Monthly commentary discusses recent developments across both the Diversified Bond and Credit Income Opportunities Funds.
November was the month for vaccines and the “reopening” trade; small caps, value stocks and distressed high yield bonds had a formidable month, as investors rapidly rotated into the investments they though would benefit the most from a return to “normal”. At the time of writing, both the Pfizer and Moderna vaccines had reported >90% efficacy and should start being distributed in the US, Canada and the UK around mid-December, although in small quantities. The Astrazeneca vaccine also reported good efficacy numbers (70%), but it was later released that manufacturing inconsistencies had tainted the results consequently the trials would need to be extended.
The two remaining unknowns are how extensively those vaccines will be distributed and what will be the uptake by individuals. The most expensive and effective vaccines (Pfizer and Moderna) need to be kept at very low temperatures and the supply chain logistics required have pushed Pfizer to design their own dry ice shipping containers. Additionally, those vaccines require two injections, which further complicate the administration of the vaccination program. So, while manufacturers assure us that they will produce enough doses to vaccinate a large portion of the north American population by the third quarter 2021, the jury is still out on whether or not the logistics and medical supply chains will be able to deliver this outcome.
The other important question is, what will be the uptake by the general population? Experts say that we need about 70% of the population to be immune to the disease to develop herd immunity, the threshold for return to “normal”. Figures across countries vary, but recent polls show that only about 35-60% of the citizens of countries such as US, UK and France are willing to get vaccinated for COVID-19. That’s still too low for herd immunity, but we suspect that over time, as the vaccines prove their safety and efficacy, the people’s reluctance to take them will diminish.
Still, the “grand reopening” assumption that the market is currently trading under is a probable scenario, but the timing remains very much an open question, and with every passing day under restrictions/lockdown, the damage to the economy becomes a bit more persistent. Following in Europe’s footsteps, the second (or third?) wave of COVID-19 infections and the associated lockdowns across many regions of North America serves as a reminder that, as good as the vaccine news is , we are not out of the woods just yet (Figure 1).
Monetary authorities are well aware of this reality, hence their insistence on more stimulus. In Europe, the ECB has recently increased its QE program by 500bn Euros and extended its subsidized lending programs to banks by another 12 months. In the U.S., given the lack of additional fiscal impulse and the deceleration of the economic data in November, we expect that the Federal Reserve will need to provide additional forward guidance on its quantitative easing programme at its December meeting. Furthermore, it is highly likely that they decide to tilt their purchases of treasuries to the long end, keeping rates better anchored along the yield curve.
Following the positive vaccine news, credit, just like equities, continued to rally strongly. As of November month-end, corporate credit spreads were within a few basis points of their pre-covid lows (Figure 2). The rally has been relentless, appetite for corporate bonds is such that the few new issues that came to market last month were sometimes oversubscribed by a factor of six.
Current market conditions feel stretched. As discussed last month, given our outlook for interest rates (very low for a long time), it is natural for investors to congregate to spread product, as it is the only place where one can generate an acceptable return. However, at current spread levels, we find it hard to get overly excited to put money to work. As long-time readers would know by now, we are disciplined in our process, preferring to reduce risk when market conditions feel stretched, as opposed to increasing risk to reach for additional return. Accordingly, we are taking a wait and see approach.
November was a good month for the DBF, gaining 84bps. Most of the month’s returns were driven by the strong performance of our credit positions. Also, the large increases in interest rates witnessed ahead of the US Election have subsided as the outlook for further fiscal stimulus have diminished. While we still maintain a position in long term government bonds for ballast, we have decided to protect the portfolio from further rates induced volatility by moving some of our US treasuries into the TLT ETF and entering into a no cost put spread collar. These changes effectively reduce the volatility of those positions by half but maintain our upside participation should rates decline. These changes affect the geography of the fund characteristics table below, (government bonds decline, ETFs increase). Fund duration has declined, mostly due to the effect of the TLT options (-0.2 years). Over the next month we will be evaluating the second wave of the virus and its impact on growth relative to our positioning. We should also have some clarity on the US fiscal package and perhaps some new information on changes to the Fed’s purchasing program. Its still early, but our bias is to start reducing our government bond positions and the duration of those securities. On the credit front we are considering extending the duration of our IG credit, potentially adding some high yield if conditions warrant. Emerging markets are also a consideration, as they should benefit from an extended period of low interest rates.
Credit continued to perform exceptionally well throughout November and the Credit Opps fund had a solid month, returning 2.94%. Over the month we participated in many attractive new issues. Consequently, we increased leverage slightly to take advantage of these opportunities. Although its difficult to fight this move in credit we think its prudent to lighten up on some of the credit positions we purchased this year, reducing leverage in the coming months. We have a great line-up of securities and trades that we are currently researching. Even in this ultra-low rate environment there still exists opportunities to generate yield and higher income with attractive risk reward characteristics.
We are in the middle of the second wave of the pandemic, restrictions and lockdowns are bound to increase and negatively impact economic activity. Markets are trading at all time highs, ignoring the present and instead focusing on a future when things come back to normal, thanks to widespread vaccination. While we do not disagree with the end point, the road to get there is bound to be a bit bumpier than what market participants seem to be implying. This apparent disconnect is traditionally a source of future volatility. We are patiently waiting for this volatility to deploy more capital.
Until next month,
Mark & Etienne
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 November 30, 2020 1 All Ninepoint Credit Income Opportunities Fund returns and fund details are a) based on Class F units; b) net of fees; c) annualized if period is greater than one year; d) as at November 30, 2020.
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