Investment Commentary Q3 2023
The increasing interest rate environment continued to be the central market theme in the third quarter. The US Federal Reserve and Bank of Canada each raised their rates by 0.25% in July, although bond yields in both countries increased by an even wider margin over the quarter as investors weighed the probability that interest rates would remain higher for longer.
Since July, five-year Canadian and US government bond yields have increased by over 0.50%, while ten-year yields rose approximately 1% in Canada and 0.75% in the US. Because an increase in bond yields results in a decrease in bond prices, the US and Canadian Aggregate bond indices returned -3.2% and -3.8% in Q3.
Higher interest rates are putting pressure on businesses, consumers and homeowners as borrowing costs have increased more than fourfold in some cases over the last 18 months. We are beginning to see the broader impact of this across the economy as spending moderates and the inflation rate gradually declines from its highs last year. The primary question remains whether the economy will achieve a hard or soft landing which is largely dependent on the ability of central bankers to appropriately calibrate monetary policy to reduce inflation without overshooting and causing a significant recession.
Our current view at Bridgeport is that we are nearing the end of the central bank interest rate hiking cycle and, as such, bond yields should begin to stabilize later this year or in early 2024. This should be good news for the bond market. As we have written in previous investor letters, we believe we are entering one of the most favourable markets for fixed income investors in over a decade as current income yields on short to medium term Canadian investment grade corporate bonds are now in the 5% to 6% range, while similar higher quality, high yield bonds yield between 6.5% and 7.5%. These returns are available to investors who are able to carefully screen the credit worthiness of the companies to which they lend and are patient enough to hold the bonds to maturity.
Rising bond yields and uncertainty around inflation also negatively impacted most equity markets in the quarter. The large cap-oriented S&P 500 and TSX Composite indices declined 3.3% and 2.2%, respectively. Small and mid cap stocks in the US fared worse as the Russell 2000 lost over 5%, while Canada’s BMO Nesbitt Small Cap index lost 1.4%.
Bridgeport’s US Equity Fund, Canadian Equity Fund and Small & Mid Cap Equity Fund all declined modestly in Q3. Despite the declines in the quarter, all three equity funds have generated positive gross returns on a year-to-date basis through September 30 with the US Equity Fund, Canadian Equity Fund and Small & Mid Cap Equity Fund up approximately 10%, 5% and 5%, respectively. All have exceeded the returns of their relevant benchmarks so far this year with the exception of the US Equity Fund, which is lagging the S&P 500 slightly as result of not having the same level of concentration in a handful of large cap technology-oriented companies as compared to the index.
We made few changes across our three stock funds over the last few months. In the US Equity Fund, we invested in Kenvue. The company was recently split off from Johnson & Johnson and owns a strong portfolio of well-known, industry-leading, consumer brands including Tylenol, Listerine and Neutrogena. We purchased the stock at a modest price-to- earnings multiple which we believe represents an attractive risk/return profile. At the same time, we exited our holding in General Motors as we became more negative on the outlook for the company.
The most significant change in the Canadian Equity Fund in the quarter was the sale of our investment in Onex. The company’s share price had increased to a level where we felt there were better investment opportunities elsewhere.
In Bridgeport Small & Mid Cap Equity Fund, we increased our position in Dentalcorp, the leading provider of dental services in the Canadian market. The company’s share price had declined to an attractive level and we believe the business will be able to continue growing at a reasonable pace through acquisitions. We also sold our Tricon shares as we believe the company’s value creating proposition will take longer to materialize than initially expected.
Bridgeport High Income Fund has gained over 2% year-to-date through September. The portfolio lost just under 0.50% in Q3 as result of higher benchmark government bond yields across the North American market. Recent activity in this fund includes purchasing a handful of short-dated investment grade-rated Canadian corporate bonds at attractive rates and topping up our bond position in Triton Continental.
Bridgeport Private Equity Opportunity, Alternative Income and Private Real Estate and Infrastructure Funds generated modestly positive returns in the third quarter, running counter to negative performance in traditional stock and bond markets. Bridgeport Private Equity Opportunities and Alternative Income Funds increased approximately 2% over the quarter due to income received and valuation increases from some of their private investment holdings. Bridgeport Private Real Estate and Infrastructure Fund was up approximately 1% in Q3 as we continue to scale its investment program and gain exposure to various real asset segments around the world. We are currently reviewing new opportunities in this fund with managers specializing in logistics, self-storage, manufactured housing and timberland, among others.
Finally, we are obviously monitoring geopolitical events more closely than ever given the horrifying terror attacks against Israel earlier this month and the ensuing war to eradicate Hamas. We pray the situation does not escalate into a wider regional or global conflict.
We wish you and your families peace, health and safety as we approach the end of the year. Please feel free to reach out if you have any questions.