Returns for the Nicola Core Portfolio Fund were +1.5% for the month of October. 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 flat for the month returning 0.0% in October while the iShares Core Canadian Universe Bond Index ETF returned -0.8% for the month. Our exposure in real return bonds was up 0.8% during the month supporting returns. Spreads in Canada widened during the month, particularly in financials, while U.S. counterparts saw some spread tightening.
Interest rates continue to be extremely volatile, with 10-year Canada bond yields starting the month at 3.17% before peaking at 3.68% and subsequently ending the month at 3.25%. The Canadian job market rebounded strongly in October while the inflation rate was also strong, despite lower gas prices. The IMF lowered its global growth forecast from 3.2% to 2.7% next year which was highlighted by Deputy Prime Minister Chrystia Freeland who warned that Canada must prepare for a recession as “Canada cannot avoid the global slowdown”.
The Nicola Global Bond Fund was down for the month, returning -1.0%. Our exposure in global inflation linked bonds supported returns while the main detractors to returns were Templeton Global Bond and our exposure in securitized credit. Emerging market central banks continued with policy rate tightening as Chile, Columbia, Indonesia, and South Korea all hiked during October. Countries in Latin America engaged in early aggressive tightening in response to higher inflation and it appears several countries are now likely to pause on this path as Chile noted that it had reached its peak terminal rate. From a relative perspective, we continue to see pockets of value in local currency bonds particularly in Asia.
The Nicola High Yield Bond Fund returned +0.3% in October while the iShares US High Yield Bond Index ETF (CAD-Hedged) returned +4.5%. The relative strong returns during the month for the index was a rebound from September’s -3.9%. Year to date the iShares US High Yield Bond Index ETF (CAD-Hedged) has returned -12.3% while the Nicola High Yield Bond Fund has returned -1.1%. Overall, our core positions in high yield remain defensive while we have taken more risk on positions via our exposure to CLO equity (collateralized loan obligations). This structure is a form of securitization where generally medium sized business loans are pooled together.
Our exposure in the equity tranche benefits from volatility in the marketplace specifically when credit spreads widen. Due to some credit spread widening, we received a large distribution from our investment which was up 13% for the month. We will continue to monitor our exposure in the space and balance upside reward with downside risks. Despite the weakness in high yield returns year to date, we continue to believe that credit spreads have room to widen further. Credit spread returns are only down -2.1% year to date and past market slowdowns indicate that there is further room for the market to decompress. Within high yield, healthcare remains a large concern accounting for a significant portion of high yield trading at distressed levels.
The Nicola Preferred Share Fund returned +0.1% for the month while the BMO Laddered Preferred Share Index ETF returned -1.6%. Recently we have increased our position in institutional preferred shares with reset spreads around 4.1%. Our position has immunized us from some of the losses suffered this year in the preferred share market. We continue to see value in the institutional preferred share market. However, with continued weakness in the $25 retail preferred shares and five-year Government of Canada yields continuing to move higher (up 0.08% and finishing the month at 3.41%) we believe that there lies significant value with preferred shares as their coupon gets reset higher over the next few years.
Returns for the Nicola Primary Mortgage Fund and the Nicola Balanced Mortgage Fund were 0.2% and 0.4% respectively for the month of October. Cash in the funds at month end was 8% in the Nicola Primary Mortgage Fund and 7% 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 and in no way is a predictor of future performance, are 4.9% for the Nicola Primary Mortgage Fund and 6.9% for the Nicola Balanced Mortgage Fund. The U.S. Mortgage Fund continues to hold a 3rd party fund comprised of U.S. commercial mortgage loans as additional individual loan investment strategies are being finalized.
The Nicola Canadian Equity Income Fund’s performance vs S&P/TSX in October was +5.4% vs +5.6%. Sentiment rebounded in October and global equities were strong. Nine out of eleven S&P/TSX sectors delivered a positive performance in October. Only Utilities (-2.6%) and Materials (-0.7%) were in negative territory. The strongest performing sectors were Energy (+13.8%) and Technology (+10.8%). Crude Oil prices surged (WTI +8.9%; Brent +7.8%) on renewed risk-on mood and OPEC+’s decision to cut its production by 2M barrels/day. Warmer-than-usual weather in Europe and elevated inventories caused Natural Gas prices (-6.1%) to ease. Meanwhile Precious Metals (Silver +0.7%; Gold -1.6%) were fairly flat for the month.
The Nicola Canadian Equity Income Fund underperformed as positive contribution from Consumer Discretionary was more than offset by relative underperformance in Technology and Financials. The Nicola Canadian Equity Income Fund remains overweight Consumer Discretionary and Consumer Staples while being underweight in Financials. In the month of October, the Nicola Canadian Equity Income Fund’s top performing holdings were Canadian Natural Resources, Shopify and Whitecap Resources. The bottom performers were Parkland Corp, Telus International and Brookfield Asset Management. We exited our positions in Barrick Gold Corp. There were no new additions.
The Nicola Canadian Tactical High Income Fund’s performance vs S&P/TSX in October was a similar +5.6%. The Nicola Canadian Tactical High Income Fund’s performance vs S&P/TSX Canadian Dividend Aristocrats: October +5.6% vs +3.6%. The Nicola Canadian Tactical High Income Fund is focused on investing in companies that pay sustainable, growing dividends. In Canada, this generally results in an underweight to the Information Technology and Health Care sectors compared to the S&P/TSX Index, and a greater allocation to Value-oriented sectors.
In October, the Nicola Canadian Tactical High Income Fund outperformed the TSX Aristocrats Index. From a sector standpoint, positive contributions from Energy, Healthcare and Financials more than offset negative contributions from Real Estate and Materials. The Nicola Canadian Tactical High Income Fund’s dividend focus has led to a sizeable overweight positioning within Energy where we expect companies with excess capital to deliver significant returns to shareholders in the form of rising dividends and share repurchases. In October, the top performing holdings of the Nicola Candian Tactical High Income Fund were Canadian Natural Resources, Suncor and Magna. The bottom performers were AltaGas Ltd, Parkland Corp and Waste Connections. We sold our position in Barrick Gold Corp and Bank of Nova Scotia. There were no new additions.
The Nicola U.S. Equity Income Fund returned +8.7% vs +8.1% for the S&P 500 (in USD$). The S&P 500 returns in October were broad based with all sectors in the green, which was the complete opposite from the prior month when all sectors were in the red. Investors were more positive in October as Q3 earnings came in better than expected, weaker economic data provided hope that the Fed may scale back their monetary tightening, and mid-term elections (both house and Senate) were skewing more favorably towards Republicans.
The Nicola U.S. Equity Income Fund’s relative outperformance came from sector allocation (overweight Energy and Industrials and underweight Consumer Discretionary, Utilities and Real Estate) and positive stock selection within Communication Services (Netflix +24%, AT&T +21% and not owning Meta -31.3%), Consumer Discretionary (Hyatt +16.4% and Ross Stores +13.6%) and Financials (Bank of America +19.3%, JP Morgan +21.6% and Blackrock +17.4%).
The Nicola U.S. Equity Income Fund was active in writing both Puts and Call options during the month as a volatility increase in the 1st half of the month; the Nicola U.S. Equity Income Fund executed 6 covered-call options and 14 Put options generating attractive annualized option premiums. The Nicola U.S. Equity Income Fund ended the month with a delta-adjusted equity exposure of 94% (10% in covered calls); the Nicola U.S. Equity Income Fund consists of high-quality names with healthy balance sheets, strong free cash flows and attractive consensus forward 12-month ROEs (41% vs 22% for S&P 500).
The S&P 500 witnessed its second bear market rally this year returning 8.1% for the month of October; hopefully this lasts a little longer than the two month rally we experienced this summer. The Nicola U.S. Tactical High Income Fund slightly outperformed the market with a return of +8.2% (in USD$). The Nicola U.S. Tactical High Income Fund’s relative outperformance was mainly attributable to positive stock selection within Financials (Banks and Asset Managers), Consumer Discretionary (Hotels and Retail Discounters) and Communication Services (Telecom Services).
The strong stock selection was partially offset by negative sector/asset allocation as the Nicola U.S. Tactical High Income Fund was underweight most of the top performing sectors (Energy, Financials, Healthcare) and overweight the worst performing sector (Communication Services) and Cash. The Nicola U.S. Tactical High Income Fund ended the month with a 92% delta-adjusted equity exposure due to the minimal amounts of options outstanding; the Nicola U.S. Tactical High Income Fund wrote 1 Covered-Call options which generated low-double-digit annualized premiums.
For October 2022, the Nicola International Leaders Fund was +4.8%, vs the MSCI ACWI ex-USA Index +1.9%. For the month, International Markets (+4.3%) outperformed and Emerging Markets (-4.1%) underperformed. In Europe (+6.2%), new measures were announced to address the energy crisis including a price cap and common purchase system. In addition, high storage levels and warmer autumn temperatures continued to drive gas prices lower (~60% lower than the August peak). The ECB also raised rates by an expected 75 bps and acknowledged that the Eurozone was likely heading for a recession.
The underperformance in Emerging markets during the month was driven by a sell-off in China (-17.7%). After Xi Jinping secured a historic third term as president at China’s 20th Party Congress, markets sold off over future policy risks as well as no signs of change from its zero COVID policy. The Nicola International Leaders Fund outperformed in October’22 mainly due to stock selection in Health Care and Europe. One of the biggest contributors in Health Care was Sanofi (leading global healthcare company with a portfolio of pharmaceuticals, vaccines, and consumer healthcare). Sanofi shares re-rated during the month on strong quarterly results with higher-than-expected pharma and vaccine sales leading to an increase in its FY22 earnings guidance. In August 2022, the Nicola International Leaders Fund was -2.1% vs the MSCI ACWI ex-USA.
The Nicola Sustainable Innovation Fund returned -0.2% (USD) / -0.6% (CAD) in October and -18.2% (USD) / -12.0% (CAD) year-to-date. Our top performers during the month were Alstom, Evoqua Water Technologies, and Xylem while NIO Inc., Li Auto, and Plug Power were the biggest laggards. The broader equity markets largely recovered from earlier losses in October; however, growth companies like many of those in our portfolio, lagged the wider market recovery during the month. In late October, Xi Jinping secured a historic third term as leader of China, resulting in a swift market selloff in Chinese equities on fears of further geopolitical tensions and a continuance of China’s zero-COVID policy.
We had a small portfolio exposure to China (less than 3%) through three automotive companies focused on electric and new energy vehicles, BYD, NIO and Li Auto, which we exited during the month given the weakening outlook for their shares. While we liked the companies, we feel there are other ways to invest in the alternative transportation theme right now, with less geopolitical risk. Following these position exits we are carrying a bit higher than normal cash position, which we expect to deploy in the coming months opportunistically.
During the month we also initiated the transfer and swap of several of our European equity positions from American Depositary Receipts (ADRs) into their local listings. This process carried over to October at the month-end and has resulted in some double-referencing of positions which we expect to be cleaned up in November. There were no new positions added in October, but we were active in trading throughout the portfolio adding to positions in Orsted, Plug Power, TPI Composites, and Sunrun Inc.
The Nicola Alternative Strategies Fund returned 0.3% in October. Our dividend arbitrage strategy, Bolton, had a very strong month returning +1.2% helping to support returns. As we continue the process of winding the Nicola Alternative Strategies Fund down, we are making a distribution back to clients at the end of November. According to Eurekahedge, overall hedge funds returned +1.5% for the month while the Eurekahedge Arbitrage Hedge Fund Index returned +1.1% and the Relative Valued Hedge Fund Index returned +1.9%. In what has been a difficult year for risk assets, the Nicola Alternative Strategies Fund is up 11.0% year to date.
The Nicola Precious Metals Fund returned -3.6% for the month of October. Underlying gold stocks in the S&P/TSX Composite index returned -1.5% and gold bullion was down -3.1% in Canadian dollar terms. Prior to October, we have been reducing our exposure to gold equities due to market headwinds and the additional volatility in equities versus bullion. We have since started to increase our equity exposure. Gold has experienced extremely poor sentiment under the backdrop of rising bond yields. Net short positions (investors positioning to profit if the value of the asset falls) remain high which is symbolic of the weak sentiment. We view the current levels as extreme and thus have a contrarian view. We see the potential for mean reversion and a rebound in bullion and gold stocks as investors who are short start to cover (close) their positions.
The Nicola Infrastructure and Renewable Resources LP returned -0.8% for the month of October in Canadian dollar terms. Currencies had a slightly negative impact over the period; agnostic to currencies, our assets returned -0.6%. This was primarily driven by a write down at the Crown Capital Power Fund related to a project that is no longer economically feasible due to high natural gas prices. We continue to closely monitor this investment and Crown Capital have indicated that they will facilitate our exit in 2023 once all projects are operating.
Over the period, our investment in Macquarie’s global infrastructure fund and our U.S. energy as a service co-investment continued to deliver positive performance results. The Nicola Infrastructure and Renewable Resources LP is at $180 million of AUM with a waitlist of $25 million that is expected to be fully drawn by year end from a combination of existing fund commitments and co-investment.
The Nicola Global Real Estate Fund’s performance vs iShares S&P/TSX Capped REIT Index (XRE) was -1.2% vs +3.1%. Publicly traded REITs rebounded slightly in October. Currency was a drag on performance, with the CAD strengthening against the Euro, USD and other currencies. Valuation appears attractive. Our global REIT manager estimates that our listed REIT portfolio has an attractive 3.8% dividend yield (74% payout ratio). On their valuation models, the portfolio trades at a 22% discount to Intrinsic Value. In other words, a lot of bad news has been priced into share values. In short, we expect near-term volatility will likely persist until visibility on rates and inflation improves. For investors taking a long-term view, current valuation levels are a reasonable entry point particularly for the multi-family and industrial subsectors. We view these two property types as best positioned to mitigate value erosion through NOI growth.
Nicola Canadian Real Estate LP NAV per unit has increased to $156.7538 (previously $156.4646), effective October 31, 2022. This represents an increase of 0.2% and a positive return for September of 0.6%. YTD return as of September 30, 2022 is 13.1%. Portfolio Leverage is 42.95%. The positive return was primarily a result of increased appraised values of the Aero Portfolio, Advanced – Squamish, and Grace Road.
The Nicola U.S. Real Estate LP NAV per unit has increased to US$197.0567 (previously US$195.4958), effective October 31, 2022. This represents an increase of 0.8% and a positive return for September of 1.2%. YTD return as of September 30, 2022 is 20.6%. Portfolio Leverage is 45.93%. The positive return was primarily a result of increased appraised values of Valencia at Westchase, Zang Triangle, and the Minneapolis North Sub-Portfolio.
The Nicola Value Add Real Estate LP NAV per unit has increased to $231.9523 (previously $228.6346), effective October 31, 2022. This represents an increase of 1.5% and a positive return for September of 1.5%. YTD return as of September 30, 2022 is 17.9%. In September, we funded $37.5M for two new projects that closed (GSW Portfolio and GTA Infill Industrial) and a total of $10.9M 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. 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.