This year proved to be a challenging one for investors as inflation, rising interest rates, and a looming recession led equity and bond markets to one of their worst annual declines on record. While the year’s final quarter provided some relief for market participants, the traditional 60/40 portfolio of stocks and bonds saw a decline of more than 11% over the calendar year, which has not been seen since the 1930s. Fortunately, Kinsted relies less on public equity and bond markets to generate returns for client portfolios.
During the quarter, the MSCI World Equity Index climbed 8.4%, while the TSX climbed 5.6%. Stock markets in Europe and Asia posted exceptionally strong results, up 17.8% and 10.5% (in CAD), respectively. The Canadian bond universe rallied in the first two months of the final quarter but faltered in December, sending the index down 11.8% for the year.
In response to persistent inflation, central banks continued to raise interest rates at its fastest pace on record, with the Federal Reserve’s target rate and range climbing to 4.25% - 4.50% and the Bank of Canada to 4.25%. Statements made by central bankers indicate that interest rate hikes will continue through 2023 until inflation is on a “sustained downward path,” according to Fed chair Jerome Powell. As of November, the year-over-year increase for the consumer price index (CPI) in Canada was 6.8% and 7.1% for the United States, which is still high but leveling off the last couple of months which has given the markets some hope.
Aside from interest rates and inflation, there were some newsworthy events that impacted markets.
• Covid-19 started to rear its ugly head again in China after the country abandoned its “zero-covid” policy near the end of the year. Unconfirmed reports from CNN estimated that 250 million people in China may have caught the virus in the first 20 days of December. The rapid increase in daily Covid-19 infections led some countries to impose restrictions on international travelers, thereby curtailing economic activity.
• FTX, a major crypto exchange, declared bankruptcy following fraud allegations and saw its valuation fall from $32 billion to $0 in less than a week. The exchange collapse gained international attention as major investors are expected to lose billions on the investment. The fraud rattled the already shaken crypto community as Bitcoin investors experienced a loss of roughly 70% in 2022. Kinsted had no exposure to FTX.
• The war in Ukraine continues to prolong supply chain issues. Also, energy prices initially spiked to USD$130/bbl, followed by declines to the low $70’s in the year’s second half.
As long-term investors, we must recognize and embrace the volatility of investing in the financial markets. Historically, the 3, 5, and 10-year forward returns following a significant market correction are overwhelmingly positive. While we anticipate short-term volatility in markets that may last months at a time, we do not dwell on it. Our efforts are focused on ensuring that you have the necessary exposure to a long-term asset mix suited to your risk tolerance, time horizon, and needs.
Kinsted’s long-held view is that volatility within the public markets will remain elevated over the long haul. To help provide some insulation to the vagaries of the public markets, Kinsted has materially reduced the exposure to public stocks and bonds in our client’s portfolios; and opted for a heavier exposure to private assets. By including such investments, our clients should experience less volatility than traditional stock and bond portfolios.
KINSTED STRATEGIC INCOME POOL
The Kinsted Strategic Income Pool finished the quarter up 2.0% versus 0.1% for the Canadian bond market. The calendar year performance was 8.5% which outperformed the market by just over 20%. The Canadian bond market’s twelve-month return of -11.8% was one of its worst returns in history. Historically, bonds have tended to provide diversification benefits within balanced portfolios, given that they’ve behaved inversely to stocks. Unfortunately for balanced investors in 2022, bonds did not provide that diversification benefit, as they performed in lock step with stocks. This was certainly not expected and not something one desires from the “low-risk” allocation of one’s portfolio.
While traditional bonds continued to display significant volatility, most of the Strategic Income Pool’s holdings exhibited very low volatility. This is mainly due to the Strategic Income Pool’s low exposure to interest rate risk. As interest rates rise, private credit, music royalties, infrastructure debt, etc., are not negatively impacted to the same degree as traditional fixed-income securities.
The Pool’s largest holding, the Pretium Residential Credit Fund, should add incremental value over the next few months. Pretium has stated that its portfolio will continue to support the annual distribution of 5%, while the total return is expected to be in the mid-to-high teens.
One of the pool’s holdings we would like to highlight is the Mesa West Real Estate Income Fund, which focuses on the commercial lending side. Its most recent performance came at a very strong net return of 11.4%. As traditional lenders such as banks and life insurance companies continue to curtail their lending activity, the pipeline for loan maturities in the US continues to grow. This supply/demand imbalance has strengthened long running tailwinds which Mesa West believes will benefit the Fund as they continue to entrench their position as a “bank alternative” to institutional owners in the US.
During the quarter, the pool eliminated its exposure to the Fiera Direct Lending Fund while trimming its exposure to bank loans and high-yield debt while adding to some short-term money-market funds that provide liquidity at reasonable yields.
The Strategic Income Pool, when combined with the Kinsted Real Asset Pool, is designed to provide consistently higher returns than the GIC alternative.
KINSTED REAL ASSET POOL
The Kinsted Real Asset Pool finished the quarter up 0.6% and 8.9% for the calendar year, comparing favourably to what the public equity and fixed income markets provided in the year.
There were certainly some positives, such as the Stafford Infrastructure Fund and the Henderson Park Real Estate Fund, each up over 3% during the quarter.
One holding we would like to highlight is the Brookfield Global Transition Fund (BGTF), which is Brookfield’s flagship vehicle for investing in and facilitating the global transition to a net-zero carbon economy. The fund was looking to raise $7 Billion, but the demand was so significant that they ended up raising close to $15 Billion. Apart from Brookfield investing $2 Billion of their own money, other anchor investors were Ontario Teachers’ Pension Plan and Temasek Holdings Limited (Temasek is a Singaporean state-holding company owned by the Government of Singapore). According to Mark Carney (former Governor of the Bank of Canada), achieving net zero will require a complete economic transition, creating the most incredible commercial opportunity of our time. We are thrilled that Kinsted can provide our client’s the exposure to an opportunity such as this alongside the large institutional investors previously mentioned.
One recent investment that BGTF participated in was California Bioenergy (“CalBio”). CalBio is a leading California-based developer, operator, and owner of renewable natural gas (“RNG”) assets. Given its deep strategic partnerships across feedstock and project development partners, they have a first-mover advantage. They believe that demand for agricultural RNG is expected to outpace the rest of the RNG market over the next decade as corporations, particularly in the transport sector, and utilities increasingly seek to decarbonize gas supply.
KINSTED STRATEGIC GROWTH POOL
The Kinsted Strategic Growth Pool finished the quarter down 1.2% and a calendar year performance of a positive 4.5% which compares favourably to what the public equity markets did over the past year. One standout was the Kline Hill Partners Fund IV which was allocated in June 2022. Kline Hill’s focus is on the smaller side of the Private Equity secondary market. Its recent quarter-over-quarter performance was more than 100%, which was phenomenal given the current environment.
One new addition we made to the pool over the past quarter was to a Collateralized Loan Obligation Fund (“CLO”). CLOs tend to be complex and thus can offer excellent investment returns. Historically, funds launched in and around market turbulence (such as the one we are currently experiencing) have done very well. This asset class targets a return rate in the mid-teens, with very strong cash distributions in the 8%-10% range. We believe this addition will further diversify the pool amongst other asset classes that are targeting returns superior to what one can expect from public equities over the long haul.
We couldn’t be more excited about the longer-term prospects for this pool, given the opportunities that will present themselves over the next few years within the private equity, venture capital, and distressed debt sectors.
KINSTED CANADIAN EQUITY POOL
The Kinsted Canadian Equity Pool posted a positive return of 4.2% in the quarter and was -3.9% for the year. This was outstanding on two fronts: (1) the TSX market was -6.2% for the year; (2) It outperformed while having minimal exposure to Oil & Gas, which was up a remarkable 38% for the year (after six years of a negative 80% return between 2014-2020). Kinsted’s Canadian equity mandate is to seek investments with consistent revenue and profit growth, well-established business models, good management teams, quality of earnings, a dividend yield greater than 2%, and the opportunity for dividend growth. As a result, we will typically be underweight cyclical companies as they generally do not fit this profile.
KINSTED GLOBAL EQUITY POOL
While the Kinsted Global Equity Pool posted a positive return of 2.5% in the fourth quarter, its higher exposure to growth stocks (mainly technology) was the main culprit of underperformance for the full year. During the quarter, the Pool further reduced its cash exposure while continuing to diversify away from growth-oriented equities.
Strategically, we have reduced global equities in all client portfolios over the last 2+ years, which helped mitigate some of the downside risks. Public equities are but one asset class within a well-diversified Kinsted portfolio. Our portfolio returns are not solely dependent on public equities and bonds.
Would you be interested in learning Kinsted's view on what's next for Q1 2023? Click here.