Manager commentary - December 31, 2018

The weakness of global economic data was a cause for concern throughout 2018. European economic data weakened from January onward and the vulnerabilities of several emerging markets were pushed to the forefront in the months that followed.

The fourth quarter was marked by high volatility across all stock markets. The S&P 500 Index suffered a decline of nearly 15% over the quarter, erasing all gains made since the beginning of the year.

The most important factor affecting global financial markets over the year was probably monetary policy tightening by the U.S. Federal Reserve (Fed). The correction in the fourth quarter is a reminder of the impact that tightening liquidity conditions in financial markets can have on portfolio returns.

When the Fed raises its key rate, two phenomena are usually observed: 1) increased volatility in the markets and 2) stock market value, measured by the ratio of price to profit, contracts; that is, investors are willing to pay less to invest in markets despite an increase in corporate profits.

Further adding to uncertainty, trade tensions created by President Trump were omnipresent throughout the year. The renegotiation of the North American Free Trade Agreement (NAFTA) and, more recently, U.S.-China negotiations, took center-stage. At year-end, a truce seemed to have been achieved between the two superpowers, which agreed to speed up negotiations during the first quarter of 2019.

Moreover, several geopolitical risks made headlines throughout 2018, with North Korea, Iran, Brexit and Italian politics topping the list.

Finally, the meltdown of some emerging markets, such as Turkey and Argentina, added to market volatility. For the moment, it appears that these situations are isolated and the risk of contagion is low.

In Canada, growth in the third quarter of 2018 was disappointing, especially where corporate investments are concerned. In mid-October, the Bank of Canada published its Q3 Business Outlook Survey, which indicated a sharp increase in investment intentions despite the uncertainty surrounding NAFTA renegotiations. Recent data, however, shows that Canadian corporations have not yet concretized their intentions and have put new projects on hold.

A factor that probably contributed to the slowdown was weakness in Canadian oil prices. In fact, not only have oil prices been under severe pressure across the world in the fourth quarter (the price per barrel for American crude fell from $75 to $45 at the beginning of October), but the price per barrel of Western Canadian Select slid to around $13 in mid-November. The reason for this major price difference was the difficulty in transporting heavy Canadian crude to export destinations (mainly the U.S.) because pipeline capacity and rail transportation were lacking, leading to a stockpile in Alberta.

In the last quarter of the year, the Canadian bond market, represented by the FTSE Canada Universe Bond Index, posted a gain of 1.7% (1.4% in 2018). The FTSE Canada Short Term Bond Index posted a return of 1.4% (1.9% in 2018). Finally, the FTSE Canada Long Term Bond Index rose to 1.9% (0.3% in 2018).

The American stock market, represented by the S&P 500 Index, had a total return of -13.5% in the fourth quarter (-8.6% in Canadian dollars). The Canadian stock market, represented by the S&P/TSX Composite Index, suffered a decline of 8.9%. For 2018, returns for North American stock markets were -4.4% for the S&P 500 (+4.2% in Canadian dollars) and -7.6% for the S&P/TSX.

The European market, represented by the MSCI Europe1, posted a return of -11.2% in the fourth quarter and -10.6% in 2018 (-7.7% and -6.6%, respectively, in Canadian dollars) while the MSCI EAFE Index1 posted -12.2% for the quarter and -11.0% for 2018 (-7.6% and -6.0%, respectively, in Canadian dollars) and the MSCI World Index1 posted -13.1% during the quarter and -7.4% in 2018 (-8.5% and -0.5%, respectively, in Canadian dollars). Emerging markets, represented by the MSCI Emerging Markets Index1, posted a return of -7.4% for the quarter and -9.7% in 2018 (-2.2% and -6.5%, respectively in Canadian dollars).

Distinction Conservative Class invests across all asset classes, including fixed income, Canadian equity and foreign equity funds. The Fund’s return is primarily determined by the mix and performance of the underlying funds.

Over the fourth quarter, the Fund slightly outperformed its benchmark before fees. IA Clarington Canadian Conservative Equity Fund, IA Clarington Canadian Dividend Fund and IA Clarington Strategic Equity Income Fund, which together made up approximately 35% of the Fund, all outperformed the S&P/TSX Composite Index over the quarter. Their positive return differentials were primarily due to successful security selection. IA Clarington Global Value Fund detracted from the Fund’s performance, primarily due to its currency hedging management and unsuccessful stock selection in the financials, industrials and consumer staples sectors.

The Fund’s fixed-income holdings, representing close to half of the Fund’s total holdings, all detracted from performance. IA Clarington Bond Fund, which represents nearly 25% of the Fund, underperformed primarily due to an overweight exposure to corporate bonds and unsuccessful duration bets carried out using U.S. Treasury futures and options on U.S. Treasury futures. The Fund was positioned for a flattening of the U.S. Treasury curve, which steepened dramatically in November and then again at the end of December.

One of the key risk factors that the fund manager will be monitoring over the next quarter is the level of American corporate debt, as corporations took advantage of low interest rates over the past 10 years by borrowing at low rates, primarily to finance share buybacks. This has left record debt levels in corporate accounts and the amounts that need to be refinanced over the coming years could prove challenging as the Fed continues with its contractionary monetary policy in order to normalize interest rates. The housing sector is another segment of the American economy to monitor due to its sensitivity to interest rates.

Fund and benchmark performance as at December 31, 20181 year3 yearSince Performance Start Date  (Feb. 2014)
Distinction Conservative Class - Series A-5.0%1.3%2.2%
15% MSCI World Index1, 35% S&P/TSX Composite Index, 50% FTSE TMX Canada Universe Bond Index-2.4%4.2%4.6%


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1MSCI 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 15% MSCI World Index, 35% S&P/TSX Composite Index and 50% FTSE Canada Universe Bond Index. The blended benchmark presented is intended to provide a more realistic representation of the general asset classes in which the Fund invests. 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 24 developed market country indices. 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 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 Fund's fixed income component can invest in both investment grade and high yield bonds while the benchmark has exposure only to investment grade bonds. The Fund’s geographic exposure may differ from that of the benchmark. The Fund may have different currency risk exposure than 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. Effective February 7, 2014, Distinction Conservative Portfolio merged into this Fund. Historical performance for this series is calculated from the date of the material merger.