What Happened in Q3?

Date postedOct 13, 2021

We were approximately nine days away from closing the books on a relatively boring third quarter of 2021 when the market gods decided to play spoiler. While global equity markets generally finished positive for the three-month period, rising bond yields, which had remained range-bound for quite some time, decided to perk up in the last days of September. This led to the markets giving back some substantial gains. If you recall the first quarter of 2021, rising bond yields negatively impacted stocks, especially growth stocks.

While the sell-off in bonds was for a brief period of the quarter this time around, it certainly affected Kinsted's growth-oriented U.S. stocks in a similar fashion to the first quarter of the year.

One thing that we've been vocal about over the past two years is our negative view on traditional fixed income. Our view was, and remains, that given their low yields, bonds provide little income and limited downside protection in the event of stock market volatility. But by far, the biggest concern we currently have with bonds is their potential downside in the event of greater than anticipated inflation. While we are not suggesting that inflation will continue to gather steam, it's better to be prepared in the event it begins to impact monetary policy. As mentioned, we don't believe we are giving too much up from a risk and return perspective, given the limited downside protection bonds currently offer.

Our thinking comes down to the following, monetary and fiscal policy is still very accommodative for global economies. As a result, we would be hard-pressed to produce a scenario under which a recession could occur over the next 12-18 months; a scenario in which bonds tend to provide downside protection.

A more likely scenario is that rising inflation, coupled with central banks looking to normalize monetary policy, could lead to an equity market correction. In such a scenario, both stocks and bonds will sell-off, resulting in traditional balanced portfolios of stocks and bonds having nowhere to hide.

Many individuals believe there's little risk in holding bonds. While it's true that there's little absolute risk if one's holding period matches the maturity of their bond holdings, there is risk that their purchasing power erodes if inflation gradually moves higher. In fact, since the beginning of the year, the Canadian government bond index has been down over 4%. Could it get worse if inflation does start to pick up? Absolutely! But that is yet to be determined, so stay tuned!

The interesting thing about official inflation readings is that outside of used car inflation (as shown in Chart 1), core inflation is apparently below where it was pre-covid (The orange line in the chart represents the pre-pandemic trend line). Anecdotal evidence sends a different message, but we'll stick with the official measures of inflation for now.

In early August, we trimmed the Global equity pool's U.S. equity exposure by approximately 10%. The reduction was a tactical decision to decrease the pool's exposure to the more volatile technology sector. The cash raised was/is earmarked to increase client's exposure to both the Kinsted Real Asset and Strategic Growth Pools. During this time, we were given the opportunity to invest in a pre-IPO company within the crypto-currency space. This company should go public sometime this coming quarter. We are very excited about its long-term prospects.

During the quarter, we received several capital calls from our partners in both agriculture and infrastructure. One notable addition within the infrastructure component of the real asset pool was the acquisition of Tele Columbus AG, one of Germany's leading fiber network operators with a total footprint of more than three million homes connected.

The pool also gained exposure to a well-diversified portfolio of public-private partnerships (PPP), predominately in the U.K. These assets are expected to provide a very stable cash yield in the 7% range over the time horizon of our ownership. As mentioned in the past, it does take some time to build up exposure to private investments, given the capital call structure. That said, most of our investments are currently on track to meet their targeted net IRRs, in the 10% range.

Within agriculture, one of our partners acquired a diversified property in California consisting of over 3,700 acres of almonds, wine grapes, prunes, raisins, and open land. This property's total return target is around 8.8%.

The Kinsted Strategic Income pool received several capital calls during the quarter from its private debt partners, which we believe could significantly increase the potential return on the pool over the next several years.

The Kinsted Strategic Growth pool meaningfully increased its exposure to private equity/venture capital this quarter as the pool made its first investment in a venture capital fund-of-funds.


Kinsted Wealth