October 2024
In September, the US Federal Reserve made a bold move by cutting the federal funds rate by half a percentage point. The central bank acknowledged that while economic activity is expanding solidly, job gains have slowed.
US inflation eased to 2.5% in August, but the core measure, which excludes food and energy costs, is still above 3%. Rising tensions in the Middle East could also affect the Federal Reserve’s plans to cut interest rates. In addition, the upcoming US election poses a challenge, as both candidates are unlikely to be committed to prudent fiscal policy.
North of the border, the Bank of Canada cut its overnight rate to 4.25% as economic activity weakened. The central bank is cautious about the slower pace of hiring combined with elevated wage growth. Headline inflation has slowed further to the bank’s 2% target, but core inflation remains higher.
Bond markets rallied over the period as interest rates fell across the government yield curve. Longer-duration indices benefited most from the decline. In parallel, corporate credit spreads tightened further in the third quarter. They have made a positive contribution on a year-to-date basis.
CORPORATE BOND STRATEGY
A decline in yields and tighter corporate credit spreads positively impacted fixed income markets in the third quarter. Pembroke’s Corporate Bond Strategy returned 3.25% in the quarter. However, this strong absolute result lagged the benchmark return of 4.7%, which benefited from a longer duration.
Positive contributors to the portfolio included Avis, Corus and Hertz, along with limited recourse capital notes that continue to drive year-to-date outperformance. Year-to-date, the portfolio is up 6.67%, ahead of the benchmark by 0.79%.
Overall, the portfolio’s credit quality improved as it reduced high yield issues and corporate floating rate notes in favour of AAA-rated National Housing Act Mortgage-Backed Securities and Canada bonds. Floating rate holdings dropped by 20.3%, ending the period at 8.4%, while the Federal Government weight increased by 17.3%, ending the period at 41.3%.
Proceeds were primarily reinvested in five to seven-year Canada bonds, increasing the midterm cohort by 17.3%. As a result, portfolio duration also increased by 1.5 years, ending the quarter at 3.6 years, still meaningfully below the benchmark duration of 5.8 years. Falling interest rates and a move to higher quality holdings reduced the portfolio yield to 5.4%, which remains above the index by 1.3%.
The strategy continues to hold select high yield issues that are well structured and remain attractive from a risk-adjusted perspective. It is postured conservatively with emphasis on liquid and high-quality instruments, such as Government of Canada bonds and National Housing Act Mortgage-Backed Securities, which can be used to fund future credit opportunities.
CANADIAN BOND STRATEGY
Pembroke’s Canadian Bond Strategy returned 4.47% over the third quarter, slightly underperforming the benchmark return of 4.67%. Positive contributors included long-dated issues from Coastal GasLink Pipeline, Hydro One, Enbridge and 407 International. Limited recourse capital notes continue to be a driver of outperformance on a year-to-date basis. The portfolio’s year-to-date return of 4.68% is 0.41% above the benchmark.
The strategy extended duration by 0.8 years through a reduction of the allocations in short-term and floating-rate securities. Despite the increase in duration over the period, having a shorter duration than the benchmark during a period of falling yields detracted from performance.
As a result of falling interest rates, the strategy’s yield fell by 0.6% to end the period at 4.0%. It remains 0.5% ahead of the index. The strategy is conservative, with a focus on liquid, high-quality instruments, such as Government of Canada bonds and National Housing Act Mortgage-Backed Securities, which can be used to fund future credit opportunities.
Other Articles Of Interest
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.
