Most experienced flyers have gone through their fair share of turbulence and through experience, have learned to place their emotional reaction to turbulence in check, replacing it with a more rational, informed response. Given the capital market volatility we've lived through since the beginning of the year, we're hoping that investors can also replace their emotional reaction to what is occurring with a more rational response. In the past, we've written about how knee-jerk reactions to market volatility can have a severe long-term impact on a portfolio. As long as one's asset mix is properly structured, we think the best way to approach market volatility is through a favorite song of ours by The Beatles:
We get it; it's easier said than done!
Inflation continued to be the main culprit during the quarter, leading to another $9 trillion being wiped from the global equity market. While Canadian bonds held their own during the quarter, the 20% plus losses incurred by global government bonds over the past year are similar to what was seen post World War I and II, as well as the great depression of 1931. Over the past 12 months, global stock and bond markets have shed over $46 trillion in combined market value.
While things unraveled in the second half of the quarter, there was a bit of optimism during the first half as global stocks rallied 10% between July and mid-August. Unfortunately, hotter than expected inflation numbers and the Fed's rate hike guidance quickly put an end to that optimism. Global equities subsequently plunged 15% from mid-August, ending the quarter down 6.1% in US dollar terms. The relative weakness of the Canadian dollar, vis-a-vis the USD, resulted in global equities being flat for the quarter in CAD.
The S&P 500 and the Nasdaq suffered their third straight quarterly loss. This is the longest losing streak for these indices since the Great Recession in 2008-09 and the Dow's longest in seven years. While the bear market in US equities is now over 275 days old and has so far experienced a peak-to-trough decline of over 25%, it's important to recognize that it is still relatively short and shallow compared with past drops. Since 1950, the average US bear market has lasted 391 days with an average peak-to-trough drop of just over 35%, according to Yardeni Research.
Apart from the stock markets, other events provided additional fuel for the dumpster fire. The British pound dropped to an all-time low versus the US dollar, prompting policy makers to step in to help stem the rise in government bond yields. The Bank of Japan also announced an unscheduled bond-purchase operation to cap upward pressure on yields.
It's amazing to think that just over two and a half years ago (pre-pandemic), it seemed the global economy would continue along its goldilocks path – where economies were neither too hot nor too cold, pulling markets along with it. Those days are certainly over for now. What happened? Bank of America analysts explain it quite succinctly: "peace, globalization, and easy money are being replaced by an inflationary era of war, nationalism, fiscal panic, quantitative tightening, high rates, high taxes."
While this preamble is very gloomy, please recognize that there has never been a market correction or recession not followed by a recovery. While we don't know when it will occur, based on history, it is just a matter of time when it will happen. This is why we need to stay focused on the appropriate asset mix for your individual time horizons, return objectives, and risk tolerance and not react to the gloom and doom scenario already priced into the current markets.
Over the past few years, Kinsted has materially reduced public equity allocations in our client's portfolios and eliminated bonds (for now). This has helped preserve capital and minimize downside risk, so you have more money at work when the markets eventually recover.
For conservative investors, GICs are finally looking like a decent place to invest their money. However, this goes against any type of long-term investment strategy in two fundamental ways:
Following a bear market, recoveries more than recoup their losses while also providing surplus gains. For example, if this is the market bottom, you could expect a 25-35%+ stock market recovery. This has occurred in every bear market – the further the market goes down, the more it recovers. All we need is patience and discipline, and if you have a well-thought-out plan (which you should at Kinsted) – let it be.
The Kinsted Global Equity pool outperformed the global equity benchmark by 1.8% during the quarter in CAD. The CAD weakness was the only reason global equities were up during the quarter. That said, we mentioned in last quarter's webinar that reducing growth exposure and adding to some value-oriented ETFs had certainly reduced the pool's volatility relative to the benchmark, and that continued in the third quarter. The pool continues to hold a large exposure to cash (13% at the end of September) which also contributed to lowering downside risk.
The Kinsted Strategic Income Pool finished the quarter up 3.1%, which compares favorably to the bond market, which closed down 0.4%. The 12 month return of 8.3% was well ahead of our expectations and significantly ahead of the Canadian Bond Universe which was down 12.2% in the same period.
Like the prior quarter, bank loans and high-yield bonds struggled due to widening credit spreads. That said, bank loans are becoming more attractive as the yield on the bank loan fund has increased from 3.8% at the end of 2021 to over 8% at the end of the quarter.
The floating rate nature of private credit means that they are not impacted in the same manner as publicly traded bonds. As rates rise, traditional bonds lose value, but floating-rate private credit yields rise with rising rates, without a corresponding decline in price. This was illustrated in the quarter as most of our private credit continues to perform well.
The pool's largest holding, the Pretium Residential Credit Fund, continued to perform as expected, posting a return of 7% YTD. Two of our mortgage funds increased their annual yields to 5.9% and 7.6%, which should add some incremental return going forward.
Of note, the Crescendo Music Royalty Trust yield is currently 7.1% and they recently acquired rights to some of Janis Joplin and Gordon Lightfoot's most popular music. We are excited about this asset class for several reasons: Growing market penetration; access to devices and changing demographics are leading the growth of music streaming worldwide; and correlations between music royalties and stock and bonds are negative, allowing for very effective diversification benefits.
The Kinsted Real Asset Pool finished the quarter up 1.2%, while the 12 month return was up 10.9%. Much of the return in the quarter came from three of the pool's holdings: The Land Trust was up 10.1%, the Real Estate Core Trust was up 4.1% and the Canadian Property Portfolio was up 2.1%.
The pool's exposure to Global agriculture was mostly down during the quarter (in USD), as many of the global holdings were down due to foreign currency losses. The cash yield on the Brookfield Supercore Investment Partners Fund is above expectations, with a trailing cash yield of close to 7% paid on a quarterly basis.
One new addition to the Real Asset Pool during the quarter was Henderson Park's acquisition of La Quinta, a 777-key five-star hacienda-style hotel in the Coachella Valley, California. The truly iconic asset originally opened in 1926 and was a hangout for movie stars during Hollywood's 'golden era.' Since the onset of COVID-19 and restrictions on international travel, there has been a rising demand for domestic leisure. La Quinta is positioned to exploit this domestic leisure theme due to its strategic location within driving distance of Los Angeles, San Diego, Phoenix, and Las Vegas. Henderson Park acquired the property at a discount to both replacement costs (~70%) and recent comparable transactions (~35%). We're excited about the long-term prospects of many of the pool's recent acquisitions.
The Strategic Growth Pool closed the quarter down 2.0%, which is not surprising given the correlation between private equity and public equity. While the pool was down for the quarter, several of the pool's holdings did exceptionally well in a very difficult market environment. SpaceX, one of the pool's larger exposures, was up 25% in the third quarter due to a capital raise in June which revalued the company up 25%.
We're very excited about the prospects for the pool over the coming years as our managers can acquire assets at very attractive valuations versus where they were trading six months ago. As one manager told us recently, the returns they expect on assets acquired in the next year or two will rival those from 2010-2011. Those assets performed exceptionally well over the ensuing years.