Research : Perpetual Hockey Sticks

A new edition of Canadian Moneysaver has been issued, so I can re-publish my article from the penultimate publication!

Many readers will be familiar with the “hockey stick” pattern of option returns – if not, don’t worry, I explain it in the article. This paradigm is pretty practical for those people (and practitioners) perplexed by the price pattern of perpetual preferreds.

Look for the research link!

As a bonus, I have also made available the spreadsheet I used when writing the article.

6 Responses to “Research : Perpetual Hockey Sticks”

  1. Drew says:

    Great article James. My impression is that HIMIPref takes duration into account in making its recommendations, all with a view to ensuring a suitable distribution of holdings throughout the yield curve. Is my impression correct and, if so, does it extend or shorten portfolio duration to take advantage of valuation opportunities?

  2. jiHymas says:

    Duration is taken into account when making recommendations. In the issueMethod of trading (in which all you want to do is have reasonable assurance that your trade will be profitable) the riskDistance is calculated using the optimized riskAttributes, several of which are duration-based (using various measures of duration). Thus, for instance if an IssueMethod portfolio holds preferred share “A” and has a choice between trading into either of shares “B” or “C”, both of which are identical save for these various duration measures (which never happens, of course, but never mind), then it will trade into the share that is closest to the extant holding in riskSpace; that is, it will attempt to minimize riskDistance in the course of the trade.

    One can visualize this decision in terms of wanting to keep control of the relatively random factors … it is easier, for instance, to determine the relative value of two split shares of 5-year term , than it is to compare a floating rate with an Operating Retractible. The more dissimilar the two issues, the greater the riskDistance, the more increase in presumed value we want before we trade.

    Calculations are similar in the portfolioMethod of trading, except that riskDistance is measured according to the difference from the index; that is, if the portfolio holds “A” and can buy either “B” or “C”, it will compute the degree of similarity of the three possible portfolios (‘keeping A’, ‘trading A->B’, ‘trading A->C’) with the index and, all else being equal, will recommend the portfolio with the greatest similarity to the index.

    Thus, the system wants to be the index. It is willing to trade away from the index if it thinks it can make some money, but the further away from the index it gets, the more money it wants to make.

  3. […] In my article How Long is Forever?, I made the point that yield spreads between perpetuals and retractibles can be so large that rates would have to be extremely high in the future for total return over the period to favour the retractible. In Perpetual Hockey Sticks, I look at the trade-off between “expected yield” and “protection from future higher interest” in more detail. Enjoy! […]

  4. […] PerpetualPremiums as a group were cushioned from the blow (as readers of Perpetual Hockey Sticks will have expected) […]

  5. […] When selecting a fixed income portfolio, one always bears three scenarios (at least!) in mind – rates generally rise, rates generally fall, rates are essentially flat. More sophisticated analysis is, in many ways, simply an elaboration of these basic assumptions about the future. So, when we compare a low-coupon, low-price PerpetualDiscount to a high-coupon high-price PerpetualDiscount, we come up with the following implications of each scenario (for more information, see my article Perpetual Hockey Sticks): […]

  6. […] do we have the slope of the yields being in the wrong direction (see my articles on Convexity and Perpetual Hockey Sticks) but … doesn’t the spread seem a little … er … extreme to anybody? […]

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