Investment Commentary Q4 2023
2023 was a positive year for investment performance across most asset classes as markets turned up sharply in November and December. North American publicly traded equities performed well after generating significant losses in 2022. Full year 2023 gross returns in local currency for the TSX Composite, S&P500, Russell 2000 (US Small & Mid Cap index) and BMO Nesbitt Burns (Canadian Small & Mid Cap index) were 11.8%, 26.3%, 16.9% and 1.6%, respectively.
Bonds also rebounded in 2023, recapturing some of their losses from the prior year. US and Canadian five-year government bond yields spiked in September and October before falling again to end the year about 0.2% below January levels. Overall, the Canada and US All-Bonds Indices rose 6.5% and 5.5% in 2023 with most of this return coming at the end of the year as bond yields declined.
The last two years continued to demonstrate the importance adhering to a plan, appropriately diversifying and thinking long term. The significant drop in stock and bond markets in 2022 undoubtedly led some investors to change course at the beginning of 2023 as the general economic consensus at that time was the economy was headed for a recession. This, in combination with elevated interest rate levels, was expected to lead to negative (or at least muted) stock market returns for the year. As we know, the opposite happened in 2023 and equity investors ended up more than recouping their losses from the prior year.
It is obviously much easier to stay the course and think long term in the middle of a downturn if your portfolio has been constructed to be less volatile than broad equity and fixed income markets. Human nature often comes into play when investors experience losses, causing them to liquidate holdings when prices drop to avoid the emotional pain associated with the possibility of additional declines. This behaviour is incredibly damaging to long-term portfolio returns as it goes without saying that selling at a low and buying at a high is never a winning strategy. One way to avoid this mistake is to attempt to reduce portfolio volatility so that the temptation to sell during difficult periods is less severe.
We strive to do our best to minimize portfolio losses at Bridgeport during periods of market turbulence in order to improve the probability of our clients achieving their long-term investment goals. The roller coaster ride that the stock market took investors on over the last two years provides an interesting comparison to the experience of a typical Bridgeport client portfolio in this regard.
For example, the S&P 500 earned a total cumulative return over the last two years of 3% in US$, experiencing an 18% loss in 2022 and a 26% gain in 2023. Over the same two years, a typical Bridgeport client portfolio, which might have consisted of a 50% allocation to our publicly traded equity strategies, 15% to our High Income Fund (primarily corporate bonds and similar income-oriented investments) and 35% to our three private asset funds, would have yielded a total gross cumulative return of over 7%, but more importantly the Bridgeport portfolio only declined 3% in 2022 before rebounding over 10% in 2023. The lower volatility for Bridgeport’s typical portfolio hopefully enabled investors to better focus on the long term and avoid the temptation to make ill-advised portfolio changes when markets were declining in 2022.
We strive to reduce client portfolio volatility in three ways: (i) by taking an institutional approach to asset allocation and diversifying widely across both publicly traded and private asset classes, (ii) by selecting high quality, cash flow generating investments within each asset class with a specific emphasis on downside protection during market corrections and (iii) by appropriately sizing each investment within our portfolios.
On this latter point, position sizing for each investment has become especially important in recent years as a handful of technology-oriented, growth stocks have come to dominate the S&P 500. In 2022, the top seven stocks representing 26% of the index lost 47% of their value on average. Many investors had significant exposure to these equities based on their strong performance in recent years, but were faced with a difficult decision at the start of 2023. Despite being attractively valued after their share prices declined, market sentiment suggested that these stocks would not perform well in 2023 in a higher interest rate environment. Given the size of these holdings in many portfolios, many felt compelled to sell down to manage risk. This turned out to be disastrous timing as this basket of stocks gained over 100% on average in 2023, demonstrating the importance of ensuring your investment sizing is appropriate irrespective of market indices and what the rest of the investing crowd is doing.
Moving on to Bridgeport’s portfolios, our three equity funds generated gross returns between 13% and 17% in 2023. The best performers in our US Equity Fund were large cap technology stocks including Meta (+158% total return), Alphabet/Google (+55%) and Microsoft (+54%). To our point above, our exposure to these stocks is material but was not so large heading into the start of the year that we felt compelled from a risk perspective to reduce holdings. Bottom performers in the US Equity Fund included Hershey (-4%) Johnson & Johnson (-1%) and Kenvue (-7%).
Bridgeport Canadian Equity Fund saw significant gains from its investments in Constellation Software (+56%), Colliers International (+35%) and Alimentation Couche-Tard (+27%). Negative results were attributable to Nutrien (-2%), Saputo (-12%) and Allied Property REIT (-27%).
Lumine Group (+98%), Watsco (+72%) and NVR (+48%) all contributed positively to Bridgeport Small & Mid Cap Equity Fund results, while Park Lawn (-19%), and Redishred (-22%) were the more significant detractors.
Bridgeport’s High Income Fund generated a gross return of approximately 8% for 2023. Most of this return was earned in the last two months of the year as bond yields returned to levels comparable to where they started the year. Overall, this portfolio has an income yield of approximately 7% and could benefit from some additional capital appreciation in 2024 if central banks cut interest rates and bond yields compress.
Bridgeport’s three private asset funds focused on private equity, credit and real assets all generated positive returns in 2023, earning gross returns of approximately 6%, 5% and 1%, respectively. Consistent with prior year, performance of these funds has been relatively uncorrelated with our equity and fixed income returns, often yielding superior returns relative to stocks and/or bonds when public markets are in a downturn and sometimes lagging when those markets are hot.
Going forward into 2024, it will be important to monitor geopolitical events for their potential impact on portfolios including the wars in Israel/Gaza and Ukraine/Russia as well as the possibility for rising tensions between Taiwan and China.
On a more micro level, we see attractively valued opportunities in various areas of the equity markets, particularly within certain out-of-favour industries as well as across the small and mid- capitalization company landscape. We think it is likely that the large capitalization technology stocks that contributed so greatly to the stock market rally in 2023 will generate more muted returns in 2024. We also remain encouraged about fixed income given the current yields earned on our investments and the potential for additional appreciation in the event market yields decline. After generating more modest returns in 2023, private assets should also perform well as many of our underlying portfolios are maturing nicely and our manager partners are deploying capital into attractive opportunities.
We wish you and your families all the best in 2024. Please feel free to reach out if you have any questions.