Equity markets were turbulent in the first quarter of 2016. Canadian equities endured the worst start to a year in over a decade, with the TSX Composite down 11% at one point in January and 26% off its peak in late 2014. At that point, oil prices had reached $27, a stunning collapse from the highs of over $130 in 2014.
Over the quarter, we saw sentiment shift and become less pessimistic as major producers indicated they would be willing to talk about limiting production to support prices. In addition, the number of oil rigs in operation in the U.S. declined. As a result, oil bounced almost 50% from its 13-year lows, before ending the quarter at $38. Other areas of the Canadian economy also began to show signs of improvement with our banks reporting an impressive growth in loans – a growth rate that has steadily increased over the last two years. Our Canadian Equity Fund had a good quarter, outperforming the TSX, as it benefitted from the oil price rebound and the improving domestic sentiment. Many of the companies that underperformed for us in 2015 have started to recover well this year.
The changing sentiment we saw in the market is an example of the “noise” we see regularly as investors. A few months ago the focus was on a slowdown in China and a sharp rolling over of commodity prices, with some forecasters calling for $20 oil. Now, the view is more sanguine and recession risks are being priced out of the market. We take a more forward-looking view and are not influenced by the noise. As contrarians, we selectively added to positions in this period to take advantage of the recent weakness, which should bode well for returns going forward.
Despite socio-political tensions arising from terrorist attacks, risks surrounding “Brexit” and an ongoing refugee crisis, economic conditions in Europe also improved during the quarter, particularly in forward-looking surveys. In the U.S., the latest economic surveys are also more encouraging. However, the appreciation of the Canadian dollar hurt global equity returns, which were generally negative to start the year. Our global equity results were mixed, with outperformance internationally before fees, but underperformance in the U.S. versus the S&P 500.
Canadian bonds benefitted during the quarter from a further decline in global government bond yields. The decline was primarily led by the revision lower in expectations for rate hikes by the U.S. Federal Reserve, which supported global bond prices elsewhere. We believe further rate cuts from the Bank of Canada are now less likely, due to a combination of rebounding oil prices, a stimulatory Federal budget, and signs of improvement in domestic economic indicators, particularly in the export sector.
Canadian Equity Fund
The TSX Composite Index found its footing in the first quarter, rising 4.5%. However, the market had a bad start to the year, representing a continuation of the weakness we saw in 2015 with concerns about China’s slowdown, commodity prices grinding lower and higher odds of a recession in North America. As a result, our dollar declined to levels not seen since 2003. Mid-way through the quarter, sentiment started to change and reversed quite sharply. Economic conditions improved a little, statements and actions from oil producers provided rational support for higher oil prices, and confidence returned. Comments from the Federal Reserve also soothed markets, with Janet Yellen indicating that interest rate hikes will be slow.
Fundamentally, the world did not change, but the extreme pessimism in the market lifted. As a result, we saw commodity prices rebound, and the Canadian dollar strengthened. Given our market’s exposure to more cyclical sectors, this meant that Canada finished the quarter as one of the best performing developed markets. More importantly, as the gloom lifted, investors began to see good value in many of our holdings that were hurt in 2015.
The Canadian Equity Fund outperformed the overall market, returning 6.3% after fees and expenses during the first three months of 2016. Stocks that contributed to performance included Saputo (TSX:SAP, Financial) (+26%) and Canadian Tire (TSX:CTC, Financial) (+15%). Not having any exposure to Healthcare (i.e. Valeant) was also a positive for the Fund. Not having exposure to gold detracted from performance as gold was viewed as a “safe haven” once again amid talks of negative interest rates.
Canadian Dividend Fund
Similar to the Canadian Equity Fund, the Canadian Dividend Fund performed well, returning 5.9% after fees and expenses during the quarter. Stocks held in the Consumer Staples, Consumer Discretionary, Industrials and Financials sectors performed well.
U.S. Equity Fund
Similar to Canada, the U.S. market had a difficult start to the quarter, followed by a sharp comeback. The S&P 500 was down almost 10% in local currency before mid-February, at which point positive news on the U.S. economy seemed to steady investors’ nerves. This allowed the market to rebound into positive territory, up 1.4% in U.S. dollars over the quarter. However, the strengthening in the Canadian dollar resulted in negative returns for Canadian-based investors.
During the downturn in January, the U.S. Equity Fund lagged market. This was due to stock selection in the Energy sector, as the companies you held were impacted by the decline in oil prices to a low of $27.
As previously communicated, we transitioned the management of the U.S. portfolio from Sprucegrove to Barrow Hanley over a few days at the end of January, while remaining fully invested. The transition went smoothly and Barrow Hanley took over full management of the portfolio as of February 1st.
During February and March, the portfolio performed well, but lagged the S&P 500 primarily due to stock selection. Lowered expectations for further interest rate hikes in 2016 hurt the Financials sector, and specifically Banks – an area we have an overweight position. Most notably, Bank of America (BAC, Financial), Wells Fargo (WFC, Financial) and Citigroup (C, Financial) were a drag on relative performance. However, care should be taken when reviewing such a short period. Banks will benefit when rates eventually rise, as their ability to expand net interest margins and, therefore, profitability will improve.
International Equity Plus Fund
The International Equity Plus Fund declined by 9.1% after fees and expenses, in line with the MSCI EAFE Index in Canadian dollars. Similar to our Canadian funds, areas that hurt us in 2015 helped fund performance in 2016. Currency had a large impact on absolute return as a stronger Canadian dollar detracted from performance. Stocks that performed well during the quarter included Priceline Group, Freeport-McMillian and Vinci. Stocks that detracted from performance during the quarter included AerCap Holdings, Telecom Italia and Aviva.
We transitioned the holdings of the Fund to a new sub-advisor, Edinburgh Partners, at the end of the quarter as detailed at the end of this report.
The country weightings of the International Equity Plus Fund at March 31, 2016 were:
Balanced Fund
The Balanced Fund declined by 0.4% in the first quarter of 2016 after fees and expenses. The asset mix for the Fund at March 31, 2016 was:
Unrestricted Diversified Fund
The Unrestricted Diversified Fund returned 0.0% in the first quarter of 2016 after fees and expenses. The asset mix for the Fund at March 31, 2016 was:
Income Advantage Fund
The Income Advantage Fund advanced by 2.3% after fees and expenses during the first quarter, led by the strong performance of the Fund’s dividend paying common stocks. Preferred shares declined during the quarter, while both investment grade and high yield bonds were positive. We trimmed our position in high yield bonds over the quarter and added to common and preferred equities.
The asset mix for the Income Advantage Fund at March 31, 2016 was:
Fixed Income Fund
Fixed income investments performed well during the quarter, benefitting from a continued rally in federal government bonds. This was partially offset by an increase in yields between government
and corporate bonds the start of the quarter. Although corporate bonds recovered in mid-February, they ended the quarter relatively unchanged from levels at the beginning of the year.
The Fixed Income Fund slightly lagged the FTSE TMX Universe Bond Index during the quarter, returning 1.3% after fees and expenses compared to 1.4% for the index. This was primarily due to the Fund maintaining a modest corporate overweight position, which was focused on high-quality, shorter-dated issues.
Our medium-term view continues to be that global bond yields will rise very modestly as the U.S. Federal Reserve continues to normalize monetary policy cautiously through 2016. Given the uncertain economic outlook, we continue to position the Fund conservatively in terms of overall corporate credit risk and interest rate positioning.
In provincial credit, we moderately added to our overall exposure during the quarter. Most notably, we continue to diversify the Fund’s provincial holdings to benefit from significant relative spread widening in peripheral provincial credit, such as in Newfoundland. We also added to our position in Quebec bonds given the ongoing improvement in the province’s economic outlook.
Our outlook for Canadian fixed income markets remains cautious. We think the probability of further monetary policy easing is highly dependent on oil prices and the global economic backdrop. The economic outlook for Canada has improved during the quarter, most notably, in showing signs that recent currency weakness is helping non-energy exports. However, this adjustment process is still in its early stages and remains uncertain. In addition, reduced expectations for U.S. rate hikes and a recovery in energy prices have resulted in the Canadian dollar strengthening recently, which – combined with an uncertain global economic backdrop – makes the outlook for Canadian exports particularly uncertain.
In this environment, we continue to focus on allocating assets to the best risk-adjusted investments. Our view is that there are better opportunities in credit markets rather than in interest rate markets, given the uncertain and divergent global interest rate outlook. We continue to look for high-quality opportunities to add to the Fixed Income Fund’s overall credit exposure, but our economic outlook suggests we should be cautious about the speed with which we increase this exposure.
Corporate Fixed Income Fund
After a weak start to corporate bonds in 2016, the Corporate Fixed Income Fund rebounded later in the quarter and returned 0.6% after fees and expenses during the first three months of 2016. The majority of the holdings in the Fund were investment grade securities which focused on high quality, short- to mid-dated bank deposit notes. During the quarter we added to our holdings in the consumer and telecom sector and reduced our position in bonds in the financial sector.
High Yield Bond Fund
Similar to equities, the High Yield bond market began the year negatively, but improved in the second half of the quarter. Currency played a big impact on the unhedged series as the strengthening Canadian dollar impacted the return during the first three months of 2016. We focus on quality in selecting securities to hold in the Fund and feel valuation in the sector is attractive.
Notice of Change to the International Equity Plus Fund sub-advisor
Following a detailed review of Thornburg Investment Management (“Thornburg”), the current sub-advisor of our International Equity Plus Fund, we have decided to replace them. As a result, management of the assets in the International Equity Plus Fund was transitioned to Edinburgh Partners (“Edinburgh”) on March 31, 2016. Edinburgh currently manage in excess of CAD$14 billion on behalf of their clients and are among the preeminent value-oriented international equity investment managers globally.
This decision was supported by an extensive evaluation our foreign equity managers following a number of changes to the in personnel managing the portfolio at Thornburg. We conducted the review in conjunction with investment consulting firm Callan Associates (“Callan”). Callan is among the largest independently owned investment consulting firms in the U.S.
The Leith Wheeler International Equity Plus Fund is a stand-alone fund and is also a component of the Leith Wheeler Balanced Fund. Looking ahead, we are very excited to be able to offer our clients of the International Equity Plus Fund access to Edinburgh’s value-driven international equity investing. Please contact your Advisor or Portfolio Manager at Leith Wheeler for further information.
Questions about your portfolio?
If you have questions about your Leith Wheeler portfolio, funds or services, please contact your Portfolio Manager or Karey Irwin at 604-683-3391 or 1-888-292-1122.
FORWARD-LOOKING STATEMENTS
This report may contain forward-looking statements about the Leith Wheeler Funds. Forward-looking statements include statements that predict future events, conditions or results - including strategy, expected performance or prospects, opportunities, risks and possible future actions. Forward-looking statements are based on current expectations and projections about future events and are inherently subject to risks, uncertainties and assumptions about the Funds and economic factors.
Forward-looking statements are not guarantees of future performance, and actual events and results could differ materially from those expressed or implied in the forward-looking statements. These statements require us to make assumptions and are subject to inherent risks and uncertainties. Our predictions and other forward-looking statements may not prove to be accurate, or a number of factors could cause actual events, results, performance, etc. to differ materially from the targets, expectations, estimates or intentions. These factors could include, among others, market and general economic conditions, interest rates, regulation, competition and the risks set out in the Funds’ Simplified Prospectus. Do not place undue reliance on our forward-looking statements. Please note the Funds have no intention of updating any forward-looking statements, whether as a result of new information, future events or otherwise.
Leith Wheeler Investment Counsel Ltd. is the manager and primary investment advisor for the Leith Wheeler Mutual Funds. Leith Wheeler Investment Funds Ltd. is the principal distributor of the Leith Wheeler Mutual Funds. Leith Wheeler Mutual Funds are also distributed through authorized dealers. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed or covered by the Canada Deposit Insurance Corporation, Leith Wheeler, or any other deposit insurer. Fund values change frequently and past performances may not be repeated. The unit value of money market funds may not remain constant.
Additional information about the Leith Wheeler Funds is available in the Funds’ Annual Information Form, Fund Facts, Management Report of Fund Performance and financial statements. You can get a copy of the Simplified Prospectus, and the other documents, at no cost by calling 1-866-292-1122, on our website at http://www.leithwheeler.com or by contacting your dealer. These documents and other information about the Funds, such as information circulars and material contracts, are available at www.sedar.com.
