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Markets, investing and what matters most: Quarter in review Q2, 2021

By Curtis Huska, CFA 23 July 2021 7 min read

Written by Curtis Huska, CFA, co-authored by Daniel Spencer, CFA and Travis Higgins, CFA on behalf of Private Investment Counsel, who believe in a holistic investment counselling approach to helping high net worth clients.

It’s been said that investing is like piloting a plane; hours of boredom interrupted by moments of sheer panic. The swift market declines (the ‘panic’) of February and March 2020  seem a distant memory and have given way to a market that is benign in comparison, maybe even boring to some.  Even the excitement of ‘meme’ stocks and crypto currencies that occupied the first quarter (Q1) of 2021 have somewhat faded into the background. As vaccines continue to rollout around the world, expectations about future economic growth have picked up, and markets have tempered the wild swings in either direction. 

The second quarter (Q2) brought positive returns across all the major asset classes, including bonds, which had a rough Q1.  While recent years have seen the US equity market hog the spotlight with their strong returns, the Canadian market has, through the first half of 2021, managed to steal away a bit of the thunder, returning 17.3 per cent year-to-date. 

Whether or not the recent spike in inflation is transitory, concerns over inflation caused long-term interest rates to move up in Q1. In Q2, long-term interest rates contracted slightly and have since stabilized. This helped bonds provide a positive return in Q2. 

Talk by central banks about normalizing monetary policy has begun, sooner than anticipated. This is a sign that economies are expected to recover at a faster rate than initially expected. Central banks are also taking the rise in inflation seriously, although it looks like policies are not normalizing anytime soon.

 

Headlines that mattered this quarter

COVID and vaccines

  • Healthy rates of vaccination mean many of the major economies are opening for business.

Growth, with capacity for more

  • Jobs have recovered significantly and hiring continues. Some sectors are experiencing staffing challenges, most notably the hospitality industry. 
  • Increased household savings will be spent to satisfy consumers’ pent up demand.

Inflation

  • Inflation is ticking up over the two to three per cent target, but evidence suggests this is transitory.
  • The Federal Reserve and Bank of Canada are keeping an eye on inflation but their focus is on employment.

 

Chart of the quarter

Canada’s vaccination efforts got off to a slow start. However, in recent months, Canada has greatly accelerated its vaccination program, such that, as of the end of June, it now leads most other developed countries for the percentage of population with at least one dose.

This is an important metric as it has been shown that even a single dose can provide a significant level of protection against the disease, allowing, in theory, for a faster economic recovery.

Share of people who received at least one dose of COVID-19 vaccine
data to June 30, 2021

* China vaccination data added on June 10 to explain sudden increase in Asia
Source: https://ourworldindata.org/covid-vaccinations


Inside the portfolio

In Q2 of 2021, all Compass Portfolios (series O) and ATBIS Pools (series O) enjoyed positive returns. Bonds, which struggled during Q1, recovered some lost ground as yields fell slightly pushing bond prices up. The market seemed to agree with the central banks that the recent inflation spike will be transitory.

In the fixed income portion of the Compass Portfolios, the commercial mortgage backed securities (CMBS), as well as both Canso corporate bond mandates, continued to perform well in the second quarter. The positive returns outpaced the benchmark (FTSE Canadian Bond Universe) with modestly higher credit exposure but a significantly shorter maturity profile (four years duration vs 8.2 years for the Canadian bond index).

Year-to-date within the Canadian equity space, our sub-advisors modestly underperformed their respective benchmarks (S&P/TSX Composite TR). This was due to a relative underweight to the energy sector and an underweight in Shopify, which now represents approximately seven per cent of the S&P/TSX Composite Index. Historically, the energy sector has been in an underweight position in the Compass Portfolios to diversify some of the risks associated with high exposure to energy in the Alberta economy.

Energy and financial sectors were the strongest contributors to Canadian equity market performance year-to-date. This led to strong performance in our sub-advisor Cardinal’s Canadian equity mandate, with their large weight in financials. Despite being underweight in the energy sector, the Mawer Canadian Equity mandate benefited from the strong performance of Canadian Natural Resources and higher growth names like Shopify.  Relative underperformance of Mawer New Canada year-to-date is largely due to an energy and material sectors underweight.  

In US equities, the first half of 2021 saw small cap companies outperform their larger cap brethren. The relative small- and mid-cap overweight in the Compass Portfolios, and the ATBIS US Equity Pool roughly offset the relative underperformance of our active large-cap US component.

Finally, our International Equity mandate slightly underperformed the benchmark in the first half due to softness in European industrial and financial names. However, long-term performance is above the benchmark (MSCI EAFE net TR CDN$) and remains very strong.

Compass Portfolios and ATBIS Pools returns, series O
Q2, 2021

Source: ATB Investment Management Inc.


The road ahead 

Looking ahead, two major concerns remain in the minds of investors; rising interest rates and inflation. Here is what our team is doing to protect and grow client capital in this environment:

Equities:

  • We remain slightly overweight equities to fixed income, because we believe that equities continue to represent a better value for investors in this low interest rate environment.
  • Our equity sub-advisors invest on behalf of our clients in resilient businesses. In part, these businesses are resilient because:
    ○ They have strong balance sheets and manageable debt levels that can withstand a rise in rates.
    ○ Most have the ability to raise the prices of their goods and services, ultimately passing on increases in the cost of inputs to the end consumers.

Fixed Income:

  • Our bond portfolios have relatively lower duration resulting in lower sensitivity to interest rate changes than major bond indexes like the FTSE Canada Universe Bond index. This helps protect against the negative effects interest rate increases have on bond prices.
  • By holding proportionately more corporate bonds to government issues, our clients are better rewarded in this low and rising interest rate environment.
  • Our fixed income sub-advisor, Canso Investment Counsel, remains very flexible and opportunistic to take advantage of opportunities as they arise.

Sub-advisor spotlight

 

Each quarter we highlight what’s ‘under the hood’ of your investment portfolio by focusing on one of our sub-advisors. Each sub-advisor hired to manage our client’s investment assets is chosen based on a number of factors, including a disciplined investment process, strong internal governance, and an experienced and proven track record, particularly during periods of market decline.

CMLS Financial Ltd.

Firm profile

CMLS Financial is one of Canada’s largest independently-owned mortgage services companies. It was established in 1974 and is owned by both current and retired employees. CMLS has over 290 employees and eight commercial offices across Canada CMLS is the highest-rated mortgage servicer in Canada. While its focus has been commercial mortgages, it also has a growing single-family residential mortgage operation.

What are commercial mortgages?

A commercial mortgage is a loan secured by a commercial property, such as a shopping mall, hotel, office or industrial building. Because mortgages have more default risk and are less liquid than government bonds, investors require additional compensation—in the form of a higher interest rate—as an incentive to own them.

Why are they in Compass?

Commercial mortgage backed securities (CMBS) were added to the more conservative portfolios in 2012 to diversify the fixed income exposure with high-quality securities. The goal was to enhance the yield over the Canadian Bond Universe while doing so with lower volatility. 

All mortgage exposure in our portfolios is backed by income-producing commercial properties, and not by properties in the midst of development. The mortgages have an average loan-to-value ratio of 65 per cent, and are all first lien mortgages. In many cases, the security against a default goes even further, with personal or corporate guarantees if the property alone is insufficient to repay the loan.

The chart below shows the cumulative growth of $100 of the CMLS mortgage portfolio when compared to the broader Canadian bond market as measured by the FTSE Canadian Bond Universe.

Growth of $100, CMLS vs Canada FTSE Universe Bond Index
June 2012 to June 2021

Source: ATB Investment Management Inc., Bloomberg


What are we reading and listening to? 

The speed of the economic recovery from the global pandemic has surprised many. In ‘Technology Saves the World’, Marc Andreessen lays out a compelling case that it was our rapid advances in technology that were largely responsible. In a world largely filled with negative media, this one offers a welcome dose of optimism. Highly recommended!

In ‘10 things we (still) know for sure about markets and investing’, long-term industry veteran, Tom Bradley, opines that despite the rapid changes in the investment markets and the proliferation of new investment products, the fundamentals of investing remain timeless.  

It is easy to get caught up in the day to day gyrations of the ‘stock market’.  This article offers us an important reminder that what we are investing in is ownership of some of the most profitable, well run global businesses.  

Lastly, and a little closer to home, ATB Economics discusses the strong recovery in the manufacturing sector in Alberta.

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