IA Clarington U.S. Dollar Floating Rate Income Fund
Manager Commentary - Q3 2019
Equities moved higher during the period, with most positive returns generated in the second quarter of 2019. Concern over global growth and the U.S.-China trade dispute led to heightened volatility. Developed market central banks remained accommodative, with the U.S. Federal Reserve (the Fed) cutting interest rates twice and the European Central Bank announcing new stimulus, which buoyed fixed-income assets. Large capital gains from declining bond yields fueled above-coupon returns in investment-grade fixed-income indexes. Senior loans lagged, while both duration (interest-rate sensitivity) and tightening credit spreads (the difference in yield between debt instruments with similar terms, but different credit ratings) helped high-yield bonds post above-coupon returns.
The Fed cut the federal funds rate twice over the period, in July and September, with each decrease being 25 basis points (bps). The three-month U.S. dollar London interbank offered rate (LIBOR) decreased approximately 51 bps to end at 2.09%. The Bank of Canada left its overnight lending rate unchanged at 1.75%. The three-month Canadian dollar offered rate (CDOR) decreased approximately 5 bps to end at 1.97%.
U.S. loan funds and exchange-traded funds (ETF) posted their 12th consecutive month of outflows, with year-to-date outflows totaling US$22.9 billion. Loan prices remained relatively stable during the period as institutional investors invested US$82.6 billion into the loan market through collateralized loan obligation (CLO) creation.
Credit spreads widened during the period. Loan spreads, as represented by the three-year discount margin of the Credit Suisse Leveraged Loan Index, increased by 11 bps to end at 4.78%. High-yield bond spreads, as represented by the ICE Bank of America Merrill Lynch U.S. High Yield Index, increased by 5 bps to end at 4.20%. U.S. investment-grade corporate bonds, as represented by the ICE Bank of America Merrill Lynch U.S. Corporate Index, decreased by 6 bps to end at 1.20%. Default rates remained below historical averages, with the par-weighted default rates for loans and high-yield bonds ending the period at 1.4% and 2.5%, respectively.
The Fund’s bias toward higher-rated credit contributed to its performance, as high-quality loans and high-yield bonds outperformed. Top individual contributors to the Fund’s performance included a senior secured term loan issued by Entercom Communications Corp. (LIBOR + 2.75%, 17/11/2024), a second lien senior secured term loan issued by Advantage Sales & Marketing Inc. (LIBOR + 6.5%, 25/07/2022) and a senior secured term B loan issued by WKI Holding Company Inc. (LIBOR + 4.0%, 02/05/2024). Entercom reported better-than-expected financial results despite modest challenges to the business. Advantage posted new business wins, stabilized gross margins and is achieving the expected synergies from recent acquisitions. WKI Holding Company completed a transformative acquisition.
The largest individual detractors from the Fund’s performance were a senior secured term B loan issued by Amneal Pharmaceuticals LLC (LIBOR + 3.5%, 04/05/2025), a senior secured term loan issued by Harland Clarke Holdings Corp. (LIBOR + 4.75%, 03/11/2023) and a senior secured term loan issued by Securus Technologies Holdings LLC (LIBOR + 4.50%, 01/11/2024). Amneal Pharmaceuticals experienced delays in its drug development pipeline, causing downward revisions to its earnings. Harland Clarke reported weak financial results and has a short-term bond refinancing requirement. Securus Technologies Holdings LLC experienced the loss of expected contract renewals.
Loan and high-yield default rates may increase from current levels, but the fund manager believes they will continue to be below long-term averages for the next year. In the fund manager’s view, central bank accommodation is the primary reason for such low default rates. With the more accommodative stance from central banks, recession risk may remain muted, creating an environment that is supportive of credit. However, there may be continued periods of short-term volatility.
The Fund is positioned conservatively to limit price volatility and surprise risk. Loan and high-yield bond holdings are focused on issuers that the fund manager believes can weather an economic downturn. In the event that economic fundamentals deteriorate, the fund manager will look to add protection through a modest government bond exposure, or by leaving a small portion of the Fund’s U.S.-dollar exposure unhedged.
The fund manager believes that the average loan price should stay stable. Further declines in outflows from U.S. loan mutual funds and ETFs is necessary, in the fund manager’s view, for average loan prices to move further to par. As U.S. retail investors become an increasingly smaller part of the loan buyer base and are replaced by traditional institutional investors focused on spread rather than absolute coupons, the fund manager believes the asset class will become increasingly stable.
|Fund and Benchmark Performance as at: September 30, 2019||1 year||3 year||Since Inception (Dec. 2015)|
|IA Clarington U.S. Dollar Floating Rate Income Fund - Series A||6.7%||4.0%||4.2%|
|Credit Suisse Leveraged Loan Index USD||3.1%||4.7%||5.7%|
Learn more about IA Clarington U.S. Dollar Floating Rate Income 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 benchmark is the Credit Suisse Leveraged Loan Index USD which is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market. The Fund's geographic, sector and credit quality exposure may differ from that of the benchmark. The Fund can invest in high yield corporate bonds and government bonds, which are not included in the benchmark. For this Fund, performance is reported in USD and any investments in non-U.S. based issuers (including Canadian issuers) may be purchased in currencies other than U.S. dollars. When these non-U.S. investments are purchased in a currency other than U.S. dollars, the value of the investment will be affected by the value of the U.S. dollar relative to the value of the other currency. If the U.S. dollar rises in value relative to the other currency but the value of the non-U.S. based investment otherwise remains constant, the value of the investment in U.S. dollars will have fallen. Similarly, if the value of the U.S. dollar has fallen relative to the other currency, the value of the U.S. Dollar Fund's investment will have increased. As the Fund’s performance is reported in USD, the U.S. indices referenced within are also quoted in their native currencies of U.S. dollars to reflect the performance of the holdings. 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.