January 2025
During the fourth quarter, the Federal Reserve cut interest rates by a further two-quarter points. The central bank acknowledged that economic activity is strong and the labour market reasonably healthy. While inflation has eased, it remains above its two percent target.
Investors were surprised when the Fed cautioned against further aggressive rate cuts in the future. Going forward, the inflation numbers could be muddied by the president-elect’s tariffs and deportation of unauthorized immigrants. His other campaign promises of tax cuts and looser regulation could also prove inflationary.
As for the Bank of Canada, it lowered its overnight interest rate as economic activity softened due to lower business investment and exports. However, consumer spending and housing activity have picked up in response to lower interest rates. Employment growth has slowed, but wage growth remains elevated.
Lower immigration and tariffs from the new US administration are expected to weaken economic growth. The Canadian dollar has depreciated significantly against the US dollar, which could weigh on consumer sentiment and raise import prices.
CORPORATE BOND STRATEGY
Pembroke’s corporate bond strategy returned 1.53% in the fourth quarter, outperforming its benchmark by 0.50%, as tighter corporate credit spreads offset a rise in government bond yields. For the year, the portfolio is up 8.30%, outperforming its benchmark by 1.33%.
Limited recourse capital notes, including issues from Manulife, Sunlife and TD Bank, continued to lead performance in the final quarter of 2024. These securities outperformed in every quarter through the year. A long-dated junior subordinated floating rate note issued by TransCanada Pipelines also gained $6 in the fourth quarter as spreads tightened. In addition, high yield holdings in Air Canada and Hertz continued to benefit from positive market sentiment.
The strategy remains conservatively positioned with 48.4% invested in AAA/AA-rated securities, of which 40.9% is in government bonds. The proportion of the portfolio invested in variable-rate bonds fell to 5.5% from 29.6% at the beginning of the year. These securities protected the portfolio from rising interest rates as monetary policy began to tighten, but are less attractive when central banks cut rates. Duration ended the period at 3.6 years, well below the benchmark duration of 5.8 years.
The portfolio continues to hold selected high-yield bonds that are well structured and remain attractive on a risk-adjusted basis. It is conservatively positioned with an emphasis on liquid, high-quality instruments, such as Government of Canada bonds and National Housing Act mortgage-backed securities. These assets can be used for future opportunities.
CANADIAN BOND STRATEGY
Pembroke’s Canadian bond strategy returned 0.54% in the fourth quarter, outperforming its benchmark by 0.58%, as tighter corporate credit spreads offset a rise in government bond yields. For the year, the portfolio is up 5.24%, outperforming its benchmark by 1.01%.
A limited recourse capital note issued by Great West Life, which accounts for 2.4% of the portfolio, led performance in the fourth quarter after rising 6% in price as spreads tightened. This security outperformed every quarter through 2024. Also contributing to performance over the last three months were the long A-rated bonds of 407 International, Enbridge Gas, Coastal Gas Link and Hydro One, which experienced spread tightening of between 17 and 33 basis points.
Duration ended the period at 7.2 years, which remains broadly neutral relative to the benchmark. The strategy is conservative, with an emphasis on liquid, high-quality instruments, such as Government of Canada bonds and National Housing Act mortgage-backed securities. These assets can be used for future 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.
