Income Fund Commentary

Market Overview

The bond market (DEX Universe Bond Index) turned in a total return of 9.7% in 2011 as a broad sell-off in global stock markets drove investors to low-risk assets. Yields fell sharply in the latter half of the year (when yields fall, prices rise). 10-year government bond yields hit 3.5% early in the year, but dropped to under 2% in December, leading to strong price gains.
The Canadian stock market dropped 8.7% as resources stumbled. Higher-quality dividend-paying stocks, however, weathered the storm better.

Portfolio Specifics (2011)

Federal and provincial bonds were the fund’s top performers in 2011.
The fund’s corporate bonds performed well, but lagged government issues, as investors favoured the safest assets. The manager, CC&L, feels corporates are still very attractive relative to government bonds, and the majority of the fund’s fixed income investments remain in these securities.
Within corporates, the emphasis remains on the financial sector. CC&L likes the outlook for insurance and bank bonds in particular.
The yields on U.S. high yield bonds rose sharply. As they moved close to 10%, CC&L initiated a position in October. The manager feels that the high yield sector, which is very sensitive to the global economy, will be a big area of opportunity as the the fiscal situation in Europe improves.
The fund has a relatively short duration to protect it from the negative impact of rising interest rates. However, CC&L is reluctant to get too defensive on this front because there is a lot of anxiety about debt in Europe, and interest rates could remain depressed in 2012.
The fund’s income-equities held up well, gaining 8% in aggregate. REITs were a stand-out, with the sector gaining 20%. CC&L’s focus on dividend growers and avoidance of the mining sector were key reasons why the fund’s equity component fared much better than the broad market.

Notable Transactions (Fourth Quarter)

Equities were trimmed across the board, bringing this portion of the portfolio down from roughly 32% to 26% of total assets. The proceeds were invested in high yield bonds and other fixed income securities.
Gibson Energy and Rogers Communications were purchased, while Northland Power and Artis REIT were sold.

Positioning

The manager believes that interest rates are too low and corporate bond spreads too high. They will look for opportunities to further shorten duration and/or add to credit exposure. Catalysts would be an improvement in Europe (e.g., recapitalization of the banking system), better fiscal co-ordination or a repair of business confidence.