IA Clarington Tactical Bond Fund
Manager commentary - December 31, 2018
The fourth quarter of 2018 was a challenging one for risk assets. Global equity markets posted sharp declines as investors grappled with a myriad of issues, including continued U.S. central bank interest rate hikes, slowing global growth and rising geopolitical concerns (Brexit, Italian politics, continued trade tensions between the U.S. and China). Equity market weakness spilled into the credit markets resulting in materially wider credit spreads in investment grade, high yield and senior loans. One of the few bright spots during the quarter was government bonds, as they lived up to the traditional role as a safe haven for investors in time of market turmoil.
The Bank of Canada (BoC) raised its overnight rate once during the period (October), its third rate hike in 2018. The BoC subsequently maintained the rate at its December meeting, softening its economic outlook amid energy sector weakness and implying that there may be less urgency to raise rates in the near future. South of the border, the U.S. Federal Reserve (Fed) followed through on an expected 25 basis point rate hike at its December meeting, marking its fourth rate hike in 2018. The Fed shifted to a slightly more dovish stance as it signaled it expects to raise rates twice in 2019, down from previous guidance of three hikes.
Investment grade corporate spreads materially widened over the period, particularly in December, as market sentiment shifted to a risk-off tone. Canadian and U.S. spreads ended the period wider by 35 and 46 basis points, respectively, and finished the year at their widest levels since 2016.
Both U.S. and Canadian yield curves continued their flattening trend (when short- and long-term bonds are offering similar yields and the benefit of holding longer-term bonds is diminished) during the period. The spread between U.S. 2-year and 10-year Treasury yields reached its lowest level since the financial crisis. The U.S. Treasury 10-year yield decreased from 3.06% to 2.68% over the quarter, while the Government of Canada 10-year bond yield decreased from 2.43% to 1.96%. Much of the decline in yields occurred in December as prices were bid up from investors seeking a safe haven from market volatility.
Notable contributors to the Fund’s performance included holdings in Concentra Bank AAA-rated MBS (2.61%, 06/01/2021), TransAlta Corporation senior unsecured bonds (5.0%, 11/25/2020) and NBC Asset Trust subordinated fixed-to-floating rate notes (7.447%, 06/30/2020). Notable detractors from the Fund’s performance included General Electric Co. subordinated fixed-to-floating rate notes (5.0%, 01/21/2021), Enbridge Inc. 4% fixed-to-floating rate preferred shares, and Manulife Financial subordinated fixed-to-floating rate notes (7.405%, 12/31/2019).
We believe this recent market volatility reflects a reset in valuations as the market comes to grips with a lower level of global growth caused, in part, by the removal of central bank liquidity. We do not believe the market is pricing in an imminent recession, as recent data suggests the economy remains on a solid footing. In our view, the Fed’s intention to continue increasing interest rates into 2019 is a further indication of a stable U.S. economy. Nonetheless, we need to be mindful of tail risks from escalating trade tensions between the U.S. and China and oil price weakness.
We remain constructive on credit overall as our base case does not call for a recession or a spike in default rates in 2019. Additionally, the meaningful increase in yield caused by recent widening of credit spreads and higher overall interest rates provides additional cushion for further spread widening. We do not see material spread tightening next year and believe that astute credit selection and a bias towards higher-quality issues will be critical to success in 2019.
In general, we continue to position the Fund quite conservatively in order to limit price volatility and surprise risk. The Fund continues to maintain a low duration, as the flat yield curve does not provide sufficient compensation for longer maturities. Our collateralized loan obligation (CLO) positions provide the portfolio with floating rate exposure. We are focused on tranches rated AAA and AA, which provide much better relative value compared to other similarly rated fixed-income securities. Our investment grade corporate exposure comes primarily from the Canadian market, where spreads have been more stable.
|Fund and benchmark performance as at December 31, 2018||1 year||3 year||5 year||Since inception (Jul. 2010)|
|IA Clarington Tactical Bond Fund - Series A||-1.0%||1.0%||1.0%||1.8%|
|75% FTSE Canada Short Term Corporate Bond Index, 15% Credit Suisse Leveraged Loan Index USD, 10% BofA Merrill Lynch U.S. High Yield Master II Constrained Index (CAD Hedged)||1.2%||2.7%||2.6%||3.4%|
Learn more about IA Clarington Tactical 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 benchmark is a blend of FTSE Canada Short Term Corporate Bond Index (75%), Credit Suisse Leveraged Loan Index USD (15%) and the BofA Merrill Lynch U.S. High Yield Master II Constrained Index (CAD Hedged) (10%). 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 Short Term Corporate Bond Index is comprised of Canadian investment grade corporate bonds and has significantly different portfolio duration characteristics. FTSE Canada Short Term Corporate Bond Index consists of a broadly diversified selection of investment-grade corporate bonds, with maturities between 1 and 5 years, issued domestically in Canada. The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market. The BofA Merrill Lynch U.S. High Yield Master II Constrained Index (CAD Hedged) tracks the performance of U.S. dollar denominated below investment grade corporate debt publicly issued in the U.S. domestic market. The Fund's geographic, sector and credit quality exposure may differ from that of the benchmark. The Fund aims to fully hedge the portfolio’s foreign currency exposure at all times to remove any currency fluctuation risk. As a result, the U.S. indices referenced within are quoted in their native currencies of U.S. dollars to reflect the performance of the holdings as opposed to currency performance. 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. Effective February 23, 2015, the investment strategies of the Fund were changed and the sub-advisor of the Fund changed from Aston Hill Asset Management Inc. to IA Clarington Investments Inc.