Alpha Generation Through Fixed Rate Bonds: Amplus Credit Income Fund's Timely Strategy
In March 2023, Amplus Credit Income Fund harnessed a compelling investment opportunity with TC Energy’s Primary Canadian Debt Offering. They issued two bonds, giving us the ability of choosing the one that presented better value:
Option 1: A 3-year floating rate note at $100, offering a competitive 5.93% initial yield and +140 spread over Canadian Overnight Repo Rate Average (Corra)
Option 2: A 3-year fixed rate note at $100 with an initial yield of 5.419% and a +154 spread.
Both options were structured in such a way that gave the issuer the optionality of taking them out in 1 year’s time (2024) at $100.
Due to the fund’s aversion to interest rate risk and what we perceived to be a punitive structure of the fixed rate bonds, the Amplus team made the calculated decision to exclusively hold floating rate bonds, accumulating a substantial size over time.
Fast forward to July 2023, TC Energy concluded their strategic review by divesting and spinning off assets, prompting the need to rebalance debt between entities. TC Energy was now forced to consider the most cost effective way of shifting debt accordingly. The least punitive way highlighted was likely the take-out of both securities mentioned above by choosing to elect the option of 1 year take out at $100 (issue price). In hindsight, we suspect they thoughtfully chose to structure this debt 4 months prior for this very reason.
Amplus Fund’s Current Investment Landscape:
The fund purchased in mid-October the TRP 3-year fixed bonds at $98.65. They offer a 6.03% yield with a +130 spread to March 2026. What’s more, there’s a chance they may get called at $100 in March 2024, potentially yielding a remarkable 8.85%. This stands out, especially when compared to similar maturity bonds without a call option, which trade at a 5.8% yield—a 20-basis point premium. Also worth highlighting that TC Energy chose to issue similar debt in USD around the same time. The fixed bonds trade much closer to $100 in USD, not providing the same upside potential for an early 2024 take out.
Simultaneously, Amplus divested the TRP 3-year floating bonds. While they’ve been reliable, they now offer a steady 5.85-5.90% yield without upside optionality.
In Summary:
March 2023: Amplus bought floating bonds at $100, earning around 6.15% in accrued interest over seven months. Eventually, selling them at a nice gain. Spreads narrowed from +140 to +86, driving the decision to divest.
October 2023: Amplus strategically acquired the fixed rate bonds (which initially yielded 5.419%). Due to changing market dynamics, the yield on these bonds stood at a compelling 6.03%, with the potential for an 8.85% yield. During this period, spreads tightened from +158 to +130.
The key takeaway— fixed bonds have shifted from yielding 50 basis points less than floating bonds to offering yields ranging from 20 to 300 basis points more, depending on the call decision in 2024. This showcases the effectiveness of our investment strategy.
Fast Forward to today, the 3 year fixed bonds have participated in the recent interest rate rally, gaining over $0.70 in a couple of weeks, now trading close to $99.25. Meanwhile, the floaters remain roughly at the same price we’ve sold them at. This trade highlights our ability of pouncing on opportunities, and being able to generate alpha for our clients. Interestingly, floating coupon bonds aren’t part of the main fixed income universe, therefore a traditional fixed income fund limited to benchmark constituents wouldn’t have had the ability of replicating this trade.
