The following commentary is courtesy of Cardinal Capital Management Inc., the sub-advisor for the VPI Canadian Equity Pool and the VPI Canadian Income Pool. The opinions, market outlook, and asset allocation strategies are those used in the design of the mutual funds they manage that we utilize in client portfolios.
From reading our regular Newsletters, and by seeing the way we have our portfolios structured, most of you are likely aware that in recent years Cardinal has managed our portfolios around the risk of rising interest rates. With rates and yields artificially repressed by central banks in reaction to the crisis of 2008, the danger has always been – what will happen when rates start to be free to follow the market? Well, last quarter, the rest of the world caught up to us as Ben Bernanke pointed out that some tapering of the repression would be warranted as the economy improved. Now, despite that being a very obvious event which had to occur sometime, markets reacted like they had never even considered the possibility. Bond yields jumped dramatically. In Canada, the Government of Canada 5 and 10 year benchmark bond yields rose about 60% from 1.15% and 1.67% in early May to 1.87% and 2.55% in July. As Cardinal had feared, bond prices fell, REIT share prices fell and share prices of high-yielding interest-rate sensitive stocks, like utilities and pipelines, fell.
It was gratifying for Cardinal to have these events prove us correct. We succeeded in protecting clients from this risk. Our 6 month Canadian equity return was over 5% whereas the market was down 0.9%. All our balanced mandates were positive, whereas the bond index was down 1.7%. While yields have dropped back somewhat from their highs, we continue to expect yields to creep upwards over the next several months. The Federal Reserve has made it clear that they will act only as the economy can sustain itself, but as the economy strengthens the day gets closer when they will reduce Quantitative Easing. Cardinal will continue to avoid overvalued high-yield stocks and will keep our bonds in short duration. In the meantime, we are pleased to own Canadian banks and life insurance companies who will actually benefit from the higher yields. Even now, more Canadians are locking into higher rate fixed mortgages from lower-rate variable ones. This means extra revenue for the banks without a material increase in their costs. As well as paying out over 4% in dividends over the past few years, banks and lifecos are poised for capital gains if (when) yields rise. Sun Life has already seen its share price bounce 80% from $18 last fall, to over $33 now. We look forward to more.
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It is part of our due diligence process to closely monitor the asset managers who make the underlying investment selections within our clients’ portfolios. We always remain well informed of their opinions, forecasts, and investment philosophies.