Monthly commentary discusses recent developments across both the Diversified Bond and Credit Income Opportunities Funds.
As expected, macroeconomic data continued to stabilize. Chinese PMIs were slightly higher in April, European data surprised to the upside (from very depressed levels) and the U.S. economy continues to do well. The April non-farm payrolls were very strong, sending the US unemployment rate to a 49-year low of 3.6%. Encouragingly, after a decade of slow growth, productivity growth is finally ticking up the U.S. (stronger productivity growth means higher non-inflationary growth is possible). Overall, decent data in the U.S. and a decrease of downside risks overseas led Chair Powell to re-emphasize strongly that the Fed is nowhere near cutting rates, as it had become consensus amongst market participants that the Fed would make an “insurance cut” in the near future. Once again the Fed has had to dispel the belief that they are more inclined to cut than raise rates (Figure 1). With the Brexit can kicked down the road again, Chinese and European growth stabilizing and trade tensions (hopefully) coming to an end, the list of downside risks has eased somewhat.
Source: Ninepoint Partners
At the time of writing, the Trump administration was reigniting fears of additional tariffs on Chinese goods. After months of complacency, markets are reacting negatively to these headlines. The situation is very fluid, and it is unclear yet if this is simply a negotiation tactic or if trade tensions are set to re-escalate meaningfully, in which case downside risks to global growth would re-emerge.
Closer to home, Canadian GDP growth continues to disappoint, prompting the Bank of Canada to drop its hawkish bias and to downgrade full year growth expectations to a measly 1.2% (street consensus currently sits at 1.5%). For now, the BoC is officially joining the club of “patient” central bankers, keeping things on hold as they wait for better data in the quarters ahead.
Credit continues to perform surprisingly well; in Canadian Investment Grade (IG), spreads compressed about 10bps in April (a roughly 1-standard deviation move, Figure 2). Spreads are now back to the top end of their old trading range of 110-120bps. The primary market (new issues) remains well subscribed, partly owning to a dearth of supply (year-to-date, supply is down 16%).
Source: Ninepoint Partners
In High Yield (HY), spreads compressed a further ~35bps in April. As discussed last month, we do not believe that current spread levels offer adequate compensation, and as such we have low exposure to that asset class. Recent trade tensions have changed the narrative; in the last few days we have seen HY spreads widen by as much as 15bps. If things escalate further, we might have an opportunity to find some HY bargains.
Diversified Bond Fund (DBF)
April was a relatively good month for the DBF, returning 35bps while broad Canadian bond indices suffered mild losses due to higher interest rates (Figure 3). The impact of higher rates on our government bond positions were relatively muted as French OATS outperformed (only up 5bps vs 10bps in equivalent Canadian and US bonds) and option hedges on our US 30-year government bond position dampened the impact of the rise in yields.
Source: Ninepoint Partners
Our outperformance this month was primarily driven by credit. Conditions were generally favourable as spreads in both HY and IG compressed mildly. Additionally, a strong earnings season for some of our overweight names such as Ford and GE lead to further positive performance.
Most of the changes that we made to the fund were modest, consistent with last month’s commentary. There was a slight increase in duration (now about 4 years) through the purchase of European government bonds. High Yield bonds now make up less than 10% of the fund and their overall credit quality is high (BB). Unless market conditions change materially, we do not expect to make substantial changes to the current portfolio composition.
Diversified Bond Fund Portfolio Characteristics:
Source: Ninepoint Partners
Credit Income Opportunities Fund (Credit Opps)
April was another solid month for the Credit Opps, with a net return of 70bps. As discussed previously, credit continues to perform well and the low duration bias of this fund shields it from the slight increase in interest rates that we witnessed this month.
The main change to the portfolio is the continued decrease in HY, where we have sold most higher risk positions; we took advantage of the move higher in energy to sell down E&P bonds that were up $4-5 from the lows. In addition, we have generic HY hedges expressed through options on the HYG ETF, this accounts for about 20% notional weight, taking our effective HY weight below 0%. Leverage continues to hover around 1x and should remain in this range until IG spreads become more attractive.
For now, our “spring cleaning” is over and we do not expect to make material changes to the fund in the foreseeable future.
Credit Income Opportunities Portfolio Characteristics:
Source: Ninepoint Partners
For now, we are in a wait and see mode; both portfolios are defensively positioned and have a healthy dose of available liquidity. We will continue to collect carry and roll maturing positions into high quality corporate bonds until market dislocations create new opportunities.
In other words, we have no intention of going up the risk spectrum until we get appropriately compensated for it.
Until next month,
The Bond Team: Mark, Etienne and Chris
1 All Ninepoint Diversified Bond Fund returns and fund details are a) based on Series F units; b) net of fees; c) annualized if period is greater than one year; d) as at April 30, 2019; e) 2010 annual returns are from 08/05/10 to 12/31/10. 1 All Ninepoint Credit Income Opportunities Fund returns and fund details are a) based on Class A units (closed to subscriptions); b) net of fees; c) annualized if period is greater than one year; d) as at April 30, 2019. The index is 100% FTSE TMX Canada All Corporate Bond Index and is computed by Ninepoint Partners LP based on publicly available index information.
The Ninepoint Diversified Bond Fund is generally exposed to the following risks. See the prospectus of the Fund for a description of these risks: capital depletion risk (Series T, Series FT, Series PT, Series PFT, Series QT, and Series QFT units only); concentration risk; credit risk; currency risk; cybersecurity risk; derivatives risk; exchange traded funds risk; foreign investment risk; inflation risk; interest rate risk; regulatory risk; securities lending, repurchase and reverse repurchase transactions risk; series risk; short selling risk; substantial unitholder risk; tax risk.
The Ninepoint Credit Income Opportunities Fund is generally exposed to the following risks. See the offering memorandum of the Fund for a description of these risks: speculative investment; general economic and market conditions; assessment of the market; not a public mutual fund; limited operating history for the fund; class risk; charges to the fund; changes in investment objective; strategies and restrictions; unitholders not entitled to participate in management; dependence of the manager on key personnel; reliance on the manager; resale restrictions; illiquidity; possible effect of redemptions; liability of unitholders; potential indemnification obligations; lack of independent experts representing unitholders; no involvement of unaffiliated selling agent; valuation of the fund’s investments; concentration; foreign investment risk; illiquidity of underlying investments; part X.2 tax; litigation; fixed income securities; equity securities; idle cash; currency risk; suspension of trading.
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