Norrep Credit Observations

April 12, 2016 Bill Holy MBA, CFAOwen Morgan MBA, CFA

Market Update

Total returns for U.S. and Canadian capital markets for YTD 2016 turned sharply positive in mid-February (across all asset classes), following a period of challenging conditions. The turnaround was due to the reversal of a general downward trend in economic data for the better part of a year, stabilization of commodity prices following months of decline, growth surprises, announcements outlining stimulus plans in the EU, Japan and Canada, and dovish statements from the Federal Reserve, easing fears of interest rate hikes.

Return
  March YTD
B of A Merrill Lynch U.S. High Yield Index (HOAO) 4.4% 3.2%
B of A Merrill Lynch Canada High Yield Canadian Issuers Index (HCCO) 3.2% 1.9%
S&P/LSTA Leveraged Loan Total Return (LLI) 2.8% 1.5%
S&P 500 Total Return 6.8% 1.3%
S&P/TSX Total Return 5.3% 4.5%
Yield
  Dec. 31, 2015 Mar. 31, 2016
US 10-Year Treasury Yield 2.2% 2.2%
CAD 10-Year Treasury Yield 1.4% 1.2%

High yield bond returns in both the U.S. and Canada were "V" shaped year-to-date, as the steep declines experienced in January and early February were followed by even more vertical recoveries. Spreads for the U.S. High Yield Index widened to almost 900 bps over U.S. treasuries by mid-February. By the end of March, this had narrowed to approximately 700 bps over U.S. treasuries as a result of the rally in the high yield market as the appetite for risk and a search for yield returned. Equally encouraging was the return of adequate levels of liquidity to the high yield market (recall liquidity in the high yield market was strained in mid-December 2015). While the recovery was generally broad-based, bonds and sectors which suffered the most in the 2015 and early 2016 downturn have rebounded the highest YTD: Mining (+11%), Retail (+7%), Gas Pipelines (+6%), and longer duration names (+6.1% for 10+ year paper vs +2.4% for 3-7 year names).

Outlook and Fund Strategy

As of March 31, 2016, Norrep Short Term Income Fund had an internal weighted average current yield of 6.1%, with a modified duration of 2 years. Approximately 55% of the Fund was invested in investment grade and high yield bonds, while 30% was invested in loans.

At the end of March, Norrep High Yield Class fund had an internal weighted average current yield of 8.0% with a modified duration of 2.2 years. Approximately 60% of the Fund was invested in high yield bonds while 20% was invested in loans. Please see the monthly fund summaries for complete performance statistics.

Our view on the high yield market is that we consider it to be fairly valued, and on the cusp of moderately attractive. Yields are near or slightly above the long term, historical mean. That said, a variety of factors will affect it, namely: Leverage across the market is rising, lending standards are tightening, while new high yield issuance is very weak (-66% y-o-y); and the future direction of energy prices remain a big question. In addition, the Federal Reserve will be watched closely to see whether it raises rates for the second time since December’s lift off.

We believe our funds are well positioned to weather these potential challenges and to prosper. In Norrep Short Term Income Fund we continue to hold shorter dated names and 1st lien term loans, both of which have shorter durations. We have increased the weighting in the Investment Grade bucket. These should buffer the impact of rate rises or of a general flight to quality, while participating in any upside. In Norrep High Yield Class, we also have an up-in-quality bias given the risk factors listed above, while keeping duration low, and have lightened our weighting in commodity-related bonds and taken the opportunity to exit some of these names as they have rallied.

 


About The Author

Bill HolyPortfolio Manager, Fixed Income - Cumberland Investment Counsel Inc. Affiliate of NCM Asset Management

Bill is a Portfolio Manager in fixed income, co-manages NCM Short Term Income Fund, and is part of the asset allocation team for NCM Pension Portfolios. Bill is a CFA charterholder, holds a Master of Business Administration from the Rotman…

Owen MorganPortfolio Manager, Fixed Income - Cumberland Investment Counsel Inc. Affiliate of NCM Asset Management

Owen is a Portfolio Manager in fixed income and co-manages NCM Short Term Income Fund. Owen is a CFA Charterholder and holds a Master of Business Administration from NYU Stern and a Bachelor of Arts (Econ) from Bishop’s University. Previously,…

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