Investment Commentary Q3 2022

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“The stock market is a device for transferring money from the impatient to the patient.” 

– Warren Buffett

Warren Buffett’s wise words on the virtue of patience ring especially true so far this year as both stock and bond markets continue to test investors’ fortitude.  The third quarter was another roller coaster ride as most major stock market indices rose in July before declining again in August and September to end in the red for the three-month period.

On a year-to-date basis through September 30, 2022, the S&P500, Nasdaq, Russell 2000 and TSX Composite declined -24%, -32%, -25% and -11%, respectively.   Bonds haven’t fared much better this year – the Bloomberg US and Canadian Corporate Bond indices are down -19% and -11%, while the lower credit quality Bloomberg US High Yield index lost -14%.  As recently noted by Bank of America, annualized current year’s results for a typical 60% / 40% equity and bond portfolio have generated the worst rate of return in the past 100 years.

Inflation remains the number one issue affecting investment results.  Central banks truly have only one lever to pull to curb inflation which is raising interest rates.  And they have done so at an unprecedented rate.  The Bank of Canada has increased its benchmark rate this year five times with the most recent increase moving the rate to 3.25%.  Forecasters believe that this rate could increase another 1% before the end of 2022.

Although monetary tightening has done little to dampen inflation numbers thus far, many commentators have rightly pointed out that the nature of the inflation rate calculation is such that it can be slow to decline in the face of real-world price decreases.  Anecdotally, there is some evidence that inventories are building across certain parts of the economy and the world could soon be awash in too much supply relative to consumer demand – potentially a complete reversal from the situation during the COVID period.  This phenomenon has been noted by a few of the private equity firms with whom we work who are advising that in many cases they are already seeing lower demand relative to supply for certain products manufactured by their portfolio companies.

Stock markets are likely to rally at the first sign that monetary policy is working to counteract inflation.  Just as we saw the S&P 500 decline about 13% in the back half of September when US monthly inflation came in at +0.1% higher than the prior month versus an expectation of -0.1%, the opposite market reaction may occur with even a slight inflation decrease. 

Getting back to the Buffet quote above, these are clearly times that will reward those with patience.  While predicting the direction of the market in the short term is impossible, the historic odds of positive returns after a period of significant stock market decline are extremely favourable.  Of the eight periods since 1960 when the S&P500 declined by 25% or more, the index was higher one year later in seven of those instances and the average one-year return was over 21%.  In the three and five years after a 25% or more index decline, the S&P500 was up a cumulative +37% and +83%, respectively, in all eight of the past occurrences.

We believe our portfolios are well positioned to take advantage of the inevitable rebound in the stock market whenever it may occur.  Bridgeport’s three Equity Funds and our High Income Fund have all outperformed the indexes on a year-to-date basis,  despite generating negative returns.  Our outperformance versus broader markets is a result of our focus on above average quality companies run by proven management teams with business models that are able to withstand challenging economic conditions.  

For example, in the Bridgeport Canadian Equity Fund, two of our largest positions are Brookfield Asset Management and Intact Financial.  Both of these companies are global businesses with excellent growth prospects and strong management teams. Similarly, Bridgeport’s US Equity Fund owns shares in Walt Disney and Google, two companies with substantial economic moats and irreplaceable assets that now appear to be substantially undervalued.  In our Small & Mid Cap Equity Fund, we have invested in companies such as Park Lawn Corporation (cemeteries and funeral homes) and Parkland (fuel supply and marketing) which are both market leaders in their respective industries and have benefited from consistent demand through various economic cycles. 

Bridgeport’s High Income Fund invests in North American, higher interest-paying, corporate bonds, loans, preferred shares and dividend paying equities.  Higher interest rates translate into lower bond prices so the fund is also having a rare down year, although it has performed much better than the broader fixed income markets which are down between approximately 10% to 20%.  It is important to note that, as far as we can currently discern, our fixed income investments in this fund have not suffered any permanent impairments in value – they have only experienced temporary pricing declines.   On the plus side, as a result of lower prices, most of our High Income Fund investments are now expected to distribute income on a yield-to-maturity basis of approximately 7% to 8%.  We have not seen yields in this range for similar investments since 2016, excluding a very brief spell during the early weeks of the pandemic.  We believe investors will be well-rewarded for their patience in the quarters ahead as a result of these elevated yields.

Our private asset-focused funds continue to perform well in the context of current markets.  Bridgeport’s Alternative Income Fund has produced a modestly positive return so far this year, despite holding some investments more vulnerable to public markets performance.  Bridgeport’s Private Equity Opportunities Fund is having a strong year and was recently nominated for a top private equity fund award. And our newest fund, Bridgeport’s Private Real Estate & Infrastructure Fund, is off to a good start as it builds its diversified real asset investment program.  Initial allocations include commitments to several well-known real estate and infrastructure funds which provide exposure to multi-and single family residential, medical, self-storage, digital and office real estate as well as energy, transportation and telecom infrastructure assets. 

Overall, we believe our ability to provide our clients with a diversified mix of publicly traded and private assets will continue to be an important factor in reducing overall portfolio volatility, ensuring we maximize returns going forward as markets eventually recover.

As always, please feel free to reach out with any questions.  We wish you all the best for the balance of the year!

Yours truly,

John Fisher