flow to shareholders.

There are a lot of companies that have “covid characteristics”, whereby one has to look back to 2019 results of being more representative of a baseline performance. 2020 to 2022 are abberations for many companies.

In 2019 (backing out dividends), CF was trading at around $5-6/share. Even after adjusting for inflation, an $8/share price seems to have embedded in a reasonable amount of risk. It was not ridiculously under-valued.

However, the special committee to review this CAD$11.25 deal is not thrilled:

The Special Committee and the Management Group engaged in prior discussions concerning a proposal from the Management Group regarding a potential Board-supported transaction to be executed by way of a plan of arrangement. The Special Committee advised the Management Group that it was not prepared to support an offer of $11.25 per common share based on the preliminary financial analyses conducted by RBC. To date, engagement between the Special Committee and the Management Group has not resulted in an agreement on a value per common share that the Special Committee could support and recommend to shareholders.

…

Importantly, the Special Committee has not agreed to recommend that shareholders accept the Proposed Offer.

One danger of investing in smaller-capped companies is that on occasion you will have management try to low-ball an acquisition of the rest of the company. Jimmy Pattison’s firm tried to take out the minority stake in Canfor (TSX: CFP) which nearly succeeded. I still remember being resentful when Cervus Equipment got taken out by management. Almost anything with the name “Brookfield” in it is susceptible to this phenomena. There are plenty of other stories out there. The danger of having these management-lead buyouts increases in proportion to the smallness of the company and the proportion of ownership of management.

As a final point, my last ownership in CF has been through its preferred shares many years ago – which I have long since sold. In early 2016 they were yielding double-digits and were too tempting to not purchase (indeed, they were a steal at the time). However, preferred shareholders get no preferred treatment as a result of this management buyout – the CF.PR.A shares traded up today, but basically at the asking price of a very high bid-ask spread. CF.PR.C traded down! The shares reset in September and June of 2026, respectively, and with current yields of 7.09% and 8.31%. If you believe that 5-year interest rates will remain at around 3.25% around the middle of 2026, the reset rate goes up considerably.

Progression of quantitative tightening

Bank of Canada, projected QT by year, assuming they maintain the existing trajectory:

2023 Bank of Canada Quantitative Tightening Schedule

Snapshot from January 9, 2023
Government of Canada Bonds ($368.3 billion) and Canada Mortgage Bonds ($7.7 billion)
YearAmountPct
2023 $89,864,250,000 24%
2024 $55,880,720,000 15%
2025 $44,235,821,000 12%
2026 $37,432,059,000 10%
2027 $14,158,340,000 4%
2028+ $134,419,469,000 36%

 
US Federal Reserve, treasury bonds, with some annotations:

And, here is another important chart:

Covid masked up (intentional use of language!) what was probably going to be a recession. The overnight rate crisis was a huge signal that something was wrong in the financial world liquidity-wise and required the intervention of the Fed to keep things steady.

Today, the environment is different. The issue is that there is a general sense of foreboding. If this is sufficiently baked into pricing, then it will become a non-issue compared to the unknown unknowns that are not priced in (which could resolve to the better or worse).

However, one reason why I focus on the progression of QT is because it reflects the extinguishment of credit. There’s a couple analogies for this. One is slowly taking oxygen out of a room. Another is a poker analogy, which I will use the reverse – quantitative easing: imagine you are forced to play poker (a zero sum game) with a lot of other participants (every other person in the economy), but the dealer is consistently giving out chips to people (more chips go to the “preferred” participants such as government-connected entities). Eventually handing out these chips will permeate around the table (more likely to yourself if you demonstrate some skilled play in relation to the rest of the competition). With QT, the poker analogy is increasing the amount of “rake” (the amount of chips removed per game as a house take) and a logical consequence of this is that people (and asset prices) should become tighter.

These (QT, interest rates) are knowns, but when does it get to the point where things structurally blow up? Does it? This line of thinking would also suggest that fixed income should do better than not – although let me tell you, the prospect of lending the Government of Canada money for 30 years at 3.12% is distinctly unappealing.

Late Night Finance with Sacha – Episode 23

Date: Thursday January 5, 2023
Time: 7:00pm, Pacific Time
Duration: Projected 60 minutes.
Where: Zoom (Registration)

Frequently Asked Questions:

Q: What are you doing?
A: Year-end review, future projections and thoughts and time permitting, Q+A. Please feel free to ask them on the zoom registration if any questions.

Q: How do I register?
A: Zoom link is here. I’ll need your city/province or state and country, and if you have any questions in advance just add it to the “Questions and Comments” part of the form. You’ll instantly receive the login to the Zoom channel.

Q: Are you trying to spam me, try to sell me garbage, etc. if I register?
A: If you register for this, I will not harvest your email or send you any solicitations. Also I am not using this to pump and dump any securities to you, although I will certainly offer opinions on what I see.

Q: Why do I have to register? I just want to be anonymous.
A: I’m curious who you are as well.

Q: If I register and don’t show up, will you be mad at me?
A: No.

Q: Will you (Sacha) be on video (i.e. this isn’t just an audio-only stream)?
A: Yes. You’ll get to see me, but the majority will be on “screen share” mode with MS-Word / Browser / PDFs as I explain what’s going on in my mind as I present.

Q: Will I need to be on video?
A: I’d prefer it, dress code is pajamas and upwards.

Q: Can I be a silent participant?
A: Yes.

Q: Is there an archive of the video I can watch later if I can’t make it?
A: No.

Q: Will there be a summary of the video?
A: A short summary will get added to the comments of this posting after the video.

Q: Will there be some other video presentation in the future?
A: Most likely, yes.

Posted just over two years ago and still applies today

More media headline scares:

Notice the word “Kraken”. Sounds much more scary than XBB.1.5!

December 21, 2020 post: Mutant SARS-CoV-2 Viruses, Perceived Risk, Actual Risk

Here’s your Kraken virus! Run for the hills!

Many, many times in history people believe that they can control what is inherently the uncontrollable – whether it be conditions conducive to agriculture, or the spread of disease. Things have not changed, except now the ways of transmitting such information has reached a near-universal scale instead of localized sects.