Manager commentary - Q4 2019

In the final quarter of the year, global equity markets (as measured by the MSCI All Country World Index in USD terms) were driven by U.S.-China trade conflict sentiment, ending in positive territory as a preliminary trade deal took form. All sectors posted positive results for the period, led by information technology and health care, which posted double-digit gains. The information technology sector benefitted from the improved U.S.-China dynamic given its global supply chains, while the health care sector’s performance was driven by a rally in U.S. managed care companies as multiple Democratic presidential candidates adopted a more measured stance on health care reform.

After generating strong returns through the first nine months of the year, the world bond markets delivered mixed results in the fourth quarter. The U.S. Federal Reserve (Fed), which cut interest rates three times in the middle part of the year, made it clear that it was likely to keep rates on hold until there was evidence of either rising inflation or a pronounced slowdown in growth. With the Fed’s “mid-cycle adjustment” seemingly complete, bond market returns cooled in comparison to the year’s first three quarters. Nevertheless, the credit-sensitive areas of the market continued to gain ground amid signs of a stronger economic outlook, positive news on the trade front and investors’ robust appetite for risk.

Emerging market debt generated a solid gain and outpaced domestic, investment grade bonds. The asset class benefited from the combination of investors’ search for yield, the sharp downturn in the U.S. dollar in December and the constructive news regarding global growth and the U.S.-China trade conflict.

IA Clarington Global Allocation Fund Series T8 outperformed its blended benchmark (60% MSCI ACWI, 40% Barclays Global Aggregate) with a gain of 4.9% in the fourth quarter compared to 3.4%. Both the equity and fixed-income allocations of the Fund contributed positively to returns; however fixed income performance was not as strong as equity results, tempering the fund’s overall relative performance. The Fund’s target asset allocation at the end of the period was 68.5% equity, 15.75% U.S. fixed income, and 15.75% non-U.S. fixed income. The majority equity exposure is in line with the Fund’s long-term performance objective.

The top three contributors for the period in equities were UnitedHealth Group Inc., Alibaba Group Holding Ltd. and Marriott International Inc. Shares of UnitedHealth Group (UNH), a leading U.S. provider of health insurance and health care services, rallied as multiple Democratic presidential candidates toned down rhetoric on health care reform, as mentioned above. We view UNH as a high-quality company with large competitive moats in key markets. We expect intrinsic value growth to be driven by the company’s evolution into an integrated health care services provider and shares remain attractive at current prices. Shares of Alibaba, a Chinese e-commerce company, outperformed despite an overall slowdown in the Chinese economy. Retail sales and e-commerce grew at healthy double-digit rates. We see multiple levers for Alibaba to sustain growth levels, increase its monetization rate and expand its addressable market. Management continues to build infrastructure through Alibaba Cloud Computing, Cainiao Network and Alipay, reinforcing Alibaba’s dominance in e-commerce in China and potential for growth overseas. Shares of Marriott International, a global hotelier, also outperformed. Marriott’s asset-light business model is growing less dependent on a continued expansion in the lodging industry to deliver earnings growth. The company’s record pipeline of hotel owners who want to adopt the Marriott brand is indicative of healthy returns to hotel owners. Additionally, Marriott’s Bonvoy loyalty program continues to attract members, allowing Marriott to convert its members’ reservations into direct higher-margin bookings.

In fixed income, the Fund’s corporate credit allocation contributed to performance, most notably allocations to the energy, consumer cyclical, communications and banking sectors. Allocations to high-yield credit also proved beneficial as the phase one trade agreement between the U.S. and China buoyed risk appetite. Positive contributions were led by energy issuers from the U.S. independent sectors and holdings within the U.S. cable and wireless sectors. Bonds denominated in the British pound sterling and euro contributed to returns as both currencies appreciated versus the dollar. The news on Brexit had become decidedly better with the extension of the deadline to January 31 and the scheduled election for mid-December.

The three largest detractors from performance in equities were Northrop Grumman Corp., Thales SA and Temenos AG. Shares of Northrop Grumman, a global aerospace and defense company, were strong for the year and we view weakness in the quarter as largely giving back previous gains. Our investment thesis in Northrop Grumman remains intact. Shares of Thales, a diversified industrial company, underperformed as the company announced disappointing sales growth and margin targets for 2023 at its Capital Markets Day, followed by a reduction in its full-year organic growth guidance. Weakness in shares was compounded when the company announced its official results, which showed a decline in organic order intake and weakness in its space division. Despite these headwinds, our investment thesis for Thales is unchanged. Shares of Temenos, a Swiss core banking software provider, gave back some of their year-to-date gains after the company reported quarterly results that missed estimates due to a slowdown in Middle East and Africa (MEA) business. We believe the MEA performance was not due to a slowdown in demand, but rather an execution issue with regional sales leadership that Temenos management has addressed. We believe Temenos remains well positioned to benefit from the shift in the banking industry from legacy in-house software toward more modern solutions from strong third-party vendors.

In fixed income, an underweight exposure to Eurozone government bonds detracted from performance for the quarter, as German bond yields generally declined. An underweight to Japanese yen-denominated bonds also detracted as negative-yielding bonds fell further into negative levels over the year. Exposure to select emerging market currencies also had a negative impact, in particular bonds denominated in the Chilean peso. Individual issuers in the energy sector, in particular among select U.S. independent and midstream companies, failed to keep pace with broader corporate excess returns. Weak global demand growth from China and India persisted despite lower U.S. production growth and OPEC cuts.

We do not expect further escalation in the trade conflict between the U.S. and China. The phase one trade agreement is an important step in the right direction and a key support to risk appetite. The deal could deliver upside surprise if it is more comprehensive than expected, but the general truce has been enough to keep risk assets moving in a positive direction. Credit spreads are tight but should continue to receive support. Improvement in economic data and an accommodative Fed in a low growth, low inflation environment should enable credit spreads to stay well contained. Higher wages and employment costs are pressuring profit margins, but top line revenue growth has been respectable. We expect the U.S. dollar to stay in a relatively tight band in the near-term, which should help emerging market currencies and risk assets in general. While there has been some recent weakness in the dollar, there hasn’t been a substantial breakout in either direction. We are watching for more convincing evidence that economic activity is accelerating at a faster pace outside the U.S., which would increase downward pressure on the dollar. Stability in economic growth should lead to better profit growth in 2020, albeit in the low-single-digit range. We expect S&P 500 Index profits to grow around 5% in 2020, up from low single digits in 2019. A profits recession – with profits down 10% or more – would substantially increase recession risks, but that is not our base case scenario. Short-term volatility often provides 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 attractive valuations.

Fund and benchmark performance as at December 31, 20191 year3 year5 year10 year
IA Clarington Global Allocation Fund - Series T820.1%10.6%7.3%6.9%
40% FTSE World Government Bond Index (CAD Hedged) (formerly known as Citigroup World Government Bond Index (Currency Hedged)), 60% MSCI AC World Index114.8%8.2%7.9%8.5%

 

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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 . and the investment strategies of the Fund were changed.