Tactical Income Fund

Tactical Income Fund Commentary

Portfolio Sub-Advisor: Aston Hill Investments Inc.

Fund Commentary - September 30, 2011

Equity markets around the globe are reacting to a potential European crisis coupled with softening economic data. Consumer confidence has weakened while commodity and energy prices have fallen to reflect a downtrend in new construction and industrial production. However, we do not believe that this is a replay of 2008.  Back then, global commerce collapsed by more than 10%. China's export led boom contracted by 27% in February of 2009. Although all eyes are fixated on Europe, we do not believe that Europe is a good leading indicator of global economic growth. During 1992-93 and 2002-03 when European growth contracted and stagnated respectively, the rest of the world's economies were in positive growth territory. However, the threats from the peripheral European nations are not to be ignored. Therefore, the longer this debt crisis plays out the more chance it has to be a real threat to global growth.

On a positive note, U.S. capital equipment and software spending continues to be strong and accounted for almost a third of the current recovery. U.S. consumer spending, although it has softened, remains in positive territory and will likely remain that way through 2012. China's property market continues to be robust even though the new government rules have removed most, if not all, the speculative activity. A buyer's down payment for a second home in China is 50%, while the down payment for a third home is 100%.  China's GDP growth for 2012 is still expected to be robust at positive 8.5%.

The decline in equities last quarter has been well advertised with the S&P/TSX Composite Index down 12%, and the S&P 500 Index down 13.9%. During the spring, we began taking down the equity weightings in the IA Clarington Tactical Income Fund. While equities comprised more than 50% of the Portfolio in the spring, we ended the third quarter at 33% stocks in the Tactical Income Fund. The bulk of the proceeds from those equity sales were put into high yield bonds, with high yield bonds now making up about 50% of the Portfolio. This has proven costly as high yield bonds lost 8.3% in the last quarter.

The Bank of America Merrill Lynch U.S. High Yield Index now yields 9.41% and has an option adjusted spread of 827 basis points over U.S. Treasury bonds.  At this level, high yield bonds are reflecting an almost double digit rate of default, whereas the actual default rate today is two percent. As stated previously, we do not believe that this is a replay of 2008 and with yields fast approaching 10%, we believe that this is a good time to own high yield bonds. Companies are generating good amounts of free cash and we think it remains a great time to invest in the high yield space. As such, we are planning to add to our weighting in high yield bonds and expect that this asset class will return more than 10% in the next twelve months.