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.

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 the 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.

An underweight allocation to federal bonds contributed to the Fund’s performance, as these underperformed. Credit selection within corporate bonds was another contributor to performance. Top individual contributors were all long-dated bonds, which benefited from the rebound in bond yields, particularly at the long end of the yield curve. These contributors included City of Ottawa (3.25%, 10/11/2047), Greater Toronto Airports Authority (3.26%, 06/01/2037) and City of Toronto (3.2%, 08/01/2048).

The Fund’s 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. The Fund’s 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 also detracted from performance. The largest individual detractors from performance were preferred shares issued by Manulife Financial Corp., Intact Financial Corp. and Bank of Montreal.

The fund manager added several positive impact bonds during the period. These include green bonds, whose proceeds are used to fund projects that have positive environmental benefits, and sustainable development bonds, whose proceeds go towards supporting the Sustainable Development Goals set by the United Nations. A mix of high-reset (which look to have their dividends reset higher at the next reset date) and perpetual preferred shares (which have no maturity date and pay a fixed dividend for as long as it remains outstanding) were added throughout the period following the ongoing sell-off in preferred shares. Some Fairfax Financial Holdings Ltd. rate reset preferred shares were sold because of relative valuation considerations.

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 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.

Central banks have provided accommodation and appear ready to act further, if necessary. However, growing skepticism around 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, which are not as sensitive to changes in interest rates.

Fund and benchmark performance, as at September 30, 20191 yearSince inception (Dec. 2016)
IA Clarington Inhance Bond SRI Fund - Series B6.9%2.6%
FTSE Canada Universe Bond Index9.7%4.2%

 

Learn more about IA Clarington Inhance Bond SRI Fund

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 Fund’s benchmark is the FTSE Canada Universe Bond Index, which 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 Fund's geographic, sector and credit quality exposure may differ from that of the benchmark. The Fund may hold cash while the benchmark does not. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance.