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
Sceptre High Income Fund
Sceptre Income & Growth Fund
The global economic recovery started to falter in the second quarter of 2010 as many nations began to move away from massive stimulation of their economies and toward the implementation of austerity measures designed to reduce annual deficits and rising total indebtedness. Many investors, having become increasingly concerned about the future outlook for both the economy and financial markets, adopted a more risk-averse approach within their portfolios, turning to the safest assets and away from any security that might suffer in a second economic correction. In this environment, bonds outperformed equities and Government bonds outperformed corporate securities. The DEX Bond Index returned 2.9% while the Canadian equity market declined 5.5% and global equities were off 8.3%.
For the second quarter, the Fund returned -4.4% after fees. Both bond and equities underperformed their respective indices as corporate bonds, an area of the market that we are overweight, underperformed Government of Canada bonds. Equities were also weaker than the overall market as many economically-sensitive securities, particularly within the Financial and Resource sectors suffered major declines. In the case of Research in Motion (-30.5%), the company was hurt by Apple Computer’s new product introductions while Shoppers Drug Mart (-24.1%) was negatively impacted by proposed new government pricing criteria for generic drugs.
The structure of the portfolio changed modestly in the quarter as we deployed most of the Fund’s cash into Government of Canada bonds while at the same time reducing our exposure to provincial bonds. We remain overweight high quality corporate bonds which provide us with a higher yield than the overall market. The current asset mix of the Fund is 0.5% short-term investments, 38.0% bonds and 61.6% equities.
Within the equity component, new purchases included Saputo Inc, a Canadian dairy and cheese operation that has an excellent growth record, Methanex, which is benefiting from China’s increased appetite for methanol and Vermillion Energy Trust, a highly successful Canadian international energy producer. We also eliminated or reduced a number of resource-oriented holdings.
In the current weaker economic environment, the risk of a second downturn is more pronounced. Consequently, we are taking a cautious approach to our investing.
Sceptre Equity Growth Fund
Small cap stocks gave up their gains for the year during the second quarter of 2010. Concerns over European sovereign risk, the moderation of the Chinese economy and muted US economic growth prospects have placed pressure on the equity markets. Despite these economic challenges, commodity prices in copper, oil and gold continue to be strong and have allowed the Canadian stock market to outperform their global counterparts. The Sceptre Equity Growth Fund returned –6.1% for the quarter, modestly lower than the S&P/TSX Small Cap Index. We are constructive on the long term outlook for the equity markets and continue to add attractively valued companies with solid growth prospects to our portfolio.
Three outstanding gold companies were key contributors to our performance in the quarter. Semafo (+42%) is a well managed gold company with solid assets in West Africa. San Gold (+44%) is a developing gold company in Manitoba. Finally, Alamos Gold (+21%) is a volumetric growth story with assets in Mexico and Turkey. It is expected to generate strong volumetric growth and grow gold production from 175,000 oz today to 350,000 oz by 2013. Finally, The Fund’s largest positions within the energy and technology sectors also contributed strongly to second quarter performance, led by Celtic Exploration (+13%) and MacDonald Dettwiler (+16%).
Detractors for the quarter included stock selection in the Industrial sector. Although the following companies are leaders in their area, their earnings outlook was not as positive as expected. Toromont (-22%), Transat (-24%) and Aecon (-23%) all had challenging financial results.
We continue to see very good investment opportunities in the small cap universe. New purchases in the quarter included Angle Energy, a growth oil and gas producer in Alberta. This company has amongst the lowest operating costs in the industry. Production is also very strong and is expected to double in the next 3 years. We also added Fortress Paper, a leader in currency printing with excellent prospects for market share gains. Management is outstanding and the company generates a 20% return on equity and offers strong earnings growth. Both companies have entrepreneurial management and operate in desirable industries. The Fund has 78 holdings and remains broadly diversified across sectors.
Third party analytics demonstrate that the Fund continues to offer a better profit outlook and much lower valuations (16x 2010 earnings vs. 21x for TSX Small Cap Index). This is achieved with lower debt levels and higher reinvestment rates than the overall market. While we expect continued volatility in 2010, we are confident that we can maintain strong relative outperformance given the Fund’s characteristics. Our focus continues to be finding companies with excellent management, strong growth and high return on equity.
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.
