Manager commentary - December 31, 2018

In global equities, the broader market environment experienced a pronounced shift in the final three months of the year. Whereas the markets had previously been riding a wave of optimism stemming from robust economic growth and rising corporate earnings, market sentiment turned sharply lower in the fourth quarter. Concerns about U.S. trade policy and weaker economic conditions overseas sparked a reversal in global equities, pushing the MSCI All Country World Index1 down 7.8% in Canadian dollars. All sectors posted negative returns with the exception of utilities, which eked out a modest gain as investors moved to perceived safety. Energy was the worst-performing sector; concerns that U.S. and Iranian output would be greater than expected, coupled with falling demand, prompted a swift drop in the price of oil. Information technology, consumer discretionary, industrials and financials also posted large declines. Volatility in equity markets played a large role in the widening of credit spreads as stubborn trade conflict concerns, lower oil prices and the still-unresolved Brexit situation dampened risk sentiment and prompted investors to seek out safe haven cash and Treasury alternatives. In mid-December, the U.S. Federal Reserve (Fed) Open Market Committee increased its policy rate by 25 basis points, in line with market expectations. This put the new range for the Fed funds target rate at 2.25% to 2.50%. The hike was the ninth of the current cycle and left the target at its highest level since March 2008. However, market pricing reflects an expectation that the Fed may have tightened policy rates enough for the foreseeable future. While a temporary truce in the trade war between the U.S. and China was put in place in early December, global trade tensions remain.

In the fourth quarter of 2018, IA Clarington Global Allocation Fund Series T8 returned -6.1%, lagging its benchmark, which returned -3.8%. The Fund ended the period with a target allocation of 67.5% global equities, 14.5% U.S. fixed income, and 18% non-U.S. fixed income.

In global equities, the top three contributors to performance were McCormick & Company Inc., HDFC Bank Ltd. and Intercontinental Exchange Inc. Shares in McCormick & Company, a global spice and flavorings company, rose after better-than-expected results, driven by the company's acquisition of Reckitt Benckiser Group Plc’s Food Division (RB Foods) and improved guidance. We expect McCormick to continue to grow its top line through launching innovative products and expanding the distribution of products acquired from RB Foods. We also anticipate margin expansion as management continues to extract costs from the business, while simultaneously increasing its marketing spend to support long-term growth. HDFC, an Indian bank, proved resilient during the period. The company continues to take market share from the weaker public banks and grow its loan portfolio while maintaining loan quality. Intercontinental Exchange also performed well in the period as the return of market volatility in earnest boosted trading revenues. Shares were also supported by positive indications from the company's recent acquisitions, which enhanced its bond trading platform capabilities.

In fixed income, a large allocation to the U.S. dollar fixed-income market, where starting yields were competitive globally and yields declined most over the quarter, proved beneficial. In particular, defensive positions in U.S. Treasury and high-quality securitized bonds held their value or appreciated. Foreign government bond market holdings within Brazil, Italy and Indonesia added to performance, as did a long Japanese yen forward hedge position. Select corporate and government-related bonds, including North Asian and Latin American gas sector credits and property names, held their value despite unfavorable conditions for credit generally.

In global equities, the largest three detractors from performance were Inc., Northrop Grumman Corp. and Temenos AG. Amazon shares struggled in the period due to a confluence of factors. These included the announcement of a minimum wage increase for U.S. employees, the prospect of higher shipping costs, the United Kingdom's proposed Digital Services Tax and a mixed earnings announcement. While revenue growth was slightly below our expectations in the period, profitability was firmly ahead. We believe the above-mentioned factors that will likely increase Amazon's future costs will be more than offset by Amazon's rising profitability. Amazon's faster-growing businesses, such as Amazon Web Services and Advertising, carry operating margins well above the company average. This business mix effect, coupled with restrained growth in capital leases and headcount, has resulted in substantial profitability improvements in the last three quarters. We expect this dynamic to continue to favorably impact results for Amazon into the future. Northrop Grumman delivered strong third quarter results in November. However, increased uncertainty regarding the national defense budget (fiscal year 2020) weighed on shares during the fourth quarter, with multiple budget drafts being prepared. While this degree of uncertainty regarding total defense spending is unwelcome, we continue to see a generally supportive environment for defense spending and view Northrop's exposure to long-cycle and classified projects as favorable. The stock’s valuation has become more attractive following recent market volatility. Shares of Temenos, a software company focused on the banking industry, declined in the fourth quarter despite no change to the company's underlying fundamentals. Temenos sits at the centre of the digitalization effort of the world's financial institutions; we see a long runway for growth as its customers shift internal IT budget spending to external solution providers such as Temenos. A large and growing recurring revenue stream should drive steady margin improvement over time, supporting intrinsic value growth and creating additional optionality around the allocation of excess cash flow.

In fixed income, positioning with respect to high-yield corporate credit negatively affected performance during the quarter. Specifically, selection among energy issuers detracted during the period as oil prices traded lower in the fourth quarter on the back of increasing inventories and concerns related to the pace of global demand growth. Exposure to U.S., U.K. and Eurozone banking issuers weighed on performance given general weakness in the sector due to global growth concerns. Bonds denominated in the Colombian peso and Mexican peso detracted as the currencies depreciated over the period versus the U.S. dollar. A lack of exposure to the Japanese yen weighed on results as it appreciated more than 3% versus the U.S. dollar during the quarter.

We expect recent volatility to continue in global equities as stimulus is removed, trade tensions continue and political uncertainty persists in many regions around the globe. While global growth has decelerated, we believe companies with sustainable competitive advantages and strong balance sheets will prove resilient. On a more granular level, there are opportunities in financials, even with a potentially less positive economic backdrop. These include: companies that are beneficiaries of volatility, such as financial exchanges, companies that are supported by broad secular trends, such as aging and increasingly affluent populations, and companies with valuations reflecting an overly bearish economic scenario. We continue to believe there are attractive opportunities in technology and communication services, although we expect that continued negative news flow around issues such as data privacy and market concentration may pressure stocks in the short-term. Whether it is search, e-commerce or social media, these services remain highly desired by consumers.

Our inflation forecasts for the world's major economies are slightly below consensus estimates. Given the sharp decline in oil prices over the past quarter, the risk of an oil shock severely inflating prices is less likely in the near term. At the same time, growth is seemingly converging toward levels that could put more limited upward pressure on resource and wage price levels. Persistent global trade tensions and protectionist actions would be supportive of the dollar. However, the dollar already appears expensive under many valuation models. Therefore, we believe the dollar is likely to remain range bound over the coming months while macro risks continue to dominate headlines and global growth stabilizes. To the extent that events create shifts in sentiment and cause short-term volatility, they can provide us with entry points to build long-term positions in high-quality companies and opportunities to trim or sell positions at what we consider attractive levels. Rather than try to predict macro events, we focus on companies with sustainable business models and compelling valuations.

Fund and benchmark performance as at December 31, 20181 year3 year5 year10 year
IA Clarington Global Allocation Fund - Series T8-0.9%4.7%3.6%6.8%
40% FTSE World Government Bond Index (CAD Hedged) (formerly known as Citigroup World Government Bond Index (Currency Hedged)), 60% MSCI AC World Index0.2%4.8%7.4%8.0%


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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 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 World Government Bond Index (Currency Hedged) (40%) and MSCI AC World Index (60%). The blended benchmark presented is intended to provide a more realistic representation of the general asset classes in which the Fund invests. The FTSE World Government Bond Index (or WGBI) (Currency Hedged) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. The WGBI is a widely used benchmark that currently comprises sovereign debt from over 20 countries, denominated in a variety of currencies. The WGBI is a broad benchmark providing exposure to the global sovereign fixed income market. The index provides exposure to a broad array of countries. Sub-indices are available in any combination of currency, maturity, and rating. The MSCI AC World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The MSCI ACWI consists of 46 country indexes comprising 23 developed and 23 emerging market country indexes. 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. Effective February 23, 2015, the sub-advisor of the Fund changed from Aston Hill Asset Management Inc. to Loomis, Sayles & Company, L.P. and IA Clarington Investments Inc.