Sun Life Core Advantage Credit Private Pool

*Source: SLGI 

*Represents the estimated total yield earned, after adjusting for the impact of hedging activities. Note that the overall Fund yield does not take into account the benefit from hedging strategies. 

Portfolio Positioning: 

• Term Structure: The Fund continues to favour the value found in the 20 – year part of the credit curve. During the quarter, the 5-year exposure for the Fund increased above the benchmark as the yield curve remains flat and the portfolio managers took part in the shorter dated financial issuance.
• Credit Quality: The Fund increased the exposure to “A” and “BBB” rated bonds rose, while “AAA” was reduced, as the portfolio manager sold Federal bonds and high quality U.S. dollar corporate bonds in favor of Canadian dollar corporate bonds.
• Currency Mix: The foreign weighting decreased from 17.8% at the end of the first quarter to 15.8% as the portfolio manager sold U.S. dollar corporates as they outperformed in the middle of the quarter. The portfolio hedges its U.S. dollar bonds using a cashflow swap to minimize the fund’s exposure to changes in U.S. currency and U.S. interest rates.

Significant Transactions: 

The Fund’s Federal weighting was reduced by the portfolio manager, in favor of adding to its Financials and Infrastructure exposure. Within the Finance sector, the portfolio manager participated in new issues from Canadian banks, TC Pipelines and Manulife. In U.S. dollar corporates, the Fund was net sellers of corporate bonds including Microsoft, Amazon and Verizon in favour of adding Canadian dollar corporates like GTAA and Transurban.

Outlook:

With inflation running hot and yet to peak, developed market central banks are quickly upsizing rate hikes. The award so far for the biggest surprise, goes to the Bank of Canada. At its last meeting it shocked markets with a 100 basis point rate hike. Its overnight rate now sits around 2.5% and markets expect another 100 basis points of rate increases by the end of the year. The Fed has also upped its game. Having increased rates by 75 basis points at its last meeting, its expected to do the same at its next meeting towards the end of July. Central bank urgency is understandable. If inflation becomes persistently high business and consumers can quickly shift their inflation expectations and central banks lose the credibility to use inflation targeting as a tool. Central banks will remain dogged in aggressively arresting inflation even if it leads to a growth setback. The alternative of allowing stagflation to emerge, the toxic mix of high inflation and low growth, is more corrosive to long term prospects.

The Canadian unemployment rate recently hit a record low. Which caps off a remarkable recovery from the spring of 2020 when unemployment spiked at 13%. Another notable achievement is the quality of the jobs created. Research from economist Benjamin Tal of CIBC, finds that the number of jobs paying more than $30 an hour has jumped by 8% from pre-pandemic levels, while those earning less than $30 has dropped 3%. Suggesting workers have come back to better paying jobs. One of the few negatives in the Canadian employment outlook is a dip in the labor participation rate. Some of this seems related to a large swathe of workers, 55 and older, who have left the workforce. However, improving wages may help restore participation.

In the U.S., labor dynamicsare also vibrant as the number of jobs available per unemployed worker is roughly twoto one. But rising rates will in variably slow activity. Some of that is starting to show withjob openings getting scaled back and modest layoffs being reported. Jobless claims havealso marginally risen from near historical lows.

As central banks tighten, recession fears keep mounting. History suggests these episodes don’t end well. On average a recession ensues two years after the start of a tightening cycle and the current tightening is more aggressive than most as it grapples with sticky inflation. What typically exacerbates a downturn is aggressive layoffs as companies turn cautious in the hope they can quickly rehire when conditions improve. But this current labor market, with fierce competition for talent, may encourage companies to hold on to their workforce and look to ride out any set back and be better position to participate in the recovery.

Household and business balance sheets areentering this tightening cycle in solid shape. But until central banks have finished hikingrates, investors will keep worrying about the timing and severity of any growth interruption.