The final quarter of 2023 began with low expectations as investor sentiment and consumer confidence continued to decline from the previous quarter. Both the public stock and bond markets ended October in a slump, setting the stage for a notable rebound to end the year. A strong labour market, softening inflation, and prospects of interest rate cuts led investor confidence to skyrocket, fueling one of the strongest public market rallies we've seen in recent years. In contrast, private markets did not keep up with the short-term rally in public markets. However, the notable volatility in public markets as well as divergent performance between public and private markets continues to highlight the importance of a diversified investment strategy for optimal portfolio management.
Major stock indices including the S&P500, the MSCI All-Country World Index and the S&P/TSX composite, all demonstrated impressive gains, ending the quarter up 8.9%, 8.4%, and 8.8%, respectively, in total Canadian dollar terms. Following a challenging environment in the first three quarters of the year, fixed income markets experienced significant gains, marked by an 8.3% increase in the Canadian bond market, resulting in a 6.6% return for the full year. This rally was primarily attributed to the growing expectation that the Bank of Canada would begin to reduce interest rates.
As we closed out 2023, the global economy has thus far managed to avoid the highly anticipated recession predicted for much of the prior year. Moreover, it appears that central bank policies have, thus far, been effective in lowering inflation rates through the implementation of restrictive monetary measures without derailing the economy.
The Strategic Income pool ended Q4 with a positive return of 0.9%, which contributed to a favorable 12-month return of 6.1%. Although the performance fell in-line with its long-term target, the annual return trailed behind that of the Canadian Bond market, which serves as its benchmark. The entirety of the Canadian Bond markets positive returns were experienced in the last three months of the year, highlighting the inherent volatility in what most investors perceive as the low-risk segment of their portfolios.
Most holdings within the pool showed strong performance throughout both the quarter and the year. The Market Place Lending strategy, which is a type of investment fund that operates in the online lending or peer-to-peer lending space, did experience a significant drawdown due to an adjustment in the valuation treatment of underlying holdings. This decline had a nearly 1% negative impact on the overall pool. Nevertheless, we continue to have an optimistic outlook on the strategy as we believe many of the headwinds such as rising interest rates will reverse in the coming year.
Over the course of the year, we tactically increased the pool's allocation to private credit because of the yields they provide. We continue to have significant confidence in music royalties as a core holding, expecting them to deliver consistent, high single-digit returns going forward. Near the end of the year, we received our first capital call for an alternative credit fund managed by Ares (a private asset firm which manages $378 billion dollars) that we had committed to earlier in the year. While still a relatively small holding, we expect it to make a positive contribution as its exposure increases.
In summary, we have a positive outlook for the Strategic Income pool in 2024 and expect a stable total return in the 5-7% range given the diversification efforts and new additions to the pool made in 2023.
Over the past quarter, the Kinsted Real Asset pool’s performance ended relatively flat, experiencing a modest increase of only 0.09%. The pool recorded a positive return of 4.6% in 2023, but fell short of its targeted 7%-9% annualized return over the long-term.
Global agriculture holdings delivered relatively weak numbers the past year predominately due to some commodity price volatility, input costs as well as macro-economic factors. However, our Saskatchewan-focused row crop exposure continues to outperform, delivering returns exceeding 12%.
The largest detractor to the pool over the past year was the Manulife Canadian Properties portfolio, which saw a decline of over 9%, resulting in approximately a 1.5% drag on the overall pool. This negative performance is not reflective of the underlying health of the assets but rather an adjustment to valuations due to the higher interest rate environment. Since inception of the fund in 2011, it has produced a total return in excess of 11% per annum, a testament to the quality of the fund’s holdings.
The private infrastructure holdings, which represent around 18% of the Real Asset pool, provided minimal incremental returns over the past quarter. However, some of our funds are currently in a stage where the managers are actively working to increase the value of their assets. We expect a portion of these assets to be sold within the next one to two years, a move that we anticipate will positively impact the overall performance of the investment pool.
Despite the challenges posed by the higher interest rate environment, we anticipate a positive shift as interest rates look to gradually decline, ultimately turning these challenges into tailwinds for the pool. Overall, while the short-term performance may not meet expectations, the strong-risk adjusted long-term performance is in line with the goal of the pool.
The Strategic Growth pool’s Q4 performance was relatively stagnant, showing a slight decline of -0.08%. However, in 2023, the pool provided a positive performance of 5.5%. That said, since inception, the pool has consistently outperformed expectations with an impressive, annualized return of 12.6%, north of the targeted 10%+ we expect it to achieve longer term. This return is particularly notable given the remarkably low annualized volatility of 6.2%, in stark contrast to ~17% annualized volatility that is seen in the public equity markets. In other words, the Strategic Growth pool has delivered significantly higher returns per unit of risk than public equities have since the inception of the pool.
The largest detractor to the portfolio's performance in the past quarter was the strength of the Canadian dollar. Over 80% of the pool’s holdings are denominated in USD, therefore a strengthening CAD negatively impacted these holdings. While we do hedge approximately 33% of the USD exposure, it was insufficient to counteract the close to 5% rally in the CAD from November 1st, resulting in an approximate 2.6% drag on the overall pool performance.
Aside from the currency impact, it's crucial to highlight that the broader private equity sector, constituting the majority of the pool, faced challenges in 2023. By the close of Q3, private equity returns were in the mid-single digit range, notably lagging behind their publicly traded counterparts. Nevertheless, when assessing returns over a 5-10 year period, private equity significantly outperformed the returns generated by the public markets.
We anticipate the harvesting of assets from several primary funds over the next 12-18 months, which could lead to strong positive gains. Additionally, many of our private equity secondary funds hold assets that may consider IPO opportunities in the foreseeable future.
Looking ahead, we have an optimistic outlook for several private asset classes versus their public equivalents in 2024. Anticipated factors such as a potential thawing in the IPO market, attractive opportunities within the distressed debt sector, and holdings within the pool that are uncorrelated to public markets such as legal opportunities, contribute to our positive outlook.
The Canadian Equity pool slightly lagged its benchmark in Q4, with a gain of 8.3% compared to the benchmark's 8.8%. However, over 2023, the pool outperformed the benchmark by registering a 12.5% increase compared to the benchmark's 12%. This was achieved while maintaining a lower annualized volatility than the benchmark.
The strategy of the pool focuses on high-quality Canadian companies with a track record of consistently growing dividends, while demonstrating long-term earnings visibility and predictability. The pool's long-term track record of strong relative performance highlights the commitment to a well-established investment approach.
While we continue to be concerned about a potential transition to a more challenging public equity environment, the pool's focus on high-quality companies should provide some downside protection in the face of potential market volatility. The pool’s commitment to stability and quality has historically defined its long-term approach and as mentioned, we would expect it to provide some comfort to investors should the markets present challenges in the upcoming year.
The Global Equity pool delivered a solid absolute return of 4.8% in the quarter; however, it trailed behind the MSCI All Country World Index, which surged by 8.4% during the same period. Over the calendar year, the pool posted an 8% gain, lagging behind the robust 19.5% return achieved by the MSCI ACWI.
The year was marked by a significant rally in a handful of large US technology companies, overshadowing the broader market dynamics that were primarily influenced by a handful of companies. At the start of the calendar year, we began to restructure the pool, aligning it more closely with our overall investment approach that emphasizes a focus on risk-adjusted returns.
Despite the initial anticipation of a challenging year for public equities due to various headwinds, the markets delivered one of the strongest yearly returns in decades. We maintain our belief that a bear market has merely been delayed, not averted. As such, we are holding a cash position to take advantage of an expected market decline at some point this year.
Throughout the second half of the year, we added three new mandates to the pool, and expect them to significantly enhance the risk/return profile of the pool longer term. Overall, we are highly optimistic about the long-term prospects of the pool, given its significant diversification in managers and style.
To learn about Kinsted's position and view for Q1 2024 and beyond, click here.