Ninepoint Fixed Income Strategy

July 2019 Commentary

Monthly commentary discusses recent developments across both the Diversified Bond and Credit Income Opportunities Funds.

Macro

Well, the trade truce was short lived.

Notwithstanding all the important central bank meetings in July (Fed and ECB in particular), the highlight of the month was without question Trump announcing the dreaded 10% tariffs on the last $300bn of imports from China. At the time of writing, the export restriction waivers for Huawei were still nowhere to be found and China had reportedly halted all purchase of U.S. agricultural goods. Furthermore, China has allowed the Renminbi to depreciate past the psychologically important 7 level, stoking fears of currency wars. For those hoping for a stabilization of trade tensions, this is a serious setback. From our standpoint, these actions are the natural continuation of the U.S.’ strategy of containment. The incessant volte-face by the American administration has completely eroded their credibility. After everything that has happened over the past several months, it is inconceivable to us that the two sides could come together and agree on anything. Nonetheless, with Trump being Trump, we shouldn’t be surprised that sentiment around this trade war will continue to be volatile.

Across the pond, UK and Italian politics have injected another dose of uncertainty to an already feeble European economy. Boris Johnson was officially sworn in as Prime Minister, taking the British pound down over 3% in a few weeks with his hard Brexit posturing. It is now increasingly clear that he is committed to a high stakes game of chicken with the rest of the European Union, refusing to engage with them unless they rescind the Irish Border Backstop from the deal (a non-starter for them). A hard Brexit on October 31st is now increasingly more likely.

 

In Italy, the coalition government led by the League and the 5-Star movement is increasingly fragile, and elections in the fall seem like the most probable outcome. The League’s Mateo Salvini is leading in the polls and is expected to form the next government, possibly a coalition with a fringe far right party (as opposed to the current coalition with the far left 5-Star). This could spell trouble for the Euro Zone as a Salvini led government is set to clash with Brussels over budget constraints, raising the spectre of Italexit once again. Italian sovereign spreads are once again widening violently.

The bond market’s reaction to this cascade of headlines and developments was extreme; global bond yields declined precipitously, sending a record amount of global debt to negative yields to maturity (Figure 1). In several European countries, the entire government yield curve (tenors from 1 month to 30 years) has negative yields. Closer to home, although interest rates are not negative yet, the Canadian and U.S. yield curves are inverted (i.e. the 10-year yield is lower than the 3-month T-Bill yield) by 40bps and 30bps, respectively. According to our models, this suggests that the probability of entering recession in the near future (roughly 12 months) now sits above 50%. We do not take these signals lightly, as they are historically quite accurate, registering only one false alarm in the mid-1960s.

At this juncture, the bond market is telling us that we are well past this idea of “insurance cuts” by the Fed. As shown in Figure 3 below, the market is now pricing 100bps of further rate cuts by the Federal Reserve in the next 12 months (taking the total to 125bps). In the mid-1990s, mild cuts by the Fed to stabilize the economy were only 75bps. In Canada, where we would argue the BoC is behind the curve, only 55bps of cuts are priced in in the same time frame. We expect the BoC to follow the lead of global central banks and start easing soon. For the ECB, after disappointing the most dovish of expectations in July, the stage is set for them to cut rates and announce a new quantitative easing program.

Communications from central bankers at Jackson Hole in late August, along with meetings in September (BoC, ECB and Fed) will be crucial for near term market developments. While they are very unlikely to sound the recessionary alarms just yet, the tone and details of their macroeconomic forecasts for the next two years should provide some valuable insight into their probable next steps.

Source: Bloomberg

Credit

Credit remains resilient as the thirst for yield continues, but the equity volatility of the first few weeks of August is starting to influence spreads. A few corporate issuers have tried to take advantage of very low all-in yields, but investor appetite is not as strong as it was earlier in the year. We continue to be increasingly selective in the new issue market. From the recent lows, credit spreads are only modestly wider, not justifying us to take more risk. For now, we are maintaining our conservative positioning with higher quality, lower duration credit.

Diversified Bond Fund (DBF)

July was a good month for the DBF, returning 28bps (Series F), driven mostly by carry. We have continued to increase duration and our government bond allocation, consistent with our investment framework and macroeconomic views. In early August, we added 10-year U.S. government bonds to the portfolio, taking our duration up to 6 years. Our corporate bond portfolio remains very short dated and defensive, with a duration of only 2.9 years.

 Source: Ninepoint Partners

Credit Income Opportunities Fund (Credit Opps)

The Credit Opps returned 40bps (Series A) in July. Returns were driven by carry and strong credit performance following Q2 earnings. Leverage remains low and stable, consisting primarily of two to five years’ duration corporate bonds. Consistent with our macro outlook, following month end we increased our allocation to U.S. 10-year government bonds by 20%, taking the fund’s duration up to 3.5 years. We also have a roughly 15% delta notional weight in credit hedges through options and outright short positions in the HYG ETF. Given this very defensive posture, the fund is well positioned to weather the recent market volatility.

Source: Ninepoint Partners

Conclusion

As regular readers will know, we have been quite cautious since the beginning of 2019, gradually de-risking portfolios, taking duration up, spread duration down and allocating more to government bonds. Recent events have only reinforced our conviction in our end of cycle thesis. We continue to be defensive and keep our powder dry for when credit offers true bargains.

Until next month,
The Bond Team: Mark, Etienne and Chris

 

Ninepoint Diversified Bond Fund - Compounded Returns¹

1M YTD 3M 6M 1YR 3YR 5YR Inception
Fund -0.3% 4.9% 0.9% 2.5% 4.7% 3.7% 4.0% 4.5%

Ninepoint Diversified Bond Class - Compounded Returns¹

1M YTD 3M 6M 1YR 3YR 5YR Inception
Fund -0.3% 4.7% 0.9% 2.4% 4.5% 3.6% 3.9% 4.7%

Ninepoint Credit Income Opportunities Fund - Compounded Returns¹

1M YTD 3M 6M 1YR 3YR 5YR Inception
Fund -0.1% 5.4% 0.2% 1.6% 2.7% 3.6% 4.0% 4.8%

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 July 31, 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 July 31, 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.

 

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: 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; Tax; Litigation; Fixed Income Securities; Equity Securities; Idle Cash; Currency Risk; Suspension of Trading.

Ninepoint Credit Income Opportunities Fund is offered on a private placement basis pursuant to an offering memorandum and are only available to investors who meet certain eligibility or minimum purchase amount requirements under applicable securities legislation. The offering memorandum contains important information about the Funds, including their investment objective and strategies, purchase options, applicable management fees, performance fees, other charges and expenses, and should be read carefully before investing in the Funds. Performance data represents past performance of the Fund and is not indicative of future performance. Data based on performance history of less than five years may not give prospective investors enough information to base investment decisions on. Please contact your own personal advisor on your particular circumstance. This communication does not constitute an offer to sell or solicitation to purchase securities of the Fund. 

Ninepoint Partners LP is the investment manager to the Ninepoint Funds (collectively, the “Funds”). Commissions, trailing commissions, management fees, performance fees (if any), other charges and expenses all may be associated with mutual fund investments. Please read the prospectus carefully before investing. The indicated rate of return for series F units of the Fund for the period ended July 31, 2019 is based on the historical annual compounded total return including changes in unit value and reinvestment of all distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The information contained herein does not constitute an offer or solicitation by anyone in the United States or in any other jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. Prospective investors who are not resident in Canada should contact their financial advisor to determine whether securities of the Fund may be lawfully sold in their jurisdiction.

The opinions, estimates and projections (“information”) contained within this report are solely those of Ninepoint Partners LP and are subject to change without notice. Ninepoint Partners makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, Ninepoint Partners assumes no responsibility for any losses or damages, whether direct or indirect, which arise out of the use of this information. Ninepoint Partners is not under any obligation to update or keep current the information contained herein. The information should not be regarded by recipients as a substitute for the exercise of their own judgment. Please contact your own personal advisor on your particular circumstances. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds managed by Ninepoint Partners LP. Any reference to a particular company is for illustrative purposes only and should not to be considered as investment advice or a recommendation to buy or sell nor should it be considered as an indication of how the portfolio of any investment fund managed by Ninepoint Partners LP is or will be invested. Ninepoint Partners LP and/or its affiliates may collectively beneficially own/control 1% or more of any class of the equity securities of the issuers mentioned in this report. Ninepoint Partners LP and/or its affiliates may hold short position in any class of the equity securities of the issuers mentioned in this report. During the preceding 12 months, Ninepoint Partners LP and/or its affiliates may have received remuneration other than normal course investment advisory or trade execution services from the issuers mentioned in this report.

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