Balanced & Fixed Income Strategies

As inflation reached its highest level in more than a decade and positive performance became ubiquitous, US government bond yields retreated from their March 31 levels. Government bond yields had risen sharply in the first quarter, as the markets rode a wave of optimism about the economy. In parallel, the Fed officials have begun discussions about “tapering” bond purchases and have pushed forward the time frame when they expect to raise interest rates.

Many investors agree with the Fed that the high inflation is an aberration related to the reopening of the economy. Progress on vaccinations has reduced the spread of COVID-19, millions of jobs have been lost, and retail sales as well as manufacturing activity remains below pre-pandemic levels. As lockdowns have eased, employers are rushing to hire people and luring them with higher pay. Despite that, the jobless numbers remain high.

In Canada, the second wave of the virus did not dent the strong economic recovery. Consumers and businesses are adapting to containment measures, and housing market activity has been much stronger than expected. Improving foreign demand and higher commodity prices have also brightened the prospects for exports and business investment.

As a result of mid-term and long-term yields declining over the period, it was favourable to hold long-term bonds as duration was rewarded. The longer duration Provincial Index was up 2.7% in the quarter. Overall, corporate bonds outperformed Canada bonds as a result of their higher running yield.

For the quarter, the Corporate Index returned 1.3%, versus 1.7% for the Universe Index. However, in the past 12 months, corporate spread tightening has generated significant outperformance returning 0.8% versus the Universe Index at -2.4%.

Global Balanced Fund

The Pembroke Global Balanced Fund is a fund of funds that invests primarily in Pembroke-managed equity and bond funds, externally managed active funds, and externally managed passive funds and exchange-traded-funds (ETFs). During the second quarter, the fund gained 4.7% but trailed its custom benchmark (30% FTSE Canadian Universe Bond Index, 45% MSCI All-Country World (CAD) Index, and 25% S&P TSX Composite Index) which gained 5.3%.

During the quarter, the fund’s passive US and Canadian ETF holdings benefitted from having both growth and value constituents. The fund’s international active equity holdings performed strongly while the fund’s passive emerging market’s ETF gave a weaker performance as many emerging markets suffered from a rising incidences of the new Delta variant of COVID.

The fund is diversified by asset class, by region, by size (small cap and large cap), and by fund type (active and passive). At the end of the quarter the fund had an approximately 68% allocation to global equities, approximately 27% allocation to corporate and sovereign bonds and cash, and approximately 4% to a gold bullion ETF. The fixed income performance benefitted from the continued strength of the Pembroke Corporate Bond Fund.

Canadian Balanced Fund

Pembroke’s balanced portfolio, the Pembroke Canadian Balanced Fund, delivered positive returns in the second quarter of 2021. Performance was driven by gains in the equity portion of the portfolio, represented by the holdings of the Pembroke Dividend Growth Fund (see the article Canadian Equity Strategies). The fixed income portion of the fund, represented by the Pembroke Canadian Bond Fund (see below), posted flat returns for the quarter 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. The equity portion of the fund has a current annualized gross yield of 2.6%, 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 1.8% and an adjusted portfolio duration of approximately six years. Minor changes to the asset mix of Pembroke’s balanced mandates were made through the year, with approximately 25.9% of the portfolio invested in fixed-income securities on June 30, 2021.

Canadian Bond Fund

The Canadian Bond Fund returned -2.8% for the first half of 2021, which was comfortably ahead of the benchmark return of -3.5%. The Fund returned approximately -1% for the past year, which was also ahead of the benchmark return of -2.4%.

Overall, the Fund benefited from its shorter than index duration, as well as its allocation to floating rate issues. The portfolio had a yield of 1.8% and a duration of 6.1 years at the end of the period. This compares favourably to the index yield of 1.7% and the market’s duration of 8.2 years.

Corporate Bond Fund

The Corporate Bond Fund recorded a strong return of 7.2% in for the first half of the year, which was well ahead of the index return of -2.3%. The 1-year return of 21.5% was also well ahead of the benchmark return of 0.8%.

The outperformance continues to be attributable to the recovery of high yield issuers, who were adversely impacted by the pandemic. Issuers such as Hertz, AMC Entertainment, American Airlines, Air Canada, Bombardier and Occidental Petroleum continue to benefit from the increased vaccination rates and decreased number of cases, ultimately allowing businesses and travel to reopen.

The Fund is well positioned with a yield of 3.1% and a duration of 3.3 years and just over 22% 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 reinvest in attractive issues or floating rate instruments, to provide further protection against the potential risk of rising rates.

 

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• Pembroke’s Corporate Bond Fund
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