Income Fund

September 30, 2022

Market Context

  • The Canadian bond market rose 0.5% in the quarter (interest and capital appreciation).
  • Bond yields were little changed, with the 10-year Government of Canada finishing the quarter where it started, at 3.2% (although it dropped to 2.6% in July).
  • Canadian stocks fell 1.4%. Interest rate sensitive stocks such as communication services, utilities, and real estate companies were the hardest hit.

Portfolio Specifics

  • Bonds moved modestly higher in the quarter following steep declines in the first half of the year. Short-term yields rose in response to higher central bank policy rates — the Bank of Canada increased its key lending rate by a total of 1.75% — but longer-term yields fell as the economic outlook worsened. Our bond strategy factored in a ‘flattening’ of the yield curve (a rise in short-term rates and a fall in long-term rates), which played out in the quarter and benefited the fund.
  • Our manager, Connor, Clark & Lunn, expects the Bank of Canada to raise interest rates further this year to contain inflation, which has risen sharply but is showing signs of peaking. A recession is increasingly plausible in 2023, which would alleviate some inflationary pressures and allow the central bank to re-evaluate its restrictive monetary policy. This view is factored into our fixed income strategy: we expect short-term yields to face more upside pressure relative to longer-term yields, and have positioned the portfolio accordingly.
  • The environment for credit (corporate and provincial bonds) remains difficult given the slowing economy. Our corporate bond focus is on stable companies in more defensive industries, such as utilities, telecoms, and insurance.
  • While it’s been a tough year for bonds, prevailing yields are more attractive than they were at the beginning of the year and the fund is generating a higher income stream (current pre-fee yield is 4.0%), which will benefit investors going forward.
  • The equity portion of the portfolio (24%) continued to hold up better than the overall market. Our strategy remains conservative, with investments focused on dependable cash generating businesses with strong balance sheets and a history of dividend growth. We bought additional shares in steady-eddy holdings George Weston (food processing and distribution) and Hydro One (electricity transmission). We’re also looking for buying opportunities in quality, deeply discounted companies such as Finning International (Caterpillar dealer), which we added to in the quarter.
  • Of note, the fund increased its distribution to $0.06/unit at the end of September.

Positioning

  • Our manager believes economic growth will continue to slow, driven by high interest rates and inflation. Our focus is on stable, defensive companies as a result.
  • Stocks make up 24% of the fund and remain an important source of diversification.

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