A Corporate Success Story

Grant Connor's picture

open pdf versionThe Fixed Income Team at Cambridge Global Asset Management strives to build conviction in our ideas daily through research, humility and discipline. This is especially important in credit because it can humble you in the blink of an eye. However, a strong process can add significant value. In 2019, credit was an important source of alpha, or returns in excess of the market, for us. Cambridge Bond Fund returned 9.85% (excluding fees) exceeding the FTSE Canada Universe Bond Index by approximately 300 basis points (bps). The bonds of TerraFrom Power (TERP), a renewable energy producer, was one of the top contributors to our Fund’s performance, delivering a 24% return. We built conviction in the bonds of this company two years earlier. 

TERP was created in mid-2014 by SunEdison, a U.S. renewable energy company. SunEdison was one of the biggest renewable energy developers in the U.S. and was looking for a way to speed up its development of renewable assets. To this end, it created TERP, which became known colloquially as a YieldCo. SunEdison developed renewable energy assets primarily in wind and solar, then “stabilized” cash flows by signing long-term contracts for the sale of the energy from these assets. SunEdison would transfer the “stabilized” assets to TERP in exchange for cash. Having a ready buyer for their assets meant SunEdison could raise cash and fund future development much faster than they could prior to the creation of TERP.

TERP was known as a YieldCo because the assets it bought from SunEdison supported a high and growing dividend yield, which was supposed to make it more attractive than SunEdison to investors desiring lower risk and stable dividend income. The treadmill of development, transfer and more development, in combination with rapid acquisitions, was fuelled, in part, by SunEdison’s leverage. It ultimately collapsed under high leverage and declared bankruptcy in April 2016. TERP was nearly brought down with it.

Companies emerging from distress can be an attractive source of alpha. TERP was such an example. As part of SunEdison’s reorganization, it agreed to sell a majority stake in TERP to Brookfield Renewable (BEP) and its institutional partners in March 2017. It was this transaction that laid the groundwork for us to build confidence in TERP’s bonds. BEP closed the transaction for a 51% stake in TERP in October 2017. The next month TERP issued 10-year bonds. We immediately built a stake in Cambridge Bond Fund at spreads ranging from 252 bps to 261 bps, just below the new issue spread of 269 bps. 

Our belief in the bonds rested on the credibility of Brookfield and the debt reduction plan that was put forward. Brookfield’s presence alone stabilized funding costs for TERP, allowing it to roll over debt at more sustainable levels. More importantly, had TERP needed additional equity, Brookfield had the financial capacity to support it. Lastly, Brookfield had a good plan with manageable execution risk to reinvest in the portfolio to grow cash flows and cut expenses to improve margins. TERP was setting a path to become a top-quality high yield credit. The market had recognized progress towards this when we initially built our stake, but it was still a “show me” story. This offered attractive returns as Brookfield executed on their plan.

High Yield investing can have its bumps along the way and TERP was no exception. While TERP executed on its plan well, it did not escape the sell-off in high yield credit in 2018. We incrementally added in mid-2018 at a spread of about 299 bps, bringing our position in the Fund to approximately 2%. However, at the start of 2019, our TERP bonds were trading at a spread of around 395 bps. Today, they trade at a spread of 190 bps, well below where we initially bought the bonds. Over the two years from 2018 to 2019, the bonds returned 8.7% annually, more than doubling the 4.1% annual return on the FTSE Canada Universe Bond Index. It was our conviction in TERP that allowed us to hold the bonds through the underperformance in 2018 to ultimately produce attractive returns for our fund holders.

price of TERP 5% 2028 bonds since initial purchase

Source: Cambridge Global Asset Management

Credit is only one tool we use to generate alpha. Despite the underperformance of TERP in 2018, we still managed to use other tools to generate strong performance. Over the three years to the end of 2019, Cambridge Bond Fund returned 4.5% annually (excluding fees) compared to the FTSE Canada Universe Bond Index annual return of 3.6%.

To help us find more of these opportunities, we recently hired a credit analyst, Ryan Ball. He is an experienced professional who has worked in the industry for over 15 years. We are excited to have Ryan join our team. While our process remains the same, Ryan will help us respond quicker to alpha-generating opportunities, mitigate risk and broaden our universe of investable ideas. It is an exciting time for the Cambridge Fixed Income Team and we hope to carry our momentum through 2020. 

As at December 31, 2019 (%) 1 Year 3 Years 5 Years 10 Years Since Common Inception Inception Date
Cambridge Bond Fund Class I 9.85 4.52 - - 3.03 03/27/15
Category: Canadian Fixed Income 5.97 2.76 2.45 3.41 1.84 N/A
FTSE Canada Bond Universe Index 6.87 3.57 3.18 4.41 2.46 N/A

Source: Morningstar Direct (as at December 31, 2019)

Grant Connor, Associate Portfolio Manager

 

IMPORTANT DISCLAIMERS

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns net of fees and expenses payable by the fund (except for figures of one year or less, which are simple total returns) including changes in security value and reinvestment of all dividends/distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

The author and/or a member of their immediate family may hold specific holdings/securities discussed in this document. Any opinion or information provided are solely those of the author and does not constitute investment advice or an endorsement or recommendation of any entity or security discussed or provided by CI Investments Inc.

This commentary is published by CI Investments Inc. The contents of this piece are intended for informational purposes only and not to be used or construed as an endorsement or recommendation of any entity or security discussed. The information should not be construed as investment, tax, legal or accounting advice, and should not be relied upon in that regard. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Investors should consult their professional advisors prior to implementing any changes to their investment strategies. These investments may not be suitable to the circumstances of an investor. Some conditions apply.

Certain statements contained in this communication are based in whole or in part on information provided by third parties and CI Investments Inc. has taken reasonable steps to ensure their accuracy.

Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “intend,” “plan,” “believe,” or “estimate,” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what CI Investments Inc. and the portfolio manager believe to be reasonable assumptions, neither CI Investments Inc. nor the portfolio manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

Cambridge Global Asset Management is a division of CI Investments Inc. Certain funds associated with Cambridge Global Asset Management are sub-advised by CI Global Investments Inc., a firm registered with the U.S. Securities and Exchange Commission and an affiliate of CI Investments Inc.

CI Investments® and the CI Investments design are registered trademarks of CI Investments Inc. © CI Investments Inc. 2020. All rights reserved. “Trusted Partner in WealthTM” is a trademark of CI Investments Inc.

Published February 18, 2020.

Add new comment

We welcome your comments and questions for the Cambridge team and will respond as soon as possible. Please note that all comments are reviewed for their relevance to the topics discussed in the blog, and that comments may be edited.