Q2 Review

The global markets continued to face numerous headwinds as they entered the second quarter, facing the looming threat of a recession, rising interest rates, and stubbornly high inflation. However, as the quarter drew to a close, there was no confirmation of an impending recession, and central banks worldwide stayed committed to keeping rates higher for longer. Although inflation moderated slightly, it remains above the target range.

Despite facing these challenges, global equities experienced a strong rally. Within the United States, growth stocks, specifically those related to artificial intelligence, enjoyed significant support. Investors enthusiastically embraced this trend, resulting in a substantial contribution to the performance of the S&P 500 index. Nevertheless, market participants have recently expressed concerns about the concentration risk present in the US equity markets. The fact that only a small number of technology stocks accounted for the majority of positive returns has prompted this apprehension.

Closer to home, the Canadian markets exhibited modest gains, apart from the oil sector, which faced a modest decline over the quarter. Internationally, equity markets also ended in positive territory, and once again, technology stocks played a prominent role in generating significant returns compared to the broader market.

Forecasters remain cautious, highlighting various leading economic indicators calling for a recession despite the strong labor market. Central banks continued to battle inflation through higher interest rates, with the Bank of Canada raising rates by an additional twenty-five basis points in June. These rising rates have started to impact companies as they manage increased debt servicing costs and higher capital expenses. Surprisingly, despite many companies reporting negative earnings over the quarter, stock prices continued to climb.

Strategic Income

The Kinsted Strategic Income pool concluded the quarter with a positive return of 0.3%. While the absolute return for the quarter fell short of our expectations, it is important to consider the pool's impressive twelve-month return of 7.3%, which more than doubled that of the Canadian Bond Universe.

Over the past three years, the Pool has consistently achieved an annual average return of nearly 7%. This track record instills confidence in our belief that this performance trend will persist in the long term, with the potential for further growth.

The pool's most significant exposure, a US residential credit fund, is anticipated to exceed its target return in the high-teens region. Although the timing of its performance statements did not impact the pool's performance during the quarter, we expect it to contribute positively to overall performance for the remainder of the year.

Looking ahead, we remain highly constructive regarding the long-term prospects for private credit and alternative credit. During the quarter, we committed to two longer-term Limited Partnerships “LPs.” The first partnership involves an Alternative Credit strategy through Ares, one of the largest alternative investment managers globally. The strategy focuses on investments in large, diversified portfolios of assets generating contractual cash flows renowned for their historically stable performance. The second commitment was made to a digital infrastructure credit fund managed by Digital Bridge, a prominent leader specializing in digital infrastructure management on a global scale. Furthermore, we are actively deploying a substantial amount of capital into several other private credit funds. We anticipate that these strategic investments will significantly enhance future returns.

Real Assets

The Kinsted Real Asset pool delivered a return of 1.5% during the second quarter of the year. While the pool’s overall performance was affected by short-term challenges in the agriculture sector, the expectation is that this asset class will provide solid, low-volatility returns over the long term. Specific contributing factors included adverse weather conditions, which impacted timberland harvesting in the North-West of the US, ongoing trade tensions, and global economic weakness. Despite these challenges, we maintain a positive outlook for the sector, with anticipated growth in production and exports.

In contrast, all our real estate holdings posted positive returns during the quarter, demonstrating resilience in the face of real estate market concerns. Despite headlines about rising interest rates, declining GDP, declining deal flows, and fears of corrections in the housing market; sectors such as industrial, multi-residential, and single-family homes are expected to remain robust.

Private infrastructure investments continue to deliver solid returns with minimal quarter-to-quarter volatility. However, one of our funds experienced a slight drawdown during the quarter due to a publicly traded holding that saw heavy selling pressure. Nevertheless, we expect private infrastructure to generate strong returns in the coming years as our managers strategically sell some of their assets, a common practice in “LPs.” Many of our managers hold their assets at a discount relative to their perceived value, and once these assets are sold, we anticipate incremental gains in the Pool.

Moving forward, we remain focused on identifying opportunities within private infrastructure and US single-family housing strategies, seeking to capitalize on their potential for attractive returns.

Strategic Growth

The Kinsted Strategic Growth pool achieved a positive return of 1.2% for the second quarter of 2023, although it underperformed an all-equity index. While the all-equity index may not be the perfect benchmark for evaluating the pool's performance, we recognize that public equities are one of the primary growth assets available in the public markets, making it a relevant comparison. However, it is important to note that all the assets within the Strategic Growth pool have significantly higher return expectations than public equity markets over the long term, coupled with lower volatility.

During the quarter, our private equity exposure delivered relatively flat performance, as some managers performed well while others lagged. Other areas of the portfolio, such as opportunistic credit, collateralized loan obligations (CLOs), and legal opportunities, either remained flat or had yet to report their returns by the end of the quarter.

As highlighted in our previous commentary, our optimism regarding the long-term return expectations for the Strategic Growth pool remains steadfast. This is primarily due to the pool's exposure to strategies that have historically demonstrated substantial return potential, such as private equity and distressed credit. These strategies continue to offer significant opportunities in the current market environment. We firmly believe that the Strategic Growth pool is strategically positioned to capitalize on these opportunities and generate favorable long-term returns.

Canadian Equity

The Kinsted Canadian Equity Pool delivered a solid return of 1.5% during the quarter, in line with its index. This consistent performance is a testament to the pool's investment strategy and commitment to adhering to a proven investment process.

The pool’s ability to deliver relatively stable returns shows that investment decisions are well-managed and less susceptible to drastic market fluctuations. The pool has built a history of reliability and dependability by effectively navigating market conditions. We believe this aspect of the pool will be particularly appealing in anticipation of a potentially challenging economic environment.

Global Equity

Despite underperforming its benchmark, the fund displayed resilience and delivered a positive return of 0.9% during the quarter, contributing to a respectable 10% gain over the past 12 months. While the fund may not have matched its benchmark's performance, it has prioritized risk management as it seeks to safeguard investors' assets in an uncertain market environment that we expect to see. The emphasis on conservative investments demonstrates the pool's commitment to capital preservation and its cautious stance toward the potential fluctuations in the equity markets. By adopting this defensive approach, the fund aims to provide stability and peace of mind to its investors during times of heightened volatility.

To learn more about Kinsted's perspective and positioning for Q3, click here.