IA Clarington Focused Balanced Fund
Manager commentary - December 31, 2018
IA Clarington Focused Balanced Fund struggled through a difficult fourth quarter as equities around the world posted a sharp decline. Series A of the Fund returned -11.1% for the quarter compared to -6.9% for the benchmark. Instead of the “Santa Claus rally” investors were expecting, the S&P 500 Index had its worst ever December and saw its biggest quarterly decline since 2011. Canada lagged for most of the year and fell another 10% in the final quarter. There was nowhere safe to hide during the quarter and exposure to energy didn’t help. Oil prices changed course and fell sharply, and the discount in Canadian crude prices to U.S. crude neared historical levels. The Fund’s energy positions accounted for about 14% of equity assets but two-thirds of its return. Canada’s oil and gas producers were the hardest hit during the downturn. Paramount Resources Ltd. (POU) and Birchcliff Energy Ltd. (BIR) were the Fund’s biggest detractors from returns. We believe the worst is behind us. We expect WTI oil prices to turn with OPEC cuts and Canadian oil to see a stronger recovery with Canadian pipelines coming on stream, increased rail shipping and mandatory production cuts. The discount in Canadian crude to WTI has already narrowed considerably from US$50/barrel to about $10. POU has recovered +45% and BIR +30% from their December lows.
Despite the tough quarter for equities, there were some bright spots in the Fund. OceanaGold Corp. (OGC) – our largest position – was the top positive contributor to performance, returning 28% for the Fund. OGC benefited from rising gold prices as investors sought refuge in safe-haven investments. OGC outperformed other gold companies due to positive exploration results at its Waihi Gold Mine in New Zealand. We have been trimming to reduce the stock’s weighting, but continue to hold as we believe there is still considerable upside. Element Fleet Management Corp. (EFN) had a solid Q3 and the market responded well to management’s steps to de-risk and improve the firm’s financial position, and to add $150million to annual profitability in the next two years. EFN returned 4% during the quarter.
True to our style, we took advantage of opportunities to add quality investments at points of maximum pessimism. Bombardier Inc. (BBD) has been on our radar in anticipation of a growing business jet market. We stepped in when the stock price fell after the company missed free cash flow guidance and the Autorité des marchés financiers announced it would review stock transactions made by BBD executives. We believe the sell-off was overdone. The company is deleveraging its balance sheet and is well positioned for the luxury/business jet market and yet the stock trades at the same valuation it did when it struggled through balance sheet and capex issues. We also reinvested in SNC-Lavalin Group Inc. (SNC) when the stock price fell on concerns over Saudi Arabia suspending trade with Canada and news that federal prosecutors declined to negotiate a deferred prosecution agreement regarding earlier fraud and corruption charges. The stock trades at levels below where we held it previously. New management has streamlined the company, business is better and we believe it is an attractive take-out candidate at these valuations. SNC has returned 6.5% in the short time since adding the stock in October.
At the end of the period, fixed-income investments (IA Clarington Strategic Corporate Bond Fund) accounted for 38% of portfolio assets. U.S. and foreign equities accounted for 26% of portfolio assets (or 37% of equity holdings). Canadian equities accounted for 36% of the Fund (or 58% of equities). About 1% of portfolio assets were held in cash. We continue to hedge 50% of the Fund’s U.S. dollar exposure.
The Fund is positioned for continued economic growth in the U.S. – not “shoot the lights out” growth, but steady, plodding growth. At this stage in the cycle the market should shift in favour of value stocks and economically sensitive sectors. We have good exposure to high-quality companies leveraged to the economy and rising rates. We are maintaining the Fund’s exposure to resource equities. We have solid exposure to deeply discounted materials, industrials, financials and consumer goods companies with investments in Whirlpool Corp., Genworth MI Canada Inc., Element Fleet Management Corp., Labrador Iron Ore Realty Corp. and Martinrea International Inc. We have exposure to U.S. financials through investments in Allstate Corp. and Assured Guaranty Ltd.
After years in the doghouse, Canada is deeply undervalued despite solid fundamentals. We believe favourable conditions for Canadian equities are on the horizon. We’ve been calling for this for a while, but at some point valuations and fundamentals have to matter. A strong U.S. dollar and weak Canadian crude prices weighed on Canada’s commodity producers; however, earnings growth in non-resource companies is strong. The cloud over Canada’s oil sector is lifting. Oil prices are improving and the discount is narrowing. The benefits of strong oil prices reach beyond Canada’s energy producers to other sectors, including suppliers, transportation and banking. We expect the United States-Mexico-Canada Agreement – the replacement for the North American Free Trade Agreement – to be ratified and cooler heads to prevail in the China-U.S. trade negotiations once all the posturing is done. We are starting to see signs of a weakening U.S. dollar, which bodes well for Canada’s commodity sector. Lastly, we’re hopeful that this year’s federal and Alberta elections will produce more business-friendly regulation and tax policy.
|Fund and benchmark performance as at December 31, 2018||1 year||3 year||5 year||Since inception|
|IA Clarington Focused Balanced Fund - Series A||-8.1%||4.0%||0.5%||4.1%|
|25% FTSE Canada All Corporate Bond Index, 35% S&P 500 Index, 40% S&P/TSX Composite Index||-1.7%||6.6%||7.6%||9.7%|
Learn more about IA Clarington Focused Balanced 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 a blend of FTSE Canada All Corporate Bond Index (25%), S&P 500 Index (35%) and 40% S&P/TSX Composite 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 All Corporate Bond Index is based on the Corporate sector of the FTSE Canada Universe Bond Index. The Corporate sector is further divided into sub-sectors based on major industry groups: Financial, Communication, Industrial, Energy, Infrastructure, Real estate, and Securitization. The Fund can invest in both investment grade and high yield bonds while the benchmark has exposure only to investment grade bonds. The S&P 500 Index includes 500 leading companies in leading industries of the U.S. economy and is widely regarded as the best single gauge of the U.S. equities market. Although the S&P 500 Index focuses on the large cap segment of the market, its coverage includes approximately 80% of the market. 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 Fund’s market capitalization, geographic, sector and credit quality exposure 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.