Lee Goldman, MBA, CFA, is a Senior Vice President and Portfolio Manager at First Asset Investment Management in Toronto, and he currently manages more than $550 million in convertible debentures and is the Lead Manager for the following First Asset funds: First Asset Diversified Convertible Debenture Fund, Canadian Convertible Debenture Fund, Canadian Convertible Bond Fund, Canadian Energy Convertible Debenture Fund, Canadian Advantages Convertibles Fund, First Asset REIT Income Fund and Split REIT Opportunity Trust. More

TWST: Please begin with a brief introduction to the Canadian Convertible Bond Fund.

Mr. Goldman: We invest primarily in Canadian convertible debentures. The fund itself is about $55 million. It was launched in November 2009. It had a one-year return in 2010 of about 17%. It holds roughly 50 positions and is almost exclusively convertible debt, although we do have a couple of high-yield bonds and a couple of equities. It’s almost exclusively Canadian.

TWST: Broadly speaking, why is this a good time to be invested in convertible bonds?

Mr. Goldman: We tell investors in regards to the basics of the bonds, that you have the stability of a bond with the upside potential of equity. So we think that’s a pretty good combination. In this environment, with a lot of uncertainty regarding the economy and the market, I think it’s a nice combination where if the equity markets continue to do well, you are going to benefit from that, but if they struggle, you are going to have the income coming off the bonds, which is going to help the return of your portfolio. And if the equity markets do falter, the convertible will be a lot more defensive than the underlying equities themselves. The Canadian market has grown a fair bit over the last couple of years, and last year there were a little over 50 new issues for about $4.5 billion. New issues were spread across quite a few different sectors. There were 14 in the energy space, 18 diversified, eight in the real estate and eight in the materials/mining sector. In total, the universe is about 190 outstanding issues for $14.5 billion. So you can build a pretty well-diversified portfolio from that universe.

TWST: How would you describe your investment philosophy for the convertible bond fund?

Mr. Goldman: First and foremost, it’s a credit decision, so that we are comfortable with the company that we are buying. Almost all convertible bonds in Canada are not rated by a rating agency, not that you can rely on that anyway, but it means you have to do your own extra homework to be comfortable with the balance sheet and the prospects of the business. So once we are comfortable with that, then it’s really the terms of the actual convert itself. So in that, we would look at the yield to maturity, current yield and, as well, the other important factor obviously is where the underlying equity is compared to the conversion price on the bond. In an ideal world you want something high yielding with not much of a conversion premium, which is how much the conversion price of the bond is above the stock price.

TWST: Tell us a bit about your current sector allocation and why you’ve chosen to invest in those industries.

Mr. Goldman: Right now, we are about 23% in oil and gas, 17% in mining related, 14% real estate and 13% electrical distribution power generation. Partly it’s a function of the sectors that we like, and it’s also somewhat representative of the convertible landscape in Canada. I think what makes the oil and gas debentures interesting is that from a credit perspective, there are hard assets underlying the bonds.

So even if there are operational issues, if you believe that the value of the assets exceeds the value of the debt, you can be comfortable with the investment. Most people, I think, are pretty positive on energy, certainly on the oil side. On the gas side, there seems to be a bit of an overhang from too much supply, which is holding back the gas price and holding back some of the gas-related equities and convertible bonds. But overall, we are pretty favorable on that sector. On the mining side, commodity prices have done very well, certainly through 2010, which helped out a lot of our holdings. In particular, we’ve done well on some uranium holdings, Uranium One (UUU.TO) especially.

We also have some exposure on the gold side, which had a great 2010, although it’s off to a bit of rough start in 2011. The names where we have done well are Great Basin Gold (GBG.TO) and Anatolia Minerals (ANO.TO). We just recently took a position in Detour Gold (DGC.TO). The stock’s been a little soft lately, but I think that it’s got a lot of potential. On the real estate side, I think the benefit there is once again, primarily on the credit side. Canadian REITs are generally very conservative in their leverage, so I think there is a lot of coverage for the convertible bonds. Real estate also had a really good run in the last year and a half or so coming out of the credit crisis, with the equity markets opening up and the debt markets becoming more available to the Canadian REITs. The convert prices have followed the equities, with some of them trading at $130, $140, as the underlying stock has gone well through the conversion price. The names I would feature there would be H&R REIT (HR-UN.TO), Primaris REIT (PMZ-UN.TO) and First Capital (FCR.TO). Then on the electrical generation side, there are two primarily that have done very well — Algonquin Power (AQN.TO), which is primarily a renewable energy-related venture in Canada and in the states. We bought those in the $1.05 range, and they are trading near $1.20 now. And then another one would be Innergex Renewables (INE.TO). We bought those around par. They are now trading at $103 to $104 now, but the underlying stock, I think, has some potential.

TWST: Would you walk us through your nuts and bolts process for selecting holdings for the fund?

Mr. Goldman: Whether we are looking at picking up bonds in the secondary market or if it’s a new issue, we still look at credit first to make sure we are comfortable with the company and the sector that they are in. I mentioned last year there were 53 new issues. We participated in probably a third of those. We are pretty sensitive to the pricing. So it does have to be a company we like, and we have to be comfortable with the terms of the convert. New issues coupons for most of last year were in the 5.75%-to-6.5% range. The conversion premiums were about 35%. So if the underlying stock was $10 and I put a conversion price on the bond $13.50, for example. Then we saw a trend towards the end of the year where the coupons didn’t change that much, but the conversion premiums really got to what I think were very high levels, of 50% or even 60%. Those are types of deals that we would typically pass on, as there is not enough equity upside to compensate for the lower yield and seniority compared to straight debt. We could look to pick them up in the secondary market, however, if they start trading below par or if the stock price moves and the conversion premium comes in.

Most Canadian convert deals are done on what we call a bought-deal basis, where a syndicate of brokers basically guarantees a company the terms of a bond and a certain amount of money that they’ll raise. And then it’s up to them to go find people who actually want to buy the bonds on those terms. There were few deals last year that were just mispriced that the brokers couldn’t find enough investors who would pick them up. So then the brokers are stuck with the bonds on their books. Then what they’ll often do in that case is a cleanup trade, where they sell them out at a discount to par. We try to take advantage of those types of opportunities, one being a company called Superior Plus (SPB.TO), which issued a 6% coupon bond with a conversion premium in the 40s, and they just didn’t find enough investor demand. So we ended up picking them in a cleanup trade at $94. The $94 takes the yield from 6% to 7%. And in the meantime, the underlying stock had done quite well, so that conversion premium came in from 40% to about 30%. Those are the kind of deals that you can take advantage of if you are following their market pretty closely.

TWST: What are your current top holdings within the fund, and how are they representative of your investment strategy?

Mr. Goldman: Our top holding currently is a fairly new bond, which just came out in December, called Southern Pacific (STP.TO). Southern Pacific is a junior oil sands company in northern Alberta. They have an attractive project, which they just financed through the issuance of coverts and some senior debt. The convert has a 6% coupon and a conversion premium which is pretty reasonable at around 35%. I think the stock has a lot of potential upside, and the analysts quite like it. So we took a fairly decent position in that and have added a little bit to it in the secondary market. They are now trading at about $106. Another one which we’ve done quite well on is Uranium One. Uranium prices have really taken off in the last six months or so from the low $40s up to about $70. And Uranium One stock in particular has been very strong, rising from roughly $2 in June to $6 currently. They issued a convertible bond in the spring of last year with a conversion price of $3.15. We bought a fair bit at that time, thinking that longer term the uranium space looks attractive. The stock, I think, has certainly run up faster than people would have thought. But those bonds, which we bought at par on the deal, and even picked up some below par in secondary trading, are now trading over $200. So just through appreciation, that’s become one of the larger holdings of the fund.

Just Energy (JE.TO) is another top holding. The company does primarily secondary gas and electricity marketing both in Canada and the United States. The stock price has done well recently. The convert has a 6% coupon and was a large deal out of about $300 million. The deal had insufficient demand, and we were able to pick up most of our bonds well below par. Recently they have trended up and are now around $102.50. Another top holding is Superior Plus, which is a company whose primary business is selling propane. These bonds have a 7.5% coupon bond and a fairly low conversion price compared to the stock price, so it has a nice yield and potential upside from the stock as well.

The fifth of the top five is a company called Consolidated Thompson (CLM.TO), which is an iron ore mining company in northern Quebec. This convert was just done in November and it was a pretty well-priced bond. The coupon at 5% was not high, but there seemed to be lots of potential on the stock. The conversion premium was over 30%. Just about a week or two ago, a takeover of the company was announced and this bond had a clause in it that the conversion price actually comes down in the event of a takeover based on the time outstanding since the bond was issued. The initial $15.25 conversion price comes down to a $12 as a result, and with the takeover price of $17.25, these bonds are worth about $1.45. So we had a good win on those, and as a result, they are now one of the larger positions. I think we’ll hold on to these given the potential for a higher bid for the company.

TWST: What’s your risk management strategy and what would actually trigger you to reduce or eliminate your position in a holding?

Mr. Goldman: A couple of things — one, if the stock price is well through the conversion price, then they start to trade just like their stock, such as Consolidated Thompson or Uranium One. It really then becomes your outlook on the stock, so if we think there is little further upside, we would sell. If the stock price is well below the conversion price, it is really more of a credit situation, and we look at the company’s balance sheet and interest coverage ratios. If we become uncomfortable with the credit and we don’t see much conversion value in the bond anyway, we’d probably trade out that bond and into a name with more potential.

TWST: How would you describe the investor who is the ideal match for this fund?

Mr. Goldman: We either classify the fund as a fairly defensive equity-type fund because you do have equity exposure, but you also have a lot of downside protection from the bond, or as a more aggressive fixed income fund. I think it’s an excellent product for tax-sheltered accounts, because they offer a good amount of interest income, but also work well in an open account. The combination of equity upside potential, together with high income and defensiveness, make convertible bonds an attractive investment.

TWST: Thank you. (MES) Lee Goldman, MBA, CFA

Senior Vice President & Portfolio Manager

First Asset Investment Management

95 Wellington Street West

Suite 1400

Toronto, Ontario M5J 2N7