It’s not Treasuries that have been making their way into the Diversified Income Fund. The fund has virtually no exposure to government debt; rather, most of the fund’s fixed-income holdings are in the corporate space.
We have competence in the Canadian convertible debenture space, given that 75% of converts in Canada have been issued by income trusts. So we have been looking at the higher part of the capital structure of trusts for over a year. At the end of February 2009, 25% of the portfolio had been in converts (most issued by trusts), as opposed to 5% of the fund being invested in income trusts “equity”. Generally trusts are strong cash flowing entities, but weak energy prices and the current recessions have reduced revenues across many industries. While distributions to equities have been at risk to many trusts (energy comes to mind), revaluation has been another factor that the “get paid to wait” crowd forgot about. Whereas a REIT like Riocan traded at 17 times cash flow at the end of 2006, that figure is closer to 8 times cash flow in early 2009, even though the distribution is intact. Debentures, subject to credit widening and company fundamentals, are not "perfect" instruments, immune from volatility. However, they do offer less volatility than income trusts and dividend paying equities.
Another 25% of the Fund is invested in corporate and structured credit. We would also include preferred shares in this category, although these instruments area not proper fixed-income securities.
Our avoidance of government debt is based on the fact that lots of supply is coming our way as governments spend money to shore up institutions and economies during this recession. As economies recover, I don’t believe that governments will be able to reduce or withdraw stimulus in time, which when coupled with the fact that currently depressed commodity prices have led producers to suspend projects, will lead to inflation.
I don’t think the “safe” trade is so safe after all…
Eric Dzuba, Associate Portfolio Manager
Front Street Diversified Income Fund
Performance:
YTD: (as at March 12, 2009)
Series A: 0.37%