Unloading some more long term debt

One of my corporate long-term debt holdings in R.R. Donnelley (NYSE: RRD) has been trading significantly higher since my purchase point in 2009. I had invested in the 6.625% October 2029 debenture, via a trust preferred security (NYSE: PYS), which has a coupon of 6.3%.

Although I had been sitting on large unrealized gains on the issue and was intending to dispose of it in 2011, the trading above 24 proved to be too tempting so I unloaded it and realized gains. Although it’s entirely possible the bonds will continue trading this high in a couple months, I didn’t want to take the gamble.

Mathematically, assuming a continuous yield (which the trust preferreds do not trade as; they trade “as-is”), the PYS security would have a pre-tax current yield of 6.5% and an implied capital gain over 18.9 years of 0.2%. This is below what you can get with some shorter duration fixed income securities, so disposing of this will be a good decision assuming I can deploy capital more efficiently in the future.

The equity in RR Donnelley at this moment appears to look like a better investment than its long-term debt – the company’s cash generation is significant and its debt is termed out properly and has been managed well, so there is unlikely to be a liquidity risk with the operation. Even if you assume they do absolutely nothing but earn income at the rate they have been doing in the past 9 months (a false assumption due to seasonality in their business), the equity will be yielding a minimum of 7.6% at present prices – a compensation of about 1% over debt. When you factor some very conservative growth assumptions, it skews significantly in favour toward the equity relative to the debt.

In terms of overall portfolio movement, my long-term debt holdings have shrunk again and cash has increased. If/when long-term government bond yields start to rise this should prove to be a good move.

An extra $100,000 for TFSA room?

The Senate Standing Committee on Banking, Trade and Commerce is one of the more functional committees in Parliament that hasn’t dissolved into a partisan morass.

In one of their recent reports (October 19, 2010), one of the committee recommendations was that Canadians should receive a $100,000 contribution room to their TFSAs:

The federal government amend the Income Tax Act to establish, in addition to the existing annual contribution room, an amount for lifetime contributions to a Tax-Free Savings Account. The amount of the lifetime contribution room, which should be increased annually in accordance with changes in the Consumer Price Index, should initially be $100,000.

Moreover, the existing ability to carry forward unused annual Tax-Free Savings Account contribution room should continue.

Although this policy is unlikely to be enacted by the government, if they did it would be a non-trivial method of sheltering income. The actual committee report (page 35 onward) goes on to state that most Canadians are very unaware of how to use TFSAs, and that such accounts are typically used to store GICs or other equivalently conservative investments, rather than stocks or bonds.

Anybody investing in the marketplace should be trying to maximize their TFSA as quickly as possible, as it is truly the only “free lunch” that the government gives to people in terms of taxation. Mathematically speaking, the power of compound interest kicks in if you can competently manage the investment portfolio for a long duration of time. Assuming the government does not change the tax advantage of the TFSA, it removes one of the largest risks of financial planning, mainly the future income tax rate.

General Motors IPO trading on the market

It was a virtual guarantee that General Motors would start trading above its IPO price ($33/share); given that this company is purely a political entity at this point, it would have been disastrous for the IPO to crash on the initial day in the marketplace.

Given the fact that GM has not really solved any of its fundamental business problems (high costs, inferior products) it will be able to successfully use its government-held ownership to bend rules toward its favour.

Suffice to say, I would avoid this company by a long mile.

Reports of food price inflation

I am starting to read more about food price inflation – this makes logical sense when you consider that base commodities such as grain have been rising significantly.

One of Canada’s major grocery retailers, Loblaw Companies (operating Superstore), reported their third quarter results and notably stated the following:

– the Company’s internal retail food price index was flat. This compared to internal retail food price inflation in the third quarter of 2009;

My anecdotal evidence would suggest that food prices are increasing, but at least not according to Loblaw, which has less of an incentive to lie about this than the government statistics.

End of year tax planning notes

Now is about the time to think about how your portfolio should look at the beginning of 2011.

In general, it is usually a wise decision to realize capital losses if you have capital gains to offset them with (i.e. in 2007, 2008, 2009 or 2010 tax years). Each realized loss dollar will result in a “refund” of half your marginal rate for that year. One usually wants to back capital losses into the earliest possible year (2007) if available, but if you have a lumpy income stream, then the high marginal rate year would be the correct decision.

Conversely, if you anticipate lumpy income in the future, realizing capital gains in the current tax year if the current year is a low income year may be optimal – these sorts of optimization calculations are never easy to perform.

The big change from previous years is the looming conversion of income trusts to corporations. Most income trusts will be distributing income until the last possible moment. For most, this means trust holders at the end of the year will be receiving income distributions. For those holding trusts in registered accounts (RRSP, TFSA, etc.), the optimal time to move them out of the registered accounts is at the beginning of 2011 and into non-registered accounts. This assumes, of course, that there are substitute investments that bear income that can be placed into the sheltered account.

You can perform this by doing an asset swap in the case of an RRSP; just that non-registered assets that are swapped into the RRSP will have a deemed disposition – a capital gain will be realized at this point. Capital losses are not allowed to be recognized with an asset swap, so if you plan on swapping assets that are in a current loss position, you will have to wait 31 days before repurchasing in order to avoid the so-called “wash rule”.

Tax planning is quite complicated, but in terms of portfolio management, it involves in placing as much income (interest income, REIT income, and solely in the case of an RRSP and not TFSA, US corporate dividends) as possible into sheltered accounts, and as much tax-advantaged income (eligible Canadian dividends, capital gains) outside the registered account. Unlocking the assets from an RRSP in a tax efficient manner is also a non-trivial issue to examine, which strongly depends on personal circumstances. The TFSA is a simple matter with our existing rules – it should always have something inside it.