Skip to main content

An oil pump jack pumps oil in a field near Calgary.© Todd Korol / Reuters

As with many great investments, one of the best bond trades in recent Canadian history emerged through a haze of fear.

As the worst crude oil bust in decades was unfolding, reams of high-yield Canadian oil and gas bonds sank to distressed prices as the market began to expect a wave of bankruptcies.

Few at the time saw the sell-off as a rare and extraordinary opportunity, and most that did were unable to capitalize.

Read more: Why this portfolio manager is buying U.S. financials and Canadian lifecos, but not resources

Read more: Are you getting good value from your adviser fees? Here's how to tell

"Market makers were telling me, 'Hanif, you're the only buyer in town,' which was a little unnerving," said Hanif Mamdani, head of alternative investments for RBC Global Asset Management.

He and his team scooped up more than $2-billion worth of higher-quality issues discounted by as much as 40 per cent from face value. Now, with the Canadian oil patch having rallied after a painful restructuring, and with industry deal-making on the rise, those bets are being richly rewarded."Coming up on 30 years in this business, this was by far the most profitable trade I've seen," Mr. Mamdani said, pegging his gains at $1.2-billion and counting.

The plunge in oil prices began in earnest more than two years ago when OPEC refused to put limits on production, which many took as a sign of the group's intention to wage a global price war.

By February of this year, crude prices had sunk to their lowest levels in 13 years; debt issued by high-quality Canadian exploration and production companies sold off to prices that seemed to reflect high levels of default.

Yields on short-dated bonds issued by companies including Precision Drilling Corp., Baytex Energy Corp. and Paramount Resources Ltd. approached the 20-per-cent mark.

"Our worst case was close to break-even. Our best case was that we could make, in some cases, 60- to 80-per-cent returns," Mr. Mamdani said.

"It's one thing to have a flash crash where you get a nanosecond where you can buy a couple million in bonds. Here was a chance to put an awful lot of money to work at very attractive prices."

Over two days last February, for example, he said he bought $150-million in Paramount Resources paper at 60 cents to 70 cents on the dollar. Those bonds are now trading well above par.

Not that others in Canada didn't see a similar opportunity. But other prominent high-yield fund managers were facing redemptions as nervous investors pulled their money.

Some funds reliant on retail flows were forced to be sellers.

Mr. Mamdani credits his own investors' relative calm to a long track record – the PH&N High Yield Bond Fund, for example, has been under his management since 2000. And he and his senior analysts Justin Jacobsen and Emil Khimji were putting out research up to twice a week demonstrating the numbers behind the trade.

There was another Canadian fund manager, however, who was able to capitalize on the sell-off in high-yield energy debt.

In December, 2015, Barry Allan, president and chief investment officer at Marret Asset Management, launched a fund dedicated to buying up cheap energy bonds.

"The market was discounting virtually all of the mid-tier names defaulting. And we thought the market was assuming oil would stay at $30 [U.S.] a barrel for up to two years. We felt that was impossible," Mr. Allan said.

He raised about $125-million and focused primarily on U.S. names, as well as a handful of Canadian companies including MEG Energy Corp. and Precision Drilling.

In less than one year, the fund fulfilled its mandate, Mr. Allan said. He captured all the upside he had targeted and has returned almost all shareholder money at an average annualized return in excess of 20 per cent.

"I don't think we had a single name we lost money on," he said.

With a much larger stake in Canadian high-yield paper – not exactly the most liquid market – Mr. Mamdani faces a challenge in how to exit his trade.

"We need to be prudent how we harvest these gains. Rather than just trying to sell on the open market, we've been able to come up with more elegant solutions where the companies themselves have purchased the bonds from us."

Two weeks ago, for example, Savanna Energy Services Corp. bought back – at slightly above par – more than $60-million in bonds from funds managed by Mr. Mamdani, which he originally acquired at less than 80 cents on the dollar six months ago.

Through similar deals, he's reduced his position by more than $1-billion. And those bonds he still holds pay an average coupon of about 8 per cent with far less risk than when he acquired them.

"Most of these companies have now de-risked their balance sheets, they've pruned their asset portfolios and they've massively reduced their costs," he said. "The businesses are so much healthier financially and operationally than they were six months ago."

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe