The beginning to the year was a rollercoaster. Investors began 2023 feeling upbeat, as inflation appeared to be subsiding. It was widely expected that the U.S. Federal Reserve would quickly switch to cutting interest rates after raising them aggressively last year. However, the markets got a shock in March when two regional banks in the U.S., Silicon Valley Bank and Signature Bank, collapsed.
As depositors fled regional banks, the Federal Reserve intervened to calm the jittery nerves of investors. It announced a new Bank Term Funding Program to lend to banks, savings associations and credit unions. This facility offers loans for one year against pledged U.S. Treasuries, agency debt and mortgage-backed securities. These securities will be valued at par, even when the interest rate increases of last year have eroded their value. Prompt action by the Fed and the U.S. Treasury seems to have calmed bank depositors and investors.
In parallel, the Fed also increased the federal funds rate to 5%, highlighting modest growth in spending and production. The Fed is still committed to returning inflation to a rate of 2% over the longer run and expects some additional tightening.
This situation underlines an important disconnect between market expectations, which are hoping for interest rate cuts later this year, and the official Fed projections that expect rates to remain high. However, the Fed’s balance sheet, that was gradually shrinking through the reversal of quantitative easing policies, has grown again after the failure of the two commercial banks.
As for the Bank of Canada, it recently left its overnight policy rate unchanged at 4.5%. The central bank believes that monetary policy is restrictive and is weighing on household spending: business investment has weakened alongside slowing domestic and foreign demand. However, the labour market remains tight and employment growth strong.
Corporate Bond Fund
The Pembroke Corporate Bond Fund returned 2.91% in the last quarter, ahead of the benchmark’s return of 2.79%. A drop in government yields outweighed modest widening in investment grade credit spreads, driving bond prices higher. Below investment grade bonds, including issues from AMC Entertainment, Avis Budget and secured airline debt, also saw credit spread tightening and were a positive contributor to outperformance.
In addition, the portfolio holds several lines of senior unsecured Credit Suisse bonds, which were added to throughout the period. Despite experiencing significant volatility, the bonds ended the quarter higher in price.
The Fund continues to maintain a duration notably below the index, and a large liquidity position comprised of Canada bonds, which can be effectively sold to take advantage of future opportunities. Moving forward, the Fund is well positioned with a yield of 7.0%, a duration of 2.2 years and an allocation of 31% in floating rate notes, which can benefit from spread tightening, while contributing to a short duration.
Canadian Bond Fund
The Pembroke Canadian Bond Fund returned 2.84% in the first quarter, underperforming the benchmark by 38 basis points, as a relatively short duration detracted from performance when yields fell over the period. Long duration positions generally lead performance, as the drop in yields outweighed modest spread widening in investment grade bonds. Select bonds tightened in spread, such as a Bank of America Floating-Rate Note and ORNGE bonds.
The Fund enters the second quarter of 2023 with a yield of 4.4% and duration of 6.1 years, which compares favourably with the benchmark yield of 3.9% and duration of 7.3 years. The Fund will maintain its defensive positioning and increased weight in high-quality liquid bonds, which can be used to take advantage of future opportunities.
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.