Nicola Wealth Portfolio Results – October 2021 - Nicola Wealth

Nicola Wealth Portfolio Results – October 2021


Returns for the Nicola Core Portfolio Fund were +1.2% in 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 returned -0.2% in October while the iShares Core Canadian Universe Bond Index ETF returned -1.1% for the month. Elevated rate volatility, particularly for short and mid portions of the yield curve hurt bond returns as credit spreads were range bound slightly tighter.

Corporate bonds within the FTSE Canada Universe Bond Index in the short-term range returned -1.0%, while mid-term bonds returned -1.5%, and long-term bonds returned -0.2% for the month. The hawkish move from the Bank of Canada to end their quantitative easing program has led to a flatter yield curve and increased the risk of an inverted yield curve. A situation where we have an inverted yield curve is concerning as it reduces net-interest margins for banks and potentially restricts loan growth.

The Nicola High Yield Bond Fund returned +0.0% in October. Currency detracted -1.6% from returns last month as the US dollar weakened significantly versus the Canadian dollar. Our exposure to Pimco closed end funds, specifically Pimco Tactical Income Opportunities Fund, continues to perform well and returned 2.6% for the month. During October, the Pimco closed end fund traded more than 4% above the net asset value of the underlying assets. We will likely trim our exposure if the premium persists.

The largest contributor to returns during the month came from our exposure to carbon credits which returned almost 13%. The 2021 United Nations Climate Change Conference started at the end of October and will likely highlight continued concerns on the climate change crisis. We believe programs similar to the California Cap-and-trade system, which provides market-based solutions to reducing greenhouse gasses are part of the long-term solution.

The traditional high yield market sold off -0.3% for the month which was one of the worst monthly performances in the past year. Spreads saw little change during the month, however, small losses were seen across all ratings buckets as the treasury sell-off impacted high yield returns.

The Nicola Global Bond Fund was down for the month returning -1.8%. The largest detractor to returns was the Templeton Global Bond fund which was down -2.6% in October. Templeton was impacted by fiscal fears in Brazil which caused Brazil’s central bank to raise interest rates by 150 basis points at the end of October and signal the potential of another similar hike later this year. Brazil has seen interest rates move from 2% at the start of the year to 7.75% as it deals with double-digit inflation and a government that has doubled down on populism with a vow to boost welfare spending ahead of the 2022 electoral year.

Returns for the Nicola Primary Mortgage Fund and Nicola Balanced Mortgage Fund were 0.3% and 0.5% respectively for the month. Cash levels at month end were 6% for the Nicola Primary Mortgage Fund and 8% for the Nicola Balanced Mortgage Fund after wait list drawdowns of $1.8 million in the Nicola Primary Mortgage Fund and $15.0 million in the Nicola Balanced Mortgage Fund. This was because the new investment pipeline for both funds remains strong. Current annual yields, which are what both 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 3.8% for the Nicola Primary Mortgage Fund and 5.5% for the Nicola Balanced Mortgage Fund.

The Nicola Preferred Share Fund returned +2.4% for the month while the BMO Laddered Preferred Share Index ETF returned 2.6%. The reduction in the size of the preferred share market continues to be the predominate narrative as TD redeemed approximately $1 billion worth of preferred shares during the month. Our dividend arbitrage strategy with Bolton Capital continues to provide stable returns and returned 0.53% for the month. Despite cutting growth estimates for 2021 and 2022, concerns on inflation being stronger and more persistent than expected has led the Bank of Canada to end its bond buying stimulus and potentially accelerate the pace of future interest rate hikes.

As a result, 5-year Government of Canada bond yields continued their march higher, moving from 1.11% to 1.51%. During the month, RBC launched the first institutional preferred share offering. This new structure has similarities to most standard preferred shares with a few exceptions, mainly that the par value is $1000 instead of $25 and it is traded OTC (over the counter) as opposed to through an exchange. It is our view that the difference in structure is to reduce the number of retail clients who participate in the market. Preferred shares are complicated instruments and have been historically volatile and thus better suited for institutional investors.

The Nicola Canadian Equity Income Fund’s return was +6.0% while the S&P/TSX was up +5.0%. Equity markets began the fourth quarter very strongly after a rocky September, as new global COVID-19 cases decelerated in most regions. The S&P/TSX was particularly strong as commodities extended their rally on tight supply. Crude oil prices (WTI +11.4%; Brent +7.5%) led the commodity rally in October on recovering demand and also as OPEC+ continued to restrict output.

Strong inflation numbers lifted 10-year bond yields in Canada which rose from 1.51% to 1.72% during the month.  In October, Industrials (+8.8%), Energy (+8.6%, and Real Estate (+6.1%) were the strongest performing sectors. The biggest laggards were Health Care (-6.1%) and Staples (-1.5%).

The Nicola Canadian Equity Income Fund outperformed the index mainly due to overweighting and outperforming Energy and Financials. The portfolio remains positioned for a strong pickup in activity, accompanied by sustained commodity prices and rising bond yields. Overall, the portfolio is overweight Industrials, Financials, and Energy. The top positive individual contributors to the performance of the Nicola Canadian Equity Income Fund were Suncor Energy, First Quantum Minerals, and Canadian Natural Resources.  The largest detractors were West Fraser Timber, Saputo, and Air Canada. During the month of October, we sold our positions in Kirkland Lake Gold and Linamar and added Canadian Tire.

The Nicola Canadian Tactical High Income Fund’s return was +6.0% while the S&P/TSX was up +5.0%. The top three sectors contributing to relative returns were Energy, Financials and Real Estate. The primary detractors in October were Technology and Communications Services. The Nicola Canadian Tactical High Income Fund has a Delta-adjusted equity exposure of 96%.

We have increased the option writing portion of the Nicola Canadian Tactical High Income Fund recently and have written calls on 5.5% of the portfolio. Top contributors to relative performance were Suncor Energy, Canadian Natural Resources and CP Railway. The largest detractors for the month were Brookfield Asset Management, West Fraser Timber, and Canadian National Railway. During the month, we added Canadian Tire. We exited Kirkland Lake Gold and Linamar.

The October returns for both the Nicola U.S. Equity Income Fund and the S&P 500 were +7.0% (all in USD$).  Investor concerns going into October were not too different from the prior month (debt ceiling limit, supply-chain issues, cost inflation, size & scope of the Democrat social spending bill and when the Fed would start to taper and/or raise interest rates), but what was different this month was: 1) optimism around a slimmed-down and more market-friendly social infrastructure spending package; and 2) the start of Q3 earnings season where companies reported higher than average positive earnings surprises.

The Nicola U.S. Equity Income Fund’s positive performance was primarily driven by stock selection within Industrials where Union Pacific was up 23% with an earnings beat from strong pricing power and solid cost control.  The Nicola Canadian Tactical High Income Fund’s Health Care names performed well with UnitedHealth rising 17.9% after beating earning expectations and raising full-year guidance on robust cash flow generation; Merck was also up over 17% due to its successful late-stage trial for Molnupiravir (COVID pill treatment) where management forecasts $5-$7B in 2022 sales, which is close to 15% of the company total annual sales.

The Nicola U.S. Equity Income Fund’s overweight in the Material sector contributed to returns as Air Products jumped 17% this month after announcing a new blue hydrogen project in Louisiana which is expected to come online in 2026; copper producer Freeport McMoRan was up +16% after reporting better than expected free cash flow and lower copper production costs.

Despite the Consumer Staples sector being one of the worse performing sectors last month, the Nicola U.S. Equity Income Fund’s holdings in this sector outperformed the market; Costco was up +9.6%, benefitting from strong traffic and prices, as well as better than expected same-store-sales. Pepsi was up +7.4% on high single-digit topline growth and positive signs both pricing and volume growth were healthy in North America. Walmart gained +7.2% from analyst upgrades and a view that the company is more favorably positioned in regards to freight/supply relative to peers this important upcoming holiday season.

There were no new positions added to the Nicola U.S. Equity Income Fund this month.  The Nicola U.S. Equity Income Fund ended the month with a delta-adjusted equity exposure of 99.6% (there were 0% in covered calls).

The Nicola U.S. Tactical High Income Fund returned 4.54% for the month of October vs 7.0% for the S&P 500 (all in USD$).  The Nicola U.S. Tactical High Income Fund’s positive performance was primarily attributable to stock selection within Healthcare (Pharma and Managed Care companies), Industrials (rails and waste companies) and Consumer Staples (Grocers/broadline retailers).

The relative underperformance was due to being underweight in both Consumer Discretionary and Information Technology as both sectors outperformed the broader market. During Q3 earnings season, the Nicola U.S. Tactical High Income Fund was active by writing 22 Put options and by writing 19 Call option.  The Nicola U.S. Tactical High Income Fund initiated a new position in Northrup Grumman by writing Put options.  Northrup Grumman is a U.S. Defense prime contractor with attractive growth prospects from its exposure to high-growth US DoD budget areas (space and aircraft), margin expansion opportunities within Aeronautics (B-21 procurement program) and near-term inflation protection from its high exposure to “cost-plus” contracts.

The Nicola Global Equity Income Fund returned +1.0% vs +2.7% for the MSCI ACWI Index (all in CDN$).  The Nicola Global Equity Fund underperformed due to our relative underweight to the United States, one of the best performing regions during the month, and our regional overweight to Japan, one of the weakest markets in October. Performance was marginally offset by our underweight in Communication Services, which was the weakest sector during the month, as well as our overweight to Canada, which was the strongest region. Performance of our managers for the month: EdgePoint +4.5%, C Worldwide +2.7%, Nicola Wealth EAFE +0.6%, Lazard +0.8%, ValueInvest -0.8%, and JP Morgan Global Emerging Markets -1.4%.

The Nicola Global Real Estate Fund return was +2.0% in October. The iShares S&P/TSX Capped REIT Index ETF rallied +6.0% in October even as the yield on 10-year Government of Canada Bonds moved 21bps higher (from 1.51% to 1.72%) in the month. Typically interest rate sensitive sectors like REITs move lower as interest rates rise.

Perhaps one reason why REITs were strong in the face of higher rates is because of the high inflationary environment we are in. Inflation in Canada has stayed above the target range for the last 5 months and counting. In general, the sector is viewed as a good source of inflation protection and performs well relative to the broader TSX index in periods of high inflation.

As regional economies re-open over the balance of the year, it is expected that economic activity will accelerate, which would provide support to property level fundamentals. In particular we expect industrial REITs to continue to benefit from robust tenant demand and higher penetration rates in e-commerce. We also expect residential REITs to benefit from the return to office/school theme and translate into higher occupancy.  We added a position in American Homes 4 Rent to the portfolio in October. There were no deletions.

Nicola Canadian Real Estate LP NAV per unit has increased to $142.6148 (previously $140.5862), effective October 31, 2021. This represents an increase of 1.4% and a positive return for September of 1.9%. YTD Return as at September 30, 2021 is 15.35%.  Portfolio Leverage is 38.76%.  The positive return was primarily a result of increased appraised values of 880 Avonhead, 10239 Grace Road and Robert’s Manor.

Nicola U.S. Real Estate LP NAV per unit has increased to US$166.2999 (previously US$165.7273), effective October 31, 2021. This represents an increase of 0.4% and a positive return for September of 0.8%. YTD Return as at September 30, 2021 is 7.3%.  Portfolio Leverage is 48.04%. The positive return was primarily a result of increased appraised values of Ilume Apartments, Valencia at Westchase, and Villas Continental Apartments.

Nicola Value Add Real Estate LP NAV per unit has decreased to $190.9596 (previously $196.7753), effective October 31, 2021, after a cash distribution of quarterly profits of $8.1425 per unit. Although this represents a decrease in NAV of 2.96%, September had a positive return of 1.18%. YTD return as at September 30, 2021 is 9.55%. In September, we funded $9.9M for Waterfront Station, $0.5M for Treo, $0.4M for Central Surrey, $0.2M for Building O, $0.2M for Kelson, $0.1M for Cambridge, $0.1M for Cottonwood, $0.1M for King City, and $0.1M for Railway.

The Nicola Sustainable Innovation Fund returned +11.8% (USD) / +8.6% (CAD) in October, and -3.0% (USD) / -5.6% (CAD) year-to-date. Plug Power, Ameresco, Sunrun and the PIMCO California Carbon Access Offshore Fund L.P., were the top contributors to performance while Alstom, Stem Inc. and wind blade manufacturer TPI Composites were the biggest laggards in the month.

In October we added two new positions in a pair of differentiated electric vehicle (EV) companies, Li Auto and NIO Inc. NIO manufactures premium EVs and is also known for its comprehensive battery solutions which includes battery swapping and Battery as a Service (BaaS) monthly subscriptions. The battery swapping system helps alleviate some of the charging concerns that are felt by many EV owners.

Li Auto is differentiated with its Li One SUV, which is an EREV – Extended Range Electric Vehicle. The SUV comes with a 40.5kWh battery which offers 188km of EV range, and also carries a 1.2L three-cylinder combustion engine and 55L tank which charges the battery. There are multiple benefits to the EREV powertrain which include an overall extended range of roughly 900km that helps alleviate some of the range anxiety concerns as China builds out its EV charging network.

During the month we also took some profits in Enviva, Plug Power, and Ameresco and rebalanced into existing names including Ballard Power and ChargePoint Holdings. Positive momentum returned to clean energy and renewables focused names in October leading up to the United Nations Climate Change Conference, also known as COP26, held in Glasgow, Scotland. Ahead of the summit there was also a push from U.S. President Joe Biden and the Democratic Party to try and get a climate focused infrastructure plan passed so the President didn’t arrive to the conference empty handed. While the two parties were unable to come to a consensus before Biden’s departure, the prospect of a deal getting reached likely drove some of the optimism that returned to the sector during the month.

The Nicola Alternative Strategies Fund returned -1.3% in October. Currency was a headwind detracting -1.6% for the month. In local currency terms, most strategies were relatively flat in October with the exception being Bridgewater, which had a very strong month. According to the Eurekahedge Hedge Fund Index, hedge funds broadly returned 0.7% for the month with limited dispersion. Relative Value hedge funds lagged the most returning -0.7% while macro strategies were one of the largest positive contributors.

The Nicola Precious Metals Fund returned +2.9% for the month while underlying gold stocks in the S&P/TSX Composite index returned +4.5% and gold bullion was down -0.9% in Canadian dollar terms. Gold ETF’s saw net outflows in October while stocks were supported by returns from Belo Sun mining and Karora Resources. Belo Sun mining is developing the largest undeveloped gold deposit in Brazil while Karora, a gold producer with assets in Western Australia, had a record quarter in terms of gold production beating analyst estimates and reset expectations in terms of achieving their multi-year growth plan.

 

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.