Canadian Balanced Fund

Canadian Balanced Fund Commentary

Portfolio Sub-Advisor: QV Investors Inc.

Fund Commentary - September 30, 2011

Concerns of another financial crisis caused yield spreads to widen between federal government bonds and all other issuers.  Yield spreads on the lowest quality investment grade bonds (BBB) rose approximately 0.5% to 2.3% as investors sought the liquidity and relative safety of federal bonds to preserve capital. 

To that end, we trimmed two corporate issues, Canadian Pacific Railway and Husky Energy Inc., at large premiums to their purchase price to preserve gains in this environment of rising credit risks.   Corporate bond spreads could widen further in the event of another wave of panic selling in the equity markets.  This will provide an opportunity to buy good quality corporate and provincial bonds at more attractive valuations. We capitalized on two such opportunities in the quarter with the introduction of two new bonds to the strategy.

We purchased a 10-year, new issue, Intact Financial bond, rated A, at a yield of 4.7%. At the time of the purchase, this new issue bond offered a 2.3% yield advantage to Canada bonds, and a yield advantage to other A-rated bonds.  We also purchased a new issue 5-year Canada Housing Trust bond, rated AAA, and fully guaranteed by the Government of Canada. The bond at purchase offered an income yield of 1.8%, representing a 0.4% yield premium to the underlying Canada bond, thus providing an opportunity to enhance yield without sacrificing credit quality.

We trimmed selected holdings in the quarter due to above average valuations, especially in defensive names. Signs of a slowing global economy and high valuation levels increase the risk in equities and support a higher cash position.

We reduced our weight in CGI Group-a global IT services provider. Following its acquisition of Stanley, CGI has sizeable revenue exposure to the U.S. Federal Government. With slow growth and a rising deficit in the United States, together with CGI's higher relative value compared to other businesses in the Portfolio, we saw it as a source of cash. CGI also lacks a dividend, which reduces the return potential in flat or weak markets.

With the cash raised, we redeployed a portion by initiating a position in Domtar Corporation (UFS). Domtar is the world's second largest manufacturer of uncoated freesheet paper, and a leading manufacturer of pulp. A recent decline in pulp prices provided an opportunity for us to enhance the Portfolio with a business that has pricing power, generates significant cash flow, and uses its cash to reduce debt while rewarding shareholders through dividends.

Of the 32 equities in the Portfolio, Bombardier is arguably the most sensitive to the business cycle.  Despite headwinds from slower expected productivity, Bombardier Inc. has been growing its order backlog and is gaining traction for its C-series aircraft.  Debt levels at the firm are high relative to other businesses held in the Portfolio, but operating margins are improving.  We continue to assess the Portfolio's exposure to cyclical businesses, but feel the attractive valuation, and 3.0% dividend yield supports our position in Bombardier.

We expect equities may fall further in value as the global economy contracts.  We also expect the Bank of Canada to keep interest rates low, at least into 2012.  The opportunity to enhance income and growth will come from buying good quality stocks at attractive valuations.  We will hold our fixed income exposure below 40% and gradually increase equities at the right opportunity.