Manager Commentary - Q3 2019

Escalating trade tensions and increased concerns of a global economic slowdown pushed bond yields lower around the world, causing several central banks to adopt easier interest-rate policies. After changing to a more neutral stance to start 2019 (following three interest-rate increases during 2018), the Bank of Canada kept its policy rate unchanged at 1.75% throughout the period. The U.S. Federal Reserve (the Fed) cut its policy rate twice during the period and ended its balance sheet runoff earlier than scheduled. Lack of inflationary pressures and increased trade uncertainty drove the abrupt change of course, following the four rate increases of 2018.

Global equity markets felt the impact of interest-rate cuts from the Fed, mixed economic data releases and various geopolitical tensions, but recorded solid gains over the period. Equity markets have experienced three corrections in 2019, and their fifth significant drawdown since the trade dispute began in early 2018, largely driven by weak data in the U.S. and Europe. However, investors appeared to ignore this year’s growth and profits slump, on the assumption that monetary and fiscal easing will reverse the downturn.

Canadian equities also recorded solid gains over the period, despite elevated volatility that was a result of U.S.-China trade tensions and the growing collection of weak economic data releases. Equity markets experienced a rotation of investor interest, from growth-oriented stocks to more defensive equities, as the probability of a recession in 2020 rose somewhat.

Canadian bond yields ended the period sharply lower, driving a positive total return in the FTSE Canada Universe Bond Index. Yields in the mid- to long-maturity segments of the yield curve outperformed, with Government of Canada 10- and 30-year yields ending the period 26 and 36 basis points lower, respectively. With mid- and long-term maturities outperforming, the yield curve continued its flattening trend (when short- and long-term bonds are offering similar yields and the benefit of holding longer-term bonds is diminished), with many segments of the Canadian yield curve inverting (when long-term debt instruments have lower yields than short-term debt instruments).

Provincial bonds were the best-performing sector in the bond market, benefiting from its longer duration (sensitivity to interest rates) bias and the rebound in bond yields and tightening of credit spreads (the difference in yield between debt instruments with similar terms, but different credit ratings). Credit spreads ended the period modestly tighter than they started, benefiting from the Fed’s accommodative stance and the modest new issue supply in the domestic investment-grade bond market. Within the corporate sector, infrastructure and energy were the best-performing sub-sectors.

From an asset allocation perspective, the Fund’s higher allocation to global equities and Canadian equities benefited its performance. The Fund’s bond component slightly underperformed relative to the fixed-income component of the blended benchmark.

Within the Fund’s global equity component, security selection was the key driver of outperformance, particularly in the U.S., Canada and France. Top individual contributors to performance included holdings in Brookfield Renewable Partners L.P., Equinix Inc. and Pattern Energy Group Inc.

Brookfield Renewable is an independent power producer focused on hydro power. This defensive utility company had an attractive yield in a declining interest-rate environment. Equinix, a leading data centre real estate investment trust (REIT), is poised to benefit from the enterprise shift to cloud computing.

Pattern Energy is a wind power producer, another utility company that benefited from its attractive yield in a declining interest-rate environment.

A higher cash allocation detracted from performance as equities rebounded. Stock selection within the financials, industrials and communication services sectors also detracted from performance. Individual detractors included holdings in Bloom Energy Corp., SoftBank Group Corp. and Siemens Gamesa Renewable Energy SA.

Bloom Energy shares were down after it was targeted in a hedge fund short report and the company also posted a cautious 2020 outlook. Volatility in SoftBank’s underlying Vision Fund caused its shares to decline, but its first-quarter results in early August showed a 24% operating profit growth. Siemens Gamesa declined amid concerns regarding the lower pace of offshore wind installations and the effect of tariffs on component costs.

Within the Fund’s fixed-income component, allocation to preferred shares, particularly rate reset preferred shares (whose dividend rate resets at regular intervals), detracted from performance as the broad decline in bond yields negatively affected preferred shares whose dividends are linked to bond yields. An underweight allocation to the long end of the yield curve also detracted from performance as long-maturity bonds outperformed. An underweight exposure to provincial bonds was another detractor. The largest individual detractors from performance were preferred shares issued by Manulife Financial Corp., Intact Financial Corp. and Bank of Montreal.

In terms of environmental, social and governance (ESG) issues, the fund manager participated in a meeting with Loblaw Companies Ltd. to discuss the company’s approach to supply chain management and employee benefits.

The fund manager met with A&W Revenue Royalties and discussed antibiotic use in the beef supply chain and the value of increased ESG reporting for investors. Dream Industrial REIT was also engaged with on the need to increase sustainability disclosures. The fund manager engaged with Nutrien Ltd. on the risks associated with neonicotinoid regulation, and with Nutrien, Agnico Eagle and Lundin Mining Corp. regarding mine tailings management.

The fund manager met with Genworth MI Canada Inc. to encourage the company to use the Task Force on Climate-related Financial Disclosures guidelines. New Flyer Industries Inc., RioCan REIT, Genworth, Nutrien, Onex Corp., Boralex Inc., Colliers International Group Inc. and Waste Connections Inc. were encouraged to participate in the Carbon Disclosure Project.

The fund manager joined a collaborative investor engagement to encourage CVS Health Corp., Costco Wholesale Corp., Amazon and Home Depot Inc. to ensure removal of toxic pesticides from the supply chain. A shareholder resolution was filed requesting that Starbucks Corp. report on its efforts to increase the pace of sustainable packaging. An engagement was begun with Canadian Tire and CVS Health on the potential to end sales of specific pesticides. The fund manager also held a teleconference with Novo Nordisk A/S on the company’s animal testing practices and encouraged it to implement re-homing strategies for animals post-testing.

The fund manager supported the Global Investor Statement to Governments on Climate Change, and became a member of the World Benchmarking Alliance, a global network of public, private and civil society sectors supporting the measurement of corporate performance on achieving sustainable development goals. The fund manager participated in the Bangladesh Investor Initiative calling for the extension of the Accord on Fire and Building Safety.

Global economic growth remains uncertain amid an increase in geopolitical and other risks. These risks, including an escalating U.S.-China trade dispute, the U.K.’s ongoing negotiations to exit the European Union, the impeachment inquiry against U.S. President Donald Trump and upcoming elections in both Canada and the U.S., are very difficult to predict and have increased the uncertainty facing financial markets. Global manufacturing activity has slowed and is contracting in many regions as the effects of the trade dispute ripple through the global economy. Economic growth will remain challenged in Canada, as energy markets have weakened, and consumer spending remains constrained because of elevated household debt levels.

Central banks have provided accommodation and appear ready to act further, if necessary. However, growing skepticism about the effectiveness of negative interest-rate policies has led to a growing view that monetary stimulus may be reaching its limits and that fiscal stimulus may be required, which could have a very different impact on bond markets. Fiscal stimulus could lead to increased government deficits, which would be financed with increased debt issuance, likely putting upward pressure on bond yields.

With bond yields at very low levels, the Fund has a slightly short duration position and overweight credit exposure (corporate bonds and preferred shares) and underweight allocation to federal bonds. Given rising economic uncertainty, the Fund will continue to focus on high-grade credit risk exposure, moving into higher-quality companies and keeping lower credit-rated exposures to shorter-term maturities. The Fund continues to hold preferred shares in order to enhance yield. However, the fund manager has shifted the Fund toward perpetual and higher rate reset preferred shares (the former has no maturity date and pays a fixed dividend for as long as it remains outstanding, and the latter looks to have its dividend reset higher at the next reset date), which are not as sensitive to changes in interest rates.

The impact of the upcoming Canadian federal election may not be significant for long-term equity returns but there is some historical precedent that a minority government can have a positive impact versus a majority government. The average annualized performance of the Canadian equity market is 9.9% during minority governments, well ahead of the 6.5% average performance seen during majority governments.

Overall, the Fund’s equities remain focused on companies with sustainable and growing dividends, and its cash levels were substantially increased to focus on high-conviction positions.

 

Fund and benchmark performance, as at September 30, 20191 year3 year5 yearSince Performance Start Date (Dec.2009)
IA Clarington Inhance Balanced SRI Portfolio – Series A5.3%4.5%4.1%5.1%
25% MSCI World Index1 35% S&P/TSX Composite Index, 40% FTSE Canada Universe Bond Index7.6%6.4%6.3%7.2%

 

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¹Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. The performance data comparison presented is intended to illustrate the Fund’s historical performance as compared with historical performance of widely quoted market indices. There are various important differences that may exist between the Fund and the stated indices that may affect the performance of each. The benchmark is a blend of 40% FTSE Canada Universe Bond Index, 35% S&P/TSX Composite Index and 25% MSCI World Index. The blended benchmark presented is intended to provide a more realistic representation of the general asset classes in which the Fund invests. The FTSE Canada Universe Bond Index is comprised of Canadian investment grade bonds and has significantly different portfolio duration characteristics. The FTSE Canada Universe Bond Index consists of a broadly diversified selection of investment-grade Government of Canada, provincial, corporate and municipal bonds issued domestically in Canada. The S&P/TSX Composite Index is the premier indicator of market activity for Canadian equity markets, with 95% coverage of Canadian-based, TSX-listed companies. The index includes common stock and income trust units and is designed to offer the representation of a broad benchmark index while maintaining the liquidity characteristics of narrower indices. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI World Index consists of 23 developed market country indices. The Fund has exposure to securities of companies which meet the fund manager's socially responsible investment principles, while the holdings in the benchmark may not align with these principles. The Fund’s market capitalization, geographic, sector exposure and credit quality may differ from that of the benchmark. The Fund’s currency risk exposure may be different than that of the benchmark. The Fund may hold cash while the benchmark does not. Overall, the Fund's bond and equity exposure can differ, because the Fund does not use a fixed ratio similar to the benchmark. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance. Around December 7, 2009, a material fund merger occurred. Around December 14, 2009, the sub-advisor changed. These changes may have affected the Fund's performance.