Fixed Income & Balanced Strategies – Q4 2020
Fixed Income Market – Q4 Portfolio Commentary
The announcement of effective COVID-19 vaccines in November lit a fire under markets in the fourth quarter. Equity and credit markets were both strong. This strength was more broadly supported by the Federal Reserve’s plans to continue their low interest rate policy until their twin objectives of maximum employment and inflation of two per cent are reached. The Fed is prepared to allow moderately higher inflation in the short term so that inflation averages two per cent over time. The Fed maintained its pace of purchasing Treasury securities and agency mortgage-backed securities to sustain smooth market functioning.
The Bank of Canada has also acted decisively to cut interest rates to protect the Canadian economy that is reeling from the widespread impact of the pandemic. The central bank provided liquidity to Canadian banks as the government urged the banks to support businesses and consumers through these difficult times. The central bank has expanded its balance sheet significantly by purchasing mortgage bonds, corporate and provincial bonds, and commercial paper.
Corporate bonds performed well in this environment with the Corporate Index returning 1.8% during the quarter as credit spreads tightened compared with a -0.4% return for Canada bonds as Canada yields rose slightly. Spreads on lower quality BBB bonds tightened even more than the broader market and returned 9.4%. Full-year returns were also strong for the Corporate and Universe Indexes which both returned 8.7%.
Pembroke Corporate Bond Fund
The Corporate Bond Fund posted a return of 8.5% in the quarter which was well ahead of the index return of 1.8%. The 1-year return of just over 22% was also well ahead of the benchmark’s 1-year return of 8.7%. The fund benefited from the broad rally in corporate issues as the mood improved with the prospect of numerous vaccines becoming available. A portion of the outperformance can be attributed to energy-related holdings such as Cenovus and Continental. Additionally, issues such as Air Canada, American Airlines, Spirit AeroSystems, and Hertz all had strong rebounds as their business prospects improved dramatically during the period. The fund was held back by its exposure to AMC as the future of movie screenings and new releases continues to evolve, however the credit’s very healthy 10.5% coupon has nearly made up for the negative price return. The fund is well positioned with a yield of 4.6% and a duration of 4.0 years.
While the fund is opportunistic and the manager may adjust allocations to investment grade and sub-investment grade credits, Pembroke believes the current allocation of more than 60% to sub-investment grade credits may result in higher correlations with equities and lower diversification value when combined with a portfolio of equities. Please contact your Pembroke representative if you wish to review your asset allocation.
Pembroke Canadian Bond Fund
The Pembroke Canadian Bond Fund returned 1.2% in the final three months of 2020 which was comfortably ahead of the benchmark return of 0.6%. The fund posted a return of almost 7% in the calendar year which was slightly behind the benchmark index. The fund benefited from spread narrowing on its corporate holdings but was held back by its higher quality stance and lack of BBB exposure. The portfolio had a yield of 1.5% and a duration of 6.7 years at the end of the quarter. This compares to the index yield of 1.2% and duration of 8.4 years.
Dividend/Balanced Fund Commentary
Pembroke’s balanced portfolio, the Pembroke Growth and Income Fund, posted strong returns in the fourth quarter of 2020. Performance was largely driven by gains in the equity portion of the portfolio, represented by the holdings of the Pembroke Dividend Growth Fund, and were supplemented by modest returns in the fixed income portion of the fund, represented by the Pembroke Canadian Bond Fund.
As discussed in earlier commentary, equity returns of the fund were buoyed by the development of effective COVID-19 vaccines and the continuation of decisive fiscal and monetary measures designed to counter the fallout from COVID-19. Fixed income returns of the fund were driven by coupon payments from bond investments, offset somewhat by the challenges of rising interest rates on bond prices.
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 2.4%, while the fixed income segment of the fund is primarily invested in securities rated A or AA and above that, on average, have a collective yield to maturity of 1.5% and a portfolio duration of 6.7 years. Minor changes to the asset mix of Pembroke’s balanced mandates were made through the year with approximately 29% of the portfolio invested in fixed income securities at December 31, 2020.
Global Balanced Fund Commentary
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 fourth quarter, the Fund gained approximately 8.%; its benchmark (30% Canadian Universal Bond Index, 45% MSCI All-Country World Index, and 25% S&P TSX Composite Index), gained 6.7% over the same period. The Fund gained 19.0% in the year-ended December 31, 2020; its benchmark returned 10.7% over the same period.
During the fourth quarter, the Global Balanced Fund maintained a larger than usual cash position as it reduced its allocation to the Pembroke Corporate Bond Fund and made an allocation to the Lysander-Canso Bond Fund, a portfolio of investment grade-only, high-quality Canadian dollar-denominated fixed income securities including both Canadian and foreign issuers. The addition of the Lysander-Canso Bond Fund came as we reduced the Global Balanced Fund’s exposure to sub-investment grade credit, which had increased as a proportion of the Pembroke Corporate Bond Fund during the second and third quarters. While the portfolio’s sub-investment grade credit performed very well in the second half of 2020, sub-investment grade credit and equities can have relatively high correlations. The reduction in the weight of the Corporate Bond Fund was a risk reduction measure intended to reduce a rising correlation between the portfolio’s fixed income holdings and its equity holdings.
The Fund remains diversified by asset class, by region, by factor (small cap and large cap), and by fund type (active and passive). At the end of the quarter the Fund had an approximately 70% allocation to global equities and mutual funds including a passive ETF allocation of less than 3% to gold bullion. The Fund had an approximately 29% allocation to Canadian corporate and sovereign bonds and cash. The Fund’s active equity allocations benefitted from the underlying managers’ focus on high-quality growth companies in markets across the world. The fixed income performance benefitted from the continued strength of the Pembroke Corporate Bond Fund which outperformed its benchmark during the quarter. At the end of the quarter, the Corporate Bond Fund had a yield to maturity of 4.6% and a duration of 4.0 years.
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- Pembroke’s Canadian Bond Fund
- Pembroke’s Corporate Bond Fund
- Pembroke’s Canadian Balanced (Growth and Income) Fund
- Pembroke’s Global Balanced Fund
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Other Articles Of Interest
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.