December 2011
by Ben Cheng
The Fund lagged its benchmark earlier this year as Canadian equities performed well in the spring and Canadian Financials outperformed their global peers. However, the ongoing troubles in Europe continued to play havoc with investors as many flocked to the safety of the US dollar and Treasury bonds in the second half of 2011. In this environment, the Fund outperformed its benchmark in the second half and now year to date as well due to a heavier weighting in high yield bonds versus equities.
Performance in Canadian equities proved to be quite different across industry sectors. Industries with long duration assets and dependable cash flows such as REITs and Pipelines/Utilities were strong performers in 2011, while the Oil & Gas sector and the Materials sector underperformed significantly. The portfolio has maintained its weightings in REITs and Pipelines/Utilities as we believe they will continue to be strong performers if the problems in Europe are not resolved. Within the REIT sector, the portfolio held Canmarc REIT when Cominar REIT announced its intention to acquire Canmarc. The portfolio converted its holdings of Canmarc into Cominar and added more on the transaction as Cominar is a very well-run REIT that focuses almost exclusively on real estate in Quebec. The Fund also increased its holdings in Gibson Energy, a strong performer in the storage, treatment and transportation of oil, natural gas and other liquids.
The Fund added to its holdings in high yield bonds throughout 2011. Even though this asset class has lagged the performance of investment grade bonds it has still far outperformed the Canadian equity market. Within this asset class the portfolio maintains a significant weight in senior secured first lien securities, otherwise known as “bank debt”. The Portfolio sub-advisor believes these securities offer the better protection than the subordinated debt from the same issuer and in many cases still offers significant cash yield.
2012 will likely not be a kind year for our friends in Europe. Even if the European governments can agree upon the size and implementation of a bailout package for the weaker nations, the likelihood of a prolonged recession in Europe seems all but assured. Multi-year austerity packages are the flavor of the day and will severely curtail any economic recovery in the weaker nations for years if not decades. Political instability is sure to follow as the European people search desperately for the leader who will take them out of this mess without making any cutbacks to their standard of living! As one political leader after another continues to try and make the people see the reality of their situation, there is bound to be a revolving door for the top political job in many of the periphery nations.
But all is not gloom and doom out there. The US economy has shown signs that an economic recovery may be just around the corner. Fourth quarter GDP growth is likely to be 3.5% which is well above the 1.5% pace that was set in the third quarter. Auto sales remain strong and the Christmas sale season will likely show decent strength as well. Most importantly the housing market appears to be approaching a bottom. Pending home sales in December were up almost seven percent which followed pending home sales in November of almost 7.5%. Job growth in the US is key to the sustainability of this recovery. Even here we see signs of recovery, as initial jobless claims have trended down since the summer. While all of these factors point to a recovery the real test will be to see the continuation of this positive trend into 2012.
In this environment of uncertainty, high yield bonds should outperform equities until we see more significant signs of stabilization. High yield bonds still offer a yield to maturity of almost 8.5% and we find that to be an attractive rate of return for this asset class. The overall investment strategy for 2012 will remain the same, as the Portfolio Sub-Advisor will continue to focus on securities from high quality companies with either common dividends or high yield from their bonds to help generate performance for the Fund.
