Live From the Desk 1

Enhanced Income Fund Update

We bought an interesting security this week. An insurance company (I won’t tell you which one b/c we are probably buying more) floating-rate hybrid security that floats the US 10 year treasury rate +10bps. This is a great hedge to rising rates in the rest of the portfolio. Even on it’s own, the security is showing a 4.3% yield-to-maturity, but that is only because there is no 10 year futures market for Treasuries. Therefore, no-one can price it any other way other than using the current 10 year yield. Think of it as a call option on higher rates, the coupon will go up as the 10 year Treasury goes up (it could go the other way, but with our interest rate exposure, that is not a concern). Thus we look at the 4.3% yield, as a base case with no inflation, that has a good chance of being called in the next 4 years giving 13.5% YTC.

The company’s financial position has improved greatly over the past few years, so much so that it has paid off $1.5b of government investment in 2010 and will pay the final $1.5b (with a large pre-pay penalty) in the next few months.

Tim Logie