Nicola Core Portfolio Fund
Returns for the Nicola Core Portfolio Fund were +0.8% for the month of October. The Nicola Core Portfolio is managed using similar weights as our model portfolio and is comprised entirely of Nicola Wealth pooled funds and limited partnerships. Actual client returns will vary depending on specific client situations and asset mixes.
Nicola Bond Fund
The Nicola Bond Fund returned +0.5% in October, surpassing the iShares Core Canadian Universe Bond Index ETF, which had a return of +0.1%. Interest rate volatility persisted during October, and 10-year Canadian government bond yields ended the month mostly unchanged, while 2-year Canadian government bond yields declined by 0.3%. Throughout the month, Canadian headline inflation for September came in at +3.8%, falling short of market expectations for a +4.0% increase. The data indicated moderation across core inflationary measures, and the Bank of Canada opted to leave its main interest rate unchanged.
In terms of credit, Canadian spreads remained resilient despite higher rate volatility and widened by +0.1% to 1.5%. A combination of muted new issue activity, attractive all-in yields, and largely benign quarterly earnings performance could be contributing factors to spread stability. Our fund's short duration and defensive positioning played a crucial role in its relative outperformance.
Top-performing strategies during the month included PH&N Short-term Bond and Mortgage Fund, as well as East Coast Investment Grade Fund, which returned 0.7% and 0.2%, respectively, in October. These strategies continued to outperform due to their focus on short duration and high-quality investment-grade assets.
Looking ahead, we anticipate new issuance activity to pick up in North American investment-grade markets in November. We also expect volatility to persist in the Investment Grade credit market, providing attractive trading and investment opportunities for the Nicola Bond Fund.
Nicola Global Bond Fund
The Nicola Global Bond Fund (CAD) returned –0.4% in October.
The Nicola Global Bond Fund (USD) returned –2.9% in October.
The PIMCO Monthly Income Fund was the primary detractor, returning -1.1%, as global credit markets weakened. In contrast, the Nicola Global Bond Fund experienced a positive contribution of +0.8% from our BlackRock Securitized LP position, attributable to a rally in the U.S. dollar and a high carry in structured products.
Nicola High Yield Bond Fund
The Nicola High Yield Bond Fund (CAD) returned +0.5% in October.
The Nicola High Yield Bond Fund (USD) returned -2.0% in October.
The high-yield sector experienced negative total returns during the month as credit spreads increased by 0.4% to 4.4%, and U.S. treasury yields rose significantly, with 10-year treasury yields climbing 0.3% from 4.6% to 4.9%.
In October, higher-quality credits such as BBs outperformed, with an average widening of 0.2%, while Bs and CCCs underperformed, experiencing spread widening of 0.4% and 1.2%, respectively. The High Yield Bond Fund's outperformance can be attributed to its relatively shorter duration and a bias towards higher-quality credits, offering better risk/reward characteristics in the face of comparatively tight high-yield valuations.
Our investment in PIMCO California Carbon Access continued to perform well, returning +4.4% in Canadian dollar terms. Other top-performing strategies for October include Apollo Offshore Credit Strategies and Oaktree Global Credit, with returns of 2.7% and 2.5%, respectively, in Canadian dollars.
Looking ahead, the Nicola High Yield Bond Fund will maintain a defensive position in the near term, anticipating economic challenges in an environment of higher-for-longer interest rates.
Nicola Canadian Mortgage Fund
On October 31, 2023, the Nicola Balanced Mortgage Fund was renamed the Nicola Canadian Mortgage Fund. Also, on October 31, 2023, the Nicola Primary Mortgage Fund was terminated and the assets of Nicola Primary Mortgage Fund were acquired by Nicola Canadian Mortgage Fund.
The Nicola Canadian Mortgage Fund returned +0.5% in October with a trailing 12-month return of +7.9%. New loan origination activity has increased since Q3, with a strong Q4 anticipated based on loans funded so far this quarter and loans scheduled to fund by year-end. The Nicola Canadian Mortgage Fund held 6.8% in cash & cash equivalents, with 53.9% of the direct loan portfolio secured by senior ranking mortgages at month end.
Nicola U.S. Mortgage Fund
The Nicola U.S. Mortgage Fund (USD) returned 0.9% in October with a trailing 12 month return of 3.9%. The direct loan portfolio continues to grow, with a new loan funded in October. The Nicola U.S. Mortgage Fund held 17.1% in cash & cash equivalents, with 100% of the direct loan portfolio secured by senior ranking mortgages at month end.
Nicola Private Debt Fund
The Nicola Private Debt Fund (CAD) returned +0.9% in October.
The Nicola Private Debt Fund (USD) returned +0.6% in October.
Returns continue to be primarily driven by contractual cash interest income from the Nicola Private Debt Fund’s diversified portfolio of direct investments. The Nicola Private Debt Fund made one new direct investment in the month, a US$7.6 million participation in a first lien term loan to an American systems integrator that designs, engineers, deploys, and maintains critical communication, data, and security systems for commercial and government clients.
Nicola Canadian Equity Income Fund
The Nicola Canadian Equity Income Fund returned -3.3% in October. Canada's economic conditions are showing signs of weakness, evident in softer consumption patterns across housing, durable goods, and services. The Bank of Canada's quantitative tightening policy seems to be successfully dampening aggregate demand, as intended. Despite this, the Bank's core inflation measure has seen little downward momentum, resulting in the decision to maintain the target rate at 5.0%.
In financial markets, bond yields continued their ascent, with the 10-year U.S. Treasury Note briefly surpassing 5.0% intraday. This psychological milestone exerted pressure on global equity markets, including the TSX, and particularly impacted shares of bond proxies and dividend yielders, whose relative value declined in the face of a higher risk-free rate.
The current asset mix of the Nicola Canadian Equity Income Fund stands at 74% Canadian Equities, 17% Preferred Shares, 7% REITs, and 2% cash. The Canadian equity component outperformed the TSX Composite Index by 20 basis points, returning -3.0% on a total return basis compared to the TSX Composite Index at -3.2%. Key performing sectors for the month included Industrials (+1.8%), Communication Services (+0.8%), and Information Technology (-0.7%). Conversely, Materials (-15.7%), Real Estate (-9.5%), and Financials (-5.1%) were the underperformers. Sector allocation primarily contributed to outperformance, while security selection was a drag, primarily due to First Quantum Minerals facing geopolitical risks.
The top three performers for the Nicola Canadian Equity Income Fund were H2O Innovation (receiving an all-cash acquisition offer), TC Energy, and Richelieu Hardware. The bottom three performers were First Quantum Minerals, Brookfield Asset Management, and Canadian Apartment Properties REIT. Two positions were exited – Magna International and Nuvei Corp. – while two new positions were introduced – Cargojet Inc. and West Fraser Group. Opportunistic put options were written on Teck Resources. The equity component maintains competitive characteristics against the TSX Composite Index, offering double-digit growth rates at better value (12.5x P/E vs. 12.7x) and with lower debt (2.4x leverage vs. 3.6x).
With a 7% allocation to REITs, poor REIT performance negatively impacted overall fund returns. The S&P/TSX Capped REIT Index was -7.5%, driven by negative sentiment from the "higher for longer" interest rate narrative. Despite this, the Nicola Canadian Equity Income Fund believes that REITs are deeply discounted by historical standards, and a stabilization in interest rates could boost sentiment, potentially improving earnings growth and alleviating cap rate expansion concerns.
In October, the Canadian Equity Income Fund strategically invested in Canadian preferred shares. Preferred shares within the fund returned -1.6%, while institutional preferred shares averaged a return of -0.7% due to limited institutional investor activity. The BMO Laddered Preferred Share Index ETF reversed its late September gains, returning -2.4%, as investors realized that the TD rate-reset redemption was a one-off event. The Nicola Canadian Equity Income Fund maintains a preference for institutional preferred shares over the $25 preferred share market, believing both present good value to complement dividend-paying common equity.
Nicola U.S. Equity Income Fund
The Nicola U.S. Equity Income Fund (CAD) returned 1.5% in October.
The Nicola U.S. Equity Income Fund (USD) returned -1.1% in October.
The U.S. equity market faced its third consecutive monthly decline, prompted by a range of concerns. These included the removal of House Speaker Kevin McCarthy, geopolitical tensions in the Middle East, robust non-farm payroll data, higher-than-expected U.S. retail sales, and the potential for the Federal Reserve to consider interest rate hikes. The third-quarter earnings season added to market uncertainty with cautious forward guidance from company executives.
In the previous month, the fund demonstrated resilient performance, outperforming the S&P 500 by 1%. This success was driven by adept stock selections, particularly in the Communication Services sector, with AT&T standing out. AT&T gained 4.5% on the strength of strong Q3 results and an increased 2023 free cash flow guidance by $500 million. Favourable decisions within the Energy sector, such as holding European oil major Shell while avoiding Exxon Mobil and Chevron, both facing significant declines, also contributed to the Nicola U.S. Equity Income Fund’s positive performance.
Microsoft, AT&T, and UnitedHealth Group emerged as leading contributors to the Nicola U.S. Equity Income Fund’s success, while NXPI Semiconductors, Wesco International, and Prologis were the primary detractors.
Portfolio adjustments were made during the month, with target weights reduced in NXPI Semiconductors and Alphabet, while Crown Holdings and Costco saw increased target weights. The fund expanded its exposure to Real Estate Investment Trusts (REITs), specifically CubeSmart and Prologis, through put option assignments.
The Nicola U.S. Equity Income Fund predominantly comprises high-quality companies with solid balance sheets, robust free cash flows, and an attractive blended forward 1-year Return on Equity (ROE) of 27%, surpassing the S&P 500's 19%. As the month concluded, the Nicola U.S. Equity Income Fund’s delta-adjusted equity exposure stood at 87%, factoring in option positioning (approximately 3% of long positions covered and 9% in notional put options). Additionally, the fund maintained approximately 7% of its assets in cash.
Nicola Preferred Share Fund
The Nicola Preferred Share Fund returned –0.6% in October. Throughout the month, the Nicola Preferred Share Fund maintained a defensive position, concentrating on higher-quality institutional preferred shares. This strategy proved effective as these shares outperformed $25 rate-reset preferred shares, returning an average of -0.7%. In the broader preferred share market, the negative returns for the month reflected an overall risk-off sentiment. Fixed resets, floaters, and perpetuals returned -2.8%, -3.5%, and -4.2%, respectively, as credit and macroeconomic concerns exerted pressure on preferred shares.
Nicola International Leaders Fund
The Nicola International Leaders Fund returned +0.2% in October. In Europe, the European Central Bank (ECB) maintained interest rates unchanged for the first time in over a year. However, the bank reiterated its commitment to keeping borrowing costs restrictive for as long as necessary to combat inflation. In the Eurozone, there was a mixed economic picture as October's inflation figure dropped to a two-year low (year-over-year), while Q3 GDP showed contraction on a quarter-over-quarter basis. In Emerging Markets, Taiwan stood out as one of the significant contributors, driven by strength in the Information Technology sector.
The primary drivers of relative performance during the month were holdings in Industrials, Information Technology, and the United Kingdom. Notably, BAE, a global aerospace and defence company, was among the major contributors. Defence stocks, including BAE, experienced upward movement in October due to heightened geopolitical conflicts.
Conversely, the main relative detractors to performance during the month were our holdings in Healthcare, Consumer Discretionary, and Germany. A notable detractor was Sanofi, a leading global healthcare company with a portfolio encompassing pharmaceuticals, vaccines, and consumer healthcare. Sanofi's shares experienced a de-rating as the company adjusted its 2024 earnings guidance downward. This adjustment was primarily attributed to increased Research and Development (R&D) expenditures to support its late-stage pipeline.
In summary, while Europe saw stability in interest rates, the economic landscape presented a mix of positive and negative indicators. The fund's performance was bolstered by strong positions in certain sectors and regions, particularly in response to geopolitical dynamics. However, challenges were encountered, particularly in healthcare, reflecting the impact of company-specific factors on stock valuations.
Nicola Global Small-Cap Equity Fund
The Nicola Global Small-Cap Equity Fund (CAD) returned -1.9% in October.
The Nicola Global Small-Cap Equity Fund (USD) returned -4.4% in October.
During the month, International (-3.5%) and Emerging Markets (-2.5%) small caps demonstrated outperformance, while U.S. (-4.0%) small caps experienced underperformance. In the U.S., robust economic data, including GDP, job numbers, and retail sales, supported the rationale for keeping interest rates "higher for longer," leading to 10-year Treasury yields reaching new highs for 2023. In Europe, the European Central Bank (ECB) left interest rates unchanged but signalled that borrowing costs would remain at current levels until further progress is made on inflation. In China, despite several positive economic indicators, such as GDP, industrial production, and retail sales, sentiment was dampened by ongoing weaknesses in the real estate sector and additional U.S. restrictions on semiconductors.
Key contributors to relative performance during the month were holdings in Health Care and the U.S. (underweight). Notably, Draegerwerk, a leader in medical equipment for anesthesia, ventilation, and monitoring, emerged as one of the significant contributors. The company reported strong Q3 results as the easing of supply chain issues allowed it to convert its order book into sales.
Major detractors to relative performance during the month were holdings in Energy and France. One of the most significant detractors was Verallia, a leading supplier of glass containers primarily for the wine and spirits industries. Verallia's shares declined in October as the company adjusted its guidance downward, citing softening demand and destocking by customers.
Nicola Sustainable Innovation Fund
The Nicola Sustainable Innovation Fund (CAD) returned -8.0% in October.
The Nicola Sustainable Innovation Fund (USD) returned -10.4% in October.
The primary publicly traded benchmarks we monitor faced similarly challenging returns, with the iShares Global Clean Energy ETF declining by -11%, and the Invesco WilderHill Clean Energy ETF experiencing a more significant drop of -21% for the month. However, early November brought a market rebound, marked by the S&P 500 recording its best week of 2023. Clean energy-focused indexes also recovered some losses from October, aligning with the broader market trend.
Top performers during the month included investments in PIMCO California Carbon Access Offshore LP, Constellation Energy, and Xylem Inc. On the other hand, ChargePoint Holdings, Alstom, and Enphase Energy were the primary detractors from performance.
Throughout the month, we actively engaged in portfolio repositioning. Notably, we exited our position in Alstom, the French train and rail equipment maker, following a profit warning and a substantial reduction in their financial guidance. Partial rebalancing activities were conducted in several European names, including EDP Renewables, Iberdrola, and Vestas Wind Systems. Proceeds from these actions were allocated to Brookfield Renewable Partners and Constellation Energy, a nuclear power operator. Additionally, we initiated a new position in First Solar, a leading American solar technology company specializing in thin-film photovoltaic (PV) modules produced domestically. First Solar is strategically positioned with efficient technology and domestic manufacturing, making it well-suited to gain market share in the more stable utility-scale solar segment compared to residential solar markets.
At the end of the month, cash position stood at approximately 7.7%, providing flexibility for further tactical repositioning in response to ongoing market conditions.
Nicola Infrastructure and Renewable Resources Limited Partnership
The Nicola Infrastructure and Renewable Resources Limited Partnership (CAD) returned +2.4% in October.
The Nicola Infrastructure and Renewable Resources Limited Partnership (USD) returned -0.2% in October.
The CAD weakening against the USD and EUR had a favourable impact on the CAD sleeve, while it had a detrimental effect on the USD sleeve. Our overall assets, independent of currency considerations, yielded a return of 0.3% over the month. This positive performance was attributed to the Q3 2023 results aligning with expectations at our U.S. energy-as-a-service platform co-investment. Additionally, the Q2 2023 performance met expectations at our global core and core-plus infrastructure fund.
Nicola Global Real Estate Fund
The Nicola Global Real Estate Fund returned -0.8% in October. The performance of equity markets, fixed income markets, and REITs was negatively impacted by the rise in bond yields. Over the past 24 months, there have been 520 central bank rate hikes globally, with the aim of moderating inflation back to pre-pandemic trends. Despite the continuous tightening of financial conditions, inflation has proven more persistent than anticipated, and economic growth has remained seemingly robust. We feel this resilience is driven by a relatively healthy labour market and companies' ongoing efforts to hire and expand.
The prevailing "higher for longer" narrative on interest rates had a substantial impact on publicly traded REITs in October. The anticipation of prolonged higher interest rates led to increased financing costs for upcoming debt maturities, likely resulting in lower net cash flow growth in the future. This, in turn, could contribute to higher applied average capitalization rates when determining net asset values.
Despite these challenges, there is an expectation of strong underlying property fundamentals, particularly in the Multi-family and Industrial categories. The belief is that REITs are currently undervalued compared to historical standards. The stabilization of interest rates is seen as a potential factor that could boost sentiment, and the anticipation is that lower long bond yields could eventually lead to improved earnings growth and alleviate concerns about capitalization rate expansion. The overall outlook suggests a cautious optimism, balancing the headwinds posed by rising interest rates with the underlying strength in certain property categories.
Nicola Canadian Real Estate Limited Partnership
Nicola Canadian Real Estate Limited Partnership NAV per unit has decreased to $157.6372 (previously $158.1068), effective October 31, 2023. This represents a decrease of 0.3% and a positive return for September of 0.0%. YTD return as at September 30, 2023 is 4.6%. Portfolio Leverage is 44.97%. Returns were flat this month. Decreases in appraised values due to yield expansion were offset by continued strong leasing activity, an increase in market leasing assumptions, net operating income, and an increase in value of development properties.
Nicola U.S. Real Estate Limited Partnership
Nicola U.S. Real Estate Limited Partnership NAV per unit has decreased to US$200.5565 (previously US$201.7369), effective October 31, 2023. This represents a decrease of 0.6% and a negative return for September of 0.2%. YTD return as at September 30, 2023 is 4.7%. Portfolio Leverage is 49.43%. Returns were negative this month. Decreases in appraised values due to yield expansion were partially tempered by strong leasing activity, an increase in market leasing assumptions, net operating income, and an increase in value of development properties.
Nicola Value Add Real Estate Limited Partnership
Nicola Value Add Real Estate Limited Partnership NAV per unit has increased to $246.2882 (previously $245.3571), effective October 31, 2023. This represents an increase of 0.4% and a positive return for September of 0.4%. YTD return as at September 30, 2023 is 4.7%. In September, we funded $6.2M for existing projects.
