Manager commentary - December 31, 2018

Despite an exceptional rise in U.S. business profits, the decision by the U.S. Federal Reserve (Fed) to continue normalizing its monetary policy and the escalation of U.S.ÔÇÉChina trade tensions have created a highly volatile environment on Wall Street. This resulted in the S&P 500 Index posting a drop of nearly 15% in the fourth quarter of 2018, its worst quarterly performance in a decade. The last month of the year was particularly painful, recording a drop of 9.2% – the worst December since the 1930s.

In the fund manager’s view, the main factor that affected global financial markets in 2018 was the Fed’s monetary policy tightening. The correction in the fourth quarter is a reminder of the impact that tightening liquidity conditions in financial markets can have on portfolio returns.

When the Fed raises its key rate, two phenomena are usually occur: 1) increased market volatility and 2) stock market value, as measured by the price-to-earnings ratio, contracts; that is, investors are willing to pay less to invest in markets despite an increase in corporate profits.

Further adding to uncertainty, trade tensions created by President Trump were omnipresent throughout the year. The renegotiation of the North American Free Trade Agreement (NAFTA) and, more recently, U.S.-China negotiations, took center-stage. At year-end, a truce seemed to have been achieved between the two superpowers, which agreed to speed up negotiations during the first quarter of 2019.

Moreover, several geopolitical risks made headlines throughout 2018, with North Korea, Iran, Brexit and Italian politics topping the list. Brexit was the centre of attention in the last quarter of the year. The U.K. parliament’s vote on Brexit was postponed to January 2019 because there was clearly not enough support in December, creating more uncertainty around the globe.

In Canada, the main factor that contributed to the economic slowdown was the weakness in Canadian oil prices. Not only have oil prices been under severe pressure across the world in the fourth quarter (the price per barrel of American crude fell from $75 to $45 in Q4 of 2018), but the price per barrel of Western Canadian Select slid to under $13 in late November. The reason for this major price difference was the difficulty in transporting heavy Canadian crude to export destinations (mainly the U.S.) because pipeline capacity and rail transportation were lacking, leading to a stockpile in Alberta.

As for the bond market, yields started Q4 on a high note after news broke of the United States-Mexico-Canada Agreement, which replaces the North American Free Trade Agreement. Nevertheless, worries over deteriorating U.S.-China trade negotiations, combined with concerns surrounding Brexit and Fed overtightening, quickly resulted in equity market volatility and a flight to safety, which brought down bond yields. Although the strong decline in oil prices was the main culprit in driving down Canadian yields, this effect was not limited to Canada, as 10-year yields in the U.S., Europe and Japan also closed the quarter lower.

In the last quarter of the year, the Canadian bond market, represented by the FTSE Canada Universe Bond Index, posted a gain of 1.7% (1.4% in 2018). The FTSE Canada Short Term Bond Index posted a return of 1.4% (1.9% in 2018). Finally, the FTSE Canada Long Term Bond Index rose to 1.9% (0.3% in 2018).

The American stock market, represented by the S&P 500 Index, had a total return of -13.5% in the fourth quarter (-8.6% in Canadian dollars). The Canadian stock market, represented by the S&P/TSX Composite Index, suffered a decline of 8.9%. For 2018, returns for North American stock markets were -4.4% for the S&P 500 Index (+4.2% in Canadian dollars) and -7.6% for the S&P/TSX Composite Index.

The European market, represented by the MSCI Europe,1 posted a return of -11.2% in the fourth quarter and -10.6% in 2018 (-7.7% and -6.6%, respectively, in Canadian dollars) while the MSCI EAFE Index1 posted -12.2% for the quarter and -11.0% for 2018 (-7.6% and -6.0%, respectively, in Canadian dollars) and the MSCI World Index1 posted -13.1% for the quarter and -7.4% in 2018 (-8.5% and -0.5%, respectively, in Canadian dollars). Emerging markets, represented by the MSCI Emerging Markets Index1, posted a return of -7.4% for the quarter and -9.7% in 2018 (-2.2% and -6.5%, respectively, in Canadian dollars).

The Fund’s positive return is largely the result of its heavy fixed-income allocation (99.85% at quarter-end). Provincial spreads were affected by global credit spread widening during the last quarter of the year. The highlight for the provincial bond segment was the deterioration in the tax position of the province of Alberta due to the rapid decline in oil prices, which widened spreads. Ontario provincial spreads also increased, but did not entirely offset the yield decline observed in the Canadian bond market. Ontario strip (Strip bonds are bonds that don’t pay interest. Instead, investors buy them at a discount, and they mature at their face or principal value) with maturities close to 2020 ended the quarter with lower yields, which was positive for the Fund’s performance.

Series A of the Fund did not “click” during the quarter, as the month-end NAV did not achieve a new month-end historical high.

The equity component of the Fund posted a negative return during the fourth quarter. The portion allocated to equities within the portfolio (approximately 0.15% of the portfolio at quarter-end) did not meaningfully impact the Fund’s overall performance.

Fund and benchmark performance as at December 31, 20181 year3 year5 year10 year
IA Clarington Target Click 2020 Fund - Series A-1.9%-0.3%1.3%2.8%
20% MSCI World Index1, 80% FTSE TMX Canada Universe Bond Index1.2%2.8%4.9%5.6%

 

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1MSCI 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 Canada Universe Bond Index (80%) and MSCI World Index (20%). 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 Universe Bond Index is comprised of Canadian investment grade bonds and has significantly different portfolio duration characteristics. The FTSE Canada Universe Bond Index consists of a broadly diversified selection of investment-grade Government of Canada, provincial, corporate and municipal bonds issued domestically in Canada. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI World Index consists of 23 developed market country 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. On December 5, 2011, the portfolio manager changed. This change may have affected the Fund's performance.