Monthly commentary discusses recent developments across both the Diversified Bond and Credit Income Opportunities Funds.
Between the Fed, the ECB and the G20, June was another busy month in global affairs.
After the escalation of the US/China trade war witnessed in May, all eyes were on the G20 meeting in Osaka, where Presidents Trump and Xi were scheduled to meet and discuss trade matters. Given the circumstances, the outcome of the meeting was as good as it could have been as both leaders agreed on a truce. Trump is pausing for now on further increases in tariffs (i.e. the last $300bn of goods imported from China) and agreeing to relax some export restrictions on technology firm Huawei. Both sides have agreed to resume talks, but at the time of writing, we have yet to see any meaningful interactions.
From our perspective, the damage of the trade war to the global economy has already been done. Business sentiment is low, companies are deferring investments and moving supply chains to other countries. This disruption is akin to a negative supply shock, which is now feeding through the global economy (Figure 1).
Source: Goldman Sachs
Notwithstanding the “trade truce”, Central Bankers have acknowledged the increased risks to the downside and are acting promptly. First was the ECB’s outgoing President Mario Draghi, who delivered a speech that cemented market expectations for another easing package. The Eurozone economy remains very weak and inflation expectations are plummeting. The ECB has very few monetary bullets left, and it knows it. In this context, it is widely accepted amongst central bankers and academia that a strong and forceful response is the best course of action. As such, we expect the ECB to announce further rate cuts and another round of quantitative easing by their September meeting.
In the U.S., the Federal Reserve’s Chairman Jerome Powell has all but confirmed market expectations for a rate cut in July. The main question now is how many further “insurance cuts” the Fed delivers against a constructive domestic backdrop and increasing downside risk to the global economy. It remains to be seen if a few decreases in the Federal Funds Rate will be enough to offset the negative shock to confidence stemming from the Trade War.
In Canada, the BoC kept rates unchanged at its most recent meeting, acknowledging the same cross-currents to global growth as other Central Bankers. However, given strong economic data and with inflation right on target, the tone was decidedly less dovish than Draghi or Powell. While the BoC is duly aware of the sensitivity to global (and particularly U.S.) growth of a small open economy like Canada, they have decided for now to remain patient.
With the Fed and the ECB all but certain to ease monetary policy (joining a plethora of other smaller central banks that have already eased in recent weeks), we find it odd that Governor Poloz would maintain a neutral bias. In the short term, diverging monetary policy stances should put upward pressure on the Canadian dollar. Eventually, Poloz will have no choice but to follow the global easing cycle. For now it seems like the BoC could be falling behind the curve.
Credit, just like equities, is performing very well. Both Investment Grade (IG) and High Yield (HY) spreads continue to grind tighter as the thirst for yield drives strong demand. We continue to believe that easier monetary policy on the back of weaker economic growth is nothing to be celebrated. Unless investors think that central banks will ease policy irresponsibly even if growth miraculously picks up, we see more downside than upside risks to equities and credit.
Diversified Bond Fund (DBF)
June was a good month for the DBF, returning 41bps, driven by a combination of spread tightening and carry. We continue to increase duration and our government bond allocation, consistent with our investment framework and macroeconomic views. We added 30-year Canadian government bonds to the portfolio, taking our duration up to 5.4 years.
With 23% government bonds and a very conservative IG and HY positioning, we would not expect drastic changes to the portfolio in the near term. On the margin, we are exploring options to best benefit from a second round of QE in Europe and might modify the composition of our eurozone government bonds.
Diversified Bond Fund Portfolio Characteristics:
Source: Ninepoint Partners
Credit Income Opportunities Fund (Credit Opps)
The Credit Opps returned 28bps in June. Returns were driven by two offsetting factors. First, as discussed previously, Canadian investment grade credit continues to perform well, benefiting the fund’s credit positioning. On the flip side, the strong rally in HY led to offsetting losses in our credit hedges (through HYG options). Leverage remains low and stable, consisting primarily of two to five years’ duration corporate bonds. Cash and equivalents is high, but this is primarily driven by our participation in the commercial paper market, where we have found attractive opportunities that yield considerably more than short term, highly rated corporate bonds.
Credit Income Opportunities Portfolio Characteristics:
Source: Ninepoint Partners
Global macroeconomic developments and the associated monetary response is top of mind. We continue to monitor the situation and, while we definitely have a bearish bias, we remember vividly the 2016 rebound in the global economy and as such remind open minded. After month end, we hedged both fund’s US dollar exposure to 0%, consistent with our BoC outlook.
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 June 30, 2019 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 June 30, 2019.
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 shares only); Capital gains risk; Class risk; Concentration risk; Credit risk; Currency risk; Cybersecurity risk; Derivatives risk; Exchange traded funds risk; Foreign investment risk; Inflation risk; Interest rate risk; Liquidity risk; Regulatory risk; Securities lending, repurchase and reverse repurchase transactions risk; Series risk; Short selling risk; Specific issuer risk; Tax risk; Tracking risk.
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