The Market

North American markets closed the second quarter of 2021 at all-time highs, buoyed by persistent investor optimism in the reopening of the economy as well as continued accommodative fiscal and monetary policy by global policy makers.

On the home front, the S&P/TSX 60 outperformed other markets due to a heavier weighting in financials and energy, both of which have benefited from the economic reopening thesis. Oil prices rebounded dramatically from the COVID-19 induced demand fallout with WTI Crude up 85% for the August 2021 contract on a year-over-year basis.  Financials in Canada also received a boost with higher profit margins due to shrinking loan loss provisions and healthy guidance on expected net interest margins (the spread between the interest rate charged to customers versus the interest rate paid on term deposits).

The table below shows the market performance in Canadian dollars as of close on June 30, 2021, in Canadian dollar terms.

Performance

On a 2021 year-to-date basis, the YouFirst Growth composite at 9.4% outpaced the 9.1% return of the FPX Growth benchmark. The YouFirst Conservative Growth composite at 8.5%, as one might predict, landed in between the 9.1% for the FPX Growth and 5.4% for the FPX Balanced benchmarks.  The outperformance was largely due to holding hybrid income securities rather than fixed income securities.

A Note About Benchmarks

Many investors compare the performance of their portfolio against a market index (e.g. S&P500) and often think, “the markets returned 16% last year, why didn’t my portfolio perform the same?”.  This would be somewhat analogous to saying, “my car does 0-60 in 5 seconds!”.  Is this good or bad? Well, compared to a Honda Civic, it’s excellent, but compared to a Ferrari 812, it’s not so good (2.8 seconds for those interested).  This is why we need a relative (apples to apples), not an absolute (apples to oranges) measure to judge value and performance.

Since our clients’ portfolios are well diversified and not allocated 100% to a single market or asset class (stocks, bonds, cash, etc.), we do not compare our performance against a market equity index, but rather a benchmark that is independent of the firm and closely resembles our asset mixes.  We use the Financial Post Indices (FPX) as our benchmarks against the YouFirst portfolio composites that provide our clients with a relative and risk-adjusted measure of their portfolio performance.  These benchmarks are calculated daily and posted on the Croft Group’s website:

https://croftgroup.com/benchmark-performance/

A benchmark should be specified before an investment is made so that the portfolio manager is clear about the client’s objectives and expectations, constructing the portfolio  accordingly.  When we introduce new clients or perform an annual “Know Your Client (KYC)” review, in the Investment Policy Statement we select an investment profile with our clients’ input that best matches an investor’s overall risk and return objective – “balanced”, “conservative growth”, “growth”, for example, which should be compared directly against that category’s benchmark for an apples-to-apples comparison.

Portfolio Activity

Referring to our outlook in the next section, we have increased our exposure to international equities (Europe, Asia, and Far East) as well as a small emerging markets slice via the Manulife (Mawer) World/International Equity Pool (MMF8621/3904) as we believe that these markets will outperform US market equities in the near-term, primarily due to elevated valuations in the US.

We trimmed Hydro One (H:TSX) in some portfolios which had become slightly overweight and topped up on additional shares of Northland Power (NPI:TSX) on recent price weakness to maintain our allocation in utilities and to increase our portfolio exposure to more pure-play renewables with an ESG focus in mind.

Additionally, we continued to add to First Capital Realty REIT (FCR.UN:TSX).  Even with the recent price growth since last quarter, we believe that FCR still trades at a relatively fair valuation and has yet to recover to pre-COVID-19 lockdown price levels. While REITs with long term tenant leases tend to sell off during periods of sharply rising bond yields, we expect any such material downward pressure could present attractive opportunities to include additional REITs, particularly for investors with an income orientation and a longer-term focus.

On June 28, 2021, Brookfield Asset Management (BAM.A:TSX) completed the spinoff of Brookfield Reinsurance Partners Ltd. (BAMR:TSX).  BAM Reinsurance is a paired share to Brookfield Asset Management and will be used to grow BAM’s reinsurance business, similar in structure to Brookfield’s other spinoffs (Brookfield Renewables Corp, and Brookfield Infrastructure Corp.), which have been successful in the past.  YouFirst clients holding the Class A common shares of BAM will receive a special dividend in the form of one share of BAMR for every 145 shares of BAM.A.  For clients with less than 145 shares of BAM.A, a cash dividend will be paid in lieu.  This transaction will be reflected in your June 2021 FCC statement as well as this quarter’s YouFirst Q2 2021 report.

For accredited investors, we entered a position in the Next Edge Private Debt Fund (NEC452).  Private debt/credit is an alternative investment that can be broadly defined as privately negotiated loans that take place outside the traditional banking network.  Private debt/credit has a low historical volatility and correlation compared to traditional fixed income and equity investments.  Previously, the private credit market was available only to institutional investors such as the Canada Pension Plan but as a Portfolio Manager, we are now able to tap the private credit market for our income-oriented clients.  We have chosen the Next Edge Private Debt Fund as all their outstanding loans are senior secured in the capital structure of their borrowers and importantly they have not had any principal investment losses in the history of the fund (inception June 2015). The fund also provides reasonable liquidity and an attractive risk/return profile targeting an 8% net annual return.  Furthermore, as discussed in the next section, with our expectation for rising yields in the near-term, the fund provides a relatively lower interest rate sensitivity than traditional credit.

Finally, expectations of rising interest rates have resulted in higher rate-reset preferred share prices, providing an opportunity to sell a few of our holdings: Northland Power 5.1% (NPI.PR.C), Pembina Pipeline 4.7% (PPL.PR.S) and Artis REIT 5.66% (AX.PR.A).  Replacements consisted of rate-reset preferreds with minimum reset rates which will outperform the former as the dividend rate is reset in the future at higher levels if rates rise, but have an effective “floor” in yield if interest rates decline.

Outlook

Ending the quarter, valuations in all global markets continue to stretch beyond historical multiples.  At this time, the Shiller Price-to-Earnings (P/E) Ratio of the S&P500 is 38x relative to an average of 17x which foretells valuation risk since historically, the market tends to revert back to average valuations over time.  All else constant, with plenty of positive sentiment baked into the current market price levels, investors should prepare for lower return expectations in the short term unless earnings growth rates can be sustained in double-digit territory as they have been during the COVID-19 recovery.  While we don’t expect a significant market correction in the near-term, precipitous levels may lead to equity market volatility which will keep investors alert.  Regardless, we will follow prudent portfolio management practice and trim equity positions when asset mixes become skewed.

With the  US Federal Reserve and the Bank of Canada continuing their accommodative monetary policy in combination with continued government spending from the fiscal side, we expect that the yield curve will continue to steepen, anchored at the short end of the curve (bond prices are inverse to yield).  However the narrative from policy makers continues to change dynamically.  At the June 2021 US FOMC meeting, the Fed has indicated that rate tapering might begin as early as 2023 due to views that inflation might be less transitory than initially predicted.

One of the biggest stories that topped news headlines over the quarter is the fear of runaway inflation.  With consumer price index (CPI) levels increasing at their highest rate over the quarter in more than a decade, these fears have certainly divided the investment community (with important note, however, is that base year effects from Q1 2020 play a large role in the large deltas reported).  We believe that we are still heading into a period of global economic growth and rising inflation (whether transitory or not is anyone’s guess): PMI’s suggest that global manufacturing continues to advance and job growth continues to exceed expectations.

Certain asset classes tend to perform well in such an inflationary environment: Canadian stocks (weighted towards commodities such as oil), and US small caps to name a couple. Furthermore, emerging market equities enjoy their best performance in an accelerating growth/inflation environment.  We believe international and emerging market equities have the potential to outperform developed market equities this year as long as COVID-19 variant-based outbreaks can be controlled.

Notice from the Ontario Securities Commission

The Canadian Securities Administration (CSA), along with IIROC and MFDA have established new disclosures regarding
the ”Client Focused Reforms” (CFRs) initiative under National Instrument 31-103 with respect to enhanced disclosures of
Conflicts of Interest.

The new disclosures are now posted on Fidelity Clearing Canada’s website and will also be included in your June 30, 2021 statement package which will be delivered electronically or via paper depending on your previous selection for statement delivery.

https://www.clearing.fidelity.ca/fcc/en/home 

YouFirst Financial has adopted and abides by the Code of Ethics and Standards of Professional Conduct (the Codes and Standards) of the CFA Institute.  Section VI of the Codes and Standards outlines the minimum guidelines for addressing Conflicts of Interest in our business including appropriate disclosures, priority of transactions and referral arrangements.

For more information or questions regarding the Enhanced
Conflict of Interest Disclosure please contact us at
simon@youfirstfinancial.com.

Doug Garner, P.Eng., CFA
President, Portfolio Manager

Jane Garner, BA, EPC
VP Operations and Client Experience

Simon Chun, P.Eng., Passed CFA Level III
Associate Portfolio Manager