Income Fund

September 30, 2023

Market Context

• The Canadian bond market declined 3.9% in the quarter (interest less capital depreciation).
  
• Bond yields ended the quarter higher, with the 10-year Government of Canada yield rising from to 3.3% to 4.1%, its highest level since 2007.
  
• Canadian stocks declined 2.2%. The utilities, real estate, telecom and consumer discretionary sectors were the weakest, while energy stocks were an area of strength.
  

Portfolio Specifics

• The fund declined in the quarter (-3.8%) as bonds experienced broad price declines in the wake of rising yields across the maturity spectrum (when yields rise, prices fall). The notable increase in yields over the last six months reflects a change in interest rate expectations. Investors were expecting rates to decline by the end of the year, but the market is now starting to price in a ‘higher for longer’ scenario. This is a product of central banks’ fight against inflation and stronger than expected economic activity.
  
• Our manager, Connor, Clark & Lunn, has positioned the portfolio defensively in response to the economic headwinds. They continue to prefer bonds issued by governments (federal, provincial and municipal) over corporations. That said, corporate bonds remain an important component of the fund, with a focus on companies with strong balance sheets in the insurance, banking, and utilities sectors.
  
• Although an outcome of higher bond yields has been a decline in prices, they have also allowed the fund to incorporate securities with higher coupon payments into the portfolio, resulting in a higher income stream. The fund’s yield (pre-fee) is now 4.7%, which is up more than half a percent since the beginning of the year.
  
• The equity portion of the fund (24%) declined more than the market, as utilities, REITs and financial holdings proved challenging. Brookfield Infrastructure Partners, Canadian Apartment Properties REIT and Royal Bank were key detractors. On the other hand, energy holdings ARC Resources, Canadian Natural Resources and Tourmaline Oil were strong performers.
  
• Within REITs, CC&L’s bias is towards those with exposure to residential and industrial properties. They’re staying away from office space given the increasing vacancy rates.
  
• The fund’s higher income stream enabled us to increase the quarterly distribution to $0.07/unit at the end of September (up from $0.06/unit last quarter).
  

Positioning

• Our manager believes a recession is likely within the next year, and that monetary policymakers are approaching the end of their interest rate hiking cycles.
  
• Stocks make up 24% of the fund and remain an important source of diversification.
  

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