Balanced and Fixed Income Strategies

Fixed-Income Outlook

In a clear sign that the Federal Reserve is shifting to tighter monetary policy, the Fed Chair Jerome Powell recently decided to retire the word “transitory” and acknowledge that inflation is proving to be more persistent than expected.

Stubborn inflation readings have been the result of strong demand and supply side issues coupled with record levels of unfilled job openings and widespread labour shortages. As a result, the Fed decided to reduce its monthly pace of security purchases and pushed forward the time frame when they expect to raise interest rates.

The expectation of increased administered rates in both the U.S. and Canada pushed the shorter end of the yield curve higher during the quarter, while longer-term government bond yields reacted to news of Omicron, a new and more infectious variant of coronavirus.

Falling long-term government bond yields were able to overcome credit spread widening in the wake of Omicron and drove the 1.1% return of the Canadian Corporate Index. The high quality and longer duration Universe Index prevailed, with a 1.5% return in the period.

For the calendar year 2021, high quality bond markets remained decidedly negative, as government bond yields are markedly higher overall. Strong demand for higher-yielding credit continued in the fourth quarter, and high yield markets once again proved resilient with spreads rallying into year-end to finish as the top performing segment in the credit markets this year.

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 fourth quarter, the fund gained in absolute terms but trailed its custom benchmark (30% FTSE Canadian Universe Bond Index, 45% MSCI All-Country World Index, and 25% S&P TSX Composite Index).   

Broadly speaking, global equity markets gained in Canadian dollar terms during the quarter. There were, of course, sectoral and regional differences. The top-performing equity market sectors included the information technology, utility, and real estate sectors. The communication services, financials, and energy sectors were among the bottom performing sectors.

The information technology sector, at the end of the quarter (December 31, 2021) carried a weight of more than 23% in the MSCI All Country World Index. The rise of the information technology sector and the US-domiciled companies that dominate it has also contributed to a rising US country weight (over 61%) in the MSCI All Country World Index. Emerging markets were generally weak during the quarter with declines (in Canadian dollar terms) in the Brazilian, Russian, Indian, and Chinese (BRIC) markets.

Within the Pembroke Global Balanced Fund, the top-performing holdings during the quarter included those strategies with exposure to large cap US information technology, namely the iShares S&P 500 ETF (IVV), and the Guardian Capital Fundamental Global Equity strategy. The iShares S&P TSX60 ETF (XIU) was also a strong performer during the quarter.

Bottom performing strategies included the iShares Emerging markets ETF (EEM), The Pembroke Canadian Growth Fund (see the article Canadian Equity Strategies), and the Pembroke International Growth Fund (see the article International Equity Strategies). The strategy’s holding in the iShares Gold Bullion ETF (CGL.C) gained during the period.

As for the Fund’s bond holdings, they turned in an overall positive performance led by the Pembroke Canadian Bond Fund (see below). The Fund’s holding in the Lysander Canso Bond Fund declined slightly 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 69% allocation to global equities, approximately 27% allocation to corporate and sovereign bonds and cash, and approximately 4% to a gold bullion ETF. 

Global Equity Pooled Fund

The Pembroke Global Equity Fund is a Pooled Fund. This is a prospectus-exempt product that is only available to investors who meet the definition of an “accredited investor” under securities legislation.

The Pembroke Global Equity Pooled Fund is a diversified global equity strategy with exposure to Canadian, US, and international developed and emerging equity markets. The intent of the managers is to maintain diversification by region, by market cap size, by manager, and by passive and active strategies.

During the quarter, the fund’s top holdings included the Guardian Capital Fundamental Global Equity strategy, the Pembroke Dividend Growth Pooled Fund (see the article Canadian Equity Strategies), the Pembroke Canadian Growth Pooled Fund (see the article Canadian Equity Strategies), and the Pembroke US Growth Pooled Fund (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 under 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 Pooled Fund (see the article Canadian Equity Strategies).    

By region, about 40% of the fund was allocated to Canada during the quarter, about 31% to the US, nearly 12% to Europe, over 2% to Japan, and about 14% to other regions. By sector, the fund’s top exposures include the information technology, industrials, financials, and consumer discretionary sectors. 

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, but trailed its benchmark. The top-performing holdings were the iShares Core S&P500 ETF and the Guardian Capital Fundamental Global Equity strategy—both of which have exposure to large capitalization US information technology stocks. The bottom performing holdings were the Pembroke Canadian Growth Pooled Fund, and the iShares Emerging markets ETF.

Canadian Balanced Fund

Pembroke’s Canadian Balanced Fund posted modestly positive returns in the fourth 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 gains in the quarter in a volatile, but constructive environment for stocks. The fixed income portion of the Fund, represented by the Pembroke Canadian Bond Fund (see below), also posted slight gains during the quarter, weathering a period of rising interest rates and monetary policy uncertainty.

Income in the balanced fund is generated from a combination of dividends and interest. The equity portion of the fund has a current annualized gross yield of 2.99%, 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 24.67% of the portfolio invested in fixed-income securities on December 31, 2021.

Canadian Bond Fund

The Pembroke Canadian Bond Fund returned 1.25% in the quarter versus 1.47% for the FTSE Canada Universe Bond index benchmark, as credit spreads widened. The Fund’s higher weight in corporate bonds was a negative in the period. Issuers recovering from the pandemic, such as Highway 407 and G.T.A.A., outperformed, along with most BBB issues.

For the year, the -1.78% return was well ahead of the -2.54% turned in by the benchmark. A shorter-than-benchmark duration was a positive over this period, as was the Fund’s allocation to floating rate issues. At the end of the year, the Fund had a yield of 2% and a duration of 6.1 years, which compares favourably to the benchmark yield of 1.9% and duration of 8.4 years.

As the economy continues to reopen and recover from the pandemic, we expect corporate spread for the issuers more affected by the pandemic than others to narrow further. Yields may also climb higher, reflecting the inflationary environment. We expect the Fund to continue to reduce duration and improve quality by opportunistically trimming issues as they reach full valuation and reinvesting in attractive issues or floating rate instruments to provide further protection against the potential risk of rising rates.

Corporate Bond Fund

The Pembroke Corporate Bond Fund returned 0.42% in the quarter and 8.51% over the full year, ahead of the FTSE Canada All Corporate Bond Index benchmark’s full-year return of -1.34%. Performance in the quarter was led by high-yield bonds, including issues of Bombardier, Occidental Petroleum and Air Canada, whose spreads continued to normalize following the impact of the pandemic. The Fund underperformed the Index by 0.65% for the quarter, as long government rates fell during the period.

For the year, performance can be attributed to the recovery of names affected by the pandemic, such as AMC Entertainment, American Airlines, Occidental Petroleum, Continental Resources and Spirit Aerosystems, all of which experienced significant spread tightening in the period.

The Fund continues to maintain a duration that is meaningfully below that of the Index to mitigate the negative impact of increasing interest rates, as experienced on a full-year basis. The Fund is positioned with a yield of 4.0% and a duration of 3.0 years, and approximately 29% in floating rate notes.

As the economy continues to reopen and recover from the pandemic, corporate spreads for the issuers more affected by the pandemic than others could narrow further. Yields may also climb higher, reflecting the inflationary environment. We expect the Fund to continue to reduce duration and improve quality by opportunistically trimming issues as they reach full valuation, and reinvesting in issues or floating rate instruments to provide further protection against the potential risk of rising rates.

 

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