Market Review
Interest rate volatility was elevated as investor expectations for central banks changed significantly during the first quarter of 2023. While headline Canadian price inflation peaked in the middle of 2022, the slow pace of its decline kept investors on edge regarding what action the Bank of Canada might take. In March, the Bank of Canada finally moved to the sidelines. Days later, a series of small- to mid-sized bank failures in the U.S., coupled with the rapid collapse of Credit Suisse, gave bond investors and central bank watchers cause for concern over the potential for contagion in the banking system at the same time as inflation remained elevated. When the quarter ended, yields were lower across the Canadian bond curve with nine-year bonds leading the way down with a 42-basis point (bp) decline.
Credit markets carried some of 2022’s positive momentum into the first quarter of 2023, but the mood quickly soured as banking crises emerged later in the quarter. The Bloomberg Canadian corporate aggregate spreads outperformed U.S. credit spreads, but still ended 5 bps wider at highs not seen since last November with the financial sector having the poorest performance. Corporate bonds of smaller financial institutions as well as subordinated debt of the major banks were key underperformers. After starting January with very strong corporate bond new issuance, February and March saw some of the lowest issuance for those months in at least a decade. While lower new corporate issuance and the resilient economy were supportive for credit spreads, client money flowing into corporate fixed income was mixed between inflow and outflows.
Fund Review
The Fund underperformed its benchmark in the first quarter of 2023, largely driven by credit spread widening. During the month of March, with news of small- to mid-sized bank failures and fears of contagion in the financial system, there was a flight to safety into bonds that drove yields sharply lower and credit spreads higher. Credit spreads, especially in financials where the Fund has an overweight position, took a hit but began to recover slowly as time passed and fears of more issues abated.
The Fund’s holding in the SLC Management Short Term Private Fixed Income Plus Fund once again outperformed its short corporate debt benchmark (FTSE Canada Short Term Corporate Bond Index) which also contributed to positive credit returns this quarter. The Fund’s slightly short duration positioning was narrowed in the quarter, resulting in performance for duration and yield curve positioning matching that of the index.
Fund Positioning
With inflation moving in the right direction, albeit at an elevated level of 5.2% for February, the Bank of Canada began to pause their rate hikes in March. The portfolio management team continues to believe the bond market is too confident that inflation will return to previous 2% targets soon. As a result, the portfolio management team is maintaining the Fund’s overweight position in Canadian real return bonds.
Significant Transactions
While new corporate issuance in Canada remains low this year, the Fund participated in new issues from Metro, GM Financial, Manulife Financial and Magna International, as well as Marsh & McLennan in the U.S.
