Market review
Global fixed income markets eked out positive total returns during the second quarter of 2024 (Q2), as measured by the Bloomberg Global Aggregate Index (CA$). Coupon income helped offset the impact of higher sovereign yields and wider credit spreads. Securitized sectors generally outperformed credit.
Performance
As of the end Q2, Sun Life Wellington Opportunistic Fixed Income Private Pool series F (the Fund) generated -0.9%. The blended benchmark for the Fund returned -0.1% over the same period. The portfolio realized mixed total return contributions during Q2. During Q2, strategic and tactical sector themes generated negative returns while relative value delivered positive performance.
Attribution
The portfolio’s performance was affected by higher rates and a strong US$ in April. However, since the beginning of May, the Fund has recovered and generated positive total returns.
At the portfolio level, duration and currency drove negative total returns in Q2. Credit exposure was additive within the portfolio, particularly within sectors such as bank loans, high yield, and structured products.
Strategic sector positions detracted modestly in Q2, as negative contributions from the emerging markets (EM) opportunities and core challenges theme outweighed positive contributions from activist governments, short cycle credit and term premia normalization. The portfolio's exposure to EMs, particularly EM local debt, and high-quality sovereign bonds were pressured as markets repriced expectations for the number of cuts from the U.S. Federal Reserve (the Fed) this year. Within the short cycle credit theme, exposures to bank loans, structured products, and high yield were additive. The activist governments and term premia normalization themes benefitted from the repricing of inflation expectations.
Relative value strategies were additive in Q2, driven by positive contributions from the global credit absolute return (GCAR) and discretionary macro rates strategies. Within the GCAR strategy, the short position in European iTraxx indices contributed strongly in June as European credit markets were spooked by the French election.
Tactical strategies detracted in Q2, driven by negative contributions from U.S. agency mortgage exposure and the long position in the Japanese yen. While the U.S. rates sell-off was a headwind to performance in April, agency mortgages performed well in the portfolio in Q2.
Positioning and outlook
Over the last year, our sub-advisor Wellington Management Canada (Wellington), has been positioning the portfolio for decelerating U.S. economic data. Robust fiscal spending in the U.S. boosted the economy, despite high level of interest rates. However, the growth rate of government spending is slowing and excess consumer savings accumulated during COVID have been largely exhausted, leading U.S. economic data to weaken.
Wellington believes that the inflation is weak enough to justify a Fed rate cutting cycle. Shelter inflation, which has been high and sticky, has started to decelerate.
- Global interest rates: The overall level of duration in the portfolio remains elevated relative to history. Wellington anticipates plentiful opportunities to tactically trade rates during the second half of this year.
- Inflation-linked bonds: Inflation-linked bonds were one of the largest positive contributors to the portfolio in Q2. Wellington thinks policies of one-party government in the U.S. could be potentially inflationary.
- Credit: Credit spreads have tightened significantly over the last year. At current valuations, Wellington does not feel the market is pricing in the risk of a deterioration in the business cycle. While overall valuations are tight, the Fund continues to find attractive opportunities across structured credit, contingent convertible bonds and preferred securities.
- EM: The sub-advisor maintains its exposure to EM local debt. The sector underperformed throughout Q2 due to the market perception of unfriendly election and political outcomes, most notably in Mexico and Brazil. Regardless, the sub-advisor believes that EM local bonds could be one of the biggest beneficiaries as EM inflation continues to surprise to the downside.
- U.S. agency mortgages: Wellington reduced the allocation to agency securities within the portfolio and currently owns 12% within its tactical allocation.
- Currency: The sub-advisor expects to manage currencies tactically. They’ve maintained an underweight to US$ as the currency looks expensive across a range of valuation measures. Wellington believes the US$ has embarked on a multiyear secular decline as the Fed finally embarks on its rate cutting cycle.
