Income Fund Commentary
July 2010
The bond market had a strong second quarter, rising 2.9% (measured by the DEX Universe Bond Index), as investors focused on safe assets in light of the European debt problems and uncertainty over the global economic recovery. The S&P/TSX Composite Index dropped 5.5% amid the negative sentiment surrounding stocks. Over the past year, the two indices were up 6.9% and 12.0%, respectively.
With safety once again in high demand, investors favored government bonds over corporate bonds and stocks. This pushed yields lower on Canada bonds, which correspondingly led to a rise in prices. Corporate bond yields also fell, albeit more modestly, and for the first time since 2008 ‘governments’ outperformed ‘corporates’.
The Income Fund gained 0.8% in the quarter, and was up 15.6% over the past 12 months. Since its inception in February ‘07, the fund has gained 5.4% per year (in annualized terms).
The manager, Connor, Clark & Lunn (CC&L), made a few noteworthy adjustments to the portfolio in the quarter. In the government bond portion, they reduced the fund’s exposure to federal bonds (‘Canadas’) and increased its weighting in provincial bonds, as they feel the relative valuations of the latter are more attractive. As a whole, government securities were the greatest contributors to performance in the quarter, and they now make up roughly 37% of the fund.
On balance, however, CC&L still favours corporates, although they have trimmed some positions in recent months as spreads (the difference in yield between governments and corporates) have narrowed. At the end of the quarter, the fund held 40% of its assets in these bonds, with an emphasis still on bank, insurance and infrastructure issuers. The manager may look to increase the portfolio’s exposure to corporates if spreads become more attractive, but they feel it is not the right time at present given the increased economic uncertainty.
The other notable shift took place within the income-equity portion of the portfolio. Early in the quarter, the manager reduced the fund’s exposure to dividend-paying stocks as a cautionary measure. This was achieved by trimming a few holdings and investing cash inflows primarily in fixed income securities. At quarter-end, income-equities comprised 23% of the portfolio, down from 31% at the end of March.
TD Bank and Royal Bank continue to be the largest equity positions, while CIBC, Manulife, Enbridge and Brookfield Infrastructure Partners are other notable holdings. Overall, the yield of the income-equity component of the fund is 6.3%.
CC&L also added to a few real estate positions, as they continue to like the outlook and yields of these securities. In particular, they feel that apartment investments represent good value (including Canadian Apartment Properties REIT, Killam Properties and Transglobe Apartment REIT).
The fund’s pre-fee yield at the end of June was 4.1%. This represents a yield advantage of roughly 1.0% over a Government of Canada 10-year bond.
A renewed flight to safety has investors on edge once again. While CC&L is closely following the current debt issues, they feel the global economic expansion remains in tact, and the situation is not spinning out of control as some observers may suggest. The manager believes that progress may be slow and halting at times, and they intend to use their full tool kit and remain tactical in navigating the fund through the recovery.