Returns for the Nicola Core Portfolio Fund were -0.6% for the month of September. 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.
The Nicola Bond Fund returned -0.5% in September, -0.2% in the third quarter, and +2.8% year-to-date, surpassing the iShares Core Canadian Universe Bond Index ETF, which had a monthly return of -2.5%, quarterly return of -3.8%, and year-to-date return of -1.5%. The Nicola Bond Fund’s short duration contributed to its relative outperformance as Canadian government bond yields rose sharply in September with the Canadian 10-year government bond yield rising +0.4% from 3.6% to 4.0%. This was driven by the realization that rates are likely to remain higher for longer, given sticky inflation and the resilient economy. In terms of credit, Canadian spreads ended September unchanged at 1.5% despite headwinds from heavy new issuance and the drastic rise in government bond yields. We selectively participated in a few issues that offered new issue concessions and had strong credit fundamentals. Top-performing strategies during the month include East Coast Investment Grade and Sun Life Short Term Private Fixed Income, which returned +0.7% and +0.6%, respectively. These strategies outperformed as they have a focus on short duration, high-quality investment-grade assets. We expect market volatility to persist in October, and our defensive positioning allows us to take advantage of attractive opportunities as they arise.
The Nicola Global Bond Fund (CAD) returned -1.1% in September, +0.6% quarter-to-date, and +2.8% year-to-date.
The Nicola Global Bond Fund (USD) returned -1.0% in September, -1.5% quarter-to-date, and +3.0% year-to-date.
BlackRock Securitized Investors LP contributed +0.4% (total return in Canadian dollars) to September returns, while the main detractors were PIMCO Monthly Income and Templeton Global Bond, which declined 1% and 0.6%, respectively. Within BlackRock, CLOs outperformed during the month, benefiting from their floating rate nature and high single-digit carry. PIMCO and Templeton returns suffered due to rising global yields caused by hawkish inflation events and central bank rhetoric. In particular, the Fed's stronger economic outlook and forecast for fewer 2024 rate cuts fueled investors' higher-for-longer narrative and hurt global bond prices. Oil prices in September also temporarily surged on reports that Saudi Arabia and Russia would extend measures to limit production through the end of 2023. Currency was a headwind for the Nicola Global Bond Fund in September, as Asian currencies in the portfolio, led by the Japanese Yen, Indonesian Rupiah, and South Korean Won, weakened against the Canadian dollar.
The Nicola High Yield Bond Fund (CAD) returned +0.1% in September, +2.8% quarter-to-date, and +5.4% year-to-date.
The Nicola High Yield Bond Fund (USD) returned +0.2% in September, +0.7% quarter-to-date, and +5.6% year-to-date.
The Nicola High Yield Bond Fund (CAD) surpassed the iShares US High Yield Bond Index ETF (CAD-Hedged), which had a monthly return of -1.6%, a quarterly return of +0.6%, and a year-to-date return of +4.1%. High yield experienced negative total returns in September as credit spreads ended the month +0.2% higher at 4.0%, and U.S. Treasury yields also rose significantly, with the 10-year Treasury yields increasing +0.5% from 4.1% to 4.6%.
During the month, the Federal Reserve delivered a widely anticipated rate pause in September's FOMC meeting. However, Fed officials also indicated they expect to keep rates higher for longer (through 2024) than they anticipated earlier this year. The Nicola High Yield Bond Fund outperformed as the fund had a relatively shorter duration and was defensively positioned, given comparatively tight high yield valuations. Our investment in PIMCO California Carbon Access also continued to perform well, returning +3.0% in Canadian dollar terms. Other top-performing strategies in September include PIMCO Tactical Income Fund and PIMCO Tactical Income Opportunities Fund, both returning +1.3% in Canadian dollars. The fund will continue to focus on higher-quality credits with better risk/reward characteristics in the near term, as we expect cracks to form in the economy in a higher-for-longer rates environment.
The Nicola Preferred Share Fund returned +0.4% in September, -1.0% quarter-to-date, and +0.1% year-to-date. During September, the Nicola Preferred Share Fund underperformed its respective market as riskier, lower backend rate-reset preferred shares rallied over news of an unexpected redemption of TD.PF.K. We view this as an isolated event, as TD had plenty of excess capital resulting from terminating their First Horizon acquisition. In comparison, National Bank recently chose to extend their preferred share issue, and other banks have also extended theirs throughout this year. In addition to the TD redemption, the higher Canadian 5-year yield and flat corporate spreads drove rate-reset preferred shares higher. The Nicola Preferred Share Fund continued to preserve liquidity as we believe risks remain balanced in this space. We remain cautious about potential tax-loss selling over the coming months but anticipate the rate-reset universe to reset to a higher overall yield in early 2024.
The Nicola Primary Mortgage Fund returned -0.1% in September, with a trailing 12-month return of +4.5%. The negative return for the month was a result of downward mark-to-market valuation adjustments to the book value of existing loans that have lower fixed interest rates. However, it's important to note that these adjustments are not reflective of the credit quality of those loans. Investment activity continues to be limited in anticipation of the termination of the Nicola Primary Mortgage Fund and the transfer of assets to the Nicola Balanced Mortgage Fund, expected to occur on or around October 31, 2023. As of the end of the month, the Nicola Primary Mortgage Fund held 15.6% in cash and cash equivalents, with 100% of the direct loan portfolio secured by senior-ranking mortgages.
The Nicola Balanced Mortgage Fund returned +0.7% in September, with a trailing 12-month return of +7.8%. New loan origination activity, which was slow over the summer months, has picked up, and there is a healthy pipeline of new loans scheduled to fund in Q4. As of the end of the month, the Nicola Balanced Mortgage Fund held 2.9% in cash and cash equivalents, with 49% of the direct loan portfolio secured by senior-ranking mortgages.
The Nicola U.S. Mortgage Fund (CAD) returned -0.2% in September with a trailing 12-month return of +1.3%.
The Nicola U.S. Mortgage Fund (USD) returned -0.1% in September with a trailing 12-month return of +2.6%.
The negative return for the month was primarily due to ongoing fund expenses, as well as September falling between the quarterly distribution of the Nicola U.S. Mortgage Fund’s largest investment. The direct loan portfolio continues to grow, with a new loan funded in September and additional loans scheduled to fund in Q4. As of the end of the month, the Nicola U.S. Mortgage Fund held 17.9% in cash and cash equivalents, with 100% of the direct loan portfolio secured by senior-ranking mortgages.
The Nicola Canadian Equity Income Fund returned -1.7% in September, -2.1% quarter-to-date, and +0.5% year-to-date. Canadian equities posted a second consecutive month of negative returns in September, along with a negative return for Q3. Economic conditions are continuing to deteriorate, as evidenced by soft Canadian GDP data points, weakening retail figures, and falling small business confidence (now at recessionary levels). Another Bank of Canada interest rate announcement is scheduled for October 25th, but the debate is already shifting from "more hikes to come?" to "higher for how much longer?"
Following the signal from the U.S. Fed, Canadian equity investors have been adjusting to the higher-for-longer narrative, resulting mainly in the underperformance of long-duration stocks and bond proxies, such as information technology, utilities, and REITs. The potential for inflation to stay elevated for longer than desired led to a 9% and 29% lift in WTI oil prices in September and Q3, respectively. Therefore, the Energy sector remained a bright spot for the TSX, being the only sector with positive returns in the month and one of two sectors with positive returns in the quarter. In September, the top three sectors of the TSX that contributed to returns were Energy, Health Care, and Consumer Staples. The bottom three detractors were Information Technology, Materials, and Financials.
Inside the Nicola Canadian Equity Income Fund, the top-performing sectors in the month were Energy (+2.0%), Financials (+0.1%), and Utilities (-0.4%). The bottom-performing sectors were Consumer Discretionary (-6.1%), Real Estate (-6.1%), and Communication Services (-5.1%). The fund maintains an overweight posture in Energy based on the expectation of strong cash flow generation driving further returns of capital to shareholders. It continues to underweight Financials (and Banks) due to the expectation of continued profit pressures in a slow lending environment.
From an attribution perspective, security selection was the biggest contributor to outperformance. The Nicola Canadian Equity Income Fund’s top-performing positions were Canadian Western Bank, Parkland Corp., and Suncor Energy, while the bottom performers were Nuvei Corp., Canadian Tire Corp., and Richelieu Hardware. No positions were exited. The Nicola Canadian Equity Income Fund trimmed areas of strength to add to those with more compelling risk-reward ratios and attractive dividend yields. Put options were written opportunistically on West Fraser Group. We believe the Nicola Canadian Equity Income Fund maintains competitive characteristics against the TSX, with double-digit growth rates being generated through better value (12.1x P/E vs. 12.3x) and less debt (2.8x leverage vs. 3.5x).
The Nicola U.S. Equity Income Fund (CAD) returned -3.2% in September, +0.8% quarter-to-date, and +8.6% year-to-date.
The Nicola U.S. Equity Income Fund (USD) returned -3.2% in September, -1.3% quarter-to-date, and +8.8% year-to-date.
In September, the S&P 500 experienced a decline of -4.8%. September lived up to its reputation as one of the most challenging months of the year, as the S&P 500 experienced a significant 4.8% decline. Notably, this marked the second consecutive month of negative market returns, resembling the pattern observed in August and September 2022.
For the third quarter of 2023, the Nicola U.S. Equity Income Fund (USD) delivered a return of -1.3%, compared to the S&P 500's return of -3.3% (total return in U.S. dollars). During the month of September, the market grappled with concerns around the health of consumers, driven by factors such as elevated oil and gas prices, a deceleration in spending data, rising credit losses, the resumption of student debt payments, a cooling employment landscape, a potential government shutdown, and labour strikes. The situation was further exacerbated on September 20th when the FOMC signalled reduced expectations for future rate cuts in the upcoming year; this coincided with the Treasury 2-year yield surging to ~5.13%, a level not witnessed since 2006.
The Nicola U.S. Equity Income Fund was overweight in the top-performing sector, Energy, while maintaining an underweight allocation in one of the worst-performing sectors, Information Technology. Additionally, stock selection contributed to relative returns, particularly in Health Care and Communications Services, where UnitedHealth Group, Gilead Sciences, Abbvie, and AT&T made notable contributions.
The Nicola U.S. Equity Income Fund’s top individual contributors to performance were UnitedHealth Group, Shell PLC, and AT&T. The top detractors to performance were VISA, Wesco International, and Union Pacific. Regarding portfolio adjustments, the fund made several notable changes. It reduced exposure to big tech by reducing its weighting in Apple, as well as trimming exposure to materials, specifically selling Freeport McMoRan. In contrast, the Nicola U.S. Equity Income Fund increased its exposure to Healthcare and U.S. REITs.
Among the noteworthy additions to the portfolio last month were two pharmaceutical companies: Gilead Sciences and Biogen. Gilead Sciences holds a dominant position in the HIV sector, accounting for approximately 70% of its sales. The company has been expanding its product portfolio in areas such as oncology and cell therapy. We feel Gilead Sciences boasts relatively strong financial health, characterized by a solid balance sheet, strong free cash flow, and a well-supported 4% dividend.
The other addition, Biogen, offers an attractive opportunity to enter the Alzheimer's market, particularly with its potential blockbuster drug, Leqembi. Biogen's valuation is compelling, primarily supported by its legacy products in areas such as Multiple Sclerosis, Spinal Muscular Atrophy, Biosimilars, and manufacturing. The company has historically consistently generated free cash flow and maintains a clean balance sheet.
Overall, we feel the Nicola U.S. Equity Income Fund is comprised of high-quality companies with healthy balance sheets, strong free cash flows, and attractive blended forward 1-year Return on Equity (ROE) figures (31% compared to 18% for the S&P 500).
The Nicola International Leaders Fund returned -2.5% in September, -1.2% quarter-to-date, and +9.3% year-to-date. In Europe, markets were affected by higher bond yields following the ECB's announcement that interest rates would remain restrictive for as long as necessary to combat inflation. In Emerging Markets, China's economy displayed signs of recovery, but ongoing stress in the property markets added to concerns.
The main contributors to our performance during the month were our investments in the Financials sector and Japanese holdings. Notably, our positions in Japanese banks, including MUFG (the largest bank in Japan) and SMFG (the second-largest bank in Japan), performed well in September, driven by speculations around monetary policy normalization by the Bank of Japan.
Conversely, the primary detractors of our performance during the month were our holdings in the Utilities sector and Germany. Specifically, our investments in Utilities, such as Iberdrola and Enel, were negatively affected by the increase in long-term bond yields.
The Nicola Global Small-Cap Equity Fund (CAD) returned -3.8% in September, +0.5% quarter-to-date, and +4.2% year-to-date.
The Nicola Global Small-Cap Equity Fund (USD) returned -3.7% in September, -1.6% quarter-to-date, and +4.4% year-to-date.
In the U.S., markets faced pressure as 10-year Treasury yields reached their highest levels in over a decade, following the Federal Reserve's indication that interest rates would need to stay elevated for an extended period. Similarly, in Europe, the European Central Bank (ECB) also signalled that interest rates would remain high to combat inflation. In Emerging Markets, India's market saw positive support with a +0.8% gain, driven by better-than-expected economic data.
The primary contributors to our performance during the month were our holdings in the Information Technology sector, and our underweight position in the U.S. market. Notably, one of the significant contributors was Jabil, one of the largest manufacturing services providers. Jabil's stock moved higher in September as the company's strategic shift toward secular growth markets, including renewables, electric vehicles, and healthcare, continued to drive margin expansion and earnings growth.
Conversely, the primary detractors from performance during the month were holdings in the Consumer Staples sector and Germany. A notable detractor was Gerresheimer, a leading supplier of specialty glass and plastic packaging products, including syringes, inhalers, vials, and bottles, mainly used in the healthcare industry. Gerresheimer's shares declined in September as sell-side analysts lowered growth estimates, citing lower resin prices and the ongoing ramp-up of higher-margin syringe programs as factors impacting the company's performance.
The Nicola Sustainable Innovation Fund (CAD) returned -10.3% in September, -14.6% quarter-to-date, and -20.1% year-to-date.
The Nicola Sustainable Innovation Fund (USD) returned -10.2% in September, -16.4% quarter-to-date, and -20.0% year-to-date.
Top performers during the month included Mobileye Global, Constellation Energy, and our investment in PIMCO California Carbon Access Offshore LP. On the other hand, TPI Composites, NextEra Energy Partners, and ChargePoint Holdings were the biggest drags on our performance.
September proved to be another challenging month for the sector, with several headwinds impacting the renewables space and causing a broader decline. Notably, one of the significant developments was NextEra Energy Partners, a major player in the renewable power asset sector, reducing their dividend growth rate expectations and overall growth outlook. This announcement led to several analyst downgrades on the stock and had ripple effects across the renewables space, affecting related companies as analysts and investors assessed the impact of higher costs of capital and rising interest rates.
Given the persistently high interest rates, elevated costs, and ongoing uncertainty, it may take some time to find a stable footing for the renewables sector. To navigate these challenges, the Nicola Sustainable Innovation Fund has increased its cash position to approximately 4% as of early October. This approach allows the Nicola Sustainable Innovation Fund to be defensive and have dry powder available for tactical opportunities. The Nicola Sustainable Innovation Fund did not add any new positions to the portfolio during the month, and it received a small net cash distribution from an investment in Ares Climate Infrastructure LP following the return of capital from several of their early investments.
The Nicola Infrastructure and Renewable Resources Limited Partnership (CAD) returned -0.1% in September, +2.0% quarter-to-date, and +2.6% year-to-date.
The Nicola Infrastructure and Renewable Resources Limited Partnership (USD) returned +0.0% in September, -0.1% quarter-to-date, and +2.7% year-to-date.
Currency movements, particularly the weakening of the euro and the British pound against both the U.S. and Canadian dollars, had a negative impact on the USD and CAD sleeves of the Nicola Infrastructure and Renewable Resources Limited Partnership portfolio. However, when agnostic to currencies, assets returned 0.5% over the month, contributing to positive performance for the quarter and year-to-date.
Nicola Infrastructure and Renewable Resources Limited Partnership performance for the quarter was in line with expectations, with the Ports America Group co-investment playing a significant role. This positive contribution was partially offset by ongoing challenges in our North American integrated energy platform fund and updated interest rate assumptions in our North American data center co-investment. It's worth noting that despite these challenges, leasing at the data centers has remained ahead of budget, and most markets have experienced significantly higher new lease rates, which has helped mitigate the impact of higher costs.
The Nicola Venture Capital Limited Partnership (CAD) returned +1.4% in September, +1.4% quarter-to-date, and -5.8% year-to-date.
The Nicola Venture Capital Limited Partnership (USD) returned -0.7% in September, -0.7% quarter-to-date, and -5.6% year-to-date.
Performance was primarily impacted by foreign exchange movement and a write-up in an existing co-investment. Although venture financing activity in Q3 remained below the peak levels seen in 2021, there were some positive signs in the long-stagnant venture-backed IPO market, with notable IPOs from Kaviyo and Instacart. From a pipeline perspective, the Nicola Venture Capital Limited Partnership continues to focus on partnerships with top-quartile performing U.S. venture capital managers and on secondary investment opportunities. The Nicola Venture Capital Limited Partnership has identified several actionable opportunities for Q4 and into 2024. There were no new investments or realizations during the quarter.
The Nicola Private Equity Limited Partnership returned 0.5% in September, +4.0% quarter-to-date, and +5.7% year-to-date.
The performance during the quarter was driven by valuation write-ups in four co-investments: MDA, Micross Components, Palladin Decowraps, and Project Avon. MDA, a Canadian space robotics company, reported strong earnings results with EBITDA well ahead of expectations and continues to see a strong pipeline across its government and commercial businesses. Micross, a manufacturer of specialty microelectronic components, continues to deliver strong earnings growth and capitalize on its acquisition pipeline. Palladin Decowraps, a floral packaging business, improved EBITDA margins by reducing transportation costs and implementing other cost optimization initiatives. Project Avon, a US-based healthcare services business, was previously negatively impacted by Omicron; however, the company is recovering, and various operational initiatives are helping drive EBITDA growth and margin expansion. Currency had approximately a 150 bps positive impact on fund performance for the period.
There were no new investments or realizations during the quarter.
The Nicola Global Real Estate Fund returned -2.9% in September, -2.2% quarter-to-date, and -2.7% year-to-date. The "higher for longer" narrative has negatively impacted publicly-traded REITs, along with other equities often considered bond proxies. The recent significant rise in bond yields has led to a decline in REITs and similar equities. This spike in interest rates has helped moderate inflation but has also contributed to an economic slowdown. Additionally, with tighter credit conditions and limited visibility in private market pricing, flows into the sector have been affected.
On the bright side, the appeal of fixed income investments is growing, with the 10 Year Government of Canada Bond yield reaching 4.02%, a level not seen since late 2007. Despite the headwinds, we believe the sector's fundamentals remain strong, particularly in property types like multi-family, industrial, and self-storage. REITs are trading at significant discounts relative to historical standards, and as interest rates stabilize, sentiment may improve. Furthermore, the eventual decline in long bond yields could positively impact earnings growth and alleviate concerns about cap rate expansion.
The Nicola Canadian Real Estate Limited Partnership NAV per unit has increased to $158.1068 (previously $157.3668), effective September 30, 2023. This represents an increase of +0.4% and a positive return for August of 0.8%. YTD return as at August 31, 2023 is +4.5%. Portfolio Leverage is 45.22%. The positive return was primarily due to increased appraised values of Advanced - North Vancouver and Cathedral Energy.
The Nicola U.S. Real Estate Limited Partnership NAV per unit has decreased to US$201.7369 (previously US$202.2925), effective September 30, 2023. This represents a decrease of 0.3% and a positive return for August of 0.1%. YTD return as at August 31, 2023 is 4.9%. Portfolio Leverage is 48.43%. The positive return was primarily due to increased appraised values of Gateway Corporate Center, Carlyle Place, and Ventana.
The Nicola Value Add Real Estate Limited Partnership NAV per unit has increased to $245.3571 (previously $243.7594), effective September 30, 2023. This represents an increase of 0.7% and a positive return for August of 0.7%. YTD return as at August 31, 2023 is 4.3%. In August, we funded $5.2M for one new project that closed (3865 W. Van Buren) and $1.8M 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 Management Ltd. (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. ETF’s 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.
