There is much to read into the changing global political landscape from the surprise Trump election win. Eric Bushell's commentary/blog post from November 9 “And Now For Something Completely Different” articulated our thoughts on the long-term economic impact of the increasing populism, as demonstrated by the Trump victory.
In the trenches, the surprise Trump election win initially felt like the Brexit response. However where the surprise Brexit “Leave” result was met with monetary backstops from the BOE and ECB, the Trump victory has fiscal ramifications if his campaign promises of fiscal stimulus, deregulation, and tax cuts lead to higher economic growth (albeit with higher government bond issuance.) The strengthening in the U.S. dollar was not then a “risk-off” move but predicated on the potential for higher short-term interest rates should the Fed need to be more aggressive curtailing inflation expectations. Higher growth expectations have also pushed commodities and stocks higher.
At the margin, we are more positive on credit and more positive on Signature High Income Fund's prospects, than prior to the election. Credit is ultimately a cyclical investment, although one with much less volatility than equities. Corporate bonds are absorbing much of this impact meaning credit spreads are tightening as government bond yields are heading higher. The shorter-duration, more economically-sensitive nature of below investment-grade (i.e. high yield) bonds means the ability to absorb higher rates will be greater.
We are positioned with a reflationary theme in the high-yield book with overweight positions in metals (names like Freeport-McMoRan and First Quantum), energy (companies like Cenovus and Permian Basins producers such as Endeavor Energy) and energy infrastructure. Health care has been slightly weaker as hospitals could see volume losses as ACA (a.k.a. Obamacare) is repealed or changed. Some of the pharmaceutical issuers, notably Valeant and Concordia, have also been weak but that is more due to very disappointing Q3 results. We don’t own Concordia or Valeant. Signature High Income Fund currently holds 43.5% in high yield bonds. Government bonds are not a core asset class of the fund although we may hold them for defensive positioning. Approximately 11% of the fund is in investment-grade bonds but 2% of that is in bonds that mature in less than two years (a higher yielding cash proxy) and 9% in investment-grade rated fixed-floating financial preferreds companies (e.g. JP Morgan, Bank of America, Citigroup, and Credit Suisse.) High-yield bonds will continue to be a good volatility-adjusted asset class and our base case has spreads tightening further from the current level of approximately 500 bps.
The move higher in rates impacted the REIT sector negatively. Real estate currently makes up 14.6% of the fund. We like valuations here on stock-specific opportunities as growth expectations have been washed out and many names are now trading at a discount. The interest rate back-up seems already priced in to a large extent and generalists have been avoiding the space on these rate concerns as well as e-commerce and department store weakness. However, with high income earners in line for a large tax cut, A-class mall valuations, while already attractive, will see more fundamental strength. While we believe B, C, and D-class malls will see more closures, A-class malls are an important anchor of broader retail strategies.
On the infrastructure side (19.2% of the fund), the differences within the asset class are very noticeable. Energy infrastructure, which we have been adding to in recent months, has enjoyed a near-term lift as a Trump administration and Republican control of congress holds forth the promise of expanded oil and gas production and a more favourable regulatory environment for project approvals. We recently added TransCanada to the fund and the prospect of approval of Keystone XL has pushed this stock up 3%. Williams Company, another new addition, recorded strong gains as an important approval of one of its projects is now more likely. We think energy infrastructure trades well over the intermediate-term as valuations are reasonable and positive catalysts visible. The move in rates however has impacted infrastructure positions like the Sydney Airport and Transurban Australian positions. Australian 30-year government bond yields are 30 bps higher, pushing stock prices down as investors require a higher dividend yield. These are regulated companies and over time, the rate move will increase the mandated returns for these companies but the short-term response has been negative.
The wind and solar power generation space has also seen short-term pressure on the expectation that regulation against coal will lessen and government incentives for renewables will decline. This feels overdone. Renewables can now compete without subsidies with traditional forms of power generation. Additionally, many mandates for renewables have come from states or businesses that are contracting for solar/wind to meet internal “zero emission” environment and social commitments. We have meetings with two renewable providers in the coming week and we view this as an attractive sector. While it may take time for value to be recognized, there are juicy dividend yields along the way. The non-core equity component of Signature High Income Fund (7.2% of fund) has performed well with the move in rates and the prospect of Dodd-Frank being repealed thus pushing financials higher. The fund specifically owns Citibank, Wells Fargo, and Swedbank that have each seen good moves higher.
Stocks are up and bonds are down which is typical of economic expansion. Quantitative easing managed to achieve “stocks up and bonds up” at different points in time over the past nine years with this summer’s post-Brexit vote being the most recent. The markets are in transition. This change in bond/equity correlation back to negative is important – higher cyclical inflation pressures from tighter labour markets, stronger economic activity and higher trade barriers are driving markets more so than monetary policy and deflation expectations. We think equities and credit can perform reasonably well but we want to ensure the short duration fixed-income component of Signature High Income Fund is not overwhelmed by the longer duration equity portion. Our game plan includes a rotation at the margin from high-yield bonds as spreads tighten into equities for better relative value. We will also work the short-term investment-bonds (a cash proxy) down, reinvesting into income equities.
This commentary is published by CI Investments Inc. It is provided as a general source of information and should not be considered personal investment advice or an offer or solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this commentary is accurate at the time of publication. However, CI Investments Inc. cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. This commentary may contain forward-looking statements about the fund, its future performance, strategies or prospects, and possible future fund action. These statements reflect the portfolio managers’ current beliefs and are based on information currently available to them. Forward-looking statements are not guarantees of future performance. We caution you not to place undue reliance on these statements as a number of factors could cause actual events or results to differ materially from those expressed in any forward-looking statement, including economic, political and market changes and other developments. Commission, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The historical annual compounded total rates of return for Series A units of Signature High Income Fund as of October 31, 2016 are: 1 year 5.3%; 3 years 4.8%; 5 years 7.0%; 10 years 5.4%; and 9.0% since inception December 18, 1996. The indicated rate[s] of return include changes in unit value and reinvestment of all distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.