Nicola Wealth Portfolio Results – September 2021 - Nicola Wealth

Nicola Wealth Portfolio Results – September 2021


Returns for the Nicola Core Portfolio Fund were +0.3% in the month of September. The Nicola Core Portfolio Fund is managed using similar weights as our model portfolio and is comprised entirely of Nicola Wealth Pooled Funds and Limited Partnerships. Actual client returns will vary depending on specific client situations and asset mixes.

The Nicola Bond Fund returned +0.1% in September while the iShares Core Canadian Universe Bond Index ETF returned -1.5% for the month. Quarter to date the Nicola Bond Fund returned +0.6% versus the ETF at -0.7% and year to date the Nicola Bond Fund returned +1.9% versus the ETF at -4.3%.

For the month of September in Canada, a rising yield curve hurt the Canadian bond universe as the Bank of Canada gave guidance that it would increase interest rates first before reducing its government bond holdings. A further steepening of the curve continued throughout the month as Government of Canada 2-year bond yields moved slightly higher from 0.43% to 0.53% while Government of Canada 10-year bond yields moved higher from 1.22% to 1.51%. Meanwhile credit spreads were slightly tighter which helped offset the negative returns for the overall Canadian bond market duration exposure. Marret, East Coast, and Sun Life all contributed positively to returns for the month while real return bonds and PH&N were slight detractors.

The Nicola High Yield Bond Fund returned +1.1% in September. Quarter to date the Nicola High Yield Bond Fund returned +3.5% and year to date the Nicola High Yield Bond Fund returned +6.0%. Currency contributed 0.5% to returns last month as the US dollar strengthened versus the Canadian dollar. The largest contributor to returns in local currency terms was our position in California Carbon Allowances (CCA) which returned +4.5% as carbon prices pushed higher.

Slightly higher exposure to energy names and lower exposure to technology names were also positive contributors to the portfolio this month generating our portfolio solid returns for the month despite a soft month overall for risk assets. The month marked some weakness in the high yield market with BB rated names coming under pressure from interest rates and elevated supply. September was a busy month for new issuance with $52 billion of high yield issuance, almost double the historical monthly average, as LBO financing has occurred at a torrid pace.

The Nicola Global Bond Fund was down for the month returning -0.8%. Quarter to date the Nicola Global Bond Fund returned +0.6% and year to date it has returned -1.5%. Emerging markets currencies weakened during the month giving back gains from a strong August thanks to the Fed’s hawkish tilt, leading to some softness in returns from the Templeton Global Bond fund.

Some of the weaker returns were offset by the BlackRock Securitized Investors LP fund which in local currency returned 0.69%. From a global perspective, China’s most indebted developer, Evergrande, continues to sort itself out with asset sales as a path to help assist its debt burden. However, a small developer, Fantasia Holdings, has missed its debt payment and thus renewed some fears of contagion within the Chinese fixed income markets.

Returns for the Nicola Primary Mortgage Fund and Nicola Balanced Mortgage Fund were 0.3% and 0.4% respectively for the month, and 1.2% and 1.5% for Q3. Cash levels at month end were 4% for the Nicola Primary Mortgage Fund and 5% for the Nicola Balanced Mortgage Fund. Current annual 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 3.9% for the Nicola Primary Mortgage Fund and 5.7% for the Nicola Balanced Mortgage Fund.

Both funds are well positioned with good levels of investment activity in Q3, particularly the Nicola Balanced Mortgage Fund which has deployed more capital in 2021 YTD than any previous full calendar year. The current investment pipeline remains strong for both funds as we head into Q4.

The Nicola Preferred Share Fund returned +1.1% for the month while the BMO Laddered Preferred Share Index ETF returned +0.3%. Quarter to date, the Nicola Preferred Share Fund returned +2.9% while the ETF returned +2.5%. Year to date the Nicola Preferred Share Fund returned +25.2% while the ETF returned +21.5%.

The differential between our Nicola Preferred Share Fund and the ETF returns was due in part to end of month pricing for the ETF, which ended last month with a slightly elevated price causing returns in the ETF to be higher in August and more subdued in September. Our dividend arbitrage strategy with Bolton Capital has provided us with stable returns and helped enhance the Nicola Preferred Share Fund by allowing us to pivot away from more expensive preferred shares that are trading at or above par ($25) with limited upside potential into more attractive opportunities.

During the latter part of the month, the FOMC held a press conference where Chairman Jay Powell transitioned to being hawkish, surprising markets and generally avoided using the term transitory to describe the ubiquitous inflationary pressures. The hawkish turn impacted Canadian markets with 5-year Government of Canada bonds moving from 0.84% to 1.11% a level last seen in February 2020.

The Nicola Canadian Equity Income Fund’s performance vs S&P/TSX: September was -1.5% vs -2.2%; Q3 2021 +0.9% vs +0.2%; YTD +16.2% vs +17.5%. The Canadian market ended Q3 almost flat. An energy shortage from Europe to Asia lifted energy prices in the third quarter. Natural Gas prices (+60.7%) were up sharpy while WTI (+2.1%) rallied to 2018 levels.

Prospects of an earlier-than-expected increase in benchmark interest rates from the Federal Reserve caused a change in leadership in the market at the end of September with Value stocks surging while Growth counterparts lagged. In September, the only positive performing sector in the Index was Energy (+8.9%), while Financials (-1.1%) was the only other sector to outperform the broader S&P/TSX Index (-2.2%).

Within the Nicola Canadian Equity Income Fund, the top three sectors to contribute to relative outperformance in the month were: Information Technology, Materials, and Financials. The bottom three performing sectors on a relative basis were Industrials, Energy, and Real Estate. The portfolio remains positioned for a strong pickup in economic activity, accompanied by sustained commodity prices and rising bond yields.

The Nicola Canadian Equity Income Fund remains overweight Industrials, Financials, and Energy. The top individual contributors to performance of the Nicola Canadian Equity Income Fund were Suncor Energy, Canadian Natural Resources, and West Fraser Timber. The biggest detractors were Nuvei Corp, TFI International, and Franco Nevada. We added quality and growth to our portfolio with a position in pet goods and services retailer, Pet Value Holdings Ltd. We exited Restaurant Brands International, Allied Properties REIT, Cargojet, and Brookfield Renewable.

The Nicola Canadian Tactical High Income Fund’s performance vs S&P/TSX: September -1.3% vs -2.2%; Q3 2021 +0.6% vs +0.2%; YTD +16.9% vs +17.5%. The top three sectors contributing to returns were Technology, Materials and Financials. The primary detractors in September were Industrials, Real Estate, and Consumer Staples.

The Nicola Canadian Tactical High Income Fund has a Delta-adjusted equity exposure of 98% and the projected cashflow yield on the portfolio is 4.3%. While volatility has remained depressed, we noticed a move up in volatility near the end of September which would make option writing strategies more profitable.

Currently we have written calls on less than 5% of the portfolio but as profitability for options rises, we could see that number move higher. Top contributors to relative performance were Canadian Natural Resources, Suncor Energy, and West Fraser Timber. The largest detractors for the month were Nuvei Corp, Air Canada and TFI International. During the month, we added Pet Value. We exited Allied Properties REIT, Brookfield Renewable, and Restaurant Brands International.

Returns for the Nicola U.S. Equity Income Fund and the S&P 500 for the month of September were -4.6% vs -4.7%; Q3 2021 returns were -0.2% vs +0.6% (all in USD$). The Nicola U.S. Equity Income Fund’s relative outperformance in September was primarily driven by the underweight in Information Technology and from stock selection within Communication Services, Health Care (Merck -0.66% & Thermo Fisher Scientific +3%) and Consumer Discretionary (Dollar Tree +5.7% & Tractor Supply +4.3%).

The Nicola U.S. Equity Income Fund initiated a new position in Northrup Grumman which is a U.S. Defense and Space 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.

Northrup Grumman is a high-quality name (double-digit ROIC, low net debt, durable competitive advantages) and adds some protection to the portfolio from rising geopolitical tension. The Nicola U.S. Equity Income Fund sold its remaining Qualcomm position (80bps) to help fund this new position.
The Nicola U.S. Equity Income Fund ended the month with a delta-adjusted equity exposure of 99.6% (Fund had 0% in covered calls). The Nicola U.S. Equity Income Fund consists of high-quality names with relatively low leverage and attractive consensus forward 12-month ROE (35% vs 22% for S&P 500).

Returns for the Nicola U.S. Tactical High Income Fund and the S&P 500 for the month of September were -2.9% vs -4.7%; Q3 2021 returns were +0.2% vs +0.6% (all in USD$). The Nicola U.S. Tactical High Income Fund’s positive relative performance was primarily attributable to the underweight in Information Technology, Healthcare, Real Estate and Communications Services. Stock selection was mixed with positive selection within Communication Services, Consumer Discretionary and Healthcare being more than offset by negative selection within Financials and Industrials.

In terms of the option market, volatility in the market (as measured by the VIX Index) increased 19% by month-end. There was also a higher temporary spike mid-month from events in China (fear of Evergrande contagion), the FOMC comments about a possible tapering at its next meeting in November and uncertainty around the U.S. debt ceiling and infrastructure bill.
The Nicola U.S. Tactical High Income Fund was able to find opportunities to generate attractive option premiums by writing 32 Put options and 1 Call option.

In September, the Nicola Global Equity Income Fund returned -3.5% vs. -3.6% for the MSCI ACWI Index (all in CDN$). For Q3/21, the Nicola Global Equity Fund returned -0.2% vs. +1.3% for the MSCI ACWI Index (all in CDN$). YTD, the Nicola Global Equity Fund returned +7.5% vs. +10.8% for the MSCI ACWI Index (all in CDN$).

For the month of September, the Nicola Global Equity Fund outperformed due to our overweight to Japan which was the best performing region. Our underweight to US equities also contributed positively as the region underperformed despite USD appreciation. From a sector perspective, we outperformed due to our overweight to Consumer Staples which performed well during the month. We also benefited from underweights in Information Technology and Communication Services, which were the two worst performing sectors.

Performance was marginally offset by an underweight in Energy, one of the best performing sectors. Performance of our managers for the month: ValueInvest +0.6%, Lazard -3.0%, Nicola Wealth EAFE -3.1%, C WorldWide -3.9%, EdgePoint -4.3%, and JP Morgan Global Emerging Markets -4.4%.

The Nicola Global Real Estate Fund’s performance vs iShares S&P/TSX Capped REIT Index (XRE): September -0.2% vs -3.2%; Q3 2021 +5.1% vs +2.3%; YTD +13.1% vs +24%. The REIT sector suffered the first pullback in monthly performance since the beginning of the year as interest rates moved up sharply over the past few weeks. The yield on 10-year Government of Canada Bonds moved from 1.21% to 1.51% in the last eight trading days of September and as a result, interest rate sensitive areas in the market moved lower. The sector does indeed react negatively to rising rates, but we would note that current rates remain in line with pre-pandemic historical lows.

Overall, the outlook for real estate remains favourable. As regional economies re-open over the balance of the year, it is expected economic activity accelerates, which would provide support to property level fundamentals. We believe this sets up for a combination of multiple expansion and NAV growth. Risk/reward looks particularly good in the residential and industrial asset classes. There were no new additions or deletions in September. Subsequent to the quarter, we will continue to diversify the Nicola Global Real Estate Fund and give our clients exposure to high quality international real estate by increasing our allocation to the Invesco Real Estate – European Fund.

The Nicola Canadian Real Estate LP NAV per unit has decreased to $140.5862 (previously $141.2376), effective September 30, 2021. This represents a decrease of 0.5% and a negative return for August of 0.01%. YTD Return as of August 31, 2021 is 13.2%. Portfolio Leverage is 38.68%. The negative return was primarily a result of a decreased appraised value of the Hat at Five Corners, a 199-unit purpose-built apartment building in downtown Edmonton. This property experienced a decrease in value as a result of a significant increase in property taxes, and slower than anticipated lease-up of the property due to COVID-19. The value of the property is expected to increase as additional lease-up occurs.

The Nicola U.S. Real Estate LP NAV per unit has increased to US$165.7273 (previously US$164.8051), effective September 30, 2021. This represents an increase of 0.6% and a positive return for August of 1.1%. YTD Return as of August 31, 2021 is 6.4%. Portfolio Leverage is 44.87%. The positive return was primarily a result of increased appraised values of Balmoral Village, Tree Park Apartments, and Bala Woods.

The Nicola Value Add Real Estate LP NAV per unit has increased to $196.7753 (previously $194.3801), effective September 30, 2021. This represents an increase of 1.2% and a positive return for August of 1.2%. YTD return as of August 31, 2021 is 8.3%. In August, we funded $24.6M for York Mills, $19.4M for Brooklin Lands, $5.9M for 1777 Frances St., $5.7M for Eastfield Industrial, $5.4M for 5th & Columbia, $4.8M for Building O, $4.1M for Gordon Drive, $1.1M for Deep Cove Dr., $0.4M for Treo, $0.2M for Encore, $0.1M for Cottonwood, $0.1M for King City, and $0.1M for Railway.

The Nicola Sustainable Innovation Fund returned -6.3% (USD) / -5.4% (CAD) in September, -7.7% (USD) / -5.1% (CAD) for the quarter, and -13.2% (USD) / -13.1% (CAD) year-to-date. PIMCO California Carbon Access Offshore Fund, L.P, Innergex Renewable Energy, and Vestas Wind Systems were the top contributors to performance while Iberdrola, Xebec Adsorption, and Orsted were the biggest laggards in the month.

In September we added to several existing positions including Stem Inc., a pure-play smart energy storage company, ChargePoint Holdings, TPI Composites and Aptiv. Heightened volatility returned this month with the U.S. markets suffering their largest selloff since March 2020. A variety of worries including rising Treasury yields, concerns over a potential U.S. government debt default, the breakdown and possible market contagion from indebted China Evergrande Group all weighed on markets in September.

In addition to these fears, we’ve also seen major disruptions to power supplies over recent weeks in China and Europe. In China, more than half of all provinces witnessed power disruptions following a rise in manufacturing and exports amidst increasing coal and gas prices which led to blackouts in some areas and forced power shutdowns in others. Natural gas prices in Europe surged 60% over two days in early October before correcting on news that Russia would step in with additional supply. While both regions are supportive of decarbonization and transitions towards net zero economies, these disruptions highlight the ongoing reliance on fossil fuels for baseload power in times of peak demand. Given the intermittent nature of renewables, these situations demonstrate the need for further investment and deployment of batteries and other energy storage solutions such as those from our portfolio company Stem, as well as hydrogen to help offset fossil fuels in the broader process of energy transition.

The Nicola Alternative Strategies Fund returned 1.4% in September. Quarter to date the Nicola Alternative Strategies Fund returned +2.9% and year to date the Nicola Alternative Strategies Fund returned +6.8%. Currency was a tailwind contributing 0.6% for the month of September. Volatility in the month created more opportunities for arbitrage focused strategies while leading to some losses for long short equity strategies.

During the month we initiated a position in the Accelerate Arbitrage Fund which provides exposure to SPAC arbitrage and merger arbitrage. The Nicola Alternative Strategies Fund has a heavier focus on SPACS (special purpose acquisition companies). With this, the aim is to generate consistent low volatility returns by exiting a SPAC at a premium to NAV. As this happens once the SPAC announces a business combination or an exit at NAV, it includes the IPO price plus accrued interest, through a redemption before the deal vote or through the liquidation of the SPAC.

The Nicola Precious Metals Fund returned -7.6% for the month while underlying gold stocks in the S&P/TSX Composite index returned -9.7% and gold bullion was down -2.6% in Canadian dollar terms. Quarter to date the Nicola Precious Metals Fund returned -8.3% and year to date the Nicola Precious Metals Fund returned -16.5%.

A hawkish shift by some central banks led to higher US yields and as a result created a challenging environment for gold. Gold held in steady for the first half of the month reacting positively to US employment data earlier in the month however, the Fed signaled that it was almost ready to begin tapering asset purchases. The reduction of asset purchases will likely be followed by interest rate hikes which will be a headwind for gold in the short to medium term.

September also marked a mega merger between Agnico Eagle Mines and Kirkland Lake Gold. The merger will create the third largest gold miner in the world. The transaction marks a zero or low premium takeover which we have seen in the gold space more recently and as a result was met with some trepidation from Kirkland Lake shareholders. Nevertheless, there should be significant synergies with the combined entity as the geography of assets are quite complementary.

The Nicola Private Debt Fund returned +2.3% in Q3, bringing 2021 year-to-date returns to +8.5%. The main driver of Q3 performance was the Nicola Private Debt Fund’s investment in the Morgan Stanley Alternative Lending Fund which contributed approx. 0.84% to returns for the quarter. Consistent with prior quarters, Project Strength, Project Merion and Project Access all continued to provide strong contributions to performance from contractual interest income.

The Nicola Private Debt Fund received a total of $23.1 million of early repayments during the quarter including full early repayment of Project Orion and the remaining balance of Project Karma. During the quarter the Nicola Private Debt Fund invested $10 million in a $60 million syndicated senior term loan to CareRx, Canada’s largest specialty pharmacy and healthcare services provider to Canadian seniors in assisted living and long-term care homes. The Nicola Private Debt Fund also made a US$65 million commitment to Ares Real Estate Enhanced Income Fund which invests primarily in US commercial real estate debt.

The Nicola Private Equity LP returned +8.7% during Q3 and +22.9% year to date. Drivers of investment returns this quarter were from write-ups in Micross (formerly known as Corfin), a direct co-investment; secondary investments sourced through Overbay that were acquired at attractive valuations; as well as from fund investments including Headwater II and Behrman VI.

A stronger USD helped returns by approximately 180 basis points. New investments included: VTrips, a Florida-based vacation rental management business led by founder Steve Milo; as well as Project Icebox, a combination of two Canadian refrigeration and freezer merchandising equipment manufacturers, both based in Toronto.

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. Projected cash yields are estimates for the next 12 month yield assuming current yield stays constant (there are no major disruptions to payments, credit spreads, or interest rates) with the level of indicated yield from dividends, interest payments and options premiums annualized based on frequency. Actual cash flow results may vary from the Projected Cash Yield.