Investment Commentary Q1 2023
For those who enjoy drama, the first quarter of 2023 certainly didn’t disappoint. Just when we thought we had seen it all over the last few years with a once-in-a-century global pandemic, the Russian invasion of Ukraine and inflation rates not seen since the early 1980s, we also witnessed a banking crisis in early March.
Silicon Valley Bank (SVB) was the second largest bank failure in US history and the largest since the 2007-2008 financial crisis. Two other US banks, both with significant exposure to cryptocurrency, also failed as fears of a wider banking crisis took hold. Thankfully regulators responded swiftly with several measures including guaranteeing the customer deposits of these failed banks beyond the normal $250,000 federal deposit insurance level.
The failure of these institutions was primarily triggered by a classic “run on the bank”, a situation which occurs when an unusually large number of depositors simultaneously attempt to withdraw funds, often in a panic. SVB’s problems were precipitated by rising interest rate levels which led its depositors to move money out of the bank into more attractive, higher interest-paying investments available elsewhere. This in turn forced SVB to sell some of its fixed income holdings to fund withdrawals. Because these investments were made when interest rates were lower, they were liquidated at a loss which led the bank to announce it was raising additional share capital to strengthen its financial position. This further spooked markets and many prominent investors began recommending companies pull their funds from the bank, further worsening the situation. While SVB’s risk management practices and decision to invest in low interest rate long term bonds are rightly being questioned, the situation was clearly exacerbated by SVB’s business being primarily concentrated in the venture capital and technology sectors, which have gone through a rough period after a decade-long boom.
Notwithstanding these issues in the US banking sector, equity markets surprisingly staged a modest recovery in the first quarter, amidst falling inflation and an emerging consensus that Canadian and US central banks may be nearing the end of their rate hike cycles. While fears of a recession and a so-called “hard landing” remain, the economy continues to be remarkably resilient in many respects.
Many of the big publicly traded technology stocks that were the largest losers in 2022 have led the stock market recovery so far in 2023. For example, Apple, Meta (Facebook) and Microsoft were up 27%, 76% and 20%, respectively in Q1 2023, outpacing the broader US market by a wide margin. The reverse was true for value-oriented U.S. stocks which generally led the market in 2022, but actually lost about 1% in Q1 2023. And of course, US banks also sold off in the quarter due to the SVB debacle, ending the quarter down 22% (whereas Canadian banks managed to gain almost 2% in the quarter despite the banking turmoil).
Bonds are also up slightly in 2023 after having one of their worst years in recent history in 2022. The main driver of the positive performance was a decline in bond yields coupled with a modest tightening in corporate bond spreads. As we mentioned in our last quarterly report, the overall attractiveness of the fixed income market has improved markedly over the last year as bonds are now offering much higher returns relative to past years. The only unknown going forward is the extent to which central banks are finished raising interest rates in their effort to tame inflation which has gradually decreased from last year’s highs.
Bridgeport’s three equity funds all had a strong first quarter, increasing approximately 5% across the board. Outperformers in Bridgeport US Equity Fund in Q1 2023 included Meta Platforms (share price was up +76% in the quarter), Microsoft (+20%) and Walt Disney (+15%), while underperformers included Johnson & Johnson (-12%), United Health Group (-11%) and Blackrock (-5%). One new addition to the US Equity Fund was L3Harris Technologies, an aerospace and defense company that provides mission critical solutions to government and commercial customers worldwide. The company was added to the portfolio as the intermediate outlook for defense companies remains strong and we believe L3Harris has the best growth outlook of the large defense contractors.
In Bridgeport Canadian Equity Fund, we added to or subtracted from a number of our holdings during the quarter to take advantage of market conditions. Positive performers in the fund in Q1 2023 were Constellation Software (+23%), Granite REIT (+22%) and Brookfield Asset Management (+15%). Allied REIT (-4%) and Element Fleet Management (-3%) were detractors in the quarter. One new holding added to the portfolio at the end of Q1 was Suncor, an integrated energy company operating in Alberta’s oil sands. The company is trading at an attractive valuation and we believe the newly appointed CEO will be able to refocus the company and continue to generate significant free cash for many years to come.
The first quarter was an active one for Bridgeport Small & Mid Cap Equity Fund. Winners in the portfolio included ATS (+34%), Watsco (+29%) and NVR (+21%), while Trisura Group (-27%), Chesswood Group (-20%) and Cogeco Communications (-13%) were the major decliners. New additions to the portfolio in Q1 2023 were Auto Canada (a leading North American auto retailer of both new and used cars), Evertz Technologies (the largest manufacturer of broadcast production equipment), Topaz Energy (a focused royalty and energy infrastructure company in western Canada) and Lumine Group (a recent spin-out of Constellation Software focused on software for communication and media companies).
Bridgeport High Income Fund was up approximately 2% in the quarter. The portfolio remains well diversified across different types of income-generating securities issued by a wide range of companies and benefits from yields in the 7%+ range. Bridgeport’s three private asset funds that are focused on private credit, private equity, and real estate and infrastructure all had relatively quiet quarters and generated flattish to modestly positive performance over the quarter. Some investments in these funds posted gains over the last few months whereas others recorded modest valuation markdowns to reflect changing market conditions.
On the whole, we are of the view that it will be particularly important to take a balanced approach to investing in 2023 as the environment is fast moving and there are certainly several known economic and geopolitical risks. If there is something to be learned from events of the past few years including the recent SVB crisis, it’s that sometimes the biggest risks are unknown and therefore nearly impossible to anticipate. To mitigate the impact of such surprises, diversification across asset classes and proper balance among investments is paramount.
We wish you all the best as we head into spring. As always, please feel free to reach out with any questions.