Nicola Wealth Portfolio Results – February 2022 - Nicola Wealth

Nicola Wealth Portfolio Results – February 2022


Returns for the Nicola Core Portfolio Fund were +0.6% for the month of February.  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 -0.4% in February while the iShares Core Canadian Universe Bond Index ETF returned -0.7% for the month. February saw a continuation of themes that drove market returns in January. Yields continue to rise while credit spreads continue to widen. 10-year Canadian bond yields moved from 1.77% to 1.81% while credit spreads widened from 1.27% to 1.40%.

In Canada, the communication and real estate sectors widen the most at 18 basis points and 20 basis points respectively. A weaker technical backdrop with high issuance in the coming months means new issue concessions will likely stay elevated. New issuance concessions moved from 2 basis points to 11 basis points which creates attractive opportunities for our trading-orientated strategies.

The Nicola Global Bond Fund was down for the month returning -0.6%. As a diversified global fund, we have exposure to both developed and emerging markets. Our emerging market positions continue to be focused in Asian and Latin American countries whose fundamentals have limited sensitivity to the conflict in Ukraine and our overall direct exposure to Russia is muted at approximately 0.8% of the Nicola Global Bond Fund. Our currency exposure is bar-belled with select exposure to higher growth emerging market currencies coupled with defensive currencies to help offset risks of further escalation of the conflict in Ukraine.

The Nicola High Yield Bond Fund returned -0.2% in February while the iShares US High Yield Bond Index ETF (CAD-Hedged) returned -0.3%. The limited credit spread widening was surprisingly muted given the volatility in interest rates and the sell-off in equity markets. The concerns on the Russian Ukrainian conflict impacted Euro denominated high yield corporate bonds, which were down -2.7%. The Nicola High Yield Bond Fund saw net negative flows however, given the lack of demand was met with limited supply as high yield new issuance was also quite limited. We anticipate there may be further widening of credit spreads for the overall high yield market, however, we do not believe there will be a material pick up in default rates and energy positions should provide a buffer to overall weakness.

The Nicola Preferred Share Fund returned -1.8% for the month while the BMO Laddered Preferred Share Index ETF returned -2.7%. The sell-off in preferred shares appears to be more general redemption pressures and liquidity-driven as the largest most liquid portions of the market came under the most pressure. Fixed resets underperformed both floaters and perpetuals, and Enbridge and Cenovus preferred shares sold off -3.5% and -5.3% respectively, despite being in a favourable environment with escalating energy prices.  We will look to be a liquidity provider in this environment and purchase preferred shares that have lower prices due to selling pressures.

Returns for the Nicola Primary Mortgage Fund and the Nicola Balanced Mortgage Fund were 0.3% and 0.5% respectively for the month. Cash levels at month-end were 11% in the Nicola Primary Mortgage Fund and 11% in the Nicola Balanced Mortgage Fund, which remain elevated net of new investments made and existing investments repaid. Current annual yields, which are what they 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 3.8% for the Nicola Primary Mortgage Fund and 5.7% for the Nicola Balanced Mortgage Fund.

The Nicola Canadian Equity Income Fund’s performance vs S&P/TSX in February was +1.4% vs +0.3%.  The MSCI AC World slipped -2.7% in February as Ukraine’s full-scale invasion by Russian troops sparked widespread de-risking among investors. Fears that the conflict will exacerbate inflation dynamics generated unease among investors.

The S&P/TSX Index faired quite well thanks to strong performance in commodities. Crude oil (WTI +8.6%, Brent +10.7%) continued its climb last month. Precious Metals (Gold +6.2%, Silver +8.8%) and Copper (+2.8%) also gained momentum. Agricultural markets performed strongly, with wheat and soybean prices rising double digits. The best performing sectors in the Index for the month were Materials (+12.8%, Energy (+6.5%) and Communications (+2%). The worst performing sectors were Technology (-18%), Discretionary (-4.3%) and Health Care (-2.7%).

Within the Nicola Canadian Equity Income Fund, the top three sectors contributing to relative outperformance were: Technology, Industrials, and Consumer Staples. Materials, Energy and Communications Services were the biggest detractors. The Nicola Canadian Equity Income Fund is overweight Industrials, Energy and Consumer Discretionary. The top individual contributors to the performance were Barrick, First Quantum Minerals and Canadian Natural Resources. The biggest detractors were IA Financial Corp, Telus International and Royal Bank. We added Shopify, Parkland Corp, and CCL Industries to our portfolio in February.

The Nicola Canadian Tactical High Income Fund’s performance vs S&P/TSX Composite in February was +2.3% vs +0.3%.  Another relative comparable, S&P/TSX Canadian Dividend Aristocrats, was -0.2%.  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, and a greater allocation to Value-oriented sectors.

Ukraine’s full-scale invasion by Russian troops sparked widespread de-risking among investors. Fears that the conflict will exacerbate inflation dynamics generated unease for investors. The S&P/TSX Composite Index faired quite well relative to other global equity markets thanks to strong performance in commodities.

The best performing sectors in the Index for the month were Materials (+12.8%), Energy (+6.5%) and Communications (+2%). The worst performing sectors were Technology (-18%), Discretionary (-4.3%) and Health Care (-2.7%).  The best performing sectors of the TSX Aristocrats index for the month were Energy (+4%), Materials (+3.5%) and Real Estate (+0.5%). The worst performing sectors were Industrials (-1.7%) and Information Technology (-10%).

The Nicola Canadian Tactical High Income Fund’s dividend focus has led to sizeable overweight positioning within Financials and Energy. In both sectors we continue to expect companies with excess capital to deliver significant returns to shareholders in the form of rising dividends and share repurchases. Top-performing sectors contributing to relative returns were Energy, Materials and Communications Services. The primary detractor was Financials. We have not written calls on the portfolio, but as profitability for options rises, we could return to writing options on select positions. The top individual contributors to the performance were Canadian Natural Resources, Suncor and Barrick Gold. The biggest detractors were IA Financial Corp, Royal Bank and Canadian Western Bank. No new positions were added or removed.

The Nicola U.S. Equity Income Fund returned -2.0% vs -3.0% for the S&P 500 (in USD$). Relative outperformance for the month was driven by stock selection within Communications Services (Alphabet -0.2% vs sector -7%), Energy (Cheniere Energy +19% vs energy sector +7.1%), Materials (Freeport McMoRan was the 4th top-performing stock in the S&P 500 with a +26.1% return vs the sector’s return of -1.2%) and Industrials (Northrup Grumman was the 6th best-performing stock last month with a +20% return vs the sector’s return of -0.8%).

Sector allocation also contributed to performance from being overweight Energy (6.2% vs 3.5%) and underweight Information Technology (22% vs 28%).

New names:  Cadence Design Systems is a high-quality company (primarily subscription-based, high ROE, robust FCF conversion and net cash on the balance sheet) that offers electronic design automation software to the semiconductor industry.

The Nicola U.S. Equity Income Fund also added Bank of America, which has a greater share of U.S. consumer banking exposure relative to the other U.S. money center banks and is expected to benefit from higher loan growth and from higher U.S. interest rates.  We also trimmed Pepsico and sold Emerson Electric.  The Nicola U.S. Equity Income Fund ended the month with a delta-adjusted equity exposure of 98% (we had 3.1% in covered calls); the Nicola U.S. Equity Income Fund also consists of high-quality names with relatively low leverage and attractive consensus forward 12-month ROE (44% vs 23% for S&P 500).

The Nicola U.S. Tactical High Income Fund returned -1.4% vs -3.0% for the S&P 500 (in USD$).  The outperformance was due to being overweight in Energy, Industrials and Materials while being underweight the worst performing sectors (Consumer Discretionary, Info Tech, Real Estate and Communication Services).  Stock selection was strong within the Communication Services sector by owning Alphabet (-0.2% vs sector -7%) and by not owning Meta Platforms (-32.6% last month).  Stock selection was also positive for sectors and names exposed to higher inflation and/or geopolitical risks such as Energy (U.S. LNG exporter Cheniere +19%), Materials (copper producer Freeport McMoRan +26%) and Industrials (defense contractor Northrup Grumman +20%).

The Nicola U.S. Tactical High Income Fund was active in the last week of the month to take advantage of the elevated option volatility by writing 21 Put options and 5 Covered-Call options.  New names included Cadence Design Systems, a high-quality company (primarily subscription-based, high ROE, robust FCF conversion and net cash on balance sheet) that offers electronic design automation software to the semiconductor industry.  The Nicola U.S Tactical High Income Fund also added Bank of America which has a greater share of U.S. domestic consumer banking exposure relative to the other large U.S. money center banks and is expected to benefit from higher loan growth and from higher U.S. interest rates.  The Nicola U.S. Tactical High Income Fund trimmed Texas Instruments, Costco, Morgan Stanley and sold Emerson Electric.

The Nicola Global Equity Income Fund returned -3.3% vs -2.6% for the MSCI ACWI Index (all in CDN$). Despite the positive contributions from a regional and sector allocation basis, the Nicola Global Equity Fund underperformed primarily due to negative stock selection within various Funds.  Performance of our managers in descending order was Lazard Global Small cap -1.1%, Edgepoint Global Portfolio -1.2%, Nicola EAFE-2.2%, Pier21 Global Value -2.8% (relative performance was negatively impacted from the underweights in Energy and Materials as well as negative stock selection within Consumer Discretionary, Consumer Staples, Healthcare and Information Technology), Pier 21 Worldwide Equity -4.7% (negative stock selection within Consumer Discretionary and Financials with Home depot, Sony and HDFC Bank down -14%, -8.3% and -9.5% respectively in CDN$) and JP Morgan Global Emerging Markets -6.4% (exposure to stocks in Russia and Belarus).

The Nicola Sustainable Innovation Fund returned +4.4% (USD) /+4.2% (CAD) in February and -11.3% (USD) /- 11.2% (CAD) year-to-date. Ameresco, Orsted, and Vestas Wind Systems were the top performers during the month while Fluence Energy, Itron, and Stem were the biggest laggards. We added a new position in Enphase Energy, a manufacturer of solar energy and storage equipment in both the home and commercial segments. Enphase has gained significant share in residential solar markets and have over 300 patents on their technology including their microinverters which are in their 8th generation.

In early March we also received another capital call for our investment in the Ares Climate Infrastructure Partners LP. To date, the ACIP portfolio has closed on 15 investments involved in renewable energy, battery storage, and energy efficiency, with nearly 50% of the fund committed today.

Volatility in the equity markets remained elevated last month following the Russian invasion of Ukraine and the ensuing humanitarian crisis. One of the abrupt effects of this action by Russia was a renewed focus on energy security and in particular many European nations’ reliance on Russia for oil and gas.

Historically somewhere between 30-40% of Europe’s gas demand was fulfilled by Russian imports and so the European Union is expected to take swift actions to look to decarbonize and move away from this reliance on Russia. Many of our renewable and clean technology-focused companies with exposure to Europe will be beneficiaries of this accelerated move away from Russian gas and we’ve seen some recovery in these names over the last few weeks despite a weaker broader market. In the near term, we may see countries like Germany reassess their planned timelines for phase-outs of coal and nuclear power to bridge the interim power demand though this should not undermine their broader long-term decarbonization focus.

The Nicola Alternative Strategies Fund returned +0.3% in February. Currency was a headwind, detracting -0.1% to returns for the month as the US dollar weakened versus the Canadian dollar. According to the Eurekahedge Hedge Fund Index, hedge funds broadly were flat for the month. The Eurekahedge Relative Hedge fund index returned -0.4% for the month while the Eurekahedge Arbitrage Hedge Fund Index returned -0.6%.  Leading into the year there were limited opportunities for arbitrage, thus several of our strategies were defensively orientated both with respect to their underlying positions but also with lower leverage. With heightened volatility and an increase in opportunities, likely our funds will take advantage of an expanded opportunity set to achieve more robust returns.

The Nicola Precious Metals Fund returned 9.5% for the month. For the month of February underlying gold stocks in the S&P/TSX Composite index returned 11.5% and gold bullion was up 6.0% in Canadian dollar terms. The strong returns marked the highest returns for gold since May 2021 as gold benefitted from a flight to safety due to the conflict in Ukraine and the economic sanctions that ensure as well as concerns on higher inflation coupled with reduced expectations for the aggressiveness of interest rate hikes. Global gold ETFs saw net inflows of $2.1 Billion USD in both North American and European funds. We anticipate that the safe-haven demand for gold should continue to support both bullion and gold equity prices in the near term.

The expected rate increases and stronger US dollar negatively impacted gold, as Powell noted after the January 26th meeting that a March liftoff was likely and opened the door to more frequent and potentially higher hikes than anticipated. Directionally the movement is a negative for gold however, longer-term the higher levels of real and nominal rates will likely be capped.

In February the Nicola Private Debt Fund returned +0.3%, bringing the YTD return to +0.9%. The main driver of February performance was cash interest income from the Fund’s diversified pool of co-investments. The Nicola Private Debt Fund’s YTD returns were negatively impacted by an elevated cash balance which peaked at approx. 20% of AUM in early February following significant new investor capital inflows over the preceding 4 months.

The Nicola Private Debt Fund’s cash position returned to a more normalized 8% of AUM by the end of February following two significant fund investment capital calls from Ares Capital and Vistara Growth, and a new US$10 million direct investment in a first lien term loan to a US-based railway services provider. Overall, the Nicola Private Debt Fund’s investment pipeline leading into March remains robust, and we anticipate maintaining a lower allocation to cash in the Fund for the balance of 2022.

The Nicola Infrastructure and Renewable Resources Fund returned -0.1% for the month of February in Canadian dollar terms. Effectively all of the small negative impact was due to currency fluctuations and weakness in the fixed income markets where we held positions for our cash weight. During the month we closed on a co-investment in a district energy platform. District energy is a network of underground pipes and centralized thermal energy centers which provide heating and cooling to densely populated areas. By utilizing economics of scale, one is able to provide heating and cooling to buildings at significantly lower costs than individual building systems while having a meaningful reduction in carbon emissions. We believe that this asset is similar to unregulated utilities and should benefit meaningfully as part of the solution to buildings and communities seeking to reduce their carbon footprint.

The Nicola Global Real Estate Fund’s performance vs iShares S&P/TSX Capped REIT Index in February was +0.2% vs +1.2%. CBRE Limited recently published its Q4 2021 Canadian Cap Rates and Investment Insights report. As expected, cap rates continued to compress across the entire industry supported by the combination of strong transaction momentum as well as the return of M&A activity. Demand for Industrial assets was notably strong and showed the greatest amount of cap rate compression. Geopolitical uncertainty with Russia and Ukraine at war is a concern going forward but the real estate sector appears well-positioned, supported by improving fundamentals, healthy growth outlook, still low rates, and reasonable valuations. We are particularly bullish on the industrial, self-storage, and residential sectors as these areas are better equipped to deliver cash flow and NAV growth in a rising rate environment. There were no new additions or deletions in February.

Nicola Canadian Real Estate LP NAV per unit has increased to $145.5927 (previously $144.3838), effective February 28, 2022. This represents an increase of 0.8% and a positive return for January of 1.3%. YTD return as of January 31, 2022, is 1.3%. Portfolio Leverage is 42.86%. The positive return was primarily a result of increased appraised values of The Rex, 55th Avenue, and GTA West Portfolio.

Nicola U.S. Real Estate LP NAV per unit has increased to US$173.1465 (previously US$170.3333), effective February 28, 2022. This represents an increase of 1.7% and a positive return for January of 2.2%. YTD return as of January 31, 2022, is 2.2%. Portfolio Leverage is 46.66%. The positive return was primarily a result of increased appraised values of Champions Green, Canton Mills Lofts, and Preserve at Baywood.

Nicola Value Add Real Estate LP NAV per unit has increased to $198.5850 (previously $196.7992), effective February 28, 2022. This represents an increase of 0.9% and a positive return for January of 0.9%. YTD return as of January 31, 2022, is 0.9%. In January, we funded $16.2M for 5179 NSR Burlington, $10.1M for 9555 Airport Road, $5.8M for 2410 Columbia St., $2.5M for West 49th, $0.3M for Building O, $0.3M for King City, $0.2M for Encore, $0.1M for Country Club, $0.1M for Douglas Floreani, $0.1M for Kelson, $0.1M for McCarthy, $0.1M for Queen Anne, and $0.1M for Railway.

 

 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.