Market Commentary: A Recipe for Inflation


By Rob Edel, Chief Investment Officer

Highlights this Month

 

March In Review 

Last month saw markets mark the one-year anniversary of the pandemic and the March 23rd, 2020 lows. While Covid-19 remains a global concern, massive fiscal and monetary aid, as well as the prospect of vaccines providing a pathway to herd immunity and normalcy, have helped engineer a remarkable recovery in asset prices. As of market close on March 22nd, 2021, the S&P/TSX’s one-year total return topped +73%, while the S&P 500 delivered nearly +55% (all in C$ terms). According to BMO’s Investment Strategy Group, the S&P 500’s +79% total return (in US$ terms) was the highest first-year return for any bull market since 1945.

The markets showed very strong returns last month.

Contributing to these remarkable one-year results were very strong returns last month, with the S&P/TSX gaining 3.9% and the S&P 500 +3.3% (all in C$ terms). For the first quarter in total, Canada outpaced global markets with a +7.3% (price return in C$) compared to +5.8% (price return in US$) for the S&P 500. Both indices consistently hit new all-time highs in March, fueled by what Goldman Sachs reported as the largest equity inflows on record. Not all risk assets performed equally, however, particularly bonds. Below we attempt to explain why and take a closer look at inflation and how it may influence investment returns in the future.

Slow progress is being made towards herd immunity.

First off, we can’t talk about the markets without commenting on the pandemic and the progress being made towards herd immunity. From a US perspective, the speed at which vaccines have been rolled out has exceeded expectations and allowed the US economy to re-open quicker than expected, perhaps too quickly.

While a recent Gallup poll shows Americans are increasingly becoming less and less concerned about catching Covid-19, the US has not yet reached herd immunity and there are some concerns that mutations of the virus could cause another wave of infections (what are we up to in the US, a fourth wave?). It was certainly unsettling to see the hordes of college students descending on Florida beaches during Spring Break, as well as sudden decisions in many States to discontinue mask-wearing mandates and other restrictions. New cases have in fact started to trend higher, especially amongst the unvaccinated younger population, but fortunately, death rates have continued to drop.

Canada and Europe have been less fortunate. Vaccination rates have been slow to gain momentum as access to vaccines has been problematic. Europe in particular is more reliant on the Astra Zeneca vaccine, which has been associated with blood clots in younger people and has had numerous missteps in reporting trial results. The US has had its own issues with the Johnson and Johnson (JNJ) vaccine, but Moderna and Pfizer have been able to successfully scale the production of their vaccine making access to the JNJ vaccine less important.

With many Eurozone countries already battling vaccine hesitancy, the missteps in communicating the efficacy and safety of the Astra Zeneca vaccine will inevitably lead to lower vaccination rates, even if supply becomes available. With Canada, it’s more an issue of securing product. After a slow start, vaccine supply is starting to ramp higher, but unfortunately so are the more infectious variants. In both Europe and Canada, it is becoming a race between rolling out the vaccine and battling the variants. We’ll get there eventually, but the next couple of months could be challenging, from both an economic and health perspective.

The markets have moved on from the pandemic.

As for the market’s view of the pandemic, it has largely moved on. According to a March Bank of America survey, Fund Manager’s no longer view Covid-19 as the market’s biggest “tail risk”. Taking over the top two spots on their list of worries are higher than expected inflation and a “tantrum” in the bond market. Signs of both were evident last month and dominated market action.

Ten-year bond yields jumped nearly 34 basis points and ended March at 1.74%, and according to the Bloomberg Barclays treasury index, bonds fell 4%, their largest monthly decline since 1980. Equities appeared to be unaffected, however, as the carnage in the bond market only managed to slow the ascent of global stocks down. While the broader equity markets continued to melt higher, however, it was the less interest-rate-sensitive cyclical sectors and stocks that were leading the way.

Continuing to lose momentum were higher duration growth stocks.

While the Dow Jones Industrial Average was up 8.2% (total return US%) and the Russel 2000 Value EFT soared +21.3%, the growth-orientated NASDAQ gained only 3.0% and the more concentrated NASDAQ 100 a mere +1.8%. The ARK Innovation ETF, a collection of notable high-flying growth names, actually fell 8.0% last month. Also losing some steam was the SPAC (Special Purpose Acquisition Companies) market, with the average monthly performance of SPAC’s on their first day of trading barely ending the month in the black last month. Higher interest rates definitely took some of the wind out of the speculative bubble that had been building over the past few months, which is a good thing.

Fortunately, the damage appeared confined to the speculative fringes of the equity market and didn’t appear to be foreshadowing problems brewing in the real economy. This was particularly evident in the corporate credit market, where even though Treasury bond yields moved higher, spreads actually tightened. In fact, the junkier the credit, the more credit spreads rallied last month. On the equity side, broader market strength was evidenced by an increasing number of S&P 500 stocks advancing (advance/decline line hitting new high) and trading above their 200-day moving average. Market strength in both credit and equities are signs the increase in Treasury Yields are being interpreted as a sign of economic strength, and foreshadowing further gains are still possible.

Backing up the market’s view, signs the economy is on the verge of a historic comeback are building. Purchasing manager indices were very strong last month and rising restaurant seatings are an early indicator of a resurgent service sector. Most strategists have been increasing their forecasts for 2021 GDP growth, with the average estimate now +5.7% versus last year’s 3.5% contraction. It is now estimated the US should hit pre-pandemic GDP levels by mid-2021, well before either Europe or Japan (or Canada for that matter).

Massive fiscal stimulus might result in an overheated US economy.

A faster than forecast vaccine rollout is partially responsible for the increased optimism, but massive fiscal stimulus is prompting many to worry the US economy might overheat. After passing the $1.9 trillion “American Rescue Plan” in early March, President Biden announced plans for an additional $2.25 trillion infrastructure bill, dubbed the “American Jobs Plans” last month.

Biden is widely expected to unveil an additional program, the “Caring Economy” bill, with an estimated $1 to 2 trillion price tag in the not too distant future. The infrastructure bill comes with increases to Corporate tax rates, and the socially orientated “Caring” bill will likely include higher personal tax rates for the wealthy, which will dampen some of the market’s enthusiasm. President Trump may have referred to Biden as sleepy Joe, but in his first 100 days in office, he has been anything but! The $1.9 trillion fiscal support package alone is estimated to lift US GDP by 3.8% in its first full year, and according to Goldman Sachs, could result in total stimulus exceeding the current output gap by a magnitude of six to one in 2021.

 

The recipe for inflation.

Already prices in certain products have moved higher during the pandemic. Used car prices spiked higher as demand recovered during the lockdowns, as did the prices of other goods in high demand, such as household products and recreational goods. Official CPI numbers likely understate the increase in inflation given the basket of goods used to calculate CPI is different than the typical pandemic consumption basket. Consumption patterns have changed and inflation is higher than reported. Brace yourself, however, inflation is likely to get a whole lot higher.

Increased demand, higher commodity prices, and supply chain disruptions are causing manufacturers to experience higher input prices, which they are going to try their best to pass on to you! The Philadelphia, New York, Kansas City, and Dallas Federal Reserve Bank surveys are all indicating higher raw materials are causing inflationary pressures, and the Atlanta Fed expects unit costs to increase 2.4% over the next 12 months.

The purchasing manager indexes for input prices for Europe, Australia, Japan, and the US have all spiked higher. Add to this the supply disruption of the Evergreen container ship blocking the Suez Canal for six days and you can more or less count on higher prices, even before economies are re-opened and pent-up demand is unleashed.

The impact of an increase in inflation.

Despite these growing pressures, the Federal Reserve is sticking with the company line that inflation will increase, but the impact will be transitory. To Chairman Powell’s credit, it’s not uncommon for the market to overestimate inflation or prematurely anticipate rate hikes. Five-year break-even rates, a common indicator of the financial market’s forecast of future inflation, consistently overshoots Core PCE (the Fed’s favourite inflation indicator), and derivative markets routinely start to discount an increase in short-term rates well before the Fed is compelled to tighten. Also, while growth might exceed output in the US, there is still plenty of excess capacity in foreign factories.

Fair point Mr. Powell, but the market is likely to test your resolve regardless as the economy strengthens and prices move materially higher. While the Fed has signalled, they will be on hold through 2023, Fed Funds futures are already pricing in at least one increase by the end of 2022. According to BCA Research, the OIS swaps curve is currently discounting four increases, or +1.00% by the end of 2023. Last month’s correction in the Bond market is not the last tantrum we are likely to see.

In the short term, the Fed may be right, inflation might spike higher in 2021, but the move will likely be transitory. Supply chain disruptions will work themselves through, and even though fiscal policy is of a magnitude not seen since WWII and will create a sizable sugar rush of economic growth, its impact will also fade.

Longer-term, inflation gets harder to predict.

Tax increases attached to the Infrastructure bill could also dampen growth as the positive impact from the spending will phase in over 10 years, while the negative impact from tax increases will be more immediate. Longer-term, however, inflation gets much harder to predict. The Bank of England’s 2025 forecast for UK inflation, for example, ranges from -1% to 5%. There are a lot of variables to consider and most are hotly debated.

Demographic is one of the most prevalent. An ageing population that would be expected to consume less is generally considered to be deflationary. Some argue, like the authors of the book “The Great Demographic Reversal”, an ageing population will reverse the deflationary pressures of the past 30 years given a greater number of retirees will still be consuming, but not producing.

An increase in the dependency ratio is inflationary because it negatively reduces supply, while demand remains strong for sectors like healthcare. They expect the balance of power between capital and labour to swing back in labour’s favour, potentially helping reduce inequality, but hurting corporate profit margins. Labour being in a stronger bargaining position means wages should increase, which is what is required for inflationary expectations to finally break higher. As Goldman Sachs recently pointed out, it was a tight labor market in the late 1960’s that resulted in rising inflation.

Government policy will play a commanding role in the inflation vs deflation debate.

Demographics matter, but we also believe government policy will play a commanding role in the inflation versus deflation debate. While President Biden’s massive stimulus programs will push debt/GDP ratios higher, the trend towards bigger government spending was already firmly in place during President Trump’s administration. We don’t see any signs of fiscal restraint in Washington (or Ottawa) from either the Democrats or Republicans.

Debt levels are going higher, which is fine as long as interest rates remain low. Debt serving costs can remain manageable even if debt explodes higher, but only if interest rates are held at very low levels. The key to keeping debt under control is for the growth rate of the economy to exceed the interest rate on debt, something Jefferies believes has happened 57% of the time historically.

Higher inflation helps increase nominal economic growth, while a cooperative central bank is required to keep interest rates low. The result is negative real interest rates, which is essential if you plan to spend your way to growth and reduce inequality. Biden is doing his part by ratcheting up spending, but the Fed appeared to fall a bit behind last month as real interest rates moved higher. The market is watching intently. As bond yields continue to move higher, at what point does the Fed take action and actively try and control the yield curve?

While Fiscal Policy has provided a rainbow of optimism, there are risks.

A steeper yield curve is a sign of a healthy economy and helps facilitate bank lending. Rates moving too quickly and too high becomes problematic for the market, however, as does signs of increasing inflationary expectations. Last month’s move higher in yields was associated with stronger growth rather than problematic inflation, and while it weighed on some interest rate-sensitive sectors, most risk assets continue to react favourably. A sector and style rotation is actually healthy and can help extend the market rally.

Going forward, this might not always be the case. Monetary policy is as dovish as it can get, and fiscal policy coming out of Washington has provided a rainbow of optimism, but both carry longer-term risks. According to UBS, 2.5% inflation (as indicated by 10-year breakeven rates) could be a problem for the S&P 500, while most fund managers (as indicated in a recent BofA survey) believe 10 year Treasury yields over 2% could cause a 10% correction in stocks. These levels will likely be challenged over the next several months, as will the current pace and direction of monetary and fiscal policy. While we still expect the course of least resistance for markets this year to be higher, it won’t be as easy as last year. Expect a few stumbles along the way and the inflation debate heats up.

Nicola Wealth Portfolio Results

Returns for the Nicola Core Portfolio Fund were +1.3% in the month of March and +2.4% in Q1 2021. 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 returned 0.0% in March while the iShares Core Canadian Universe Bond Index ETF was down -1.3% for the month. For Q1 2021, the Nicola Bond Fund was +0.5% versus -5.2% for the iShares Core Canadian Universe Bond Index ETF. The overall bond market continued to suffer during the month as the yield curve steepening continued, however this month instead of a parallel shift in the curve, the front end of the yield curve moved lower as it continues to be anchored by lower interest rates while the long end of the curve moved higher.

This phenomenon supported shorter-dated bonds while simultaneously hurting longer-dated bonds. We continue to believe that there may be continued pressure from the long end of the yield curve as inflationary pressures build and credit spreads are relatively tight. As a result, we remain defensively positioned. We will be tactical in our approach and layer into more aggressive positions as the opportunity arises, as we believe that the current backdrop remains supportive for credit spreads and any weakness will be short-lived.

The Nicola High Yield Bond Fund returned -0.5% in March and +2.0% in Q1/21. Overall returns in local currency terms were flat but currency detracted -0.5% as the US dollar weakened versus the Canadian dollar. During the month, we further trimmed our Pimco Tactical Income Fund exposure and we reduced our exposure in Oaktree Global High yield to raise funds to increase our position in Apollo Offshore Credit Strategies.

Returns during the month were bifurcated as CCC-rated names had positive returns while higher-quality BB names had slightly negative returns for the month. Technicals were weak during the month as there was a significant amount of new issuance in high yield as companies refinanced debt coupled with retail outflows as investors were selling high yield ETFs. As the economic recovery continues, default rates will likely come down from their current rate of 6.6% and credit rating upgrades would ensue.

The Nicola Global Bond Fund was down for the month returning -1.6%. Throughout the economic recovery, Templeton Global Bond Fund deployed cash and currently has built a relatively large overweight position in Asia. China’s positive growth in 2020 and effective handling of the pandemic has left the region in a position of strength relative to the rest of the world. Historically, interest rates and guidance over rates have provided a lever to manage currency levels. With interest rates anchored at zero in most of the developed world coupled with increases in fiscal spending, deepening fiscal deficits and excessive monetary accommodation, currencies are likely to be more volatile going forward. Specifically, the backdrop of this situation will weigh on certain developed market currencies particularly the US and Euro area and may cause downward pressure on their values. Strong growth prospects and healthier fundamentals will likely lead to strengthening Asian currencies relative to the rest of the world.

Returns for the Nicola Primary Mortgage Fund and the Nicola Balanced Mortgage Fund were 0.46% and 0.50% respectively for the month. For Q1/21, the Nicola Primary Mortgage Fund and the Nicola Balanced Mortgage Fund returned +1.8% and +1.3%. Cash levels at month-end were 10% for the Nicola Primary Mortgage Fund following waitlist drawdowns, and 13% in the Nicola Balanced Mortgage Fund. Current annual yields, which are what the funds would return if all mortgages presently were held to maturity and all interest and principal were repaid and in no way is a predictor of future performance, are 3.9% for the Nicola Primary Mortgage Fund and 5.3% for the Nicola Balanced Mortgage Fund.

The Nicola Preferred Share Fund returned +2.7% for the month while the Laddered Preferred Share Index returned +2.3%. For Q2, 2021, The Nicola Preferred Share Fund returned +13.7% while the Laddered Preferred Share Index returned +11.4%. Returns for the month were supported by both the 5-year Government of Canada bond yields moving from 0.88% to 1.00% and continued compression of credit spreads.

A growing portion of the market is currently trading at or above par ($25), offering limited upside to returns. We have reduced our position in these names and purchased insurance and non-financial companies with reset levels that are lower but offer capital appreciation upside.

We also increased our position in Shaw’s preferred shares to benefit from the potential take-over from Rogers. There remain large regulatory hurdles to overcome for the deal to be finalized, however, the merger will likely take place in the first half of 2022 and Shaw has preferred shares that are due in June 2021. We believe that there is a high probability that the Shaw preferred shares will be redeemed at par early as it would be in the best interest of the combined entity and the decision for redeeming the preferred shares needs to take place prior to the approval of the merger.

The S&P/TSX was +3.9% while the Nicola Canadian Equity Income Fund was +5.9%. For Q1/2021, the Nicola Canadian Equity Income Fund was +8.5% versus the S&P/TSX +8.1%. A rotation towards cyclical sectors materialized last month in Canada as only the Information Technology and Health Care sectors were in negative territory. Energy, Financials, Consumer Discretionary and Industrials delivered strong gains in March while corporate action boosted Communication Services (Shaw-Rogers mega-merger) and Consumer Staples (George Weston to sell Weston Foods).

Despite a third wave of the virus threatening lockdowns in some countries (including Canada), the reflation narrative boosted oil/commodity prices and helped the TSX index (+8% in Q1/2021) to end Q1 among the best-performing markets. Clearly, investors are focused on a ramp-up in the inoculation rate and upward revisions in growth expectations. Risk on! The Nicola Canadian Equity Income Fund had strong relative performance in Information Technology, Materials and Communication Services which offset a drag in performance from Consumer Staples where we are underweight.

The top positive individual contributors to the performance of the Nicola Canadian Equity Income Fund were Shaw Communications, Canwel Building Materials and alternative payments provider Nuvei Corp. The largest detractors were Kinaxis Inc, Cargojet, and First Quantum Minerals. We added TFI International in the month of March. TFI is a transportation and logistics company with significant exposure to the US where we expect a pickup in activity as the economy recovers. We sold our position in Pinnacle Renewable Energy as it is subject to a takeover and the share price has approached the take-out price.

The S&P/TSX was up +3.9% while the Nicola Canadian Tactical High Income Fund was +6.5% for March. For Q1/2021, the Nicola Canadian Tactical High Income Fund was +9.7% versus the S&P/TSX +8.1%. The Nicola Canadian Tactical High Income Fund benefited from the rotation towards cyclical. Strong relative performance in Information Technology and Communication Services contributed positively to the Nicola Canadian Tactical High Income Fund’s returns.

The Nicola Canadian Tactical High Income Fund has a Delta-adjusted equity exposure of 93% and the projected cash flow yield on the portfolio is 5.5%. Volatility dropped near the end of March which generally makes option writing strategies less profitable. As a result, we have reduced the amount of option writing we do in the Nicola Canadian Tactical High Income Fund temporarily. Top contributors to relative performance were Shaw Communications, Nuvei Corp, and Ag Growth International. The largest detractors for the month were Kinaxis, TC Energy, and CN Rail. During the month, we added copper producer First Quantum Minerals to the portfolio. There were no deletions.

The Nicola U.S. Equity Income Fund returned +5.3% vs +4.4% for S&P 500. For Q1/21, the Nicola U.S. Equity Income Fund returned +5.8% vs +6.2% for S&P 500. The Nicola U.S. Equity Income Fund’s positive performance was driven primarily by sector allocation–overweight Industrials, Staples and Financials while being underweight Information Technology (worst performing sector last month).

Stock selection within Consumer Discretionary (Tractor Supply +11.4%, DollarTree +16.6%, Lowes +19%) and Healthcare (Pfizer +8.2%, Merck +7.1% and UnitedHealth +12.4%) also contributed to performance. The Nicola U.S. Equity Income Fund ended the month with a delta-adjusted equity exposure of 99% (Fund had <1% in covered calls). The Nicola U.S. Equity Income Fund has an active share of 73% and consists of high-quality names with relatively low leverage and attractive ROIC (14% normalized).

This month we added Emerson Electric to the portfolio. Emerson Electric, founded in 1890, is a global leader that designs and manufactures products for industrial automation (process, discrete and hybrid solutions for customers in oil & gas, pulp & paper, chemicals, power, food and beverage), HVAC for both commercial and residential customers and has a tools & home products business (Rigid shop vacuum & other power tools, garburators, etc.). The company operates close to 200 manufacturing companies around the world (130 outside of U.S.) with close to 53% of sales in the Americas; 29% in AMEA region and 18% in Europe.

The Nicola U.S. Tactical High-Income Fund returned +4.5% vs +4.4% for S&P 500. For Q1/21, the Nicola U.S. Tactical High-Income Fund returned +5.2% vs +5.8% for S&P 500. The positive performance was primarily driven by the Nicola U.S. Tactical High Income Fund’s exposure to industrials, consumer staples and financials. Stock selection was strong within the cyclical/reopening names (DollarTree +16.6%, Lowes 19%, Citigroup +10.4%, Waste Management +16.9% and FedEx +11.9%) and within the defensive part of the portfolio (Pepsi +10.4%). Overall, the Nicola U.S. Tactical High Income Fund’s equity-equivalent exposure ended the month at 60%. No new names were added, but we did buy more Walmart and Amazon to bring back to target weights.

The Nicola Global Equity Fund returned +1.0% vs. +1.6% for the MSCI ACWI Index (all in CDN$). For Q1/21, the Nicola Global Equity Fund returned +3.7% vs. +3.1% for the MSCI ACWI Index (all in CDN$). Performance was marginally offset by our overweight in Consumer Staples and Industrials which performed well, and our underweight in Technology which was one of the weakest sectors during the month. Performance of our managers for the month: EdgePoint +3.5%, Nicola Wealth EAFE +2.5%, ValueInvest +2.0%., Lazard +1.9%, C Worldwide +1.1%, and JP Morgan Global Emerging Markets -3.1%.

The Nicola Global Real Estate Fund return was +1.3% March vs. the iShares S&P/TSX Capped REIT Index (XRE) +4.6%. For Q1/21, the Nicola Global Real Estate Fund was +3.0% versus the iShares S&P/TSX Capped REIT Index (XRE) +9.2%. Currency was a headwind for the Nicola Global Real Estate Fund as C$ was relatively strong in March and 50% of the Nicola Global Real Estate Fund is denominated in non-Canadian currency. Despite some new (and likely only temporary) local restrictions announced this week, March was strong for publicly-traded REITs as the COVID-19 vaccine rollout has finally started to accelerate.

Investors appear confident in a reopening of the economy and economic recovery in the back half of the year. Property fundamentals, which were weak last year, should recover. With GDP growth, accelerating inflation, and rising real interest rates, shorter-lease duration sectors like Residential, Industrial and Self-Storage should benefit the most.

Long-term, we are bullish on the real estate complex and we view that the distributions paid by REITs are safe and represent a large yield pick-up vs. government bonds. We also believe that the sector trades cheaply compared to what the underlying property portfolios are worth. We added a temporary position in the iShares S&P/TSX Capped REIT Index in March.

The Nicola Canadian Real Estate LP NAV per unit has increased to $130.0680 (previously $129.1073), effective March 31st, 2021. This represents an increase of 0.74% and a positive return for February of 1.25%. YTD return as at February 28th, 2021 is 1.80%. Portfolio Leverage is 42.71%.

The positive return was primarily a result of increased appraised values of the GTW Portfolio, Mountain Avenue, Lougheed Super Centre, and Golden Drive. Since COVID-19 restrictions commenced in March 2020, our average rent collection has been 97.97%. In comparison to the industry, this rate is high and is close to the Nicola Canadian Real Estate LP’s pre-COVID collection rates. This has been accomplished through the hard work of the Real Estate team and supports that our portfolio asset mix, which has a low retail component, can withstand changes in the real estate environment.

The Nicola U.S. Real Estate LP NAV per unit has increased to US$162.7014 (previously US$162.5403), effective March 31st, 2021. This represents an increase of 0.10% and a positive return for February of 0.65%. YTD Return as at February 28th, 2021 is 1.15%. Portfolio Leverage is 49.17%.

The positive return was primarily a result of increased appraised values of the University District Building, Canyon Park Heights, Venue at Hometown and District Universal Boulevard. Since COVID-19 restrictions commenced in March 2020, our average rent collection has been 97.94%. In comparison to the industry, this rate is high and is close to the Nicola U.S. Real Estate LPs pre-COVID collection rates. This has been accomplished through the hard work of the Real Estate team and supports that our portfolio asset mix, which has a low retail component, can withstand changes in the real estate environment.

The Nicola Value Add Real Estate LP NAV per unit has increased to $188.5023 (previously $187.6227), effective March 31st, 2021. This represents an increase of 0.47% and a positive return for February of 0.47%. YTD return as at February 28th, 2021 is 1.15%.

In February, we funded $0.3m for 5th & Columbia, $1.1m for Bertram, $0.3m for Central Surrey, $0.1m for West Georgia, $0.2m for Cottonwood, $0.06m for Railway, $0.02m for H. Bungalows.

The Nicola Sustainable Innovation Fund returned -4.2% (USD) / -5.0% (CAD) in March and returned -6.4% (USD) / -7.5% (CAD) Q1/21. TPI Composites, Vestas Wind Systems, and Northland Power were the top contributors to performance while Xebec Adsorption, Plug Power, and Itron Inc. were the biggest laggards in the month.

Two new companies were added in March: ChargePoint Holdings and Siemens Gamesa Renewable Energy. ChargePoint has built one of the world’s largest electric vehicle (EV) charging networks with more than 115,000 public and private charging locations spanning North America and Europe with additional access to more than 133,000 public charging sites through their roaming network partnerships.

Range anxiety and fears of a lack of charging infrastructure are often cited as concerns for individuals looking to make the move to an EV. ChargePoint and its ever-growing network of charging locations should be key beneficiaries of the increased spending building out global EV charging infrastructure. Siemens Gamesa offers one of the industry’s broadest product portfolios, including both offshore and onshore wind technology as well as industry-leading service solutions.

They are the global leaders in offshore wind, are the second largest in services, and are the third-largest provider of onshore wind solutions. March was another challenging month for the portfolio as there was some ongoing re-positioning into defensive and value names; however, we received a positive catalyst at the end of the month with the first details of President Biden’s $2.25T infrastructure plan which included specific support for renewables, EV charging, water infrastructure, and improvements and modernization of US power grids.

While some were disappointed the plan didn’t push for more spending on green infrastructure, the parts that were included are supportive for the industries and companies that we are invested in and we could continue to see support in these areas as further details on the plan are released.

The Nicola Alternative Strategies Fund returned 0.0% in March and +3.2% for Q1/21. Currency was a headwind detracting -0.8% for the month. In local currency terms since the funds were last priced, Millennium returned -1.2%, Renaissance Institutional Diversified Global Equities Fund +5.5%, Bridgewater Pure Alpha Major Markets +0.2%, Verition International Multi-Strategy Fund Ltd +2.1%, and Polar Multi-Strategy Fund +0.2%. Our Nicola Alternative Strategies Fund was largely able to avoid losses from SPACS (special purpose acquisition companies) which saw a sell-off of around -10% during the month while benefitting from a return of value factors that boosted returns in long-short strategies.

The Nicola Precious Metals Fund returned +0.6% for the month while underlying gold stocks in the S&P/TSX Composite index returned 5.4% and gold bullion was down -2.9% in Canadian dollar terms. For Q1/21, the Nicola Precious Metals Fund was -14.6%. We believe that long-term value lies in gold equities however, shorter-term given bullion lagged behind stocks during the month and the transition from safe-haven asset to inflation protectionary asset will likely remain volatile, on the margin we increased our position in bullion.

The Nicola Infrastructure and Renewable Resources Fund returned +1.6% for the first quarter of 2021 in USD terms. Currency contributed 0.2% to returns as the Canadian dollar strengthened during the quarter. Overall assets performed well however, a large cash position in the Nicola Infrastructure and Renewable Resources Fund was a drag on returns. Over the past few quarters, we have developed a robust pipeline of potential investments however COVID-19 has delayed deployment into these assets.

Investments we had anticipated to close in the second half of 2020 and Q1 2021 have now been finalized to close in early Q2 2021 and we will reduce our cash position by approximately 40% early in the quarter, bringing the Nicola Infrastructure and Renewable Resources Fund to close to full deployment. Additionally, an increase in commitments in Brookfield and Macquarie will help us maintain our exposure to a diversified portfolio of assets in the future, however, we don’t anticipate significant capital calls from those strategies until late 2021 or early 2022.

In Q1 the Nicola Private Debt Fund returned +2.6%. The main driver of the strong quarterly performance was the early prepayment fee earned by the Nicola Private Debt Fund upon the full repayment of the Project Steen credit facility which contributed approx. 60bps for the quarter.

Other top performance contributors included Project Strength, Project Karma and Project Access. During the quarter the Nicola Private Debt Fund made a new investment in the Morgan Stanley Alternative Lending Fund which invests in prime and near-prime consumer loans originated by leading established fintech lenders in the US.

The Nicola Private Equity Limited Partnership returned +3.8% in Q1. Contributors to performance included MDA, the Canadian space company that recently went public, Micross (formerly known as Corfin), BID – an investment we made with our Vancouver partner Highland West, and our investment in Headwater II.

In terms of headwinds, a weaker USD was an approximately 60bps detractor to the quarter’s performance. New Investments included: secondary private equity pool investments that we acquired at an attractive discount that was sourced from our secondaries partner, Toronto-based Overbay; a fund investment in Redbird, a NY-based PE manager specializing in Sports, Media, and Financial Services, which came with a co-investment in their recent investment in Sports; and Inveris –a Georgia-headquartered government training service provider, a business we invested in alongside Pine Island Capital Partners, a private equity manager founded by John Thain.

 

Disclaimer

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 provincial 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. For a complete listing of Nicola Wealth Real Estate portfolios, please visit https://realestate.nicolawealth.com. All values sourced through Bloomberg. Effective January 1, 2019 Nicola Global Real Estate Fund, Nicola Canadian Real Estate LP, Nicola U.S. Real Estate LP, and Nicola Value Add LP adopted new mandates and changed names from NWM Real Estate Fund, SPIRE Real Estate LP, SPIRE US LP, SPIRE Value Add LP. An investment in Nicola Infrastructure and Renewable Resources Limited Partnership is an investment in alternative asset classes. 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. Effective September 19, 2018, the fund adopted a new mandate and changed its name from the NWM Farmland Limited Partnership.