Manager commentary - Q4 2019

Equities and risk assets rallied during the final quarter of 2019 as the geopolitical risks that influenced the markets for much of the year faded. The main catalyst for the reduced market uncertainty was the improving prospects of a “phase one” U.S.-China trade deal. Economic data, namely GDP growth and the unemployment rate, continued to remain stable with leading indicators pointing towards a continued, modest economic expansion.

With market confidence buoyed, investors exited safe-haven sovereign bonds over the quarter. However, the price declines were relatively modest in relation to the large capital gains accumulated over the first three quarters of the year from declining bond yields. Both U.S. and Canadian investment-grade corporate bonds finished 2019 with significant above-coupon returns. Both senior loans and high-yield bonds rallied over the quarter amid tightening credit spreads (the difference in yield between debt instruments with similar terms, but different credit ratings). Both asset classes benefitted from a December bounce back in their lower-rated segments, which were shunned for most of the year on investor preference for higher credit quality in the non-investment grade space.

The U.S. Federal Reserve (Fed) cut the federal funds rate once during the quarter (October), its third rate cut in 2019. However, the Fed subsequently signaled that it would pause its rate cuts, stating at its December meeting that “the current stance of monetary policy is appropriate to support sustained expansion of economic activity….” The 3-month London Interbank Offered Rate (LIBOR), the floating component of most loan coupons, decreased by 18 basis points over the quarter to 1.91%. With the Fed on pause it appears the downtrend in LIBOR may have found a floor.

The exodus from the senior loan space continued in the fourth quarter with U.S. loan funds and ETFs posting their fifteenth consecutive month of outflows. For 2019, approximately $37.2 billion flowed out of the assets class. The catalyst for retail investors was the Fed’s dovish stance and multiple rate cuts during the year. However, with the Fed signaling a pause to its rate cuts, we believe the meaningful selling of senior loans by retail investors may halt in 2020.

Notable contributors to the Fund’s performance included a senior secured term B loan issued by 21st Century Oncology Inc. (LIBOR + 6.15%, 01/16/2023), senior unsecured bonds issued by GEO Group Inc. (5.875%, 10/15/2024) and a senior secured term B loan issued by Amneal Pharmaceuticals LLC (LIBOR + 3.50%, 05/04/2025). Notable detractors from the Fund’s performance included senior unsecured bonds issued by 24 Hour Fitness Worldwide Inc. (8.0%, 06/01/2022), a senior secured term B loan issued by Securus Technologies Holdings LLC (LIBOR + 4.5%, 11/01/2024) and a senior secured term loan issued by Intrado Corp. (LIBOR + 4.0%, 10/10/2024).

We remain constructive on the loan market despite the negative articles written in many mainstream publications. Concerns about higher default rates, poor underwriting and weak protections do not apply universally to the asset class, in our view. Active management will help investors avoid the borrowers that will experience a ratings downgrade, default and principal loss.

Our positive overall outlook for credit is based on the absence of signs of a recession or a spike in default rates over the next 12 months. However, we do believe we are in the latter stages of the credit cycle and, as a result, the Fund is positioned conservatively in order to limit price volatility and surprise risk. Our loans are focused on issuers that we believe can weather an economic downturn. We also favor larger issues to enhance the liquidity within our portfolio. As usual, we avoid companies with cash flows linked to commodity prices, which are inherently volatile.

Fund and benchmark performance as at December 31, 20191 year3 year 5 year Since inception (Nov. 2013)
IA Clarington Floating Rate Income Fund - Series A6.1%2.9%3.2%3.3%
Credit Suisse Leveraged Loan Index USD8.2%4.5%4.5%4.2%

 

Learn more about IA Clarington Floating Rate Income 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 the Credit Suisse Leveraged Loan Index USD which is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market. The Fund's geographic, sector and credit quality exposure may differ from that of the benchmark. The Fund can invest in high yield corporate bonds and government bonds, which are not included in 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.