Sun Life Core Advantage Credit Private Pool

Fund commentary | Q3 2022

Opinions and commentary provided by SLC Management.

Market Review

After all the daily variation in interest rates throughout the third quarter, it seems remarkable that the Government of Canada bond yield curve from the 8-year to 30-year term ended the quarter virtually unchanged from the close of the second quarter. With the Bank of Canada lifting its overnight rate from 1.5% to 3.25% during the third quarter, the short end of the curve rose significantly with 2-year Canadian government bonds up 68 basis points. As a result, the yield curve became significantly inverted with 30-year Canadian government bonds closing the quarter yielding 70 bps lower than 2-year Canadian government bonds. These bonds significantly outperformed their U.S. and U.K. counterparts during the quarter. In the U.S. and U.K., yields moved significantly higher, and inflation continues to increase, whereas in Canada inflation appears to have peaked.

Canadian credit spreads moved wider during the third quarter. Most of the widening move took place in September as financial markets began to reflect the belief that global central banks would try to rein in inflation even at the expense of growth. The credit rating agencies, which had been favouring upgrades, took a more balanced view of Canadian corporate credit in the third quarter with upgrades and downgrades relatively even as a hard landing for the economy became a stronger possibility. Investor flows into Canadian fixed income slowed as the quarter progressed and corporate new issue activity decelerated as volatility rose across financial markets to close the period. The worst performing corporate credit sectors in the quarter were insurance and REITs, which each rose 15 bps. Senior bank paper outperformed in the quarter with its credit spreads staying close to flat as new bank issuance slowed down from its faster pace earlier in 2022 and higher short-term rates spurred investor interest.

Fund Review:

The Fund’s slightly short duration positioning and curve positioning added positive alpha in the third quarter. The Fund was underweighting the very front end of the curve which steepened the most due to central bank rate hikes. The underweight in Federals and Provincials, while being overweight in corporates, however detracted from active returns as credit spreads widened, especially in the financial sector. U.S. corporate credit spreads underperformed Canadian corporates in the quarter, and the mark to market on the swap hedges also negatively impacted performance. The holding in the Short Term Private Fixed Income Plus fund added value by outperforming its short corporate benchmark during the quarter.

Portfolio Characteristics: 

  Yeild (%) Effective Duration (years) Average Credit Rating
Sun Life Core Advantage Credit Private Pool 5.17 7.23 A
FTSE Canada Universe Bond Index 4.14 7.53 AA
Difference 1.03 (0.30) -
Estimated Yield Including FX* 5.17 - -

*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. The 5-year overweight increased as the yield curve inverted, and the portfolio manager took part in the shorter dated financial issuance.
  • Credit Quality: The Fund increased the exposure in “BBB” rated bonds, while “AAA” was reduced, as the portfolio manager sold Federal bonds in favor of Canadian dollar financial bonds and a U.S. energy infrastructure corporate bond.
  • Currency Mix: The foreign weighting moved just slightly lower as the portfolio manager sold U.S. dollar Federal bonds and moved cash from US dollars to Canadian dollars. The Fund hedges its U.S. dollar bonds using a cash flow 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, in favor of adding to its provincial and financials exposure. Within the financial sector, the portfolio manager took advantage of decent new issue concessions participating in new issues from National Bank, Ford Credit Canada, Canadian Western Bank and Bank of Montreal. Within U.S. dollar corporates, the portfolio manager participated in the new issue from Kinder Morgan and sold Amgen Inc. to purchase Abbvie Inc.

Outlook:

Global growth is slowing. As high inflation persists across most regions, central banks are ratcheting up rates to cool activity. Political dynamics are also hindering economic activity. In its most recent forecast, the International Monetary Fund (IMF) expects global growth to hit 3.2% this year and continue slowing to 2.7% by next year. While it expects both developed and emerging economies to slow, developed economies are expected to take a bigger hit. Europe is expected to hit a rough patch next year with energy uncertainty and higher related costs taking a toll. Germany and Italy are likely to face a recession. The IMF expects Canada to deliver growth of 1.5% next year with the U.S. coming in at 1.0%. By comparison, consensus economic forecasts from Bloomberg for Canada and the U.S. are gloomier, with growth expectations closer to half of the IMF’s forecasts.

At this point, forecasting differences are driven by the assessment of how aggressive central banks will need to be to moderate inflation. The other factor clouding forecasts is energy disruption and how deep that could be. Europe is very dependent on outside sources to support its needs. Therefore, next year’s growth outlook will continue to be fluid as visibility on inflation and energy is still a work in progress. Indeed, the IMF made clear in its report that “for many people 2023 will feel like a recession” and sees a 25% chance that global growth could fall to the historically low level of 2%.

The market expects the BoC to hike rates by another 100 basis points by early next year with the U.S. Federal Reserve (Fed) increasing rates by 150 basis points over the same period. Both central banks are expected to pause and assess how one of the fastest tightening cycles in decades is impacting activity. The biggest challenge for central banks is calibrating their policy moves. If they overshoot on rate increases, they could ignite a rough recession and destroy jobs. If they prematurely halt, then inflation could remerge, creating more of a challenge while central banks lose credibility as competent stewards of the economy. Central bank tools are crude, and their effects usually come with a lag. Therefore, at critical stages in any tightening cycle central banks need to pause and assess how the real economy and financial system are coping with their policy moves and how much more action, if any, is needed. The BoC and the Fed should be at that point in the first quarter of next year.

Performance: 

Fund Name 1 Month 3 Month 6 Month 9 Month 1 Years 2 Years Since Inception Inception Date
Sun Life Core Adv Credit Private Pool - Sr F  (1.48) (0.32) (5.69) (12.38) (-11.12) (6.79) (-3.81) 25/02/2020
FTSE Canada Universe Bond Index (0.53) (0.52) (5.17) (11.78) (-10.48) (6.98) (-3.64)  

*Source: SLGI 

Sun Life Core Advantage Credit Private Pool Monthly snapshot:

Series A Series F

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Views expressed are those of Sun Life Capital Management (Canada) Inc., sub-advisor to Sun Life Core Advantage Credit Private Pool for which SLGI Asset Management Inc. acts as portfolio manager. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any mutual funds managed by SLGI Asset Management Inc. These views are not to be considered as investment advice nor should they be considered a recommendation to buy or sell. This commentary is provided for information purposes only and is not intended to provide specific individual financial, investment, tax or legal advice. Information contained in this commentary has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made with respect to its timeliness or accuracy.

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