Income Fund Commentary

Market Overview

Interest rates rose in the quarter, as there were positive signs that the global economy is picking up. The Canadian bond market lost modest ground (when rates rise, bond prices fall). 10-year government bond yields started the year under 2%, but rose to 2.1% by the end of March.
The Canadian stock market pushed forward, but lagged most global markets as many commodity prices declined (excluding oil).

Portfolio Specifics

While government bonds and the broad Canadian bond market fell in value, the bond portion of the portfolio held its ground, due largely to its focus on corporate bonds and its emphasis on shorter-term bonds, which are less sensitive to changes in interest rates.
10-year government bond yields are currently lower than the core rate of inflation, reflecting an enormous divergence from fundamentals. The fund holds a minimal weighting in these securities (with a focus on short-dated bonds) based on the manager’s view (Connor, Clark & Lunn Investment Management Ltd.) that rates will rise over time.
The corporate sector gained ground due to an improved outlook. Credit spreads (the difference in yield between corporate and government bonds) tightened and bank bonds in particular had a good quarter.
The fund’s U.S. high yield investments contributed to performance. These securities comprise roughly 8% of the fund.
CC&L further shortened the portfolio’s duration and added to corporate bonds. These moves, which we mentioned last quarter, were sparked by (1) ongoing improvements in U.S. economic data and (2) evidence that structural reforms are taking root in Europe and a funding crisis is unlikely.
The fund’s income-equities had a strong start to the year. Focus remains on companies with healthy balance sheets and growing dividends. REITs, banks and insurance companies remain key areas of investment.

Notable Transactions

CC&L trimmed bonds and added to income-equities in early March as they gained comfort in their base case economic scenario.
On the stock side, positions in banks and insurance companies were increased. Intact Financial and Sun Life were added to the portfolio.

Positioning

The manager continues to believe that interest rates are too low and corporate bond spreads too high. Fixed income holdings remain shorter- term in maturity and are positioned for an increase in interest rates.
The fund is seeking additional return by taking credit risk (corporate bonds) as opposed to interest rate risk (longer-term government bonds).