Returns for the Nicola Core Portfolio Fund were +1.4% for the month of January. The Nicola Core Portfolio Fund is managed using similar weights as our model portfolio and is comprised entirely of Nicola Pooled Funds and Limited Partnerships. Actual client returns will vary depending on specific client situations and asset mixes.
The Nicola Bond Fund was up for the month, returning +1.4% in January while the iShares Core Canadian Universe Bond Index ETF returned +2.9% for the month. Interest rates were the most significant driver of returns for the month as 10-year Bank of Canada bond yields moved from 3.3% to 2.9%. The Nicola Bond Fund underperformed in January as our portfolio remains lower duration. We believe yields are more attractively priced at the front end of the interest rate curve. Our exposure to the East Coast strategy and our new investment into tactical interest rates manager Algonquin Capital helped drive returns higher. In addition to interest rates, returns were also supported by credit spreads, which tightened materially during the month as Canadian corporate bond spreads moved from 1.61% to 1.49%, with financials, real estate, and auto sectors all tightening significantly. The combination of rates and credit spreads supporting returns led to one of the strongest returning months in investment-grade bonds over the past ten years.
The Nicola Global Bond Fund was up for the month, returning +1.8%. The Nicola Global Bond Fund was supported by strong returns from its holdings PIMCO Monthly Income and Templeton Global Bond fund, which were up +2.8% and +1.9%, respectively. Global credit spreads and interest rates broadly rallied, except for Japanese government bonds, which lagged as investors continued to speculate that the Bank of Japan will need to relax its yield curve control and tighten their monetary policy. Currency was again a strong contributor for the month as the U.S. dollar weakened versus most currencies. Many Asian currencies, such as the Thai Baht, Indonesian Rupiah, Malaysian Ringgit, South Korean Won, and Chinese Yuan, continued to contribute positively to returns as they strengthened again in January against the USD.
The Nicola High Yield Bond Fund returned +0.5% in January, while the iShares U.S. High Yield Bond Index ETF (CAD-Hedged) returned +3.3%. High yield spreads rallied during the month, with CCC bonds outperforming BBs by about +2.7%. We continue to be positioned in higher quality high yield and believe overall credit spreads remain slightly expensive at around 4.6%. We expect that default rates, currently at 1.4%, may move higher and could reach historical levels closer to 4% with a deteriorating economic backdrop later this year. USD exposure was also a detractor for High Yield Bond Fund as the USD fell against the CAD by -1.8% in January. During the month, we added to our PIMCO closed-end fund positions at discounts close to 5%, which we view as attractive given its relative value to other parts of credit. Additionally, we added to the PH&N High Yield Bond Fund to gain exposure to high rate-reset Bank Limited Recourse Capital Notes (LRCNs), which are attractive as they have similar yields to high-yield bonds but with exposure to investment-grade corporations.
The Nicola Preferred Share Fund returned +5.1% for the month, while the BMO Laddered Preferred Share Index ETF returned +5.8%. Strong ETF inflows and a bid for risk assets led to a strong month for preferred shares. We participated in the BMO 7.05% coupon institutional preferred issuance in January, which was the sole new issue for the month. With the relatively strong preferred share returns in January, the backdrop of the relative attractiveness of preferred shares decreased slightly. Still, we continue to see good value in institutional preferred shares and will be adding if an opportunity presents itself. Fixed-rate perpetual preferred shares outperformed while floating rate preferred shares, which base their coupon primarily on prime rates, underperformed as the Bank of Canada signalled a potential conditional pause to interest rate hikes. However, The Bank of Canada also stated they are prepared to increase the policy rate further if needed.
Returns for the Nicola Primary Mortgage Fund and Nicola Balanced Mortgage Fund were 0.4% and 0.6%, respectively, in January. Cash in the funds at month end was -3% in the Nicola Primary Mortgage Fund (remaining drawn on its credit line) and 8% in the Nicola Balanced Mortgage Fund. Current annualized yields (which are what the Nicola Primary Mortgage Fund and Nicola Balanced Mortgage Fund would return if all mortgages presently were held to maturity and all interest and principal were repaid, which is in no way a predictor of future performance) are 5.5% for the Nicola Primary Mortgage Fund and 7.4% for the Nicola Balanced Mortgage Fund. The Nicola U.S. Mortgage Fund continues to hold a third-party fund comprised of U.S. commercial mortgage loans with an individual loan program expected to make its first investment later in Q1.
For the month of January, the Nicola Private Debt Fund returned +0.5%. The primary return driver during the month was contractual interest income from the Nicola Private Debt Fund's portfolio of direct investments. New investments during the month included a US$10 million commitment to a first-lien term loan to a leading national U.S. financial advisory firm that provides valuation advisory, dispute resolution, compliance, and other advisory services. The Nicola Private Debt Fund continues to benefit from rising interest rates with approximately 84% of AUM invested in floating rate debt.
The Nicola Canadian Equity Income Fund's performance vs. S&P/TSX in January was +6.8% vs. +7.4%. Equity markets were strong in January, with most global indices benefiting from the risk-on tone. Investors viewed the impact of China's re-opening positively. Natural gas prices plummeted amid warmer weather in Europe, which improves the region's heating cost and inflation picture. The U.S. also saw recent declines in inflation. In Canada, due to the strong job report, the Bank of Canada hiked the overnight rate by 25bps on January 25, taking the BoC's policy rate to 4.5% (425 bps higher than where we were a year ago). It has now reached a level not seen since November 2007, which is well outside the estimated range of the nominal neutral rate (2-3%). In a press release, the BoC indicated that they would move to the sidelines and assess the impact of its rapid tightening on the economy. The 25-bps hike matched the expectations of the markets and economists, but most analysts did not see the central bank declaring a potential endpoint to the rate increases. The S&P/TSX Index gained +7.4%. Our Nicola Canadian Equity Income Fund at +6.8% underperformed the S&P/TSX Index as positive contribution from Energy and Consumer Discretionary were offset by negative contributions in Financials (where we are underweight) and Information Technology.
We have positioned the Nicola Canadian Equity Income Fund defensively as we are still concerned about the economic fallout from one of the most intense tightening cycles in decades and are cautious of key recession indicators, which are flashing red. In the month of January, the Fund's top-performing holdings were Shopify, Nuvei, and Lundin Mining. The bottom performers were Neighbourly Pharmacy, Waste Connections, and Canadian National Railway. We took profits and exited our position in Waste Connections. We added Stantec to the portfolio. Stantec provides engineering, consulting and design services in infrastructure, buildings, water, energy, resources and environmental.
The Nicola U.S. Equity Income Fund and the S&P 500 returned +5.8% (USD) & +6.3% (USD), respectively, for the month of January. January saw a bounce-back in risk-on activities as growth and meme stocks, which sold off significantly last year, became the best-performing stocks while the defensive parts of the market, namely Consumer Staples, Health Care and Utilities, were the only sectors posting negative returns. The Nicola U.S. Equity Income Fund underperformed the S&P 500 by 0.2% due to negative relative contributions from Industrials, Consumer Discretionary and Information Technology more than offsetting the positive relative contributions from Materials, Consumer Staples and Communication Services. The Nicola U.S. Equity Income Fund's top contributors to performance were AT&T, Visa and Hyatt, with the latter two benefiting from China re-opening. The leading detractors to performance were Pfizer, Northrup Grumman and UnitedHealth Group, which sold off from a rotation to growth names last month, as well as concerns over the upcoming U.S. debt ceiling/fiscal policy debates. The Nicola U.S. Equity Income Fund added two new names in the real estate investment trust (REIT) sector, the first being Prologis, one of the largest industrial REITs in the world with a diverse customer base of 6,300, operating in over 19 countries and managing over 1.2B square feet. We feel this high-quality REIT benefits from solid fundamentals such as low vacancy rates, favourable markets (Southern California) and high loss-to-lease while also having a lower cost of capital advantage vs. peers. The other REIT added was Camden Property Trust, a multifamily apartment operator managing 58,000 units spanning 15 markets, mainly in the sunbelt region where factors such as rent affordability, diversified jobs, strong economy, and migration trends are favourable. The Nicola U.S. Equity Income Fund sold Cadence Design System and JP Morgan to fund the REIT positions. The Nicola U.S. Equity Income Fund ended the month with a delta-adjusted equity exposure of 87% due to option positioning (20% of longs covered and 7% notional put options) and a higher cash position (3%).
The Nicola Sustainable Innovation Fund returned +5.3% (CAD) in January. Our top performers during the month were Fluence Energy, Plug Power, and Ballard Power Systems, while Enphase Energy, Enviva, and NextEra Energy were the biggest laggards. Equity markets started the year with a bit more of a risk-on tone than many expected, with recession concerns largely overlooked and growth-focused equities, including many of our portfolio companies, rebounding after a challenging 2022. In late January, there was a proposed $7.5B all-stock merger announcement between two of our portfolio holdings in the water sector: Xylem and Evoqua Water Technologies. Xylem is one of the largest global public water companies, focusing on designing and manufacturing equipment and operating as a service provider for water and wastewater applications. Evoqua specializes more in mission-critical treatment and technology, and its portfolio provides some attractive synergies to Xylem. If the deal closes, Xylem holders will own ~75% of the new combined company, with Evoqua holders owning the remaining ~25%. If completed, this would mark the fourth takeout in the Nicola Sustainable Innovation Fund's brief history and the first between two of our portfolio companies.
The Nicola Alternative Strategies Fund returned -0.2% in January. The primary factor was currency, as the Canadian dollar strengthened during the month versus the U.S. dollar. According to Eurekahedge, overall hedge funds returned +2.6% for the month while the Eurekahedge Arbitrage Hedge Fund Index returned +2.1% and the Relative Valued Hedge Fund Index returned +0.8%. Despite lagging January, the Alternative Strategies Fund returned +9.1% over a year while the Eurekahedge Hedge Fund Index was flat during this time.
The Nicola Precious Metals Fund returned +5.8% for the month of January. Underlying gold stocks in the S&P/TSX Composite index returned +9.6%, and gold bullion was up 3.8% in Canadian dollar terms. The strong rally in the precious metals fund was a function of a strong global bid of beaten-down assets and was magnified by U.S. dollar weakness. The better-than-expected recent labour and economic sentiment data may also suggest that inflation remains slightly elevated for longer which is beneficial for gold prices.
The Nicola Infrastructure and Renewable Resources Limited Partnership returned -1.2% for the month of January in Canadian dollar terms. Overall, currencies had a negative impact over the period with CAD strengthening against the USD, more than offsetting the CAD weakening against GBP. Agnostic to currencies, our assets returned -0.1%, primarily driven by a slight markdown in the value of its holding Macquarie Global Infrastructure Fund due to negative foreign exchange movements to the underlying assets more than offsetting a markup in our U.S. energy as a service platform co-investment. The Nicola Infrastructure and Renewable Resources Limited Partnership is at $218M of AUM with a waitlist of $18M that is expected to be fully drawn by the end of Q2 2023 from existing fund commitments and the near-term co-investment pipeline.
The Nicola Global Real Estate Fund performance vs. iShares S&P/TSX Capped REIT Index (XRE) in January 2023 was +4.1% vs. +10.3%. The Canadian REIT sector's -17% total return in 2022 was the second-worst year on record. REITs were poor performers globally (-37% Europe and -25% U.S.). Rising interest rates played a prominent role in the weak performance. Hopes that central banks may be close to an endpoint to the rate increases caused a sharp reversal in January as the S&P/TSX Capped REIT Index was +10% in the month.
RBC Economics forecasts that the BoC will leave the overnight rate steady through Q4 2023. While near-term volatility will likely persist until visibility on rates and the economy improves, we like our current valuation. We feel that economic and capital market turbulence last year caused by central bank monetary policy has created a significant disconnect between public REIT and private market valuations. As interest rates stabilize, the market will have a better idea of the cost of capital and therefore be able to better triangulate what real estate values will be going forward, which will help lift the uncertainty in REIT share prices. REITs with strong balance sheets, strong real estate portfolios, superior earnings potential and high-quality cycle-tested management teams will ultimately prevail. Investors turn to REITs for income growth and fundamentals appear strong, particularly in the Multifamily and Industrial sectors, which we believe sets the stage for continued growth in dividends.
Nicola Canadian Real Estate Limited Partnership NAV per unit has decreased to $155.1263 (previously $156.6871), effective January 31, 2023. This represents a decrease of 1.0% and a negative return for December of 0.6%. YTD return as at December 31, 2022, was 13.2%. Portfolio Leverage is 41.95%. The negative return was primarily due to cap rate expansion in the GTA market, affecting Aero Portfolio, Avonhead, and Joshua Creek.
Nicola U.S. Real Estate Limited Partnership NAV per unit has decreased to $197.8831 USD (previously US$198.4761 USD), effective January 31, 2023. This represents a decrease of 0.3% and a positive return for December of 0.1%. YTD return as at December 31, 2022, was 22.72%. Portfolio Leverage is 45.74%. The positive return was primarily due to increased appraised values of multifamily assets, offset by weakness in office assets in the Seattle and Houston markets.
Nicola Value Add Real Estate Limited Partnership NAV per unit has increased to $235.31 (previously $234.7639), effective January 31, 2023. This represents an increase of 0.2% and a positive return for December of 0.2%. YTD return as at December 31, 2022, was 19.6%. In December, we funded $16.5M for two new projects that closed (840 Parkway and Grauwyler) and $4.1M for existing projects.
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information presented here has been obtained from sources believed to be reliable, but not guaranteed.
Returns are quoted net of fund/LP expenses but before Nicola Wealth portfolio management fees. Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer, and Investment Fund Manager with the required securities’ commissions. This is not a sales solicitation. This investment is generally intended for tax residents of Canada who are accredited, investors. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity.
Comparisons of the historical performance of Nicola Wealth funds or models to the historical performance of indexes, mutual funds or other investment vehicles should only be undertaken with consideration of the differences that exist between the underlying investments that comprise the compared investment vehicles. Indexes may be primarily composed of a single asset type/asset class (i.e. 100% equities or 100% bonds) whereas Nicola Wealth funds may or may not contain a combination of exchange-traded equities, marketable bonds, private investments, other alternative investment classes and exempt products. When making any comparison of historical performance, these differences and their impact on the performance of each comparable should be taken into account. ETFs are pooled funds that track a specific investment universe that is expressed by a market index or a basket and that is listed on an exchange. Unlike a market index, an ETF incurs trading costs and other charges, including taxes. Because of these incurred costs, an ETF may underperform the market index that it tracks. ETF returns stated in this material are based on NAVs and are stated net of fees and other costs, including transaction costs.
For a complete listing of Nicola Wealth Real Estate portfolios, please visit https://realestate.nicolawealth.com. All values sourced through Bloomberg. Investments in alternative funds are highly illiquid and carry a related degree of risk of financial loss. Investors should consult the relevant disclosure and subscription documents for a full listing of risks associated with an investment in alternative assets and consult their Nicola Wealth advisor and relevant professionals regarding any tax, accounting, legal or financial considerations..
