What Happened in Q1?
Q1 2023 marked a solid start to the year for both the global private and public markets, with markets showing resiliency through several significant headwinds, including the continuation of an aggressive interest rate hiking cycle, elevated inflation, geopolitical conflicts, and a potential banking crisis.
Global equity markets rallied on surprisingly strong corporate earnings and a resilient consumer, with major indices such as the S&P500 and MSCI ACWI rising 7.4% and 7.7% in Canadian dollars. Private markets also saw strong capital inflows, with investment managers finding attractive investment opportunities amidst the challenging economic and interest rate environment.
The aggressive monetary policy most major central banks implemented in 2022 has begun to impact the economy, with consumer lending and housing slowing over the quarter. Contrary to the US federal reserve’s view that inflation would be “transitory,” global inflation rates continue to hover well above 5% for many developed countries. Some, like the UK, are clocking in at over 10% YoY. After unexpectedly good economic results, Fed Chair Jerome Powell noted that “the ultimate level of interest rates is likely to be higher than previously anticipated.” The FOMC expects the central bank rate to peak at 5.1% sometime this year. This is consistent with Kinsted’s belief that economic markets are entering into a “normalized” interest rate environment compared to the near-zero rate environment we have seen over the past 15 years. In contrast, the market is expecting rate declines toward the end of 2023 which is part of the reason for the strong public equity showing.
There were no shortages of financial headline news during Q1, most notably the collapse and corresponding bailout of Silicon Valley Bank (SVB). The bank failure rippled through American regional banks, including First Republic Bank (down 88% YTD) and Western Alliance Bank (down 40% YTD), to name a few. The government stepped in to ensure depositors were safe, but bank investors were not granted the same courtesy. The crisis was not limited to American banks. Deutsche Bank’s shares were down over 19% in the month of March, and Credit Suisse needed to be bought out by UBS to restore investor confidence in the global banking system.
As stated in our Q4 2022 outlook, we continue to believe there is more downside for global equities over the next year. Kinsted’s investment platform remains invested in both public and private assets, with heavier exposure to private assets. Private asset classes such as credit and infrastructure continued to perform well throughout the recent economic and market turbulence. We expect both asset classes to continue performing well even in a rising rate environment. These are a few examples of the types of asset classes Kinsted believes should be in every client’s portfolio. We have built our platform to provide more diversification and less volatility in most market environments.
The Kinsted Strategic Income pool had a respectable performance for the quarter, with a return of 1.7%. The Canadian Bond Universe had a 3.1% return for a fixed income comparison. It is important to note that the pool has relatively little interest rate exposure compared to traditional fixed-income securities, which means it may lag when interest rates decline but should maintain its value if interest rates increase. Nonetheless, traditional bonds have experienced significant volatility over the past year, with a total return of -2% as markets try to decipher the direction of inflation and the subsequent action of global central banks.
Our largest holding is a US residential credit fund. We believe it is on track to exceed its 15% targeted return over the mid-term. The strategy was launched in 2020 to take advantage of the dislocation in US residential mortgages. We feel fortunate that Kinsted’s clients are the only private clients in Canada to have exposure to this strategy.
During the quarter, we increased exposure to private credit and music royalties which should improve the pool’s overall yield. As the pool continues to navigate the evolving interest rate environment, we believe that further exposure to private credit will continue to benefit the portfolio’s overall performance.
The Kinsted Real Asset pool returned 2.3% for the quarter. The pool's exposure to private infrastructure has continued to deliver incremental returns, with two private infrastructure holdings delivering returns of more than 4% during the quarter. The real estate holdings have also done well, with the European private real estate fund producing a return of roughly 10% in its most recent quarter. It is worth noting that while many are concerned about real estate in the current economic climate, there are still sectors within private real estate that offer compelling opportunities, such as multi-residential, industrial, and self-storage.
The pool's returns from global agriculture have been less than expected over the past 12 months due to the strong U.S. dollar. However, we believe the U.S. dollar will gradually depreciate over the next several years, which will be a net positive for the pool's agriculture holdings. Furthermore, one of the domestic agriculture holdings, which focuses on three types of permanent crops, had a significant bump in valuation recently, demonstrating the potential for growth in this sector.
The Kinsted Strategic Growth pool delivered a positive return of 1.3% for Q1 2023. While this return did not keep pace with public equities, it was achieved with very little volatility, providing investors with a degree of stability that can be hard to find in the public markets. The pool's ability to generate positive returns with very little volatility is a testament to its diversification amongst different strategies, such as private equity, venture capital, distressed debt, and collateralized loan obligations (CLOs).
The returns for private equity and venture capital in the pool were mixed, with some holdings delivering solid returns in the 5-7% range while others were flat to slightly negative. It is not unusual to see such fluctuations in private equity and venture capital investments, and it is essential to have a long-term view when investing in such assets.
Distressed debt, on the other hand, was relatively flat during the quarter. However, given how we see things unfolding over the next several years, we believe there will be significant opportunities in distressed debt that should provide strong returns in the future.
The pool made an initial investment in a legal opportunities fund during the quarter. Returns for these investments will come from large legal settlements, so returns will likely be uncorrelated with the public markets.
Private equity has historically outperformed public equities over the long term, with funds launched during market turmoil providing some of the best relative returns. While investors tend to exhibit extreme caution during market volatility, it is during these periods that investors should look to add to areas such as private equity. These environments allow managers to buy assets at significant discounts to fair value, which can create significant returns over the long term.
The Kinsted Canadian Equity Pool posted a return of 6.7% in the quarter. The pool has provided consistent and stable returns based on investing in businesses with revenue and profit growth, well-established business models, good management teams, quality of earnings, and a dividend yield greater than 2%.
The Global Equity pool returned 4.6% during the quarter. Inflation and central bank policy continued to be the main drivers of volatility during the quarter. Still, we expect corporate fundamentals such as earnings to negatively influence the direction of public equity markets going forward. Consequently, we reduced our clients' exposure to public equities during the quarter as we anticipate further market softness over the balance of the year. Within the pool, we raised cash while allocating a portion of the pool’s exposure to defensive sectors such as utilities, consumer staples, and health care.
Want to know Kinsted's position and view for Q2 2023? Click here.