At the end of the third quarter, the bond market was jolted by the central bankers signalling that interest rate hikes are drawing closer. In response, investors let go of government bonds, as the US Federal Reserve and Bank of England both indicated a willingness to respond to growing inflationary pressures.
A surge in energy prices also added to investor conviction that the recent jump in inflation will last longer than central bankers previously expected. Meanwhile, the Fed’s expectations of US inflation have been creeping higher. The officials also believe that inflation could stay higher for longer if supply chain issues persist.
The Fed officials have begun discussions about “tapering” bond purchases and have pushed forward the time frame when they expect to raise interest rates. The Federal Reserve is seeking to achieve maximum employment by letting inflation run moderately over its goal of two percent. Its officials appear comfortable with this strategy, as long as inflation averages two percent over time and longer-term inflation expectations remain anchored at two percent.
In Canada, the Bank of Canada continues its quantitative easing program by purchasing government bonds and keeping yields low across terms.
The US Bond Market Index rose 0.2% during the quarter but is down 1.9% year-to-date (YTD). Corporate bonds rose 0.3%, as corporate bond spreads were mostly unchanged, and the YTD return is negative 0.9%.
The US High Yield Bond Index continued its strong run, rising 1% for the quarter and 4.7% YTD. As for the Canadian FTSE Universe Bond Index, it fell 0.5% during the quarter and is down 4% YTD. Lastly, the FTSE Corporate Bond Index declined a modest 0.1%, while the Canadian corporate bonds are down 2.4% YTD.
Global Balanced Fund
The Pembroke Global Balanced Fund is a fund of funds that invests primarily in Pembroke-managed active equity funds, externally managed active equity and fixed income funds, and externally managed passive funds and exchange-traded-funds (ETFs). During the third quarter, the fund gained in both absolute terms and relative to its custom benchmark (30% FTSE Canadian Universe Bond Index, 45% MSCI All-Country World Index and 25% S&P TSX Composite Index).
Within the broader markets, global stocks gained in Canadian dollar terms during the quarter. While energy stocks as a group performed well, the energy sector is now relatively small. As a result, the top contribution to global stock returns came from global technology, financial and health care sector stocks.
The consumer discretionary sector made the most significant negative contribution during the quarter, led down by China’s major Internet companies and some of the global luxury brands. Some consumer staples groups also declined, led by beer and alcohol companies whose input costs, while moderating, remain elevated amidst rising global food commodity prices.
Overall, the fund’s actively managed Canadian, U.S., international and global growth equity holdings all made absolute positive contributions to performance during the quarter.
As for government bond yields, they were volatile, moving up sharply in the second half of September. The Pembroke Canadian Bond Fund (see below), with a duration of 6.1 years, declined slightly during the quarter, and the Pembroke Corporate Bond Fund (see below), with a duration of three years, gained during the quarter.
Lastly, the fund’s position in the iShares gold bullion ETF gained modestly during the period.
The Pembroke Global Balanced Fund is diversified by asset class, by region, by size (small caps and large caps) and by fund type (active and passive). At the end of the quarter, the fund had an approximately 68% allocation to global equities, approximately 28% allocation to corporate and sovereign bonds and cash, and approximately 4% to a gold bullion ETF.
Global Equity Pooled Fund
The Pembroke Global Equity Pooled Fund is a diversified global equity strategy with exposure to Canadian, US, and international developed and emerging equity markets. During the quarter, the fund’s top holdings included the Pembroke Dividend Growth Pool (see the article Canadian Equity Strategies), the Guardian Capital Fundamental Global Equity Fund, the Pembroke Canadian Growth Pool (see the article Canadian Equity Strategies), and the Pembroke US Growth Pool (see the article US Equity Strategies).
Like the Pembroke Global Balanced Fund, the Pembroke Global Equity Pooled Fund invests in passive exchange-traded funds (ETFs) to achieve exposure in large cap liquid equity markets. During the quarter, the fund held four ETFs including the iShares Core S&P500 ETF, the iShares S&P TSX 60 Index ETF, the iShares Core MSCI EAFE ETF, and the iShares Emerging Markets ETF.
In total, the fund’s allocation to passively managed ETFs was just over 29%. In addition to the iShares S&P TSX 60 Index ETF, the Pembroke Global Equity Pooled fund also achieves Canadian large cap exposure through its holding in the Pembroke Canadian All Cap Pool.
By region, about 39% of the fund was allocated to Canada during the quarter, about 31% to the US, nearly 11% to Europe, nearly 3% to Japan, and about 15% to other regions. By sector, the fund’s top exposures include the information technology, industrial, financial, and consumer discretionary sectors. During the quarter, the top-performing holding was the Pembroke International Growth Fund (see the article International Equity Strategies) and the bottom performing holding was the iShares Emerging markets ETF.
The fund has a custom benchmark comprised of 64% MSCI All Country World Index and 36% S&P TSX Composite Index. During the quarter, the fund gained in absolute terms and in relative terms against its benchmark.
Canadian Balanced Fund
Pembroke’s balanced portfolio posted marginally negative returns in the third quarter of 2021.
The equity portion of the portfolio, represented by the holdings of the Pembroke Dividend Growth Fund (see the article Canadian Equity Strategies), posted modest gains during the quarter in a choppy environment for stocks. The fixed income portion of the fund, represented by the Pembroke Canadian Bond Fund (see below), posted slight losses in the period as a rising interest rate environment proved to be challenging for bond investments.
Income in the balanced fund is generated from a combination of dividends and interest. At the end of September,the equity portion of the fund had a current annualized gross yield of 2.81%, while the fixed income segment of the Fund is primarily invested in securities rated “A+” that, on average, have a collective yield to maturity of 2.0% and an adjusted portfolio duration of 6.1 years.
Minor changes to the asset mix of Pembroke’s balanced mandates were made through the year, with approximately 25.3% of the portfolio invested in fixed-income securities on September 30, 2021.
Canadian Bond Fund
During the third quarter, The Canadian Bond Fund declined in absolute terms but was slightly ahead of its benchmark the FTSE Canada Universe bond Index. The Fund has also declined in absolute terms in the year-to-date but, again, has slightly outpaced the FTSE Canada Universe Bond Index over the period.
The Fund benefited in relative terms from its shorter than index duration, as well as its allocation to floating rate issues. The portfolio had a yield of 2% and a duration of 6.1 years at the end of the period. This compares favourably to the index yield of 1.8% and the market duration of 8.1 years.
Corporate Bond Fund
The Pembroke Corporate Bond Fund gained in absolute terms during the third quarter. The benchmark FTSE Canada All Corporate Bond Index index declined slightly over the same period.
The outperformance for the third quarter is attributable to the select high yield issues of Occidental, Avis, Spirit Aerosystems and Continental Resources, all of which experienced credit spread tightening. Additionally, as at quarter end, the Fund was approximately 13% invested in Limited Recourse Capital Notes (LRCNs), whereby credit spread tightening offset the rise in yields.
The Fund is positioned with a yield of 3.6%, a duration of 3.0 years and just over 24% in floating rate notes. The Fund will continue to reduce duration by opportunistically trimming mid-term and long-term issues as they reach full valuation, and by reinvesting the capital in attractive issues or floating rate instruments to provide further protection against the potential risk of rising rates.
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This report is for the purpose of providing some insight into Pembroke and the Pembroke funds. Past performance is not indicative of future returns. Any securities listed herein, are for informational purposes only and are not intended and should not be construed as investment advice nor is it a recommendation to buy or sell any particular security. Factual information has been taken from sources we believe to be reliable, but its accuracy, completeness or interpretation cannot be guaranteed. Pembroke seeks to ensure that the content of this document is correct and up to date but does not guarantee that the content is accurate and complete and does not assume any responsibility for this. Pembroke is not responsible for decisions or actions taken or made on the basis of information contained in this document.