UNDERSTANDING THE BASKIN FIXED INCOME POOL
There has been some misunderstanding about the Baskin Fixed Income Pool, and the returns or losses that clients have experienced. We accept responsibility for bad communication on this issue. Fund accounting is tricky, and in this case, has been made harder to explain by two factors. We have, in the past, reinvested income paid by the Pool, issuing additional units to our clients rather than paying them cash; and the bond market experienced a record decline in value in 2022.
We have had phone calls and emails from clients who want to know how they could have lost 8% or 10% of their money in something that we represented to them as an investment that should have less risk than investing in stocks and be a buffer for volatility in the stock market. Rest assured: nobody has lost 8% or 10% of their money. We have failed to communicate the real return, and I will now try and explain how that happened, and what we plan to do about it.
Imagine that you invested $1,000 in the Pool at its inception date in early 2020, at its issue price of $10 per unit. Since that date, you would have received the following income:
March 2020 $6.76
June 2020 $8.49
Sept. 2020 $8.41
Dec. 2020 $7.03
Mar. 2021 $12.00
June 2021 $8.83
Sept. 2021 $8.62
Dec. 2021 $7.10
Mar. 2022 $10.76
June 2022 $9.05
Sept. 2022 $8.94
Dec. 2022 $7.93
Mar. 2023 $11.05
June 2023 $9.42
Total Income Paid: $124.39
On its face, ignoring the unit value of the Pool for the moment, this is a cash-on-cash return of 12.44% of the investment, equal to about 3.55% per year, compounded. We have not taken sufficient steps to inform investors of this cash-on-cash return, and we will remedy this going forward.
However, as you know, the value of the Pool is not currently $10 per unit. Because of the drastic fall in the bond market, it is currently more like $9.15 per unit, a drop in value of $85 on a $1,000 investment. This is the number shown on our quarterly reporting, and it is one that so many clients have found alarming. In the worst case, if a client cashed out of the fund at this price, their return from inception would be: $124.39 of income less $85 capital loss = Gain of $39.39 or 3.9% on the original cost of $1,000. Not great, certainly, but not a disaster, and arguably, even at its worst, the Pool did much better than the stock markets, which dropped more than 20% in 2022.
Why has the value of the Pool dropped to $9.15? This is a direct result of the huge change in interest rates over the past three years. When the Pool was started, a typical 10-year Canadian corporate bond had a yield of about 1.75%, pretty much an historic low. Today, the same bond has a yield of over 4%; the value of that bond has dropped by about 25%, since no investor will pay par value for a bond that is paying less than half of the currently available interest rate. Fortunately, we kept the average term to maturity of bonds held in the Pool to a much shorter period than 10 years, but none the less, we have been hit by the drop in market value caused by the surge in interest rates.
There is something that is very important to understand. We do not trade our bonds. We hold each bond we buy until maturity. So if we pay $100 for a bond, its value may fluctuate, going down when interest rates rise, and going up when they fall, but if we hold it until maturity, the bond will be redeemed at its par value of $100. The price fluctuations are of significance only to the extent that we are forced to sell; and we are rarely forced to sell. It is also important to know that we have never had a bond we own default on a payment of interest or principal.
The past year has been horrible in one sense for bond holders, as the market value of their investments has gone down, but it has been a great year in the sense that we are now able to buy bonds yielding well over 5%. This will enhance the income payments made each quarter. If and when interest rates go down, the bonds that are now paying 5% will rise in value, and we might see the value of Pool units go back to issue price. We cannot know that, of course, as we don’t know the future.
For investors looking for a low volatility source of income, the Pool is doing its job, paying out a nice cash flow stream, that is now rising nicely.
We hope that this note will be of use in understanding what has gone on, and we are working hard on improving our quarterly reporting on this security.