Manager commentary - December 31, 2018

Forstrong Global Strategist Income Fund Series A returned -0.5% for the three-month period ending December 31, 2018. The Fund's benchmark, which is composed of the MSCI AC World Index1 (35%) and the FTSE World BIG Index (CAD) (65%), returned 1.6% for the same period.

The fourth quarter of 2018 began on a promising note, as the U.S., Mexico and Canada reached an agreement on the North American Free Trade Agreement renegotiations (now called United States-Mexico-Canada Agreement). While the new deal still needed ratification by the respective legislatures of each nation, the news nonetheless boosted sentiment, as investors hoped for a turning point in escalating global trade tensions.

This optimism was short-lived, however, as a confluence of factors contributed to a sharp rise in volatility throughout the rest of the quarter. Crude oil prices plummeted, as easing U.S. sanctions against Iran, increased production from Saudi Arabia and global demand concerns led to an unwinding of speculators’ long positions. The renewed downturn in oil prices put upwards pressure on high-yield spreads and added to investor jitters following a spike in the U.S. 10-year Treasury yield above 3.2% in early October. With global economic data disappointing expectations, recessionary fears became the predominant market narrative and stock markets around the world sold off. Government bonds managed to rally, which was a crucial silver lining as the asset class had previously been unresponsive to recent volatility flare-ups.

A tentative trade truce between the U.S. and China reached during the G20 summit in early December gave rise to another fleeting bout of optimism. However, the arrest of Huawei Technologies Co., Ltd. CFO Meng Wanzhou in Vancouver at the behest of the U.S. government quickly unwound investor enthusiasm. The U.S. Federal Reserve surprised markets somewhat in late December with another 25 basis point rate hike, after Chairman Powell had made comments perceived to be dovish (or at least less hawkish) earlier in the quarter. The hike appears to have been interpreted as a vote of confidence in the U.S. economy, as stock markets managed to stabilize into year-end.

Overweight positioning in local currency emerging market bonds boosted performance, showing impressive resiliency despite a risk-off environment and outperforming global fixed income benchmarks. Additionally, an overweight exposure to interest rate-sensitive global (ex-U.S.) real estate equities benefitted from receding global bond yields.

Net asset mix positioning contributed negatively to performance during the period, as overweight exposure to equities underperformed fixed income. Underweight and partially hedged U.S. dollar (USD) exposure detracted from performance, as the Canadian dollar sold off against the USD into year-end.

Financial markets have been rattled this past year. Caught between an avalanche of tweets, dueling tariffs and rancorous media, reality has been difficult to discern. Where can one find solid footing and a clear view through the fog of uncertainties?

A review of current conditions in light of past history illumines some important perspectives. What remains a near-surety is that trends and events will remain unconventional and therefore will be broadly unanticipated by most. Moreover, what one may identify as a negative development may not have repercussions for a long time.

The “real” reality is that world economic trends have changed fundamentally and structurally. It is a new era, one that is not yet popularly understood. At its core, the causality of this new environment is attributable to deteriorating demographic factors around the world. The halcyon post-World War II era (which still tends to be viewed as a benchmark for expected market behavior) was ending at the turn of the century. In that sense, the history of financial precedents is no longer helpful for the most part. We now live in an era marked by structurally low economic growth and “on the fly” heterodox interventions from policymakers.

That said, 2018 represented a temporary disruption from that course. A politically motivated U.S. tax cut temporarily boosted economic growth to unsustainable levels. Already, the fizz of this stimulus is turning flat. Very likely, U.S. growth forecasts of 2.8% for 2019 will be disappointed. Nevertheless, we do not believe that this would be disastrous. Slow growth is again returning to the world (ultimately leading to much lower interest rates). While that view may disappoint some observers, consider that for much of the post-global financial crisis period, gross domestic product growth of 2% was adequate to support rising stock markets (and, for some time, also a decline in interest rates). This ushered in a “Goldilocks environment” where growth was not too strong to spark inflation and not too slow to prevent continuing corporate profit growth. We believe that once the anticipatory adjustments have taken place, equities are likely to perform favorably.

After outperforming in 2017, European equities succumbed to weakness relative to U.S. equities this past year. With an economic slowdown underway, investors have now concluded that there is nary a catalyst in sight that could spur an uptick in growth. But this view is likely wrong. It is now Europe’s turn to boost fiscal stimulus. Already, increased government spending has been promised in France and Italy. Not to be overlooked is that in the present age of the “near extinct” budget surplus, some of the largest survivors in the world are found in Europe (Germany, Netherlands, Sweden). As it may be, in this era, the piling on of more government debt is not an immediate concern.

We expect that a continuation of the above-mentioned trends will be constructive for emerging market (EM) securities. Though the world’s economic pace is slowing, comparatively, EM growth rates are much higher than the developed world, especially given that other senior economies such as Japan and Europe are trending towards zero per capita gross domestic product growth. At this time, EM valuations are very low due to negative consensus growth expectations and global trade tensions. In all practicality, it seems implausible that policy makers and world leaders will allow a crippling of world trade. Economic damage to date is already significant; this is clearly visible in the U.S. domestically as well as in China’s dramatic trade shifts. As such, we anticipate a rational “de-weaponizing” of the trade wars and remain overweight in select emerging markets.

Looking back to the start of 2018, most investors were giddy, predicting a year of solid returns. Sadly, however, due to the Trumpian “wrecking ball,” it turned out very differently. Financial assets have suffered. In contrast, the 2019 new year will seem a much more somber affair. Expectations are low. Investor sentiment is negative. Some are even expecting the catastrophic: another global financial crisis. Equity markets have repriced to reflect lower expectations. That leaves a lot of room for upside surprises in 2019.

Looking ahead, therefore, it is essential to ignore the media bites, the cat-calling and the high theatre of reality geopolitics. These developments can inflame emotions and provide unhelpful narratives. The reality is that the overall outlook is much more sanguine and balanced (provided that one can ignore the “noise”) than is reflected in current market sentiment. In any case, as seasoned investors know, one should never allow oneself to be induced to decamp or capitulate because of financial market volatility or trumped-up hysteria. To the contrary, such conditions afford us some opportunities.

A position in senior leveraged loans was rebought after having been liquidated in September. Loan prices were hammered last quarter, as U.S. recession fears escalated. The Investment Management team believes these concerns are overestimated in the near term, and the sell-off has provided for an extremely attractive yield with minimal duration risk. To fund the purchase, profits were taken on a position in 7-10 U.S. Treasurys, which had been employed to boost bond quality and hedge portfolio risk.

Deteriorating liquidity conditions in the offshore Chinese currency market influenced the Investment Management team’s decision to liquidate Chinese offshore bond exposure. The sale proceeds were used to initiate a position in onshore Chinese commercial paper, which offers a similar yield and interest rate risk profile, but with improved liquidity characteristics.

Fund and benchmark performance as at December 29, 20181 yearSince Inception (Aug. 2016)
Forstrong Global Strategist Income Fund – Series A-1.2%2.6%
35% MSCI AC World Index, 65% FTSE World Broad Investment-Grade Bond Index (formerly known as Citi World BIG INDEX (CAD))4.6%4.0%


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1Source: MSCI Inc. 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 Fund's strategy is to invest primarily through diversified investments in a balanced mix of ETFs ("exchange-traded funds") of multiple global asset classes. 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 35% MSCI AC World Index and 65% FTSE World BIG Index (CAD). The blended benchmark presented is intended to provide a more realistic representation of the general asset classes in which the Fund invests. MSCI AC World Index is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley Capital International, and is comprised of stocks from both developed and emerging markets. FTSE World BIG Index is a multi-asset, multi-currency benchmark which provides a broad-based measure of the global fixed income markets. The inclusion of government, government-sponsored/supranational, collateralized, and corporate debt makes the World BIG a comprehensive representation of the global, investment-grade universe. 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 and sector 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.