IA Clarington Strategic Corporate Bond Fund
Manager commentary - December 31, 2018
As we look back at 2018, we see a mix of good, bad and ugly. The good was accelerating economic growth in the U.S. that drove earnings growth to levels we haven’t witnessed in many years. That growth led to higher market returns for most of the year, while consumer and sentiment levels remained relatively high. The bad came at the beginning of the year and was likely a precursor of things to come, as interest rates increased quickly to levels that had some believing that risk-free rates were close to becoming stiff competition for the equity markets. Equity markets and interest-rate-sensitive fixed income struggled during this period before giving way to better returns as the year progressed. The ugly occurred in the last couple of months of the year as fears of an economic downturn, combined with global trade disputes and a non-accommodating central bank in the U.S., led to one of the worst-performing months of December in many decades.
Although the Fund faired relatively well during the year, we gave up some of our annual gains in December when speculation seemed to have overtaken facts. While we concede that earnings growth and economic growth in the North American markets will likely decelerate during the next 12 months, we see very little evidence of a pending recession and expect earnings growth, while lower, to remain positive, which historically has been associated with higher market returns. Based on these assumptions, we expect equity market returns to rebound as 2019 progresses and credit spreads for less interest-rate-sensitive fixed income to decrease as positive momentum is factored into investment analyses. Other potential catalysts include a thaw in trade war disputes as well as a U.S. Federal Reserve that will likely keep overall liquidity in the system relatively high by not raising short-term rates too aggressively.
We remain invested primarily in higher-yielding corporate bonds with low sensitivity to rising interest rates and find that current yields of approximately 8% and spreads at 500 basis points are attractive after overcorrecting during the fourth quarter. We believe that for the first time in two years, yields and spreads are at a level that can potentially produce capital gains in addition to an attractive current yield. Default rates are at historically low levels and will likely remain muted as long as there is positive economic and earnings growth to help support overall expected returns during the next year.
The Fund performed in-line with the high-yield index during the quarter, mainly due to its overall defensive positioning through high relative cash levels. The Fund’s exposure to bonds in the utilities sector and its cash position were contributors to returns during the past three months. We increased our defensive positioning and our cash levels during the past quarter while decreasing the Fund’s exposure to lower-rated credits. Our duration remained low relative to the benchmark during the quarter, helping to protect against rising interest rates. The Fund finished the quarter with a yield to maturity of 7.32%, excluding cash, and a spread of 464 basis points.
The Fund’s top two contributors to performance during the past three months were holdings in Chrysler Group Co. 4.5% of 2020 and Intertape Polymer Group Inc. 7% of 2026 bonds. Chrysler held in well amid the market turmoil, mainly due to its defensive characteristics and positive recent financial results. Intertape has a good business profile for fixed-income investors and has demonstrated fairly consistent revenue growth over the past several years.
The largest detractor from performance during the quarter came from our exposure to Frontier Communications Corp. 7.125% of 2023 bonds. We believe that the majority of the negative price pressure on the bonds is related to near-term weakness in communications products as well as management’s execution of recent acquisitions.
|Fund and benchmark performance, as at December 31, 2018||1 year||3 year||5 year||Since inception |
|IA Clarington Strategic Corporate Bond Fund - Series A||-1.6%||5.5%||2.9%||4.2%|
|FTSE TMX Canada Corporate Bond Index||1.1%||2.7%||3.7%||3.7%|
Learn more about IA Clarington Strategic Corporate Bond 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 FTSE Canada 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 Fund may have exposure to bonds domiciled both in Canada and outside of Canada while the benchmark only has exposure to bonds domiciled in Canada. The Fund may have currency risk exposure while the benchmark has none. 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.