Market & Fund Commentaries
| Every quarter, Sceptre investment management teams report on relevant markets, the activities within each mutual fund portfolio, and the outlook for the future. Expand the following list to view the commentary in which you are interested. Further in-depth fund information can also be viewed in the Mutual Fund area of the website. |
Second Quarter 2010
Sceptre Bond Fund
During the second quarter of 2010, the DEX Universe bond index returned 2.9%. The Fund’s underperformance of 60 basis points relative to the index for the second quarter is due entirely to an overweight position in corporate bonds. The duration of the portfolio was maintained fairly close to the index, except for two occasions, where the fund manager employed a tactical rates strategy to capitalize on a temporary rise in short term bond yields. This was affected by selling short-dated bonds and buying very short-dated bonds and floating rate notes. However, portfolio duration was returned close to the index by quarter end, with the outcome proving beneficial to performance.
Strong demand for yield and concern about the global economy during the second quarter of 2010 resulted in broad strength throughout the bond market. Corporate bonds underperformed the broader bond market as corporate credit yield spreads widened with weakness in equity markets, but this was partly mitigated by term structure and security selection.
Economic growth and inflation are in line with Bank of Canada forecasts reducing the need for rates at emergency levels. Despite the 25 basis points rate hike in June, the bond market has reduced expectations for an extensive hiking campaign, as the US Federal Reserve is unlikely to hike until 2011 and global macroeconomic recovery remains tentative. While long-term federal government bonds provided the best sub-sector return of 6.8%, the weakest sub-sector, short-term corporate bonds, managed to provide a positive return of 1.5%.
Currently, lower Government of Canada bond yields appear less compelling relative to our expectations for further Bank of Canada rate hikes over the next 12 months. Although our overweight position in corporate bonds negatively impacted performance in the second quarter of 2010 we have maintained this overweight in order to generate higher portfolio yield than the index.
Sceptre High Income Fund
The Sceptre High Income Fund outperformed the S&P/TSX Composite Index by 140 basis points in the second quarter of 2010, returning -4.1% compared to the S&P/TSX Composite Index which posted a return of -5.5%. The sectors which had positive returns for the Index during the quarter were Materials, Consumer Discretionary, Health Care and Telecommunications. The Materials sector was only marginally positive as the significant strength in the Gold and Precious Metals sub-sector offset the substantial weakness in the Metals and Mining sub-sector. The largest detractors to the Index were the Financials, Energy and Industrials sectors.
We stated in our last quarterly publication that we believe there is an appetite for yield stocks and, in particular, dividend growers. This is very much a secular theme as more and more investors are drawn to these types of investment vehicles given the recent volatility in equity markets and changing demographics. Interestingly, in the market decline during the second quarter, the S&P/TSX Capped Income Trust, Energy Income Trust and REIT Income Trust indices out-performed the broader market. Although, these sub-indices were not completely insulated from the market decline as both the Income Trust and Energy Trust sub-indexes had negative returns while the REIT Index actually had a +1.6% return.
Notable transactions during the quarter included initiating a position in Saputo Inc. which is a Consumer Staple name mainly involved in the global cheese and dairy market. We sold Shoppers Drug Mart given the regulatory headwinds the company is facing and the possibility of slower dividend growth in the years ahead. We also trimmed our position in Canadian Oil Sands to increase our weighting in Vermilion Energy which has a higher yield and better near term growth profile. We initiated a new position in Cenovus Energy which is another oil and gas company with some of the best oil sands assets in Canada and management that has indicated a commitment to growing the dividend over the long term. Finally, we added to our position in North West Company which we believe is well positioned for stable growth in the food retail sector, while reducing our Labrador Iron Ore Income Fund position.
Stocks that significantly outperformed during the quarter were Canadian Energy Services (+13.0%), Northland Power (+6.6%), North West Company (+6.4%) and BCE Inc. (+5.5%). Detractors from performance included Labrador Iron Ore Income Fund (-18.8%), Great West Life (-16.4%) and Royal Bank (-14.0%).
Despite the current market uncertainty and volatility, we will continue to hunt for yield-oriented opportunities that meet our investment criteria. Our criteria includes management teams with a strong record of execution, solid balance sheets for flexibility and a business model that lends itself to earnings and dividend growth.
Sceptre Income & Growth Fund
Sceptre Equity Growth Fund
Sceptre Canadian Equity Fund
Equity markets around the world had a difficult quarter, brought on by the European sovereign debt crisis. As well, China’s economic growth expectations were somewhat reduced, impacting commodity prices. In this uncertain environment, global investors flocked to the safe haven of gold bullion. The S&P/TSX Composite Index declined 5.5% in the second quarter, with defensive sectors such as Telecommunications, Consumer and Health Care outperforming more cyclical sectors such as Energy and Financial Services. Gold stocks in particular, did very well in the quarter. Like most diversified funds, the Fund was underexposed to this top performing sub-sector. Over the same period, the Fund declined 6.1%. On a longer term basis, the Fund has outperformed the Index on a 10 year basis.
Not surprisingly, the two stocks that had the most positive impact on performance in the quarter were gold stocks: Goldcorp (+23%) and Franco-Nevada (+20%). Other winners included Pacific Rubiales (+21%) and Silver Wheaton (+34%). Our overweight in railroads also contributed to relative outperformance. Detractors in the quarter, aside from our gold underweight, included Materials stocks Potash Corp (-24%) and Teck (-29%) as fears of a slower economy overwhelmed their improving fundamentals. Our overweight in Financials – a positive in the first quarter – hurt us in the second quarter. Manulife (-22%) and Power Corp (-16%) fell as interest rate expectations were adjusted downward. Lastly, Royal Bank (-14%) reported a quarter that was below expectations and thus underperformed.
During the quarter, we made select changes to the portfolio. In the Consumer sector we initiated a position in Saputo Inc., one of the leading cheese producers in North America. Saputo trades at a reasonable valuation and has an excellent track record of growth and high returns. We also initiated a position in Tim Horton’s this quarter. To fund these purchases we eliminated our holding in Canadian Tire. In the Materials sector, we increased our precious metals weight by adding to growth names Agnico-Eagle and Silver Wheaton, while selling out small positions in Kinross and Inmet. In the Energy sector, we trimmed Canadian Oil Sands Trust and purchased Vermilion Energy Trust. Vermilion is a diversified global energy company with assets in Western Europe, Australia and Canada. It has an excellent management team, conservative capital structure and a handsome yield. We continue to seek quality investments that have long term growth and trade at reasonable valuations.
Sceptre Global Equity Fund
The market pulled back strongly in the second quarter on concerns about the strength and duration of the global economic recovery. Governments have started to slow and reverse fiscal and monetary stimulus. Europe is struggling under the burden of heavy deficits and massive indebtedness. One of the main engines of global growth, China, is attempting to slow the pace of their growth in the face of rising inflationary pressures. With the slowdown of government participation in the global economy, the market is concerned about the ability of corporations and consumers to perpetuate the current recovery.
In second quarter, the Global Mutual Fund underperformed its benchmark. The Fund returned -10.2% vs. -8.3% for the MSCI World Index. Consumer Discretionary and Telecommunications sectors had the strongest relative performance. Energy, Health Care, and Consumer Staples had the weakest relative performance. From a stock perspective, the largest positive contributors were Goldcorp (+23%), Yum! Brands (+7%), and CSX (+3%). Anadarko Petroleum (-48%), Teck Resources (-24%), and CVS Caremark (-16%) were the biggest detractors to performance.
During the quarter, emerging market exposure was increased through the addition of British American Tobacco, a tobacco company with more than half of its sales from emerging markets, and Rio Tinto, a large mining company with significant exposure to key commodities demanded by emerging countries to strengthen their infrastructure. We also decreased our exposure to European financials with the sale of BBVA and National Bank of Greece.
Markets have dropped strongly in anticipation of a slowdown in the earnings recovery resulting in a rapid contraction in market valuation. Earnings trends have indeed flattened out. We remain cautious on global equities on concerns of a weak recovery and the potential for financial contagion leading to another global crisis. With the weak performance of global markets, valuations for many sectors and companies are somewhat attractive although we remain concerned that expectations for the duration and magnitude of the global recovery are too high.
The emerging Asian economies have been much more resilient than the Western economies and we continue to expect them to lead global GDP growth. We expect that the U.S. and Europe will continue their recovery but we think the GDP growth rates of these two regions will remain slow relative to the emerging world.
We remain relatively neutral by sector with modest underweights in Utilities, Financials and Materials and modest overweights in Health Care, Consumer Staples, and Industrials. On a regional basis, we remain underweight Europe (including UK) and Asia (including Japan), with overweight positions in emerging markets and North America.
