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Long-term investors have been rewarded.
by
Jeffrey Bunce, CFA
29-06-2016
Authors can be reached at Analyst Feedback
The managers of Lysander-Canso Corporate Value 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, led by CIO John Carswell, focuses on the
credit analysis of companies. With its size and focus, 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.
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 April 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
1.8%. Canso Corporate Value 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.
Process Pillar: Positive | Jeffrey Bunce 29-06-2016
The fund's management team looks to add value through buy-and-hold corporate credit
selection following a concentrated, go-anywhere approach that includes looking at
investment-grade and high-yield bonds both within Canada and globally. The team's
rigorous credit research in combination with its max-loss score, which is used to evaluate
securities and manage risk, sets the fund apart, warranting a Positive rating for Process.
The team sources ideas in a number of ways, some of which are more unique than others.
For instance, when the firm wins an institutional mandate, the team will evaluate inherited
positions to identify value. The team has sourced some of its European bank debt this way.
The team members will also look at credits that have been recently downgraded or look at
companies in the news and out of favour. They are also proactive, using the firm's size and
reputation in the market to conduct reverse inquiries. 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.
Overall credit risk in the portfolio 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 will focus on high-quality, safer corporate bonds or even government
securities. When spreads widen, such as in 2008 and early 2009, management will be more
aggressive and buy bonds with more credit risk.
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.
At the end March 2016, Canso held close to two thirds of its portfolio in below-investmentgrade 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 higheryielding opportunities that may arise.
Focusing on its highest-conviction ideas with the best risk/reward trade-off, 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 3% advantage
over the benchmark's.
As of March 2016, the fund held 6.5% in stocks and 1.6% in preferred shares (the fund can
invest up to 20% in securities other than bonds). Canso may buy the stock of companies to
which they are already bondholders to increase the potential upside in a name. For
example, the fund has a 7.2% weighting in Bombardier bonds as well as a 3.6% weighting
in the company's stock. All stock-bond pairings are evaluated as one position within Canso's
max loss framework. Lastly, it's not uncommon for total position sizes in a single name to
exceed 10%.
Performance Pillar: Positive | Jeffrey Bunce 29-06-2016
The Lysander-Canso Corporate Value Bond returned 1.1% in 2015. This trailed the FTSE
TMX Canada All Corporate Bond Index by 1.6 percentage points and ranked in the third
quartile of the global fixed-income category. The fund's short duration positioning in a
falling-yield environment hurt, as did widening credit spreads. A position in Bombardier's
debt and equity also detracted as that company came under pressure because of
uncertainty surrounding its new C-Series airplane.
However, year to date to April 2016 has been a different story. The fund ranks in the top
quartile, and Bombardier has been one of the fund's best-performing positions. This pattern
is similar to other periods. In early 2008, Canso Corporate Value Class C (an institutional
share class version with a history dating back to December 2001) was positioned
conservatively heading into the credit crisis with 45% of the portfolio in government of
Canada-guaranteed mortgage securities. Once the crisis hit, Canso sold its mortgage stake
at a loss to load up on more-attractive distressed credits. While the return for 2008 was a
modest 0.9% (still impressive for a corporate-heavy fund), returns of 25.2% in 2009 and
12.3% in 2010 far exceeded the benchmark returns of 16.3% and 7.3%, respectively.
Further, 2011 was a soft patch, with the fund returning 2.5% compared with 8.2% for the
benchmark. Canso established positions in European banks in 2011 during the euro debt
crisis, which detracted that year but ultimately paid off handsomely as the fund beat the
benchmark by 10.2% in 2012 and 9.1% in 2013.
Overall, periods of softer performance have been followed by outsize gains which, longer
term, has led to some of the best returns in the global fixed-income category. Since
inception in December 2011 to April 2016, the Lysander-Canso fund has returned 6.2%
annualized and has outperformed both its benchmark and the category average by 1.8%.
Similarly, Canso Corporate Value Class C, from December 2001 to April 2016, has trounced
the competition, ranking first in the category while returning 9.6% annualized (gross of
fees). This stellar track record earns the fund a Positive Performance rating.
People Pillar: Positive | Jeffrey Bunce 29-06-2016
Canso's large team of 28 investment professionals, led by CIO John Carswell, focuses solely
on the credit analysis of companies. With its size and focus, 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. This is
a distinct advantage versus peers, resulting in a Positive People rating.
Carswell has logged over 30 years in fixed-income investing, specializing in corporate debt
for most of this time. After stints at TAL Investment Counsel and Foyston, Gordon & Payne,
he founded Canso in 1997 and set about building out his team. As assets grew, so did the
team, and its current size of 28 is one of the larger groups in Canada.
Canso employs a flat, team-oriented approach where portfolio managers and analysts alike
participate in the credit research process on equal footing. There are no sector specialists on
the team. Rather, each individual is a generalist, a structure the firm believes fosters better
discussion and debate. However, management creates smaller deal teams on an ad hoc
basis whenever a special opportunity (for instance, a private debt placement) arises. Those
on the team become "experts" on the credit in question, leading to more-effective decisionmaking.
As with many boutique firms, some members of the investment team wear multiple hats-having both investment and client service, business development, or compliance duties.
Ideally, investment professionals would spend as much time as possible on research and
portfolio management and delegate the other functions.
Parent Pillar: Positive | Jeffrey Bunce 28-06-2016
Canso Investment Counsel Ltd. is a credit-focused private Canadian asset manager with a
mostly institutional client base. Lysander Funds Ltd. is a wholly owned subsidiary of Canso
and represents the firm’s retail distribution. Lysander’s mutual fund platform offers access
to external third-party investment managers as well.
Canso is 100% employee-owned and run by investment professionals. Founder, president,
and CIO John Carswell has carved out a niche within fixed income. The firm’s somewhat
unique go-anywhere, value-oriented approach meshing investment-grade domestic
corporate bonds and global high-yield issuers has generated above-average returns for
investors over the long term.
Canso is named after a naval support airplane used in World War II. The plane continued in
use long after the war and was known for its dependability. Canso’s mission is similar:
Deliver dependable returns in all environments. As such, the firm’s culture is much more
focused on achieving investment excellence than on gathering assets. However, don’t
mistake it as a plain-vanilla fixed-income shop. Canso prides itself on being different from
other managers and routinely takes big active positions in out-of-favour issuers that it
believes represent good value. It does so with conviction developed from deep fundamental
research of companies and their debt.
Disappointingly, Canso has declined to disclose its portfolio managers’ coinvestment levels
in the strategies they manage. While the majority of portfolio managers have alignment
with shareholders through ownership stakes in the firm, Morningstar considers coinvestment
to be a stronger link. Anecdotally, portfolio managers do invest alongside fundholders, but-without knowing the extent--Canso receives a C grade on Manager Incentives.
The Lysander-Canso mutual funds are, for the most part, favourably priced. Fees on some
of its smaller or newly launched funds are average relative to peers, but larger funds are
cheaper and offer good value in both the commission- and fee-based channels. Overall, fees
on both an equal-weighted and asset-weighted basis rank in the second-cheapest quintile.
Overall, the strength of Canso’s corporate culture and below-average fees distinguishes the
firm and provides for an above-average investor experience, resulting in a Positive Parent
rating.
Price Pillar: Positive | Jeffrey Bunce 29-06-2016
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, in the commission-based channel, the fund carries an MER
of 1.52% and ranks favourably against the category median of 1.85%.
With a below-average Price, the fund receives a Positive Price rating.
Morningstar Analyst Rating
Morningstar evaluates managed products based on five key pillars, which its analysts believe lead to funds that are more
likely to outperform over the long term on a risk-adjusted basis.
Analyst Rating Spectrum
Morningstar Analyst Rating
Morningstar Pillars
Process
Performance
People
Parent
Price
Copyright © 2016 Morningstar
Positive
Positive
Positive
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Positive