2017 manager outlook

Year ahead 2017icon  2017 manager outlook

The equities markets began 2016 with their worst start to the year in history as a result of investor worries over mixed economic data and earnings results combined with falling energy prices. These concerns also were felt in the high yield corporate bond market, as spreads over government bonds widened due to fears of rising default rates.

As the year progressed, economic indicators, corporate earnings and energy prices (oil prices in particular) rebounded and the equity and high yield bond markets quickly recovered, posting strong results for the calendar year.

That is not to say that there weren’t bumps along the way. In June, U.K. citizens voted to leave the European Union (“Brexit”). This surprising result left the markets unsettled for a short period of time before quickly recovering.

In November, we had an unexpected result in the U.S. election which saw Donald Trump voted into power. The markets reacted positively for the most part, as his platform of infrastructure spending and tax cuts is considered to be beneficial to economic growth. These policies, if enacted, would likely be inflationary and investment grade bond yields rose in anticipation of this.

The general consensus is that the Federal Reserve will raise rates at least three times over the course of the yearly period beginning December 2016. Though the degree of rate hikes is anticipated to be relatively small, investment grade bonds will be challenged in this environment. Non-investment grade asset classes such as high yield corporate bonds and senior loans would likely be less impacted given their higher yields and lower sensitivity to interest rates.

The elevated valuations in North American equity markets suggest that returns may be subdued over the next year, relative to those experienced in 2016. European and Asian markets may offer the potential for higher returns in 2017, given their reasonable valuations.

PM
Dan Bastasic BComm, MBA, CFA

IA Clarington Investments Inc.

IA Clarington Strategic Corporate Bond Fund
IA Clarington Strategic Equity Income Fund/Class
IA Clarington Strategic Income Fund
IA Clarington Strategic U.S. Growth & Income Fund
IA Clarington Tactical Income Fund

Where are the opportunities?

Finding opportunities to outperform the market over the next year will have as much to do with investment style as it will with good security selection. We believe that value investing will likely outperform growth investing for much of the year and that those securities that are less sensitive to a rising interest rate environment will have fewer challenges to their valuations than those that are negatively impacted in a rising rate environment. We have confidence that, over the next twelve months, inflation and oil prices will continue to progress higher and economic growth will be greater than it has been over the past two years, though there will likely be volatility in these economic indicators. We now view the opportunities in the U.S. market to be as attractive as those in the Canadian market were in 2016. Securities in the financial and industrials sectors will likely outperform securities that are viewed as bond proxies, such as consumer staples and utilities. Within fixed income, high yield corporate bonds are likely to be a better option than investment grade bonds, given their lower sensitivity to rising interest rates.

Inflation expectations are trending higher

Chart

Source: Bloomberg as of December 6, 2016. Inflation expectations reflect the yield differential between 5-year nominal U.S. Treasury bonds and 5-year inflation-protected U.S. Treasury bonds.

Where are the challenges?

The global environment is giving the first indication in a number of years that the deflationary environment, which has been a result of overcapacity, is showing signs of reversal. The prospects of an inflationary environment are positive by implication. However, the markets have subsequently responded to this possibility and have risen to a point where we believe we may have “front loaded” the potential for positive corporate and economic data in a very short period of time. This increases the potential for more than the expected two rate hikes by the Fed and the possibility of a near-term correction that will put into question the positive benefits of higher inflation, higher commodity prices and a higher growth environment. We expect this scenario to unfold within the first half of 2017 before giving way to a more positive backdrop heading into 2018.

How are you positioning the funds?

Our investment approach focuses on securities that are backed by quantifiable and sustainable businesses that exhibit relative safety in their cash flows and dividends. We are by nature value-oriented in our security analysis, whether in equities or corporate bonds, with emphasis on companies that have positive growth prospects while being mindful of the price we pay for those securities. Our Funds are currently invested with an approximately even split between what we consider defensive and cyclical holdings. The majority of our equity holdings are in larger capitalized firms, as we have been apprehensive to assume greater volatility associated with smaller capitalized companies over the past two years. Given our expectations for a positive environment that is supportive of our investment style, we may make a shift in order to assume higher exposure to cyclical and smaller capitalized securities in our Funds as the year progresses.

Why is this the right approach for 2017?

While being right is ultimately an exercise in perfect hindsight, we believe that given our expectations for those things that are positive to economic and corporate growth, the bull market in equities will likely continue for at least the next year while our focus on higher yielding corporate bonds will contribute higher yield and positive return potential as the year progresses. We view risks associated with a recession to be minimal and economic headwinds will likely turn into tailwinds as the year progresses. This environment will have positive implications for equity-related securities and high yield corporate bonds and potentially negative implications for interest rate sensitive securities. In this environment, correlations between individual securities will decrease, paving the way for active management focused on bottom-up security selection to outperform a passive investment approach.

icon  2017 manager outlook - Dan Bastasic

PM
Jeff Sujitno HBA, CPA, CIM

IA Clarington Investments Inc.

IA Clarington Floating Rate Income Fund
IA Clarington U.S. Dollar Floating Rate Income Fund
IA Clarington Core Plus Bond Fund
IA Clarington Tactical Bond Fund

Where are the opportunities?

The unexpected victory by Donald Trump has caused us to revisit our expectations for inflation, U.S. interest rate policy and the current stage of the credit cycle. While much has been made about Trump’s expected policies, we cannot be certain how much actually comes into effect. As a result, we enter 2017 with a healthy dose of uncertainty causing us to continue to embrace an overall conservative positioning within our portfolios. Investors expect us to avoid blow-ups and surprises through astute credit selection and maintaining diversification in our positions. We are not yet ready to chase alpha and higher yields in any meaningful way.

Our current expectation is for rising interest rates in 2017, led by U.S. Treasuries. With interest rate sensitivity as a clear headwind, the opportunities in fixed income will be in floating rate debt and shorter duration spread products with the ability to cushion rising interest rates. We continue to like senior loans and high yield bonds with shorter maturities. We are constructive on credit with our baseline view being a compression of spreads in 2017. We expect loan defaults to remain below the historical average and expect high yield bond defaults to decline after hitting multi-year highs in 2016 due to challenges in the energy sector. Overall, our view is that the end of the credit cycle has been pushed out.

Within the investment grade market we will seek securities which have the ability to withstand headwinds from rising interest rates. We believe that BBB-rated corporate bonds will be attractive, given the higher absolute spread combined with lower duration. Rate reset Canadian preferred shares may become an increasing focus given our expectation that reset rates will be higher following an expected increase in 5-year Canadian government bond yields. We may also look to layer in fixed-to-floating interest rate swaps to further reduce the duration of our portfolios when it is economical to do so.

Where are the challenges?

As we exit 2016, ideal conditions appear to be forming for senior loans. Coupons and yields will be supported by a further rise in the 3-month Libor (London Interbank Offered Rate), the base rate for the majority of loan coupons. The default environment is expected to be benign given improving economic conditions in the U.S. Finally, loans may be supported by strong fund flows from investors fleeing interest rate sensitive bonds.

3-month Libor is on the rise

Chart

Source: Bloomberg, November 30, 2016.

The financial press has correctly highlighted the benefits of adding loan exposure to fixed income portfolios but there are also challenges worth considering. Improving fund flows into loans has allowed borrowers to refinance or reprice existing issues (recall that loans have minimal prepayment protection). So while coupons become bigger, due to the expected rise in Libor, they will come down because of repricing activity.

Deteriorating credit quality may become a larger issue, especially as corporate executives stretch to put cash to work. We have already seen credit fundamentals deteriorate with current leverage at levels unprecedented outside of a recession. We have also seen some new loan issues structured quite aggressively, in our view.

Within the investment grade market, rising interest rates and record high interest rate sensitivity are clearly the largest challenges. Overall, we would suggest that the days of ultra-low interest rates and accommodative U.S. Federal Reserve policy seem to be in the rear view mirror.

How are you positioning the funds?

As a general comment, we continue to position all the funds we manage quite conservatively in order to limit price volatility and surprise risk. We will focus most of our effort on higher rated, larger issues in our non-investment grade positions. However, as we are constructive on credit, we expect to add exposure to higher yielding single B-rated names that are reasonably leveraged and generate predictable free cash flow.

Foreign exchange hedging costs are expected to increase due to divergence in shorter term rates in Canada and the U.S. Regardless of higher costs, we will maintain our policy of being fully currency hedged in the IA Clarington Floating Rate Income Fund and will minimize currency risk in our investment grade mandates.

Within our investment grade mandates, we will continue to be low duration. As we obtain more information and form greater clarity on Trump’s policies, we will adjust our sector exposure but will continue to shy away from the commodity sector.

Why is this the right approach for 2017?

We believe that investors want low volatility and minimal surprise risk in their fixed income, first and foremost. Our investment strategy is consistent with this view as we build portfolios that favour capital preservation over outsized returns. We want to remind advisors that our guiding principle is to generate alpha through avoidance. We believe that our investment strategy is timeless for fixed income and not limited to something we do in 2017.

icon  2017 manager outlook - Jeff Sujitno

PM
Terry Thib PEng, MESc, MBA, CFA

IA Clarington Investments Inc.

IA Clarington North American Opportunities Class
IA Clarington Growth & Income Fund
IA Clarington Canadian Conservative Equity Fund/Class

Where are the opportunities?

We are finally seeing a reacceleration of earnings in North American markets and as long as this continues, we believe markets can grind higher despite elevated valuations. Many of the drivers were already in place before the U.S. election (improving U.S. economy, increasing global demand and inflation), however, since the unexpected outcome these drivers have been amplified by the Trump administration’s proposed package of reflationary policies. If fully implemented, the positive policies could be fuel to the fire (for example, trade). Earnings should continue to grow and markets should follow in general. Another positive driver for 2017 could finally be a rotation of funds from traditional fixed income into equities given the sharp rise in rates we have just witnessed. This should help sustain multiples for a period of time.

Where are the challenges?

Valuations in general are elevated. Overall, we can expect earnings growth to drive the market in the coming year as the multiple expansion story has pretty much played out, especially given the inflation/interest rate outlook. Given where valuations are, we need to see earnings come in line or better than currently expected.

Inflation expectations are rising and the U.S. 10-year treasury is moving upward as expected

Chart

Source: Bloomberg, December 7, 2016.

Interest rates are rising. With inflation and Treasuries accelerating for the first time in years we believe that investors have to be cognizant of the risks towards low volatility and defensive sectors that have worked in the recent past. If the U.S. economy accelerates at a faster-than-expected pace driven by the implementation of reflationary policy, the U.S. Federal Reserve (Fed) may act at a faster pace and we could see rates rise faster than expected.

Correlations of sectors and returns are falling as the macro factors gives way to fundamentals (this is a good thing). With this backdrop of reaccelerating earnings and rising rates, we expect to get back to a fundamentally driven market where careful sector and stock selection will be required in order to outperform. Certain sectors such as the bond proxies (i.e. pipelines, utilities, REITs) could potentially follow bonds lower while other more cyclical sectors should follow earnings higher at this stage of the cycle.

Strengthening U.S. dollar. With monetary policy divergences around the globe, the U.S. dollar looks to continue its strength in 2017. This will pose a headwind to U.S. exporting multinationals and could impact commodities if demand is weaker than expected.

Volatility should rise. We expect to see volatility increase from the low levels experienced in 2016. With valuations and expectations running high and, as we progress through to the later stages of the cycle, we can expect to see some sharper market swings.

How are you positioning the funds?

For income generation through dividends, we are taking a more balanced approach in 2017. For our large-cap mandate, the IA Clarington Canadian Conservative Equity Fund, we have a barbell strategy where we have taken down our weighting in the more interest rate sensitive and defensive “bond proxy” sectors and added slightly to positively correlated segments such as insurance. We have also added to industrials and a few more cyclical names that should benefit from improving domestic and global growth. We have put a heavy emphasis on consistent earnings, free cash flow generation and the ability to grow dividends for the current environment. We are by no means giving up on these “bond proxy” sectors, as we still see pockets of value and the ability to clip dividends from select securities. We also feel that we will need defence during the expected periods of volatility during 2017 and these sectors can provide us with stability when we need it.

With the IA Clarington Growth & Income Fund, we continue to position this mandate as a complement to core holdings with our quality dividend growth strategy. When it comes to allocation within North America, along with the strong U.S. dollar and strength in the U.S. economy leading the way, we expect some similarities with 2015 where we looked for Canadian companies that had U.S. exposure and for U.S. companies with greater domestic exposure. We also like Canadian companies that have exposure to the global reflation trade.

Why is this the right approach for 2017?

We see a few areas that should outperform in 2017. As usual we see a focus on quality stocks that can grow earnings and cash flow and be able to increase dividends on pace with increases in the U.S.10-year bond yield as being the place to be in 2017. Dividend growth strategies tend to perform well in most environments but especially in the current type of environment we are seeing. On the valuation spectrum, we also see value stocks outperforming growth stocks. As economic growth and earnings start to accelerate, and growth in general becomes less scarce, value stocks that have typically lagged will outperform. Within our all-cap mandates we also see potential for small- and mid-caps to outperform on the back of reflationary policy, less regulation and the strength of the U.S. dollar. However, the valuation of the small-cap and mid-cap segments in North America is elevated, so we will be going where we can find value.

icon  2017 Manager Outlook - Terry Thib

PM
Clément Gignac M.E.Sc.

Industrial Alliance Investment Management Inc.

IA Clarington Monthly Income Balanced Fund
IA Clarington Yield Opportunities Fund
IA Clarington Managed Portfolios

Where are the opportunities?

The Canadian stock market could be in for another decent year as the deal to cut oil production struck by OPEC on November 30th might put a floor underneath oil prices. A return to the $50-$60 range on oil prices could act as a tailwind for the Canadian economy, as non-energy-product exports are lagging and it is still unclear whether the recently imposed mortgage rule measures will hurt a frothy housing market. We’ll keep a wary eye on Donald Trump’s plan to renegotiate the North American Free Trade Agreement, as nearly 75% of Canadian exports go to the U.S. market and Canada’s current account deficit as a share of GDP is presently the worst among developed countries. In this context, we expect the Canadian dollar to remain slightly under pressure, as the Bank of Canada could maintain a careful tone.

Among asset classes, we believe that equities in the Europe, Australasia and Far East (EAFE) region could outperform, as the weaker Euro and yen could act as tailwinds, earnings momentum is better than in North America and, at 1.5x book value (compared to 2.8x on the S&P 500), geopolitical risks seem already priced in. We also expect the European Central Bank and the Bank of Japan to remain accommodative, which would act as further support.

European equities are more reasonably valued than those in North America

Chart

Source: Bloomberg as of December 12, 2016.

Where are the challenges?

The year 2016 was marked by significant political events. The Brexit vote in the U.K. and the election of Donald Trump to the White House were both the result of an anti-globalization, anti-establishment trend, with U.K. and U.S. citizens expressing their disenchantment with free-trade policies that seem to mainly benefit the well-to-do. This political swing could even extend to France and Germany in 2017 when these two pillars of the E.U. have their general elections.

Despite the many risk factors that seemed to have crept in during the last year, equity markets were reasonably calm following the January and February scare of an impending global recession. We of course witnessed resurgence in volatility during the week that followed the Brexit vote, but it turned out to be swiftly swept under the rug. The result is that the U.S. stock market ends the year being generously valued, as many of the good news from the upcoming Trump presidency, like lower taxes and less regulation on banks, seem to be priced in. We won’t know until 2017 whether President-elect Trump will stick with his electoral promises, or whether his ambitious plan, funded largely by debt, will be blocked by Congress.

The bond market reacted quite strongly to the result of the election and the OPEC deal, as inflation expectations were revised higher and the outlook for central banks has shifted away from perpetual accommodation. The strength of the U.S. economy was sufficient for the Fed to go ahead with a rate hike at the end of 2016, and the inflationary pressures that could result from accelerating wage growth and rising protectionism should push the Fed to move forward with at least two more rate hikes in 2017.

How are you positioning the funds?

Based on relative valuations, we are overweight Canadian and EAFE equities while being underweight the U.S. We also have purchased options on the Canadian, U.S. and EAFE markets. We’ve also recently purchased ETFs in preferred shares, federal government bonds and treasury inflation protected securities (TIPS) as a tactical decision to help manage downside risks.

Why is this the right approach for 2017?

We remain of the belief that investors need to tread carefully as many risk factors are now at play, stemming mostly from politics. We thus advocate considering volatility as an asset class to be used tactically and to buy some protection when it is selling cheap.

icon  2017 manager outlook - Clément Gignac

PM
Pierre Trottier MBA, CFA

Industrial Alliance Investment Management Inc.

IA Clarington Global Value Fund
IA Clarington U.S. Dividend Growth Fund
IA Clarington U.S. Dividend Growth Registered Fund

Where are the opportunities?

Newly elected President Donald Trump has been vocal on many policies that may be positive for the U.S. stock market. We are seeing opportunities in sectors that may benefit from less regulation such as energy, pharmaceuticals, biotech, and banks. We also believe U.S. corporations with high tax rates should benefit from a proposed tax rate cut. The new administration might also put in place a one-time holiday tax break for companies who are holding cash overseas. This tax would allow companies to repatriate untaxed foreign profit at a lower rate. This could result in higher shareholder payouts (dividends/buybacks) and more mergers and acquisitions for those companies. With the prospect of rising interest rates, we expect to see the rotation continuing from bonds to stocks and compelling value may be found in sectors which have yet to benefit from the post-Trump stock market rally.

Where are the challenges?

The rising U.S. dollar could be a challenge in 2017. For U.S. multinationals, a strong U.S. dollar reduces the revenues that companies earn overseas. We are also concerned over an increase in the yield curve, which may continue to put pressure on bond proxy sectors, such as utilities, telecommunications and real estate. There remains a lot of uncertainty around the impact and timing of Trump’s proposed policies. Protectionism is probably one the most important challenges that we are going to face in 2017.

How are you positioning the funds?

Our Funds have a large capitalization bias with a dividend growth focus. We remain overweight in sectors that we believe will benefit from Trump’s proposed policies such as energy, banks, pharmaceuticals and technology. We are invested in dividend growers in the consumer staples sector that can also potentially benefit from mergers and acquisitions (Kraft Heinz Co. and Mondelez International Inc.). We are also finding attractive valuations in large-cap technology companies (Cisco, Microsoft and Apple) with large cash positions held overseas that could potentially be repatriated to the U.S. The Funds remain underweight the bond proxy sectors, given their interest rate sensitive nature.

Why is this the right approach for 2017?

We prefer dividend growth stocks compared to high dividend yield stocks. History has shown that, in a rising interest rate environment, dividend growers outperform high dividend yield stocks. This makes sense because high dividend yield stocks with a slower rate of dividend growth tend to behave more like bonds in the context of a rise in the yield of 10-year U.S. treasury bonds.

Dividend growers have outperformed in rising interest rate environments

Average Annualized Return Based on Monthly Changes in Interest Rates

Chart

Source: BMO Investment Strategy Group, FactSet, Compustat, IBES. January 1, 1990 to July 22, 2016.

We continue to use a covered call strategy to enhance the yield of the portfolio and maximize returns (typically 25% of the portfolio, with a maximum of 50%). To protect the portfolio from a potential downturn, we prefer to buy put options on the S&P 500 Index instead of owning cash because we keep the upside potential intact and we receive the dividends. We believe that value will outperform growth in 2017 and we are putting a great emphasis on the Funds’ valuation metrics.

icon  2017 manager outlook - Pierre Trottier

PM
Tyler Mordy CFA

Forstrong Global Asset Management Inc.

Forstrong Global Strategist Income Fund
Forstrong Global Strategist Balanced Fund
Forstrong Global Strategist Growth Fund

Where are the opportunities?

Economies worldwide are now approaching a key inflection point — moving from fiscal austerity to expansion. While macro fears (Trump, Brexit, etc.) continue to dominate headlines, the more important story is the return of fiscal stimulus. As we move into this next stage, expect a blurring of monetary and fiscal policy; a development that will pave the way for policies which attempt to get money directly into the hands of the private sector.

However, this adjustment will not occur all at once. More likely is a gradual transition that unfolds over years. Short-term reactions have been extreme, particularly the steep climb in yields since the election. Stability is likely as more policy visibility takes hold.

While a spike in yields is clearly detrimental to income investors, a slow and steady rise allows for a higher reinvestment rate without incurring large capital losses. This is wonderful news for retirees who have suffered ultra-low yields for years. Particularly appealing are inflation-protected and floating rate securities, which offer a prudent means to offset the dual effects of rising inflation and interest rates.

We also believe the current negativity surrounding emerging markets (EMs) presents an immense opportunity. EM assets were hit hard post-U.S. election, as a surging U.S. dollar raised solvency concerns (on U.S. dollar denominated borrowing), and Trump’s protectionist leanings threaten exports. We expect the U.S. dollar, which is already overvalued by most conventional metrics, to stabilize shortly. Regardless, many EMs have taken large strides since the Asian financial crisis to protect their economies, including building foreign exchange reserves, implementing flexible exchange rates and controlling fiscal spending.

Furthermore, many EM corporations now have global operations with revenues booked in foreign currencies, including the dollar. While trade protectionism remains a risk (we will be monitoring developments closely), oversold emerging markets with devalued currencies (boosting trade competitiveness) have become increasingly attractive. After seven years of equity underperformance (versus U.S. stocks), they are cheap on a variety of measures.

Emerging markets are attractively valued

Relative Price-to-Book Value

Chart

Source: Macrobond, MSCI, Forstrong Global Asset Management as of November 30, 2016.

Where are the challenges?

Financial market participant focus has seemingly shifted from global monetary policy to geopolitical event speculation. As an example, chatter surrounding the Federal Open Market Committee (FOMC) meeting in mid-December was unusually quiet.

While the futures market effectively fully priced in a rate hike, U.S. stocks were undeterred, hitting new highs following the U.S. presidential election.

The monumental 2016 victories of the Brexit “leave campaign” and the Donald Trump-led Republican Party in the U.S. have emboldened populist, anti-establishment movements worldwide; specifically in Europe. Key risks emanate from the upcoming Italian referendum on proposed constitutional reforms, as well as numerous 2017 Eurozone country elections, each of which feature parties that have gained traction campaigning on anti-immigration or Eurosceptic platforms.

While a win for any such party could potentially signal the beginning of the end for the Euro project, the key takeaway is that investors will continue to react emotionally before fully assessing the longer term implications (many of which will not be as severe as forecast). Tactical opportunities are abundant in this environment.

How are you positioning the funds?

When evaluating the global investment landscape, Forstrong’s primary focus is always risk management. Regardless of the degree of conviction amongst the various views taken, broad global diversification remains the “first line of defence” at all times.

With that in mind, our Funds maintain a fixed income underweight and a shortened duration profile. Correspondingly, equity and cash levels have been increased above benchmark. Emerging markets remain a predominant focus, both for equity and fixed income allocations, while unattractive currency and equity valuations have warranted caution on U.S. asset classes.

Why is this the right approach for 2017?

Our positioning balances the prospect of a fiscal expansion-driven upswing against numerous geopolitical hazards and a weak global economic backdrop. The rotation away from fiscal austerity could prove to be an inflection point in the 35-year bond bull market where yields were in structural decline. Maintaining an equity overweight (and fixed income underweight) is congruent with these themes, while an increased cash position should provide a buffer against potential political turmoil on the horizon.

We believe that the best approach in today’s atypical investment climate is to build portfolios that are globally diversified across many asset classes, informed by a concerted focus upon a variety of common and unique risk factors.

icon  2017 manager outlook - Tyler Mordy

PM
Daniel J. Fuss CFA
David Rolley CFA
Eileen Riley CFA, CIC
Lee Rosenbaum BS, MBA

Loomis, Sayles & Company, L.P.

IA Clarington Global Tactical Income Fund

Where are the opportunities?

The global economic environment continues to improve and we believe the U.S. corporate earnings recession, in particular, has ended. U.S. equity markets have responded positively to the election of Donald Trump as investors focus on his proposed pro-growth policies; namely tax cuts, infrastructure spending, and deregulation. If successfully implemented, we believe these policies will be supportive of GDP growth and equity markets, with the financials and industrials sectors likely being among the biggest beneficiaries. Outside the U.S., economic prospects appear less robust, however, political events, particularly in Europe, are creating shortterm volatility in equity markets, which presents opportunities to purchase companies with strong fundamentals.

In global fixed income, the higher yield environment in the U.S. is creating opportunities for attractive all-in yields for select emerging market hard currency bonds from credit-stable issuers. Non-U.S. global government bond yields have corrected higher, but are still quite low historically when viewed in real yield terms. Rising U.S. bond yields have had the knock-on effect of cheapening both local-pay bonds and currencies of emerging markets. Should the rotation out of retail bond funds into equity products persist, then it is quite possible valuations will again become particularly compelling for U.S. dollar corporate bonds and possibly even European corporate bonds, to the extent the European Central Bank eases back on its pace of accumulating corporate bonds in that market.

Where are the challenges?

While the aforementioned policy changes may create investment opportunities, we are mindful of obstacles in implementation. Trump will be met with a vocal constituency in Congress that is opposed to increasing an already widening U.S. budget deficit. ‘Shovel-ready’ infrastructure projects, if approved, can in practice take years to implement, creating a considerable lag in tangible economic benefits. Additionally, the populist movement that helped facilitate a ‘yes’ vote on Brexit and a Trump election win in the U.S. remains a powerful force in continental Europe. While there is currently sufficient political will to hold the euro project together, the status quo could be challenged with multiple elections (France, Germany, Italy) in 2017. If we have learned one thing recently, it is not to become comfortable with what the polls are indicating.

Congress may oppose spending that would increase the U.S. budget deficit

Debt/GDP under both candidates, as estimated by the CRFB

Chart

Source: Committee for a Responsible Federal Budget as of 8/31/2016. Opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. This information is subject to change at any time without notice.

How are you positioning the funds?

From an allocation perspective, we continue to be positioned with a significant equity exposure relative to fixed income, reflecting our view of more favourable relative value in equities. We will continue to re-evaluate this positioning and make allocation changes when shifts in relative value occur.

Within equities, our allocations continue to be driven by individual security selection. Our focus is on quality businesses, with an ability to grow their intrinsic value over time which trade at attractive valuations. At a sector level, we have significant exposure to consumer discretionary, technology and the global industrials sector.

We view developed market corporate credit as fairly priced, but well supported by accommodative central banks, improving economies, and a lack of attractive alternatives given predominantly low global government bond yields. Credit fundamentals have been deteriorating, but low interest expense and recovering earnings should help extend the cycle. Nonetheless, we have been reducing credit exposure on market strength and more full valuations. Particular areas of focus are the potential volatility surrounding higher U.S. policy rates, as a result of the U.S. Presidential election, implications from the Brexit vote and volatility from the Italian referendum. In select emerging markets, we have allocated to currencies with attractive yields that have previously been hard hit by the global commodities sell off earlier in 2016, yet are striving to reform their fiscal profile.

Why is this the right approach for 2017?

We expect the market environment to create new opportunities to allocate capital on an individual security basis across both equity and credit in the coming year, as changes in interest rates, policy uncertainty, and global geopolitical shifts create volatility. The IA Clarington Global Tactical Income’s strategy is a high conviction global opportunistic fund that has the flexibility to invest across the capital structure of a company to uncover the best equity and fixed income ideas. The portfolio combines our highest conviction “best ideas” globally in both equity and fixed income markets. We continue to focus on our guiding principles and philosophy: identifying and selecting quality companies with the ability to grow intrinsic value over time that trade at attractive valuations. We view short-term market volatility and pullbacks as an opportunity to add to our existing, high-conviction positions or establish new positions in businesses that meet our three alpha drivers of quality, growth and valuation.

icon  2017 manager outlook – David W. Rolley, Eileen N. Riley, Daniel J. Fuss & Lee M. Rosenbaum

PM
Joe Jugovic BA, CFA
Wendy Booker-Urban BA
Darren Dansereau BComm, CFA
Ian Cooke BComm, CFA

QV Investors Inc.

IA Clarington Canadian Balanced Fund/Class
IA Clarington Canadian Small Cap Fund/Class
IA Clarington Global Equity Fund

Where are the opportunities?

Brexit, negative interest rates and the surprise U.S. election outcome all represent marked shifts from the status quo and have introduced new sources of uncertainty. While uncertainty in financial markets can be uncomfortable to bear, it often leads to increased volatility, and therefore opportunity, for value investors. We own businesses that can navigate in all sorts of storms, whether they are economic shocks or political surprises. While we don’t try to implement short-term trading strategies based on anticipated outcomes, we will take action if volatility allows us to own wonderful businesses at attractive prices.

With strong compounding characteristics and reasonable valuations, we are seeing attractive risk-reward trade-offs within the North American financials sector. More broadly, we continue to find opportunities on a company-by-company basis across asset classes, sectors and geographies.

Within fixed income, strong credits that are short duration can protect purchasing power, but offer little in the way of incremental return. For equities, our focus remains on under-appreciated businesses that are able to increase their competitiveness, expand margins and maintain growth characteristics through economic and political cycles.

Where are the challenges?

Despite relatively positive economic data from the U.S. and the expected boost from President-elect Trump’s fiscal policies, global growth remains elusive and major central banks continue to uphold highly accommodative monetary policies. In Canada, indebted households, a still-struggling energy market and overheated residential real estate in Toronto and Vancouver are key downside risks that remain at the forefront of our minds.

Even with these macro challenges, equity valuations may continue climbing higher, given the lower yields of alternatives. Underlying earnings have generally not kept pace with stock market appreciation and have been growing at a below-average pace. Many quality companies today are trading at valuation multiples not seen for some time. We must manage this challenge by remaining selective and patient, ensuring we do not sacrifice quality for value, or vice versa. Still, elevated equity valuations have reduced our long-term return expectations as a whole.

Global growth remains elusive

Global GDP Growth Rates

Chart

Source: World Bank national accounts data & OECD national accounts data file as of December 2015.

How are you positioning the funds?

We maintain diversified portfolios, holding companies that have survived under all kinds of economic scenarios for many decades. In fixed income, we are positioned with low duration in high quality bonds. In equities, stocks within the portfolios are generating attractive levels of profitability while carrying below-average levels of debt. This provides a solid foundation for reinvestment, returning capital to shareholders and navigating through economic turbulence. The portfolios offer a number of attractive characteristics compared to the broader markets, providing further support in more challenging periods.

Why is this the right approach for 2017?

In an era where it is difficult to generate yield above inflation, investors are being compensated very little to take on risk. QV’s investment approach focuses on trying to manage downside risks. We take the view that it is more important to protect capital in challenging times than to try to maximize returns. We are investing in enduring businesses, run by capable and aligned leadership. We believe our focus on monitoring and managing the growth, value and balance sheet risks within the portfolios will continue to pay dividends over time.

icon  2017 manager outlook – Joe Jugovic, Wendy Booker Urban, Darren Dansereau & Ian Cooke

PM
Brad Radin B.A., B.Sc., MBA, CFA

Radin Capital Partners Inc.

IA Clarington Global Opportunities Fund/Class
IA Clarington Global Growth & Income Fund

Where are the opportunities?

We continue to believe that our investments in China remain attractive. In addition, we view the election of Donald Trump as a positive for the financials sector based on expectations of less regulation, lower taxes, and inflationary policies (with higher interest rates). We continue to believe that our large-cap bank and broker positions offer value over the long-term with valuations still substantially below long-term averages.

Where are the challenges?

Looking into 2017, we believe the biggest risks to global markets are the U.K.’s initiation of formal Brexit negotiation and the formalization of President Trump’s policies versus market expectations. In addition, with global equity markets trading close to long-term averages on certain valuation metrics, we remain cautious of downside risks should global growth not meet market expectations.

How are you positioning the funds?

Over the past three years, our investments in China have contributed to more than half of IA Clarington Global Opportunities Fund’s returns. While some of the positions have reached full value and have been sold, we believe the remaining positions in China continue to offer an attractive risk/reward dynamic consisting of companies with strong industry positions and solid balance sheets that are trading at some of the cheapest valuations in the portfolio. Financials remain the largest sector weighting in the Fund. Early in 2016, our large-cap bank and broker positions (Bank of America, Citigroup, Morgan Stanley) were some of the worst performing stocks globally as concerns over global growth, declining interest rates and energy exposure dragged the sector lower. This sell-off caused these stocks to trade close to valuations seen during the financial crisis. We felt that these prices were largely unjustified given the changes made by these companies since the financial crisis, including stronger balance sheets (capital levels have doubled since the financial crisis), safer business models (regulation has reduced exposure to high risk activities), leaner cost structure and resolution of major legal liabilities (majority of the U.S. residential mortgage mess has been cleaned up). Since the bottom in February 2016, our large-cap bank and broker stocks have rallied by over 80%. This re-rating was driven by quarterly earnings results, which showed that market fears were largely unfounded with the companies still profitable in the low interest rate environment and negligible exposure to energy in their loan books.

Why is this the right approach for 2017?

With our global long-term value approach to investing, we are constantly looking for the best investment opportunities around the world across all sectors and market cap. As a result, we are constantly replacing expensive stocks with cheap ones. This allows us to avoid areas of the market (country/sector/market cap) that may be overvalued. As a result, our Funds are currently trading at a discount to the market on an earnings basis. In addition, we focus on companies with strong balance sheets or asset value support to help protect on the downside from company-specific or macro events.

Chart

Source: Bloomberg, Capital IQ and Radin Capital as of November 30, 2016.

icon  2017 manager outlook – Brad Radin

PM
Larry Sarbit MA

Sarbit Advisory Services Inc.

IA Clarington Sarbit U.S. Equity Fund
IA Clarington Sarbit U.S. Equity Class (Unhedged)
IA Clarington Sarbit Activist Opportunities Class

Where are the opportunities?

As stock prices continued to climb in 2016, our work has been made more difficult to find wonderful businesses at bargain prices. As we continually say, we have a very strict discipline which defines the kind of companies we find attractive and the prices we want to pay for them. Even more expensive prices for the wonderful companies we would like to purchase have made our job that much more challenging. One thing we will not do: stray from our proven long-term discipline of searching for high quality businesses, managed by great people that can be purchased at prices that can provide our clients with the opportunity for outsized rates of return. We will continue to search for these investment opportunities. However, we will exercise patience, difficult as that is in an environment of high stock prices.

We have just experienced an unexpected revolution in the political structure that most predictors didn’t see coming. It’s far too early to comprehend what this will mean for the country, the economy or the stock market. We are faced with new questions: what will happen to interest rates that have been near zero for years? What will happen to the potential change in trade agreements as it impacts America and those with whom they do business? What does the next leg of economic growth look like? Will inflation and interest rates remain low? Could they rise much faster than the markets are assuming today given the President-elect’s aggressive plans for economic reform? How may this new environment affect asset prices? Will supply chains be disrupted from changes in free trade agreements? Can the European Union make the necessary reforms needed to preserve its currency and common market?

Our response is that we simply don’t have answers to these questions and we doubt that anyone else does either. We will just continue to do what we have always done: invest in businesses with certainty and predictability at cheap prices. The future will unfold but not necessarily in a way anyone can accurately see today. Conclusion? We remain cautious with our main concern today, as always, being on protection of our clients’ capital.

Where are the challenges?

The greatest test we face today, as we did in 2016, is to find companies we are excited to buy. As a team, we search continuously for what may be described as ‘Equity Bonds’ - companies with identifiable long-term coupons where we can determine what the returns will be over the next several years. And, of course, we want to purchase such businesses at cheap or reasonable prices, which helps to protect on the downside and enhances our returns. We will continue to avoid speculative issues where we have no idea what the future looks like. ‘Equity Bonds’ are companies that have sustainable competitive advantages, repeatable growing demand for their products or services, little requirement for large capital inputs and thus the ability to generate excess cash to be utilized for the benefit of all shareholders and are managed by smart, hardworking ethical individuals. After eight years of a bull market, meeting such conditions has been made that much more difficult.

How are you positioning the funds?

Because of the above circumstances, we find ourselves with over 50% cash on the sidelines. This is obviously not what we want, as equity investors. Our aspiration is to find more companies we believe will generate exciting rates of return with low risk. Alas, in our opinion, this simply doesn’t exist in the current environment. We have been in this situation before, in the early years of the current century, sitting with a great deal of cash. We waited a long time but were ultimately rewarded. As Warren Buffett has said, cash isn’t considered within a business or investment setting when present, but it is all investors are thinking about when it is absent. At some point, this cash will transform from being viewed as a burden to the most sought after asset. We have it and we can provide liquidity to those investors desperate to exit their equity investment at prices to our advantage.

Our cash levels are elevated as valuations have become stretched

Chart

Source: Bloomberg and Sarbit Advisory Services . Cash balance as at November 30, 2016. Forward P/E Ratio as at November 30, 2016. The cash weightings presented in the table represent the following mutual funds managed by Larry Sarbit from January 1988 to present: Jan 1988 to March 1998 - Investors U.S. Large Cap Value Fund; Jan 2000 to March 2005 - AIC American Focused Fund; Sep 2005 to Jun 2009 - Sarbit U.S. Equity Trust; Jun 2009 to Present - IA Clarington Sarbit U.S. Equity Fund.

Why is this the right approach for 2017?

Our approach is based on rational, business-like thought. Any other approach is ill-conceived, in our opinion. Investing because you think you know what will happen in the big economic picture is speculation, not rational, business-like behaviour. Buying overpriced assets just because you have cash is not prudent and can lead to loss of capital – the most important thing to avoid. As Ben Graham, the father of value investing said a long time ago: “The essence of investment management is the management of risks, not the management of returns”. We have no intention of reaching for potentially short-term speculative gains while at the same time, taking huge risk of losing our clients’ capital. We believe our patience will be rewarded in time.

icon  2017 manager outlook – Larry Sarbit

david
David Taylor MBA , CFA

Taylor Asset Management Inc.

IA Clarington Focused Balanced Fund
IA Clarington Focused Canadian Equity Class
IA Clarington Focused U.S. Equity Class

Where are the opportunities?

This time last year we mentioned that Canada was set to positively surprise after underperforming the U.S. for five years and that was certainly the case in 2016. The Canadian equity market rebounded to become the top performer of the developed markets during the year. It significantly outperformed the U.S. market in both base currency and Canadian dollar terms. We believe this is just the beginning.

This is proving to be a cycle like no other. The economic recovery, which has historically averaged two years in duration, has moved at a snail’s pace. After seven years we are only now back to where the last cycle ended and beginning the expansion phase. Everything is starting to normalize. We’re seeing synchronized growth around the world; unemployment is improving; wages are increasing; interest rates are rising; corporate earnings are improving; the bull market in bonds is turning over and inflation is starting to rear its head.

The current expansion is still young

Chart

Source: Evercore ISI and Bloomberg as of October 31, 2016.

The expansion phase of the cycle could last another six years. Expansion is an important phase for equities vis-à-vis bonds and for Canada in particular with its largely cyclical-based equity market. As we enter the expansion phase we can expect global manufacturing capacity to tighten, which will in turn drive up the value of many products produced here in Canada and sold globally. With capacity at its maximum and a stronger global economy, companies will start spending to reinvest in their businesses. Canada’s resource market supplies much of the materials to support that growth. We’re already seeing a recovery in many commodity prices. A strengthening global economy with limited supply response should fuel increased demand for natural resources. Also, with rising rates in the U.S., we expect the U.S. dollar to lose steam as it has with previous Fed tightening efforts. A lower U.S. dollar vis-à-vis other global currencies will benefit commodity prices. This all bodes well for Canada and for how our portfolios are positioned.

Where are the challenges?

At this stage we really don’t know which proposals and promises that Trump made during the election process were just rhetoric and which will become policy. He and his surrogates have claimed he is pro-trade but he has spoken repeatedly about voiding what he perceives to be unfair trade deals, including NAFTA. Exporters to the U.S. appear to be at risk. This could be a concern for Canada. However, where NAFTA is concerned, most of the focus has been on Mexico. Canada is a huge exporter but is also the United States’ biggest customer. We are the largest consumer of U.S. products in the world and a key supplier of materials and parts. Canada/U.S. trade accounts for about five per cent of U.S. employment and almost seven per cent of U.S. GDP. Given that Trump is pro-business and pro-jobs, scrapping a deal with Canada wouldn’t make sense. Also, company management teams we have consulted with generally agree that eliminating trade deals would have far reaching ramifications that the Trump administration couldn’t ignore – job losses, plant closures, and a lack of U.S.-based alternative suppliers or manufacturing infrastructure.

A more protectionist Trump would mean tariffs and trade barriers. Increased tariffs lead to higher prices and inflation. Trump’s plans to increase spending on defence and infrastructure will also feed inflation. Moderate inflation is natural in the cycle but significant inflation could dampen exports and hurt the U.S. economy. Ultimately, increasing inflation will lead to higher interest rates. Rising rates aren’t a concern provided they are supported by healthy economic growth. Inflation-fueled rates without a strong economy could be a challenge.

How are you positioning the funds?

The Focused Funds are close to fully invested to position for continued growth in the U.S. and an improving global economy. We started increasing our exposure to Canada in late-2015/early-2016. Canadian equities now account for about 65%-70% of the non-cash assets of IA Clarington Focus Canadian Equity Class. We have good exposure to high quality cyclical U.S. names leveraged to the economy and rising rates. However, we continue to overweight Canada with a focus on highly cyclical sectors and rate-sensitive businesses that are best positioned to benefit from the expansion. The Funds have above market-weight exposure to resource sectors that we believe are highly levered to the cycle, however we have been prudent in our security selection, focusing on quality companies that can endure inevitable periods of market turbulence. Our portfolios are concentrated, so we can be opportunistic and we have the flexibility to shift the portfolios’ sector and geographic exposure if we sense conditions changing.

Why is this the right approach for 2017?

Macro indicators including employment levels, capacity utilization and industrial production tell us that the U.S. economy has recovered and is now expanding. Inflation is gradually coming back to life and rising rates are imminent. Value is once again outperforming growth. We’re excited by this as we liken it to where we were in the cycle in 2004/2005 after recovering from the tech bubble. At that time, commodities dominated and Canada significantly outperformed. The S&P/TSX returned 70% for the period January 1, 2005 to June 30, 2008 while the S&P 500(CDN$) fell by about 4%. The Focused Funds are already being rewarded for our shift to Canada and cyclicals, and we believe there is more to come. We hope to recreate the success of the last cycle. History repeating itself can be a good thing.

icon  2017 manager outlook – David Taylor

PM
Andrew Simpson BA, CFA

Vancity Investment Management Ltd.

IA Clarington Inhance Balanced SRI Portfolio
IA Clarington Inhance Bond SRI Fund
IA Clarington Inhance Canadian Equity SRI Class
IA Clarington Inhance Conservative SRI Portfolio
IA Clarington Inhance Global Equity SRI Class
IA Clarington Inhance Growth SRI Portfolio
IA Clarington Inhance Monthly Income SRI Fund

Where are the opportunities?

2017 is shaping up to offer a positive start to the year but we believe the level of market volatility will rise. With the economy in late cycle and U.S. interest rates on a rising trajectory, portfolio diversification across geographies, sectors and asset classes can help provide a more stable portfolio return.

Despite volatility, equities remain an attractive inflation hedge and are supported by earnings revisions that are at five-year highs and rising estimates of global GDP growth.

We believe that European equities will offer opportunities as corporate earnings are low relative to history while earnings growth is forecast to rise to 12% in 2017.

Where are the challenges?

If there is a continuation of the significant sector rotation that we saw in 2016, this could result in increased market volatility. The uncertainty of U.S. policy in the lead up to a Trump presidency remains an overhang for stock markets and will also be a source of volatility.

How are you positioning the funds?

Our collaborative investment approach integrates environmental, social and governance (ESG) analysis with traditional financial analysis and portfolio management. Investing in growth companies that meet our ESG criteria along with diversification, risk management and valuation disciplines, are the hallmarks of our style.

Consumer confidence has risen since the uncertainty of the U.S. election has been removed. Furthermore a Trump administration that will most likely support pro-growth is more likely to adopt stronger pro-growth policies—lower taxes, less regulation and greater fiscal spending. We expect to add to our industrials exposure as it is a late cycle sector that tends to perform well in a rising rate environment.

In 2016, the Funds maintained a higher level of cash balances. We have been actively reducing our cash levels when the opportunities to invest in growth companies at reasonable prices present themselves.

Why is this the right approach for 2017?

Equities have historically continued to perform well in a rising inflationary environment until 3% inflation is reached. Central bankers are likely to let economies run and face inflation rather than take on deflation risk. We believe maintaining equity exposure in the Funds positions them for a positive 2017.

Equities tend to perform well during periods of rising inflation, up to 3%

Chart

Source: Thomson Reuters. Credit Suisse research as of September 30, 2016.

icon  2017 manager outlook – Andrew Simpson

IA Clarington Strategic Corporate Bond Fund
IA Clarington Strategic Equity Income Fund/Class
IA Clarington Strategic Income Fund
IA Clarington Strategic U.S. Growth & Income Fund
IA Clarington Tactical Income Fund

Where are the opportunities?

Finding opportunities to outperform the market over the next year will have as much to do with investment style as it will with good security selection. We believe that value investing will likely outperform growth investing for much of the year and that those securities that are less sensitive to a rising interest rate environment will have fewer challenges to their valuations than those that are negatively impacted in a rising rate environment. We have confidence that, over the next twelve months, inflation and oil prices will continue to progress higher and economic growth will be greater than it has been over the past two years, though there will likely be volatility in these economic indicators. We now view the opportunities in the U.S. market to be as attractive as those in the Canadian market were in 2016. Securities in the financial and industrials sectors will likely outperform securities that are viewed as bond proxies, such as consumer staples and utilities. Within fixed income, high yield corporate bonds are likely to be a better option than investment grade bonds, given their lower sensitivity to rising interest rates.

Inflation expectations are trending higher

Chart

Source: Bloomberg as of December 6, 2016. Inflation expectations reflect the yield differential between 5-year nominal U.S. Treasury bonds and 5-year inflation-protected U.S. Treasury bonds.

Where are the challenges?

The global environment is giving the first indication in a number of years that the deflationary environment, which has been a result of overcapacity, is showing signs of reversal. The prospects of an inflationary environment are positive by implication. However, the markets have subsequently responded to this possibility and have risen to a point where we believe we may have “front loaded” the potential for positive corporate and economic data in a very short period of time. This increases the potential for more than the expected two rate hikes by the Fed and the possibility of a near-term correction that will put into question the positive benefits of higher inflation, higher commodity prices and a higher growth environment. We expect this scenario to unfold within the first half of 2017 before giving way to a more positive backdrop heading into 2018.

How are you positioning the funds?

Our investment approach focuses on securities that are backed by quantifiable and sustainable businesses that exhibit relative safety in their cash flows and dividends. We are by nature value-oriented in our security analysis, whether in equities or corporate bonds, with emphasis on companies that have positive growth prospects while being mindful of the price we pay for those securities. Our Funds are currently invested with an approximately even split between what we consider defensive and cyclical holdings. The majority of our equity holdings are in larger capitalized firms, as we have been apprehensive to assume greater volatility associated with smaller capitalized companies over the past two years. Given our expectations for a positive environment that is supportive of our investment style, we may make a shift in order to assume higher exposure to cyclical and smaller capitalized securities in our Funds as the year progresses.

Why is this the right approach for 2017?

While being right is ultimately an exercise in perfect hindsight, we believe that given our expectations for those things that are positive to economic and corporate growth, the bull market in equities will likely continue for at least the next year while our focus on higher yielding corporate bonds will contribute higher yield and positive return potential as the year progresses. We view risks associated with a recession to be minimal and economic headwinds will likely turn into tailwinds as the year progresses. This environment will have positive implications for equity-related securities and high yield corporate bonds and potentially negative implications for interest rate sensitive securities. In this environment, correlations between individual securities will decrease, paving the way for active management focused on bottom-up security selection to outperform a passive investment approach.

icon  2017 Manager Outlook - Dan Bastasic

IA Clarington Floating Rate Income Fund
IA Clarington U.S. Dollar Floating Rate Income Fund
IA Clarington Core Plus Bond Fund
IA Clarington Tactical Bond Fund

Where are the opportunities?

The unexpected victory by Donald Trump has caused us to revisit our expectations for inflation, U.S. interest rate policy and the current stage of the credit cycle. While much has been made about Trump’s expected policies, we cannot be certain how much actually comes into effect. As a result, we enter 2017 with a healthy dose of uncertainty causing us to continue to embrace an overall conservative positioning within our portfolios. Investors expect us to avoid blow-ups and surprises through astute credit selection and maintaining diversification in our positions. We are not yet ready to chase alpha and higher yields in any meaningful way.

Our current expectation is for rising interest rates in 2017, led by U.S. Treasuries. With interest rate sensitivity as a clear headwind, the opportunities in fixed income will be in floating rate debt and shorter duration spread products with the ability to cushion rising interest rates. We continue to like senior loans and high yield bonds with shorter maturities. We are constructive on credit with our baseline view being a compression of spreads in 2017. We expect loan defaults to remain below the historical average and expect high yield bond defaults to decline after hitting multi-year highs in 2016 due to challenges in the energy sector. Overall, our view is that the end of the credit cycle has been pushed out.

Within the investment grade market we will seek securities which have the ability to withstand headwinds from rising interest rates. We believe that BBB-rated corporate bonds will be attractive, given the higher absolute spread combined with lower duration. Rate reset Canadian preferred shares may become an increasing focus given our expectation that reset rates will be higher following an expected increase in 5-year Canadian government bond yields. We may also look to layer in fixed-to-floating interest rate swaps to further reduce the duration of our portfolios when it is economical to do so.

Where are the challenges?

As we exit 2016, ideal conditions appear to be forming for senior loans. Coupons and yields will be supported by a further rise in the 3-month Libor (London Interbank Offered Rate), the base rate for the majority of loan coupons. The default environment is expected to be benign given improving economic conditions in the U.S. Finally, loans may be supported by strong fund flows from investors fleeing interest rate sensitive bonds.

3-month Libor is on the rise

Chart

Source: Bloomberg, November 30, 2016.

The financial press has correctly highlighted the benefits of adding loan exposure to fixed income portfolios but there are also challenges worth considering. Improving fund flows into loans has allowed borrowers to refinance or reprice existing issues (recall that loans have minimal prepayment protection). So while coupons become bigger, due to the expected rise in Libor, they will come down because of repricing activity.

Deteriorating credit quality may become a larger issue, especially as corporate executives stretch to put cash to work. We have already seen credit fundamentals deteriorate with current leverage at levels unprecedented outside of a recession. We have also seen some new loan issues structured quite aggressively, in our view.

Within the investment grade market, rising interest rates and record high interest rate sensitivity are clearly the largest challenges. Overall, we would suggest that the days of ultra-low interest rates and accommodative U.S. Federal Reserve policy seem to be in the rear view mirror.

How are you positioning the funds?

As a general comment, we continue to position all the funds we manage quite conservatively in order to limit price volatility and surprise risk. We will focus most of our effort on higher rated, larger issues in our non-investment grade positions. However, as we are constructive on credit, we expect to add exposure to higher yielding single B-rated names that are reasonably leveraged and generate predictable free cash flow.

Foreign exchange hedging costs are expected to increase due to divergence in shorter term rates in Canada and the U.S. Regardless of higher costs, we will maintain our policy of being fully currency hedged in the IA Clarington Floating Rate Income Fund and will minimize currency risk in our investment grade mandates.

Within our investment grade mandates, we will continue to be low duration. As we obtain more information and form greater clarity on Trump’s policies, we will adjust our sector exposure but will continue to shy away from the commodity sector.

Why is this the right approach for 2017?

We believe that investors want low volatility and minimal surprise risk in their fixed income, first and foremost. Our investment strategy is consistent with this view as we build portfolios that favour capital preservation over outsized returns. We want to remind advisors that our guiding principle is to generate alpha through avoidance. We believe that our investment strategy is timeless for fixed income and not limited to something we do in 2017.

icon  2017 Manager Outlook - Jeff Sujitno

IA Clarington North American Opportunities Class
IA Clarington Growth & Income Fund
IA Clarington Canadian Conservative Equity Fund/Class

Where are the opportunities?

We are finally seeing a reacceleration of earnings in North American markets and as long as this continues, we believe markets can grind higher despite elevated valuations. Many of the drivers were already in place before the U.S. election (improving U.S. economy, increasing global demand and inflation), however, since the unexpected outcome these drivers have been amplified by the Trump administration’s proposed package of reflationary policies. If fully implemented, the positive policies could be fuel to the fire (for example, trade). Earnings should continue to grow and markets should follow in general. Another positive driver for 2017 could finally be a rotation of funds from traditional fixed income into equities given the sharp rise in rates we have just witnessed. This should help sustain multiples for a period of time.

Where are the opportunities?

We are finally seeing a reacceleration of earnings in North American markets and as long as this continues, we believe markets can grind higher despite elevated valuations. Many of the drivers were already in place before the U.S. election (improving U.S. economy, increasing global demand and inflation), however, since the unexpected outcome these drivers have been amplified by the Trump administration’s proposed package of reflationary policies. If fully implemented, the positive policies could be fuel to the fire (for example, trade). Earnings should continue to grow and markets should follow in general. Another positive driver for 2017 could finally be a rotation of funds from traditional fixed income into equities given the sharp rise in rates we have just witnessed. This should help sustain multiples for a period of time.

Where are the challenges?

Valuations in general are elevated. Overall, we can expect earnings growth to drive the market in the coming year as the multiple expansion story has pretty much played out, especially given the inflation/interest rate outlook. Given where valuations are, we need to see earnings come in line or better than currently expected.

Inflation expectations are rising and the U.S. 10-year treasury is moving upward as expected

Chart

Source: Bloomberg, December 7, 2016.

Interest rates are rising. With inflation and Treasuries accelerating for the first time in years we believe that investors have to be cognizant of the risks towards low volatility and defensive sectors that have worked in the recent past. If the U.S. economy accelerates at a faster-than-expected pace driven by the implementation of reflationary policy, the U.S. Federal Reserve (Fed) may act at a faster pace and we could see rates rise faster than expected.

Correlations of sectors and returns are falling as the macro factors gives way to fundamentals (this is a good thing). With this backdrop of reaccelerating earnings and rising rates, we expect to get back to a fundamentally driven market where careful sector and stock selection will be required in order to outperform. Certain sectors such as the bond proxies (i.e. pipelines, utilities, REITs) could potentially follow bonds lower while other more cyclical sectors should follow earnings higher at this stage of the cycle.

Strengthening U.S. dollar. With monetary policy divergences around the globe, the U.S. dollar looks to continue its strength in 2017. This will pose a headwind to U.S. exporting multinationals and could impact commodities if demand is weaker than expected.

Volatility should rise. We expect to see volatility increase from the low levels experienced in 2016. With valuations and expectations running high and, as we progress through to the later stages of the cycle, we can expect to see some sharper market swings.

How are you positioning the funds?

For income generation through dividends, we are taking a more balanced approach in 2017. For our large-cap mandate, the IA Clarington Canadian Conservative Equity Fund, we have a barbell strategy where we have taken down our weighting in the more interest rate sensitive and defensive “bond proxy” sectors and added slightly to positively correlated segments such as insurance. We have also added to industrials and a few more cyclical names that should benefit from improving domestic and global growth. We have put a heavy emphasis on consistent earnings, free cash flow generation and the ability to grow dividends for the current environment. We are by no means giving up on these “bond proxy” sectors, as we still see pockets of value and the ability to clip dividends from select securities. We also feel that we will need defence during the expected periods of volatility during 2017 and these sectors can provide us with stability when we need it.

With the IA Clarington Growth & Income Fund, we continue to position this mandate as a complement to core holdings with our quality dividend growth strategy. When it comes to allocation within North America, along with the strong U.S. dollar and strength in the U.S. economy leading the way, we expect some similarities with 2015 where we looked for Canadian companies that had U.S. exposure and for U.S. companies with greater domestic exposure. We also like Canadian companies that have exposure to the global reflation trade.

Why is this the right approach for 2017?

We see a few areas that should outperform in 2017. As usual we see a focus on quality stocks that can grow earnings and cash flow and be able to increase dividends on pace with increases in the U.S.10-year bond yield as being the place to be in 2017. Dividend growth strategies tend to perform well in most environments but especially in the current type of environment we are seeing. On the valuation spectrum, we also see value stocks outperforming growth stocks. As economic growth and earnings start to accelerate, and growth in general becomes less scarce, value stocks that have typically lagged will outperform. Within our all-cap mandates we also see potential for small- and mid-caps to outperform on the back of reflationary policy, less regulation and the strength of the U.S. dollar. However, the valuation of the small-cap and mid-cap segments in North America is elevated, so we will be going where we can find value.

icon  2017 Manager Outlook - Terry Thib

IA Clarington Monthly Income Balanced Fund
IA Clarington Yield Opportunities Fund
IA Clarington Managed Portfolios

Where are the opportunities?

The Canadian stock market could be in for another decent year as the deal to cut oil production struck by OPEC on November 30th might put a floor underneath oil prices. A return to the $50-$60 range on oil prices could act as a tailwind for the Canadian economy, as non-energy-product exports are lagging and it is still unclear whether the recently imposed mortgage rule measures will hurt a frothy housing market. We’ll keep a wary eye on Donald Trump’s plan to renegotiate the North American Free Trade Agreement, as nearly 75% of Canadian exports go to the U.S. market and Canada’s current account deficit as a share of GDP is presently the worst among developed countries. In this context, we expect the Canadian dollar to remain slightly under pressure, as the Bank of Canada could maintain a careful tone.

Among asset classes, we believe that equities in the Europe, Australasia and Far East (EAFE) region could outperform, as the weaker Euro and yen could act as tailwinds, earnings momentum is better than in North America and, at 1.5x book value (compared to 2.8x on the S&P 500), geopolitical risks seem already priced in. We also expect the European Central Bank and the Bank of Japan to remain accommodative, which would act as further support.

European equities are more reasonably valued than those in North America

Chart

Source: Bloomberg as of December 12, 2016.

Where are the challenges?

The year 2016 was marked by significant political events. The Brexit vote in the U.K. and the election of Donald Trump to the White House were both the result of an anti-globalization, anti-establishment trend, with U.K. and U.S. citizens expressing their disenchantment with free-trade policies that seem to mainly benefit the well-to-do. This political swing could even extend to France and Germany in 2017 when these two pillars of the E.U. have their general elections.

Despite the many risk factors that seemed to have crept in during the last year, equity markets were reasonably calm following the January and February scare of an impending global recession. We of course witnessed resurgence in volatility during the week that followed the Brexit vote, but it turned out to be swiftly swept under the rug. The result is that the U.S. stock market ends the year being generously valued, as many of the good news from the upcoming Trump presidency, like lower taxes and less regulation on banks, seem to be priced in. We won’t know until 2017 whether President-elect Trump will stick with his electoral promises, or whether his ambitious plan, funded largely by debt, will be blocked by Congress.

The bond market reacted quite strongly to the result of the election and the OPEC deal, as inflation expectations were revised higher and the outlook for central banks has shifted away from perpetual accommodation. The strength of the U.S. economy was sufficient for the Fed to go ahead with a rate hike at the end of 2016, and the inflationary pressures that could result from accelerating wage growth and rising protectionism should push the Fed to move forward with at least two more rate hikes in 2017.

How are you positioning the funds?

Based on relative valuations, we are overweight Canadian and EAFE equities while being underweight the U.S. We also have purchased options on the Canadian, U.S. and EAFE markets. We’ve also recently purchased ETFs in preferred shares, federal government bonds and treasury inflation protected securities (TIPS) as a tactical decision to help manage downside risks.

Why is this the right approach for 2017?

We remain of the belief that investors need to tread carefully as many risk factors are now at play, stemming mostly from politics. We thus advocate considering volatility as an asset class to be used tactically and to buy some protection when it is selling cheap.

icon  2017 Manager Outlook - Clément Gignac

IA Clarington Global Value Fund
IA Clarington U.S. Dividend Growth Fund
IA Clarington U.S. Dividend Growth Registered Fund

Where are the opportunities?

Newly elected President Donald Trump has been vocal on many policies that may be positive for the U.S. stock market. We are seeing opportunities in sectors that may benefit from less regulation such as energy, pharmaceuticals, biotech, and banks. We also believe U.S. corporations with high tax rates should benefit from a proposed tax rate cut. The new administration might also put in place a one-time holiday tax break for companies who are holding cash overseas. This tax would allow companies to repatriate untaxed foreign profit at a lower rate. This could result in higher shareholder payouts (dividends/buybacks) and more mergers and acquisitions for those companies. With the prospect of rising interest rates, we expect to see the rotation continuing from bonds to stocks and compelling value may be found in sectors which have yet to benefit from the post-Trump stock market rally.

Where are the challenges?

The rising U.S. dollar could be a challenge in 2017. For U.S. multinationals, a strong U.S. dollar reduces the revenues that companies earn overseas. We are also concerned over an increase in the yield curve, which may continue to put pressure on bond proxy sectors, such as utilities, telecommunications and real estate. There remains a lot of uncertainty around the impact and timing of Trump’s proposed policies. Protectionism is probably one the most important challenges that we are going to face in 2017.

How are you positioning the funds?

Our Funds have a large capitalization bias with a dividend growth focus. We remain overweight in sectors that we believe will benefit from Trump’s proposed policies such as energy, banks, pharmaceuticals and technology. We are invested in dividend growers in the consumer staples sector that can also potentially benefit from mergers and acquisitions (Kraft Heinz Co. and Mondelez International Inc.). We are also finding attractive valuations in large-cap technology companies (Cisco, Microsoft and Apple) with large cash positions held overseas that could potentially be repatriated to the U.S. The Funds remain underweight the bond proxy sectors, given their interest rate sensitive nature.

Why is this the right approach for 2017?

We prefer dividend growth stocks compared to high dividend yield stocks. History has shown that, in a rising interest rate environment, dividend growers outperform high dividend yield stocks. This makes sense because high dividend yield stocks with a slower rate of dividend growth tend to behave more like bonds in the context of a rise in the yield of 10-year U.S. treasury bonds.

Dividend growers have outperformed in rising interest rate environments

Average Annualized Return Based on Monthly Changes in Interest Rates

Chart

Source: BMO Investment Strategy Group, FactSet, Compustat, IBES. January 1, 1990 to July 22, 2016.

We continue to use a covered call strategy to enhance the yield of the portfolio and maximize returns (typically 25% of the portfolio, with a maximum of 50%). To protect the portfolio from a potential downturn, we prefer to buy put options on the S&P 500 Index instead of owning cash because we keep the upside potential intact and we receive the dividends. We believe that value will outperform growth in 2017 and we are putting a great emphasis on the Funds’ valuation metrics.

icon  2017 Manager Outlook - Pierre Trottier

Where are the opportunities?

Economies worldwide are now approaching a key inflection point — moving from fiscal austerity to expansion. While macro fears (Trump, Brexit, etc.) continue to dominate headlines, the more important story is the return of fiscal stimulus. As we move into this next stage, expect a blurring of monetary and fiscal policy; a development that will pave the way for policies which attempt to get money directly into the hands of the private sector.

However, this adjustment will not occur all at once. More likely is a gradual transition that unfolds over years. Short-term reactions have been extreme, particularly the steep climb in yields since the election. Stability is likely as more policy visibility takes hold.

While a spike in yields is clearly detrimental to income investors, a slow and steady rise allows for a higher reinvestment rate without incurring large capital losses. This is wonderful news for retirees who have suffered ultra-low yields for years. Particularly appealing are inflation-protected and floating rate securities, which offer a prudent means to offset the dual effects of rising inflation and interest rates.

We also believe the current negativity surrounding emerging markets (EMs) presents an immense opportunity. EM assets were hit hard post-U.S. election, as a surging U.S. dollar raised solvency concerns (on U.S. dollar denominated borrowing), and Trump’s protectionist leanings threaten exports. We expect the U.S. dollar, which is already overvalued by most conventional metrics, to stabilize shortly. Regardless, many EMs have taken large strides since the Asian financial crisis to protect their economies, including building foreign exchange reserves, implementing flexible exchange rates and controlling fiscal spending.

Furthermore, many EM corporations now have global operations with revenues booked in foreign currencies, including the dollar. While trade protectionism remains a risk (we will be monitoring developments closely), oversold emerging markets with devalued currencies (boosting trade competitiveness) have become increasingly attractive. After seven years of equity underperformance (versus U.S. stocks), they are cheap on a variety of measures.

Emerging markets are attractively valued

Relative Price-to-Book Value

Chart

Source: Macrobond, MSCI, Forstrong Global Asset Management as of November 30, 2016.

Where are the challenges?

Financial market participant focus has seemingly shifted from global monetary policy to geopolitical event speculation. As an example, chatter surrounding the Federal Open Market Committee (FOMC) meeting in mid-December was unusually quiet.

While the futures market effectively fully priced in a rate hike, U.S. stocks were undeterred, hitting new highs following the U.S. presidential election.

The monumental 2016 victories of the Brexit “leave campaign” and the Donald Trump-led Republican Party in the U.S. have emboldened populist, anti-establishment movements worldwide; specifically in Europe. Key risks emanate from the upcoming Italian referendum on proposed constitutional reforms, as well as numerous 2017 Eurozone country elections, each of which feature parties that have gained traction campaigning on anti-immigration or Eurosceptic platforms.

While a win for any such party could potentially signal the beginning of the end for the Euro project, the key takeaway is that investors will continue to react emotionally before fully assessing the longer term implications (many of which will not be as severe as forecast). Tactical opportunities are abundant in this environment.

How are you positioning the funds?

When evaluating the global investment landscape, Forstrong’s primary focus is always risk management. Regardless of the degree of conviction amongst the various views taken, broad global diversification remains the “first line of defence” at all times.

With that in mind, our Funds maintain a fixed income underweight and a shortened duration profile. Correspondingly, equity and cash levels have been increased above benchmark. Emerging markets remain a predominant focus, both for equity and fixed income allocations, while unattractive currency and equity valuations have warranted caution on U.S. asset classes.

Why is this the right approach for 2017?

Our positioning balances the prospect of a fiscal expansion-driven upswing against numerous geopolitical hazards and a weak global economic backdrop. The rotation away from fiscal austerity could prove to be an inflection point in the 35-year bond bull market where yields were in structural decline. Maintaining an equity overweight (and fixed income underweight) is congruent with these themes, while an increased cash position should provide a buffer against potential political turmoil on the horizon.

We believe that the best approach in today’s atypical investment climate is to build portfolios that are globally diversified across many asset classes, informed by a concerted focus upon a variety of common and unique risk factors.

icon  2017 Manager Outlook - Tyler Mordy

IA Clarington Global Tactical Income Fund

Where are the opportunities?

The global economic environment continues to improve and we believe the U.S. corporate earnings recession, in particular, has ended. U.S. equity markets have responded positively to the election of Donald Trump as investors focus on his proposed pro-growth policies; namely tax cuts, infrastructure spending, and deregulation. If successfully implemented, we believe these policies will be supportive of GDP growth and equity markets, with the financials and industrials sectors likely being among the biggest beneficiaries. Outside the U.S., economic prospects appear less robust, however, political events, particularly in Europe, are creating shortterm volatility in equity markets, which presents opportunities to purchase companies with strong fundamentals.

In global fixed income, the higher yield environment in the U.S. is creating opportunities for attractive all-in yields for select emerging market hard currency bonds from credit-stable issuers. Non-U.S. global government bond yields have corrected higher, but are still quite low historically when viewed in real yield terms. Rising U.S. bond yields have had the knock-on effect of cheapening both local-pay bonds and currencies of emerging markets. Should the rotation out of retail bond funds into equity products persist, then it is quite possible valuations will again become particularly compelling for U.S. dollar corporate bonds and possibly even European corporate bonds, to the extent the European Central Bank eases back on its pace of accumulating corporate bonds in that market.

Where are the challenges?

While the aforementioned policy changes may create investment opportunities, we are mindful of obstacles in implementation. Trump will be met with a vocal constituency in Congress that is opposed to increasing an already widening U.S. budget deficit. ‘Shovel-ready’ infrastructure projects, if approved, can in practice take years to implement, creating a considerable lag in tangible economic benefits. Additionally, the populist movement that helped facilitate a ‘yes’ vote on Brexit and a Trump election win in the U.S. remains a powerful force in continental Europe. While there is currently sufficient political will to hold the euro project together, the status quo could be challenged with multiple elections (France, Germany, Italy) in 2017. If we have learned one thing recently, it is not to become comfortable with what the polls are indicating.

Congress may oppose spending that would increase the U.S. budget deficit

Debt/GDP under both candidates, as estimated by the CRFB

Chart

Source: Committee for a Responsible Federal Budget as of 8/31/2016. Opinions or forecasts contained herein reflect the subjective judgments and assumptions of the authors only and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. This information is subject to change at any time without notice.

How are you positioning the funds?

From an allocation perspective, we continue to be positioned with a significant equity exposure relative to fixed income, reflecting our view of more favourable relative value in equities. We will continue to re-evaluate this positioning and make allocation changes when shifts in relative value occur.

Within equities, our allocations continue to be driven by individual security selection. Our focus is on quality businesses, with an ability to grow their intrinsic value over time which trade at attractive valuations. At a sector level, we have significant exposure to consumer discretionary, technology and the global industrials sector.

We view developed market corporate credit as fairly priced, but well supported by accommodative central banks, improving economies, and a lack of attractive alternatives given predominantly low global government bond yields. Credit fundamentals have been deteriorating, but low interest expense and recovering earnings should help extend the cycle. Nonetheless, we have been reducing credit exposure on market strength and more full valuations. Particular areas of focus are the potential volatility surrounding higher U.S. policy rates, as a result of the U.S. Presidential election, implications from the Brexit vote and volatility from the Italian referendum. In select emerging markets, we have allocated to currencies with attractive yields that have previously been hard hit by the global commodities sell off earlier in 2016, yet are striving to reform their fiscal profile.

Why is this the right approach for 2017?

We expect the market environment to create new opportunities to allocate capital on an individual security basis across both equity and credit in the coming year, as changes in interest rates, policy uncertainty, and global geopolitical shifts create volatility. The IA Clarington Global Tactical Income’s strategy is a high conviction global opportunistic fund that has the flexibility to invest across the capital structure of a company to uncover the best equity and fixed income ideas. The portfolio combines our highest conviction “best ideas” globally in both equity and fixed income markets. We continue to focus on our guiding principles and philosophy: identifying and selecting quality companies with the ability to grow intrinsic value over time that trade at attractive valuations. We view short-term market volatility and pullbacks as an opportunity to add to our existing, high-conviction positions or establish new positions in businesses that meet our three alpha drivers of quality, growth and valuation.

icon  2017 Manager Outlook – David W. Rolley, Eileen N. Riley, Daniel J. Fuss & Lee M. Rosenbaum

IA Clarington Canadian Balanced Fund/Class
IA Clarington Canadian Small Cap Fund/Class
IA Clarington Global Equity Fund

Where are the opportunities?

Brexit, negative interest rates and the surprise U.S. election outcome all represent marked shifts from the status quo and have introduced new sources of uncertainty. While uncertainty in financial markets can be uncomfortable to bear, it often leads to increased volatility, and therefore opportunity, for value investors. We own businesses that can navigate in all sorts of storms, whether they are economic shocks or political surprises. While we don’t try to implement short-term trading strategies based on anticipated outcomes, we will take action if volatility allows us to own wonderful businesses at attractive prices.

With strong compounding characteristics and reasonable valuations, we are seeing attractive risk-reward trade-offs within the North American financials sector. More broadly, we continue to find opportunities on a company-by-company basis across asset classes, sectors and geographies.

Within fixed income, strong credits that are short duration can protect purchasing power, but offer little in the way of incremental return. For equities, our focus remains on under-appreciated businesses that are able to increase their competitiveness, expand margins and maintain growth characteristics through economic and political cycles.

Where are the challenges?

Despite relatively positive economic data from the U.S. and the expected boost from President-elect Trump’s fiscal policies, global growth remains elusive and major central banks continue to uphold highly accommodative monetary policies. In Canada, indebted households, a still-struggling energy market and overheated residential real estate in Toronto and Vancouver are key downside risks that remain at the forefront of our minds.

Even with these macro challenges, equity valuations may continue climbing higher, given the lower yields of alternatives. Underlying earnings have generally not kept pace with stock market appreciation and have been growing at a below-average pace. Many quality companies today are trading at valuation multiples not seen for some time. We must manage this challenge by remaining selective and patient, ensuring we do not sacrifice quality for value, or vice versa. Still, elevated equity valuations have reduced our long-term return expectations as a whole.

Global growth remains elusive

Global GDP Growth Rates

Chart

Source: World Bank national accounts data & OECD national accounts data file as of December 2015.

How are you positioning the funds?

We maintain diversified portfolios, holding companies that have survived under all kinds of economic scenarios for many decades. In fixed income, we are positioned with low duration in high quality bonds. In equities, stocks within the portfolios are generating attractive levels of profitability while carrying below-average levels of debt. This provides a solid foundation for reinvestment, returning capital to shareholders and navigating through economic turbulence. The portfolios offer a number of attractive characteristics compared to the broader markets, providing further support in more challenging periods.

Why is this the right approach for 2017?

In an era where it is difficult to generate yield above inflation, investors are being compensated very little to take on risk. QV’s investment approach focuses on trying to manage downside risks. We take the view that it is more important to protect capital in challenging times than to try to maximize returns. We are investing in enduring businesses, run by capable and aligned leadership. We believe our focus on monitoring and managing the growth, value and balance sheet risks within the portfolios will continue to pay dividends over time.

icon  2017 Manager Outlook – Joe Jugovic, Wendy Booker Urban, Darren Dansereau & Ian Cooke

IA Clarington Global Opportunities Fund/Class
IA Clarington Global Growth & Income Fund

Where are the opportunities?

We continue to believe that our investments in China remain attractive. In addition, we view the election of Donald Trump as a positive for the financials sector based on expectations of less regulation, lower taxes, and inflationary policies (with higher interest rates). We continue to believe that our large-cap bank and broker positions offer value over the long-term with valuations still substantially below long-term averages.

Where are the challenges?

Looking into 2017, we believe the biggest risks to global markets are the U.K.’s initiation of formal Brexit negotiation and the formalization of President Trump’s policies versus market expectations. In addition, with global equity markets trading close to long-term averages on certain valuation metrics, we remain cautious of downside risks should global growth not meet market expectations.

How are you positioning the funds?

Over the past three years, our investments in China have contributed to more than half of IA Clarington Global Opportunities Fund’s returns. While some of the positions have reached full value and have been sold, we believe the remaining positions in China continue to offer an attractive risk/reward dynamic consisting of companies with strong industry positions and solid balance sheets that are trading at some of the cheapest valuations in the portfolio. Financials remain the largest sector weighting in the Fund. Early in 2016, our large-cap bank and broker positions (Bank of America, Citigroup, Morgan Stanley) were some of the worst performing stocks globally as concerns over global growth, declining interest rates and energy exposure dragged the sector lower. This sell-off caused these stocks to trade close to valuations seen during the financial crisis. We felt that these prices were largely unjustified given the changes made by these companies since the financial crisis, including stronger balance sheets (capital levels have doubled since the financial crisis), safer business models (regulation has reduced exposure to high risk activities), leaner cost structure and resolution of major legal liabilities (majority of the U.S. residential mortgage mess has been cleaned up). Since the bottom in February 2016, our large-cap bank and broker stocks have rallied by over 80%. This re-rating was driven by quarterly earnings results, which showed that market fears were largely unfounded with the companies still profitable in the low interest rate environment and negligible exposure to energy in their loan books.

Why is this the right approach for 2017?

With our global long-term value approach to investing, we are constantly looking for the best investment opportunities around the world across all sectors and market cap. As a result, we are constantly replacing expensive stocks with cheap ones. This allows us to avoid areas of the market (country/sector/market cap) that may be overvalued. As a result, our Funds are currently trading at a discount to the market on an earnings basis. In addition, we focus on companies with strong balance sheets or asset value support to help protect on the downside from company-specific or macro events.

Chart

Source: Bloomberg, Capital IQ and Radin Capital as of November 30, 2016.

icon  2017 Manager Outlook – Brad Radin

IA Clarington Sarbit U.S. Equity Fund
IA Clarington Sarbit U.S. Equity Class (Unhedged)
IA Clarington Sarbit Activist Opportunities Class

Where are the opportunities?

As stock prices continued to climb in 2016, our work has been made more difficult to find wonderful businesses at bargain prices. As we continually say, we have a very strict discipline which defines the kind of companies we find attractive and the prices we want to pay for them. Even more expensive prices for the wonderful companies we would like to purchase have made our job that much more challenging. One thing we will not do: stray from our proven long-term discipline of searching for high quality businesses, managed by great people that can be purchased at prices that can provide our clients with the opportunity for outsized rates of return. We will continue to search for these investment opportunities. However, we will exercise patience, difficult as that is in an environment of high stock prices.

We have just experienced an unexpected revolution in the political structure that most predictors didn’t see coming. It’s far too early to comprehend what this will mean for the country, the economy or the stock market. We are faced with new questions: what will happen to interest rates that have been near zero for years? What will happen to the potential change in trade agreements as it impacts America and those with whom they do business? What does the next leg of economic growth look like? Will inflation and interest rates remain low? Could they rise much faster than the markets are assuming today given the President-elect’s aggressive plans for economic reform? How may this new environment affect asset prices? Will supply chains be disrupted from changes in free trade agreements? Can the European Union make the necessary reforms needed to preserve its currency and common market?

Our response is that we simply don’t have answers to these questions and we doubt that anyone else does either. We will just continue to do what we have always done: invest in businesses with certainty and predictability at cheap prices. The future will unfold but not necessarily in a way anyone can accurately see today. Conclusion? We remain cautious with our main concern today, as always, being on protection of our clients’ capital.

Where are the challenges?

The greatest test we face today, as we did in 2016, is to find companies we are excited to buy. As a team, we search continuously for what may be described as ‘Equity Bonds’ - companies with identifiable long-term coupons where we can determine what the returns will be over the next several years. And, of course, we want to purchase such businesses at cheap or reasonable prices, which helps to protect on the downside and enhances our returns. We will continue to avoid speculative issues where we have no idea what the future looks like. ‘Equity Bonds’ are companies that have sustainable competitive advantages, repeatable growing demand for their products or services, little requirement for large capital inputs and thus the ability to generate excess cash to be utilized for the benefit of all shareholders and are managed by smart, hardworking ethical individuals. After eight years of a bull market, meeting such conditions has been made that much more difficult.

How are you positioning the funds?

Because of the above circumstances, we find ourselves with over 50% cash on the sidelines. This is obviously not what we want, as equity investors. Our aspiration is to find more companies we believe will generate exciting rates of return with low risk. Alas, in our opinion, this simply doesn’t exist in the current environment. We have been in this situation before, in the early years of the current century, sitting with a great deal of cash. We waited a long time but were ultimately rewarded. As Warren Buffett has said, cash isn’t considered within a business or investment setting when present, but it is all investors are thinking about when it is absent. At some point, this cash will transform from being viewed as a burden to the most sought after asset. We have it and we can provide liquidity to those investors desperate to exit their equity investment at prices to our advantage.

Our cash levels are elevated as valuations have become stretched

Chart

Source: Bloomberg and Sarbit Advisory Services . Cash balance as at November 30, 2016. Forward P/E Ratio as at November 30, 2016. The cash weightings presented in the table represent the following mutual funds managed by Larry Sarbit from January 1988 to present: Jan 1988 to March 1998 - Investors U.S. Large Cap Value Fund; Jan 2000 to March 2005 - AIC American Focused Fund; Sep 2005 to Jun 2009 - Sarbit U.S. Equity Trust; Jun 2009 to Present - IA Clarington Sarbit U.S. Equity Fund.

Why is this the right approach for 2017?

Our approach is based on rational, business-like thought. Any other approach is ill-conceived, in our opinion. Investing because you think you know what will happen in the big economic picture is speculation, not rational, business-like behaviour. Buying overpriced assets just because you have cash is not prudent and can lead to loss of capital – the most important thing to avoid. As Ben Graham, the father of value investing said a long time ago: “The essence of investment management is the management of risks, not the management of returns”. We have no intention of reaching for potentially short-term speculative gains while at the same time, taking huge risk of losing our clients’ capital. We believe our patience will be rewarded in time.

icon  2017 Manager Outlook – Larry Sarbit

IA Clarington Global Tactical Income Fund

IA Clarington Focused Balanced Fund
IA Clarington Focused Canadian Equity Class
IA Clarington Focused U.S. Equity Class

Where are the opportunities?

This time last year we mentioned that Canada was set to positively surprise after underperforming the U.S. for five years and that was certainly the case in 2016. The Canadian equity market rebounded to become the top performer of the developed markets during the year. It significantly outperformed the U.S. market in both base currency and Canadian dollar terms. We believe this is just the beginning.

This is proving to be a cycle like no other. The economic recovery, which has historically averaged two years in duration, has moved at a snail’s pace. After seven years we are only now back to where the last cycle ended and beginning the expansion phase. Everything is starting to normalize. We’re seeing synchronized growth around the world; unemployment is improving; wages are increasing; interest rates are rising; corporate earnings are improving; the bull market in bonds is turning over and inflation is starting to rear its head.

The current expansion is still young

Chart

Source: Evercore ISI and Bloomberg as of October 31, 2016.

The expansion phase of the cycle could last another six years. Expansion is an important phase for equities vis-à-vis bonds and for Canada in particular with its largely cyclical-based equity market. As we enter the expansion phase we can expect global manufacturing capacity to tighten, which will in turn drive up the value of many products produced here in Canada and sold globally. With capacity at its maximum and a stronger global economy, companies will start spending to reinvest in their businesses. Canada’s resource market supplies much of the materials to support that growth. We’re already seeing a recovery in many commodity prices. A strengthening global economy with limited supply response should fuel increased demand for natural resources. Also, with rising rates in the U.S., we expect the U.S. dollar to lose steam as it has with previous Fed tightening efforts. A lower U.S. dollar vis-à-vis other global currencies will benefit commodity prices. This all bodes well for Canada and for how our portfolios are positioned.

Where are the challenges?

At this stage we really don’t know which proposals and promises that Trump made during the election process were just rhetoric and which will become policy. He and his surrogates have claimed he is pro-trade but he has spoken repeatedly about voiding what he perceives to be unfair trade deals, including NAFTA. Exporters to the U.S. appear to be at risk. This could be a concern for Canada. However, where NAFTA is concerned, most of the focus has been on Mexico. Canada is a huge exporter but is also the United States’ biggest customer. We are the largest consumer of U.S. products in the world and a key supplier of materials and parts. Canada/U.S. trade accounts for about five per cent of U.S. employment and almost seven per cent of U.S. GDP. Given that Trump is pro-business and pro-jobs, scrapping a deal with Canada wouldn’t make sense. Also, company management teams we have consulted with generally agree that eliminating trade deals would have far reaching ramifications that the Trump administration couldn’t ignore – job losses, plant closures, and a lack of U.S.-based alternative suppliers or manufacturing infrastructure.

A more protectionist Trump would mean tariffs and trade barriers. Increased tariffs lead to higher prices and inflation. Trump’s plans to increase spending on defence and infrastructure will also feed inflation. Moderate inflation is natural in the cycle but significant inflation could dampen exports and hurt the U.S. economy. Ultimately, increasing inflation will lead to higher interest rates. Rising rates aren’t a concern provided they are supported by healthy economic growth. Inflation-fueled rates without a strong economy could be a challenge.

How are you positioning the funds?

The Focused Funds are close to fully invested to position for continued growth in the U.S. and an improving global economy. We started increasing our exposure to Canada in late-2015/early-2016. Canadian equities now account for about 65%-70% of the non-cash assets of IA Clarington Focus Canadian Equity Class. We have good exposure to high quality cyclical U.S. names leveraged to the economy and rising rates. However, we continue to overweight Canada with a focus on highly cyclical sectors and rate-sensitive businesses that are best positioned to benefit from the expansion. The Funds have above market-weight exposure to resource sectors that we believe are highly levered to the cycle, however we have been prudent in our security selection, focusing on quality companies that can endure inevitable periods of market turbulence. Our portfolios are concentrated, so we can be opportunistic and we have the flexibility to shift the portfolios’ sector and geographic exposure if we sense conditions changing.

Why is this the right approach for 2017?

Macro indicators including employment levels, capacity utilization and industrial production tell us that the U.S. economy has recovered and is now expanding. Inflation is gradually coming back to life and rising rates are imminent. Value is once again outperforming growth. We’re excited by this as we liken it to where we were in the cycle in 2004/2005 after recovering from the tech bubble. At that time, commodities dominated and Canada significantly outperformed. The S&P/TSX returned 70% for the period January 1, 2005 to June 30, 2008 while the S&P 500(CDN$) fell by about 4%. The Focused Funds are already being rewarded for our shift to Canada and cyclicals, and we believe there is more to come. We hope to recreate the success of the last cycle. History repeating itself can be a good thing.

icon  2017 Manager Outlook – David Taylor

IA Clarington Inhance Balanced SRI Portfolio
IA Clarington Inhance Bond SRI Fund
IA Clarington Inhance Canadian Equity SRI Class
IA Clarington Inhance Conservative SRI Portfolio
IA Clarington Inhance Global Equity SRI Class
IA Clarington Inhance Growth SRI Portfolio
IA Clarington Inhance Monthly Income SRI Fund

Where are the opportunities?

2017 is shaping up to offer a positive start to the year but we believe the level of market volatility will rise. With the economy in late cycle and U.S. interest rates on a rising trajectory, portfolio diversification across geographies, sectors and asset classes can help provide a more stable portfolio return.

Despite volatility, equities remain an attractive inflation hedge and are supported by earnings revisions that are at five-year highs and rising estimates of global GDP growth.

We believe that European equities will offer opportunities as corporate earnings are low relative to history while earnings growth is forecast to rise to 12% in 2017.

Where are the challenges?

If there is a continuation of the significant sector rotation that we saw in 2016, this could result in increased market volatility. The uncertainty of U.S. policy in the lead up to a Trump presidency remains an overhang for stock markets and will also be a source of volatility.

How are you positioning the funds?

Our collaborative investment approach integrates environmental, social and governance (ESG) analysis with traditional financial analysis and portfolio management. Investing in growth companies that meet our ESG criteria along with diversification, risk management and valuation disciplines, are the hallmarks of our style.

Consumer confidence has risen since the uncertainty of the U.S. election has been removed. Furthermore a Trump administration that will most likely support pro-growth is more likely to adopt stronger pro-growth policies—lower taxes, less regulation and greater fiscal spending. We expect to add to our industrials exposure as it is a late cycle sector that tends to perform well in a rising rate environment.

In 2016, the Funds maintained a higher level of cash balances. We have been actively reducing our cash levels when the opportunities to invest in growth companies at reasonable prices present themselves.

Why is this the right approach for 2017?

Equities have historically continued to perform well in a rising inflationary environment until 3% inflation is reached. Central bankers are likely to let economies run and face inflation rather than take on deflation risk. We believe maintaining equity exposure in the Funds positions them for a positive 2017.

Equities tend to perform well during periods of rising inflation, up to 3%

Chart

Source: Thomson Reuters. Credit Suisse research as of September 30, 2016.

icon  2017 Manager Outlook – Andrew Simpson