April 2024
Going into 2024, investors had expected the U.S. Federal Reserve to cut interest rates six times this year. However, firm inflation readings and resilient economic growth have forced investors to scale back their rate cut previsions. Fears of recession have largely dissipated as consumers continue to spend and businesses continue to hire. Corporate profits are reasonable and there is general enthusiasm for artificial intelligence. In this context, the Fed has signalled three rate cuts this year, even though government spending is expected to rise due to an ageing population and high interest costs.
As for the Bank of Canada, it has kept its overnight rate at 5%. The Consumer Price Index (CPI) and underlying inflation have eased, but remain above the Bank’s target. Shelter price inflation is elevated and the Bank wants to see a sustained easing in inflation before cutting rates.
The Pembroke Corporate Bond strategy performed well in both absolute and relative terms over the last quarter. The strategy benefited from spread tightening and shorter than benchmark duration. Limited recourse capital notes performed strongly over the period and spreads on selected high yield issues from Spirit AeroSystems, LATAM Airlines and Air Canada tightened, contributing to outperformance.
In addition to shorter duration, the strategy’s 28% floating rate weighting proved defensive in a period of rising interest rates. A TransCanada floating-rate issue also benefited from significant spread tightening. The strategy remains selective with regard to credit risk.
The portfolio currently has a higher allocation to short-term, high quality and liquid instruments, such as Government of Canada bonds, National Housing Act Mortgage-Backed Securities (NHA MBS) and bank covered bonds, all of which can be used to fund future credit opportunities. It also continues to hold select high yield issues that are well protected and remain attractive on a risk-adjusted basis.
The strategy enters the second quarter of 2024 with a healthy yield of 6.6%, while maintaining a shorter duration of 2.3 years. It is positioned to take advantage of future opportunities, but is still defensive against volatile government bond yields as inflation persists above central bank targets.
The Pembroke Canadian Bond Strategy declined slightly over the last quarter, but outperformed its benchmark, which also declined. Spread tightening and a slightly shorter duration than the benchmark contributed to the outperformance as yields rose over the period. The top performer was Great West Life AT1, which benefited from significant spread tightening. In addition, the strategy’s 2.6% weighting in floating rate notes was defensive in a period of rising interest rates. TWDC, Toyota and Honda issues also experienced spread tightening of between 21 and 24 basis points.
Going forward, the strategy continues to maintain a significant position in short-term discount Canadian bonds, which can be used to take advantage of future credit opportunities. The strategy enters the second quarter of 2024 with a healthy yield of 4.7% and a duration of 6.6 years, continuing to be marginally short of the benchmark.
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Disclaimer
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.
