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PIMCO Monthly Income Fund (PMO 005 – Front End Units, PMO 105 – Low Load Units) – This global bond fund came out of the gate at full speed, gaining nearly 18% in 2011 and 24% in 2012. Obviously these returns weren’t sustainable, and have since settled down to a more reasonable level, posting a 6.4% rise in 2013, and 6.6% in 2014.
Managed by the team of Alfred Murata and Dan Ivascyn with the objective of income generation, it invests in a wide range of fixed income holdings including mortgage backed securities, investment grade bonds, high yield debt, and emerging market bonds. It can also use derivatives and engage in limited short selling. The portfolio tends to be rather U.S. focused, but will invest anywhere in the world.
The process used is a combination top down macro analysis combined with bottom up security selection. The top down macro analysis is formulated by PIMCO’s investment committee, and looks at both the long term outlook and the near term cyclical view. This analysis helps the managers set the fund’s sector mix, duration and yield curve positioning.
Once they know what they want the portfolio to look like, the bottom up analysis helps find the securities to be held by the fund. A number of techniques are used including credit analysis, which looks at the financial stability of a company and their ability to repay their debt. They will also use a proprietary quantitative model that stress tests the various issues, providing an estimate of how a particular issue is likely to react in the face of changing interest rates and market conditions.
The managers will look at the portfolio in two distinct parts; high quality core, and non-core. Within the high quality core portion, they tend to focus on investment grade issues in developed countries and agency mortgage backed securities. This portion is designed to provide downside protections and modest returns in periods when economic growth is weak. Currently, management is finding a lot of attractive opportunities in Australia, as they believe there is room for yields to fall further, providing the potential for capital gains.
The non-core portion holds lesser quality issues such as high yield bonds, emerging market debt, and non-agency mortgage backed securities. Within high yield bonds, they look for names that offer attractive income potential. Emerging market investments tend to be in large, quasi-sovereign entities and long-dated Brazilian inflation linked securities. For their non-agency mortgage backed securities, the like issues that can be bought at a discount, that allow for both income and the potential for capital gains.
They are very active in their approach with levels of portfolio turnover that have averaged more than 200% since the launch of the fund.
Unlike a lot of other monthly income funds, this one is managed with a focus on income generation. The monthly distribution amount is variable and is based on what the managers believe they can generate from the portfolio. The goal is to try to have all distribution payments come from generated income, rather than risk encroaching on invested capital. For the past 12 months, income distributions have totaled approximately $0.70, resulting in an annualized yield of 4.8%.
Costs are very reasonable, with a management expense ratio of 1.38%.
While I like this fund, I do not consider it to be a core fixed income offering. Given the underlying investments, it is more risky than what historic volatility has indicated. I see this more as a piece of a well-diversified portfolio, and believe the modest volatility, combined with the low correlation to the traditional asset classes make it a good way to help reduce the overall volatility of a portfolio.
Deletions
None
Funds of Note
PowerShares 1-5 Year Laddered Corporate Bond Fund (AIM 53203 – Front End Units) – Effective June 30, 2015, FTSE TMX Global Debt Capital Markets Inc., the provider of the index on which this fund is based announced some changes to the way the index is constructed. The biggest change was the number of bonds will gradually be increased from the current 25 to 50 over the next few years. To do this, each of the five equally weighted maturity buckets will see the number of bonds held in it double from five to ten. This will be done on a gradual basis, with the five year maturity bucket increasing its holdings to ten. All others remain holding five. Next June, when the index is reconstituted, an additional five bonds will be added, and so on. In five years, the changes will be complete.
The rationale provided for this change was to increase the diversification of the portfolio, which I believe will be beneficial in the challenging fixed income environment. After the index is reconstituted, the yield to maturity of the portfolio will increase from 1.69% to 1.80%. In comparison, the yield on the FTSE TMX Canadian Short Term Bond Index is listed at 1.03%.
A drawback of the reconstitution is there has been a modest increase in the interest rate sensitivity of the portfolio. Before the reconstitution, the duration was 2.53 years. After, it increases to 3.34. In comparison, the Short Term Bond Index has a duration that is listed at 2.85 years. This happened because the shortest duration bonds were removed from the portfolio, and new, longer duration bonds were added. Over the next 11 months, the duration will gradually fall as the term to maturity shortens. This happens each time the index is reconstituted.
Normally, I wouldn’t be too concerned about this. However, with there being a chance that the U.S. Federal Reserve may begin moving rates higher in the fall, there may be upward pressure on Canadian yields, which may affect this fund more than some of the other short term options available. Still, with a yield that is running about 30 basis points higher than my second favourite short term bond pick, the PH&N Short Term Bond and Mortgage Fund, this Powershares offering remains my top pick for those looking for short term bond exposure.
RBC Global Corporate Bond Fund (RBF 753 – Front End Units, RBF 853 – DSC Units) – The Fund had a tough quarter, losing 2.4% and underperforming its peers. A key reason for the loss was the increase in global bond yields, which were pushed higher on improving economic sentiment and expectations that the U.S. Federal Reserve will begin moving rates higher later in the year. With a duration of 6.1 years, the fund remains highly sensitive to movements in interest rates.
Another factor that weighed on it was its high yield and emerging market debt exposure. Both struggled in the face of continued weakness and uncertainty in the energy sector. Recent troubles in China will also weigh on the broader emerging market region. With continued uncertainty expected, more volatility is likely in the short term.
Despite the short-term outlook, this remains an excellent global bond fund, given the management team and process behind it. While not a core holding, it can play an important role in your fixed income allocation.
Manulife Monthly High Income Fund (MMF 583 – Front End Units, MMF 483 – DSC Units) – Since I recommended this fund in January, it has struggled to keep pace with its peers, with a modest 0.70% gain so far this year. At the end of June, it held 16% in cash, 22% in Canadian bonds, and 4% in foreign bonds. Equity exposure was 55%, with Canadian equity making up more than half. The equity sleeve is fairly concentrated, holding less than 50 names. A few of the big holdings struggled in the quarter, including Enbridge, which was down in the face of continued weakness in the energy sector, and Oracle, which sold off heavily after missing its earnings targets. The fixed income exposure is mainly in investment grade corporate bonds, which finished the quarter in the red.
Despite this recent underperformance, I believe this is an excellent balanced fund for those with a longer term time horizon. The managers use a very disciplined, bottom up process that has rewarded investors with excellent long term results, both on an absolute and risk adjusted basis. It also carries an MER of 2.04%, which is below its peers. I expect it to continue to deliver above average returns over the long term.
PH&N Monthly Income Fund (RBF 6660 – Front End Units, RBF 4660 – Low Load Units) – I have been disappointed with this fund for the past few quarters, and the nearly 2% drop posted in the second quarter did little to help matters. Since peaking in mid-2014, the fund has failed to keep pace with its peers.
The fund’s neutral asset mix is 50% Canadian equities, 35% Canadian bonds, 10% high yield, and 5% preferred shares. At the end of June, it was underweight bonds, and modestly overweight equities. Part of the reason for the underperformance would be its 5.1% weight in preferreds, which have been hit very hard in the face of the Bank of Canada rate cuts, and uncertainty remains in the short term. Performance was also hurt by its holdings in Canadian Utilities, which fell by 8.8% in the quarter, and TransAlta, which was down by more than 16%.
Looking ahead, the managers have reduced their overweight exposure to corporate bonds, and have kept the interest rate positioning close to the benchmark. Within the equity sleeve, they are looking for higher yielding names, which explains the overweight to financials, energy, and utilities. Unfortunately, the near term outlook for those sectors, particularly energy, points to further volatility and headwinds.
The fund pays out a monthly distribution of $0.042 per unit, which works out to an annualized yield of nearly 5.2%. It is this yield that makes this an attractive candidate for those looking for cash flow. However, until I see a more sustained recovery in performance I would suggest caution. I am continuing to monitor this fund closely.
TD U.S. Blue Chip Equity Fund (TDB 977 – No Load Units, TDB 310 – Front End Units, TDB 340 – Low Load Units) – U.S. large cap equity has been one of the most difficult categories to outperform the index, but this is a fund that has done a respectable job in doing just that. For the five years ending June 30, it’s 21.7% annualized gain (after all fees) has bested the S&P 500’s 21.2% rise. Year to date, performance has been even strong, gaining 13.8% while the index gained 8.9%.
While this is great, I certainly don’t expect it to be able to continue to outperform at this pace. A big reason for this view is the fund tends to be more volatile than the broader market. For the past five years, the S&P 500 has had a standard deviation of 8.3%, while the fund was 11.0%. If we look at upside and downside capture ratios, the fund tends to outperform when the index is positive, but tends to underperform by a greater margin when it falls. The reason this happens is the fund has a growth tilt to it, with healthcare, consumer cyclical and tech being the largest sector weights. Those sectors, and healthcare specifically, have had a tremendous run. As a result, the valuation metrics of the fund are on the high side, with price to earnings, price to cash flow, and price to book ratios that far exceed the index and peer group. It is also the most highly valued U.S. equity fund on the Recommended List. But, it also shows the strongest rate of earnings growth, both on a historical and forward looking basis. Factoring in the growth projections, it is not as overvalued as it may appear in isolation.
In a recent commentary, manager Larry Puglia noted that after the six year market rally, U.S. equities’ “…somewhat high absolute valuations make them vulnerable to the Fed’s timetable for returning interest rates to more historically normal levels.” He also noted that this far into the market cycle will make it difficult for many companies to expand margins by cost cutting, and only those that can effectively execute their strategy are likely to see profit growth.
Considering the above, I would suggest that if you have held this fund for a while, you may want to consider taking some profits, taking some money off the table. I expect higher levels of volatility as we enter the fall, but over the long term, I expect this fund to deliver index like returns, with higher levels of volatility.
Trimark Global Endeavour Fund (AIM 1593 – Front End Units, AIM 1591 – Low Load Units) – In a quarter that saw the overwhelming majority of funds on the Recommended List finish in negative territory, this concentrated, value focused all-cap offering posted a very respectable 2.4% gain; the best of the bunch. In comparison, the MSCI World Index lost 1.2% during the same period.
This divergence in performance highlights just how different this portfolio is from the broader markets. It has approximately 30 names, with the top ten making up just under half the fund. In a portfolio this concentrated, a good quarter by a couple of stocks can really boost returns. In the second quarter, it was DCC PLC and Lewis Group that were the key contributors to the outperformance. DCC was higher on news of an acquisition that is expected to be accretive to earnings, while Lewis rose on better than expected results.
They sold one name during the quarter, deploying some of the proceeds into other Latin American names on weakness, with the balance being held in cash. At the end of the quarter, cash sat at approximately 16%, up from 13% in March. A high cash balance can be a buffer in a market selloff, but can act as a drag in a market rally. However, given the concentrated nature of this portfolio, it is less of a concern.
Managers are still concerned about valuation levels, noting in a recent commentary they continue to find it rather challenging to find undervalued investments. They continue to find some interesting opportunities in the emerging markets. Still, given the discipline of their process, I would not be surprised to see the cash weighting increase in the coming quarters as names reach full valuation and they are sold out of the portfolio. The managers are likely to use any period of market weakness as an opportunity to pick up new quality names at attractive prices, or add to existing positions.
This remains a great mid-cap focused fund and can be a great diversifier in an otherwise balanced portfolio. Given the concentration in the portfolio, I would be reluctant to use it as a core holding. If you have held it for some time, I would suggest you take some profits.