Monthly Commentaries

“As long as poverty, injustice and gross inequality persist in our world,
none of us can truly rest.”
Nelson Mandela

This pandemic is a ‘pain in the you-know-what.’  It has disrupted our lives with all sorts of new protocols and practices, and taken some pre-existing trends, i.e. work from home, and hyper-accelerated them.

Unfortunately, one such accelerated trend is the growing divide between the haves and the have nots, with pandemic hardships disproportionately falling on lower-income and marginalized groups.

Even before the pandemic, 70% of Canadians were pessimistic about closing the gap between the rich and the poor (Pew Research 2019).  And in January, the IMF’s Managing Director referred to inequality as “one of the most complex and vexing challenges in the global economy.”

The expectation is for the situation to get worse.  In a recent survey of top economists, over 90% felt the pandemic will lead to greater inequality.  A view supported by historical evidence.

As per a recent IMF study, “if past pandemics are any guide, the toll on poorer and vulnerable segments of society will be several times worse” (2020, Ostry et al).  Their analysis showed how previous epidemics increased the income gap and damaged the job prospects for those with basic education, while scarcely affecting those with advanced degrees.

Thus far it appears COVID-19 is following this pattern.  On top of higher risk factors and less access to resources, lower-skilled workers and minorities have also faced the brunt of the recent spike in unemployment.

If we are to reverse the inequality trend, we need to address this massive loss of job opportunities.  Beyond a paycheque, work offers multiple benefits to the individual, their family, and the community.

This is why for so many, full employment, when anyone who wants to work can, is the ultimate goal.  How to achieve it, is the big question.  A question which may be getting a pandemic rethink, if the Fed’s virtual Jackson Hole meeting is any indication.

The Federal Reserve has a dual mandate, which includes maintaining low and stable inflation and creating conditions for full employment. For the last 40 years or so, the focus has been on inflation, and in particular inflation expectations.

For much of this millennium, they have managed monetary policy to keep inflation at 2%.  The few times it threatened to breach that level, the Fed responded by pre-emptively raising interest rates, and as a by-product increased unemployment.

The shift at their August meeting was to adopt a flexible average inflation targeting strategy.  This allows them to let inflation run above 2% to offset periods when it is below (i.e. the past decade).  Thus enabling them to focus on increasing broad-based employment and be more patient with rate hikes.

The Bank of Canada is also looking closely at how it manages monetary policy to achieve low and stable inflation (2%).  Their approach is described as ‘flexible inflation targeting,’ that in practice looks similar to the Fed’s average inflation methodology.  While we don’t expect the BoC to change its course of action until much further into the recovery, they could announce changes to their current philosophy.

We are encouraged to see this policy rethink, as it could be a powerful tool to combat inequality.  And as members of society, we are hopeful that along with other initiatives these shifts can help close the gap.  But as fixed-income nerds, our more immediate task (and value to the reader) is to evaluate their impact on the bond market and the macro-environment.

Our interpretation of the central bank messaging is that short-end rates should remain stuck where they are for quite some time.  North American central bankers are certainly not in any hurry to hike, and after studying the efficacy of negative rates in Europe and Japan, they are reluctant to go below zero.

The greater uncertainty lies around longer-maturity yields, where the central banks have less control.  If as the Fed indicated, they are willing to let inflation run hotter than 2% it makes sense for investors to want higher compensation to own longer-term debt.

So far, there has been little reaction in long-end rates as the central bank purchasing programs have skewed the market and depressed yields.  But should these programs taper or the economic recovery gathers steam, 10y rates at 0.55% might be unacceptably low.

Thus, we see the shift in policy leading to the potential for steeper interest rate curves: very low in the short-end with the upward pressure on the long-end.  This is good news for short-term borrowers, not so good news for savers, and as for long-bond investors, our advice is to mind the gap.

The Fund Performance.

August 2020.

As expected, August was quiet with very few new deals and reduced trading activity.  Credit spreads began the month grinding tighter before levelling off in the second half.  High-beta sectors, such as autos, REITs, and pipelines outperformed due to improving fundamentals (i.e. recovery in auto sales) and the reach for yield.

Generic Investment-Grade Credit Spreads
 

• Canadian spreads tightened 8 bps to finish at 131 bps
• US spreads tightened 4 bps to finish at 129 bps.

 
The US market slightly underperformed last month due to a larger amount of new supply, in an already record year.  North of the border, the Canadian market printed $5 bn, versus August norms of $6 -7 bn.
 

• Notable deals were the three Brookfield entities, Brookfield Properties, Brookfield Infrastructure, and Brookfield Renewables. Husky Energy, Bell Canada, SNC-Lavalin, MCAP, Canada Western Bank, and First Capital also accessed the market.

• It is interesting to note that in the early stages of the pandemic, most of these companies were unable to issue debt at reasonable levels. Last month they were able to come to market with no price concessions.  Despite this, the deals were so well received that even their secondary bonds rallied.

 
Canadian banks reported results last month, with surprisingly strong numbers driven by capital market activities.
 

• Results were boosted by fees from the massive amount of bond issuance this year, trading profits, and robust equity markets, coupled with low funding requirements.
• Another driver was low PCLs (provisions for credit losses). This indicates that bankers are optimistic that the improving economy translates into lower future loan losses.
• Despite the losses incurred thus far, reported capital levels are strengthening.
• Lastly, the banks continue to enjoy the support of regulatory, fiscal, and monetary stimulus measures.

 
The Fund benefitted from outperformance in individual credits and sectors, with the greatest contributions coming from banks, REITs, and pipelines.  Thus, despite a quiet month and limited trading opportunities, the Fund finished August with a strong return of 2%.

 
As of August 31^st, 2020

The Algonquin Debt Strategies Fund LP was launched on February 2, 2015. Returns are shown on ‘Series 1 X Founder’s Class’ since inception and for ‘Series 1 F Class’ since May 1st, 2016 and are based on NAVs in Canadian dollars as calculated by SGGG Fund Services Inc. net of all fees and expenses.  For periods greater than one year, returns are annualized.

Looking Ahead.

After a quiet summer, we anticipate market activity and volatility to pick up in the fall.
 

• The US election certainly has the potential to create some market indigestion. The rhetoric from the campaign trail, poll updates, delays in mail-in voting, and of course, the ultimate result, will add some volatility and trading opportunities.
• Narrower spreads and ultra-low rates translate into low all-in borrowing costs for issuers of all stripes. The combination of attractive funding levels, receptive investors, and a desire to avoid any US election silliness raises the odds of higher issuance activity in the coming weeks.
• Canadians await the throne speech later this month, which could drive the domestic political agenda for the remainder of the year. It should also provide clarity on the fiscal stimulus plans going forward.  The economic fallout from the government proposals could have implications on yields and credit spreads.
• With economies and schools continuing to re-open and the winter flu season upon us, the potential for a spike in COVID-19 cases could negatively affect the recovery.
• Vaccine developments, both positive and negative, will continue to have an outsized impact on the market, as we lurch from headline to headline.

 
In anticipation of the fall volatility, we have reduced exposure and rotated from a medium risk posture to low-medium.  From this position, we can purchase high-quality corporate bonds and add exposure on market weakness.

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“My new normal is to continually get used to new normals.”
Anonymous

The natural progression in economics is for an ‘unprecedented’ crisis to be followed by a ‘new normal’.  The old modes and models are discarded and replaced with ones that reflect the new post-crisis reality.

It should, therefore, come as no surprise that amidst a global pandemic that economists are rushing out with their versions of the new paradigm.  After all, the world is adapting to living with COVID-19 and several norms are being rewritten.  These changes are having and will continue to have a significant impact on the economy and financial markets.

While it is still early in this edition of the ‘new normal’, investors need to consider the changes thus far and their potential consequences, intended and unintended.

A natural and obvious starting point is the prequel or the old ‘new normal’.  Following the Great Financial Crisis of 2008, the term was popularized by Mohamed El-Erian to describe a macroeconomic environment of subpar growth, no inflation or deflation, and low-interest rates.  It was also a period characterized by accommodative monetary policy including Quantitative Easing and in some cases, negative rates.

In the current version of the ‘new normal’, we have seen an even greater amount of monetary stimulus thrown at the problem.  ‘Old skool’ Quantitative Easing has been replaced with Large Scale Asset Purchases.  While the operations appear similar, the pedantic difference is in their ultimate objectives.  The purpose of QE was to lower interest rates, while the current programs target market liquidity (and as a side effect also keep rates low).  Furthermore, the previous stimulus programs were restricted to purchasing government bonds whereas today they have expanded to include corporate debt.

On top of the overwhelming support from central banks, the new ‘new normal’ also includes ‘unprecedented’ fiscal stimulus from our governments.  In 2008 there was the moral hazard of bailing out greedy bankers, whereas today, with real businesses, jobs, and people suffering, the support borders on limitless.  This spending is being funded by printing money, as governments issue enormous amounts of debt, which in turn is bought by their central banks.

This test of Modern Monetary Theory has led to a spectrum of inflation forecasts from deflation to hyperinflation and everything in-between.  The dispersion in expectations rests on where one sees the balance between the tremendous supply of money and the impact of the pandemic on the real economy.  With the federal deficit going from a third of GDP to 100% and the government borrowing more long-term debt, there might be greater tolerance for inflation to run a little hotter than the old target of 2%.

Such inflationary pressures would mean even worse news for government bondholders.  As it is, owners of sovereign debt are earning next to nothing for the privilege, with yields having moved into a new, even lower range.  But unlike the previous ‘new normal’, this time around the central bankers are reluctant to take rates lower and into negative territory.  This leaves very little upside from further declines in rates and limited ability for bonds to hedge equity downturns.

And while interest rates are firmly anchored now, the risk factors that could see them rise in the new ‘new normal’ are different and more varied than post-2008.  Aside from the potential upward pressure from inflation, an exogenous factor such as an effective vaccine could see a return to the old ‘new normal’ world of 10y rates at 2%.  Should this occur, long-duration bond portfolios (i.e. 20y) would incur losses of 20-30%.

For now, these are all just possibilities.  There is still great uncertainty as to how the sequel to the ‘new normal’ will play out.  From what we’ve seen in the previews, it seems the themes will be unemployment, the recovery of the real economy, near-zero interest rates, and a heavy dose of government and central bank stimulus.

Of the undetermined plotlines, there is the path of growth and inflation, and the question of who is going to end up paying for all this unprecedented spending.  Historically, it has been the taxpayer picking up the tab, but if inflation reappears on the world stage or interest rates rise for other reasons, this ‘new normal’ could see the bondholders footing the pandemic bill.

The Fund Performance.

July 2020.

The recent trend of strong credit performance continued in July.  Markets shrugged off the growing virus case counts and risk assets propelled higher on the back of supportive central bank policies, extremely low-interest rates, and encouraging developments on the vaccine front.

Generic Investment-Grade Credit Spreads

• Canadian spreads tightened 21 bps to finish at 139 bps
• US spreads tightened 17 bps to finish at 133 bps.

The Canadian market saw a markedly slower pace of new issues in July, with under $5bn being printed.  The supply/demand imbalance along with declining dealer inventories meant the new deals were hugely oversubscribed.  As such, the deals not only performed well but repriced the issuers’ existing credit spreads tighter.

• Great-West Life came with a 30y deal that was met with such heavy demand that the deal was re-opened and the size doubled just a week after the initial offering. Both deals were very well received.

• Reliance LP tapped the market for $430 mm of 7-year bonds with a negative new issue concession (i.e. priced more expensively than existing debt). Despite the pricing, the deal was met with extraordinary demand and tightened 30 bps.

While these deals were notable, the most interesting transaction award goes to Royal Bank, for their issuance of AT1 regulatory capital via a novel domestic structure.  In the end, RBC brought $1.75bn of Limited Recourse Capital Notes (LRCNs) to market at a coupon of 4.5%.  The deal was very well received and rallied strongly in secondary trading.

• The new securities offer NVCC preferred share exposure in a bond structure and count as AT1 regulatory capital.

• The advantage for the bank is that bond coupons are paid pre-tax whereas pref dividends are distributed after tax.

• The advantage for the institutional investor is a more liquid market relative to preferred shares.

The issuance of these notes created a strong rally in certain preferred shares on expectations of reduced issuance of preferreds going forward.  Further limiting supply in this market is the increased likelihood that securities will be redeemed by the issuers on call dates and replaced with LRCNs (given the more favourable tax treatment).

The Fund continued to outperform the broader market rally through credit selection and active trading.  The sectors driving the outperformance in the month were pipelines, banks, insurance, and REITs.

As of July 31^st, 2020

The Algonquin Debt Strategies Fund LP was launched on February 2, 2015. Returns are shown on ‘Series 1 X Founder’s Class’ since inception and for ‘Series 1 F Class’ since May 1st, 2016 and are based on NAVs in Canadian dollars as calculated by SGGG Fund Services Inc. net of all fees and expenses.  For periods greater than one year, returns are annualized.

Looking Ahead.

Since the pandemic panic of March, the rally in risk assets has been driven by government and central bank intervention coupled with a more optimistic picture of the recovery.  Credit also has the added benefit of strong investor demand and the direct support of the central bank purchasing programs.

These tailwinds remain in place but must be weighed against potential risk factors in the months ahead.

• The strong technicals in credit markets continue, as robust investor demand is being met with limited supply. The domestic new issue market is expected to be reasonably quiet in August, which should allow for more performance in credit.

• The Bank of Canada Corporate Bond Purchasing program has experienced underwhelming take up, with only a fraction of the available liquidity being utilized thus far. This is not surprising, as dealers can readily sell to institutional investors and have no need to tap the BoC program.  This leaves the BoC with more firepower to deploy in weak markets, and as such, its mere presence is supportive of credit.

• The government stimulus programs reduce the risk of insolvencies for investment-grade companies.

On the other hand, certain headwinds keep us cautious and vigilant.

• With the market exceptionally receptive to new credit deals, more challenged companies will inevitably look to issue debt.

• Credit seasonality suggests that supply and activity pick up in the fall. But this is the new ‘new normal’, so perhaps previous patterns need not apply.

• Negative developments on the vaccine or virus front could complicate the re-opening of the economy and derail markets.

• The looming US election and political jockeying can add volatility, change sentiment, and delay necessary policy action.

• After Q2 earnings were much better than anticipated, the market expectations for Q3 could be overly optimistic, as we swing from overly bearish forecasts to overbullish.

• The fall and winter flu season and the potential for a second corona wave.

• Advanced economies are posting record unemployment and double-digit declines in GDP. In the battle of the ‘real economy vs. financial markets’, the lost jobs, lower business investment, and drop in consumer spending could manifest itself in higher risk premia.

In the short term, we continue to maintain a medium risk posture, as the demand for credit remains incredibly strong.  But given the balance of factors noted above and the strength of the recovery thus far, we are for more selective in our exposures and have been trimming positions that have outperformed.  In doing so, we have increased the dry powder available to capitalize on opportunities created by volatility and increased trading activity in the months ahead.

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“If history repeats itself, and the unexpected always happens,
how incapable must Man be of learning from experience”
George Bernard Shaw

We begin our commentary in the most unimaginative way possible, with a simple dictionary definition.

unprecedented
adjective
never having happened or existed in the past

This is not due to a lack of inspiration nor is it intended as a nostalgic nod to our grade school essays.  It is for clarification purposes.

Somewhere along the way, this simple word lost its meaning.  It started out as a gradual process.  Over the past few years steadily being diluted as it was used more and more.  But in these unusual times, the frequency of its use has hit, well, unprecedented levels.

Yet this is not the world’s first pandemic.  Nor is it the first economic crisis or the first-time businesses and entire industries have faced existential threats.

So other than the unprecedented use of unprecedented, what makes this period so unprecedented?

After all, pandemics and our responses to them are a part of our history.  Even the Black Plague was met with quarantines, restrictions on public life, economic shutdowns, compulsory hospitalizations, and isolation not only of the sick but of entire cities and regions.  All of this without even understanding the pathogen and its transmission.

But we need not reach so far back into history for perspective on our ‘unprecedentedness’.  The Spanish Flu named not for its origin but because the Spanish press was the first to report it, is estimated to have taken 40-50 million lives in 1918-19.  The events of this period might sound eerily familiar.

The initial response was to ignore and dismiss the threat.  But once the severity of the situation became undeniable, nonpharmaceutical interventions were introduced.  In addition to quarantine and isolation measures, schools, theatres, libraries, and dancehalls were closed, mass gatherings were banned, and facemasks made obligatory in many cities and regions (i.e. Alberta).  Even the 1919 Stanley Cup Final between the Montreal Canadians and Seattle Metropolitans was cancelled with only one game left in a tied series.

A study of these containment measures demonstrated that ‘early, sustained, and layered’ interventions had strong mitigating effects on the Spanish influenza (Markel et al, 2007).  It seems logical that the earlier and longer containment measures are in place the more effective they are at containing the pandemic.

Evaluating the economic impact these policies had is a trickier proposition, but Sergio Correia and Stephan Luck of the Federal Reserve, and Emil Verner of MIT took a stab.  Their findings indicated that these nonpharmaceutical interventions reduced ‘disease transmission without necessarily further depressing economic activity’ and even produced better medium-term outcomes.

But these are just the containment policies in of themselves, and of course, there was the direct economic damage of the pandemic’s effect on health and behaviour.  The limited data available shows US industrial production declined 25%, Canada suffered a 7% drop in GDP, and short-term sales were down between 30% and 70%

The difficulty here is parsing the impact of the influenza from the effects of the war.  But anecdotal evidence indicates businesses suffering from pandemic related labour shortages, supply chain breakdowns, and a lack of demand, except in the case of mattresses and pharmaceuticals.  Coincidentally, one such panacea drug that was unfoundedly prescribed and feverishly sought after was the quinine, the chemical grandfather of hydroxychloroquine.

We share these anecdotes not to draw any conclusions but to point out the risks of overusing ‘unprecedented’.  By ignoring the past and creating a greater sense of uncertainty, it can provide a convenient excuse to abdicate responsibility and avoid making difficult decisions.

People have faced similar challenges and have either overcome or succumbed.  Businesses and entire industries have had to fight for survival many times before and have either adapted or gone extinct. There are lessons to be learnt from these successes and failures.

In 2000, Blockbuster video famously rejected an offer to buy Netflix for $50mm.  We all know how that turned out.

Furthermore, by painting indiscriminately with the unprecedented brush, we also run the risk of missing the truly unprecedented.  The sudden and simultaneous shutdown of the global economy, the scale and speed of the monetary and fiscal response, the record levels of deficits government are taking on to fund this crisis.  These are unchartered unwaters and need to be given due consideration, as both the intended and unintended consequences could be incredibly significant.

As we adjust to the abrupt changes brought on by COVID19, it would be unwise to ignore history and the implications of the actual precedents being broken   And perhaps we should hope for some more of the truly unprecedented, such as avoiding multiple waves and developing a vaccine in record time.

The Fund Performance.

 
The Tale of Two Quarters.

          Investment-Grade Corporate Bond Spreads & Fund Performance.

While Q1 2020 was not unprecedented, the sell-off in Canadian credit did match the worst quarter of 2008.  The shock of the global shutdown combined with an extreme lack of market liquidity saw investment-grade credit spreads widen in a hurry.

Central banks and governments responded just as quickly.  Liquidity was injected back in the system and markets recalibrated the impact of COVID against these record amounts of stimulus.  Optimism also grew around the effectiveness of containment measures, medical progress, and our ability to recover from this crisis.

Credit markets were offered further direct support as the Federal Reserve and Bank of Canada initiated corporate bond purchasing programs.

At the end of March/beginning of April, the Fund moved from a more defensive position to a medium risk posture.  We also utilized the improved liquidity and tone to actively rotate positions.  The portfolio rotation revolved around two themes, moving from fragile to more resilient companies and from credits that have outperformed the rally to those offering more value.

June 2020.

The markets engaged in a tug-of-war between the increasing number of COVID cases in the world’s largest capital market and the record stimulus coming from central bankers and governments.  The latest round of this game favoured the authorities even with some states reclosing after having opened too early.

While the tug-of-war led to volatile equity markets, credit remained resilient and continued to rally in June.  Canadian investment-grade spreads modestly outperformed the US but remain wider on an absolute basis.

Generic Investment-Grade Credit Spreads
 

• Canadian spreads tightened 29 bps to finish at 160 bps
• US spreads tightened 24 bps to finish at 150 bps.

 
As noted in our previous commentary, domestic credit went into June with several supportive factors.
 

• June saw large numbers of bonds maturing and paying coupons, resulting in a robust inflow of cash into credit markets
• The record inflows into corporate debt funds in May added to the cash to be deployed into the market
• After the flood of deals in April and May, June experienced a lower than average supply of $7.5bn
• The Bank of Canada Corporate Bond Purchasing Program was initiated at the end of May and has provided domestic credit markets with increased confidence and stability

 
We continued to use the market recovery and liquidity to actively trade and make some portfolio adjustments.
 

• Took profits in issuers that outperformed and rotated to securities offering more attractive valuations
• Exit and reduced positions in more challenged issuers and replaced them with more resilient credits

 
On top of the generic market performance, the fund benefitted from exposures to outperforming issuers and added a little extra through active trading.
 

 
As of June 30^th, 2020

The Algonquin Debt Strategies Fund LP was launched on February 2, 2015. Returns are shown on ‘Series 1 X Founder’s Class’ since inception and for ‘Series 1 F Class’ since May 1st, 2016 and are based on NAVs in Canadian dollars as calculated by SGGG Fund Services Inc. net of all fees and expenses.  For periods greater than one year, returns are annualized.

Our Portfolio

Below is a summary of our portfolio as of June 30^th, 2020.
 

• Portfolio Yield: 7%
• 97% Investment-grade
• Average Term to Maturity: 2.3 years
• Net Credit Exposure: CR01 10 bps (medium)
• Net Credit Leverage (5y): 2.x
• Total Long Credit Exposure: 5x (not including hedges)

Looking Ahead.

It seems until there is a vaccine, we will need to learn to live with the virus.  As such, we expect several more rounds of tug-of-war, as markets determine where the balance lies between several competing factors.
 

• Governments (and society) will grapple the thorny problem of balancing public safety with economic well being. The gradual reopening of the economy will most certainly lead to a rise in cases (as we are seeing in other countries), so we should expect to see an ebb and flow in this tussle.
• With another global shutdown unlikely, markets need to assess the implications of some regions loosening restrictions while others tighten.
• The progress and breakthroughs made by medical science versus the setbacks to this process.
• The firehose of monetary and central bank stimulus against the disruption to the real economy.
• The power of fiscal stimulus against the growing number of bankruptcies. While government programs delayed the insolvency problem, more and more public companies are filing for bankruptcy, with private companies and individuals likely to follow suit.
• A significant decline in Q2 earnings versus a potential recovery in the latter half of the year.
• Deciphering the permanent losers, the temporary losers, and the winners, as consumer behaviour adjusts and businesses adapt.

 
Credit.

While credit has recovered with broader markets, Canadian investment-grade spreads are still significantly wider than earlier this year.  Generic 5y spreads are over 50% higher, while shorted dated BBBs are still 90% above February levels (with some sectors and issuers more).

Furthermore, with central bankers supporting the space and minimal new issue supply on the horizon, the expectation is for continued performance over the summer (barring negative macro developments).  And with such disperse circumstances for specific companies, we anticipate an even wider array of security selection opportunities ahead.

Given the balance of factors, we are maintaining a medium risk posture and continue to actively rotate positions.  This allows the fund to benefit from the gradual improvement in the global economy while leaving the flexibility to take advantage of trading opportunities as they arise.

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“Clowns to the left of me, jokers to the right,
here I am, stuck in the middle with you”
Stealers Wheel

The ‘middle’ can conjure up negative images and connotations: mediocrity, compromise, the dreaded middle seat. It is neither here nor there and lacks colour and tone, falling into the realm of boring, average, mundane grey. For minds designed to recognize contrasts and extremes, these neutral shades lack conviction and certainty.

As veterans of the credit markets, we are very familiar with the middle. Existing in a space somewhere between equities and fixed-income, credit is the often-overlooked middle child, lacking the glamour of stocks and the sterling reputation of government bonds.

Living in the shadows of your more popular siblings can be tough. But given the current backdrop and valuations, these days it ain’t so bad to be stuck in the middle with credit.

To understand why it’s a good time to be the middle child, we begin by looking at the predicament the other siblings find themselves in.

There is traditional fixed-income, the responsible, stable, boring eldest child: the provider of income and absorber of market shocks. Unfortunately, with government yields close to zero, there is very little income to be had, and for bonds to effectively hedge equity sell-offs, rates would need to go negative.

But the Federal Reserve and Bank of Canada have clearly stated that rates are at their ‘effective lower bound’, which in layman’s terms means ‘they ain’t going negative anytime soon.’

This doesn’t imply that central banks are absentee parents. If anything, they can be accused of being overbearing and spoiling the markets with an over-abundance of cash and support. So much so, this showering of love has led to the whispers of higher inflation, higher rates, and losses in fixed income. This does not bode well for the darling firstborn, the apple of the portfolio eye.

At the other end of the family is the young, exciting wild child, equities. Like a spoiled rich kid living a life of extravagance on their parents’ money, stocks have staged a tremendous rebound from the COVID scare, resulting in a V shape (or half a W) recovery.

As of last night’s close, the S&P is flat on the year, the TSX down 6%, and the Nasdaq up 10%. The question is whether this youthful optimism is unfounded given the problems in the real economy. Many believe earnings won’t catch up to the stock markets’ lofty expectations, and that another decline may be in order. After all, the main-street recovery may involve a letter or shape other than V, and the equity wild child is known for erratic mood swings.

Squeezed between fixed-income and equities is the misunderstood middle-child, credit: not too boring, not too exciting, but sharing traits with both siblings. In March, this dual nature made credit the monkey in the middle. Its equity-like qualities led to spreads widening as businesses closed and credit risk increased. The fixed-income nature of credit saw spreads get pounded further as corporate bonds were sold to raise cash. The combination led to a sharp and violent sell-off in credit, exacerbating the middle-child insecurities.

But a lot has changed since the dark days of March. With rates racing to historic lows and equity markets roaring towards a full recovery, credit has lagged behind its kin and offers attractive value. As while Canadian investment-grade spreads have recovered from their wides, they are still 65% higher than at the beginning of the year.

These elevated levels offer attractive yields and the potential for strong performance on normalization and a cushion in risk-off moves. Credit also benefits from direct parental intervention from the central bank, who on top of existing initiatives recently launched their corporate bond purchasing program. Given these factors, investors have started paying attention and pouring funds into corporate debt, adding further support to the space.

Thus, while we recognize that beauty is in the eye of the beholder (and our inherent biases), credit does appear to be the most attractive sibling right now. So perhaps it is time to shake off the negatives associated with the middle and remember that it is also the meeting ground for opposing views, the happy medium, and the best part of an Oreo cookie.

The Fund Performance.

 
Connecting the Dots.

          Investment-Grade Corporate Bond Spreads & Fund Performance.
 
       

After a quiet start to the year, markets were roiled by fears of a global pandemic. The initial reaction to the coronavirus and its containment measures was a sharp and violent widening of credit spreads. The sell-off was driven by an increase in systemic credit risk and a lack of liquidity in the financial system.

Since the wides of March optimism over the re-opening of the economy combined with the response from central banks and governments has led to a partial recovery of credit spreads.

At the end of March/beginning of April, the Fund moved from a more defensive position to a medium risk posture. The increase in exposure and active credit selection has meant a greater portion of the recovery has been captured thus far.

May Flowers.

May saw a continuation of the April trend with credit spreads moving lower. While the rally in the States went unabated, Canadian credit stuttered on a record-breaking amount of new issue supply.

Generic Investment-Grade Credit Spreads
 

• Canadian spreads tightened 7 bps to finish at 189 bps
• US spreads tightened 28 bps to finish at  174 bps.

 
The main driver of the performance disparity is the aggressive purchasing programs enacted by the Federal Reserve versus the more measured initiatives of the Bank of Canada.

The other trend that persisted from April to May was the tsunami of new supply.
 

• Canadian investment-grade issuance exceeded $20 bn, which was above the $17 bn issued in April and set a new monthly record
• While April was dominated by higher-quality issuers (obvious winners) coming to market, May saw several BBB and lower quality names access funding
• Notable supply included very well-received deals from the energy midstream sector (Pembina, Inter Pipeline, Keyera), telcos, insurers, autos, REITs and infrastructure
• The issuance thus far in 2020 is above the total amount for all of 2019

 
The big development in May was the launch of the Bank of Canada’s Corporate Bond Purchase Program.
 

• Unlike the Federal Reserve, which is aggressively buying corporate debt through ETFs, the BoC program is designed more as a market stabilizer and backstop
• The program involves weekly purchases of five-year and under corporate debt of companies with a BBB rating or above (complete lists and details are available here).
• The mechanics of the program imply that the amounts being purchased will be tapered on strength and increased on market weakness

 
The Fund continued to maintain a medium risk posture and opportunistically rotated positions in May with the improved market liquidity.
 

• Utilized the new issue market and improved tone to rotate from more fragile issuers to companies with the resilience to weather a weak economy
• The portfolio earned over 0.80% in yield on the month and over 1% in credit performance, benefitting from positions in outperforming securities and issuers.

 
As of May 31^st, 2020

The Algonquin Debt Strategies Fund LP was launched on February 2, 2015. Returns are shown on ‘Series 1 X Founder’s Class’ since inception and for ‘Series 1 F Class’ since May 1st, 2016 and are based on NAVs in Canadian dollars as calculated by SGGG Fund Services Inc. net of all fees and expenses.  For periods greater than one year, returns are annualized.

Our Portfolio.

 
Below is a summary of our portfolio as of May 31^st, 2020.
 

• Portfolio Yield: 9%
• 96.2% Investment-grade
  • A slight decrease from Ford being downgraded to high-yield
• Average Term to Maturity: 2.3 years
• Net Credit Exposure: CR01 10.4 bps (medium)
• Net Credit Leverage (5y): 2.07x
• Total Long Credit Exposure: 5.1x (not including hedges)
• The Fund continues to receive net inflows and has significant excess margin with all prime brokers

Looking Ahead.

 
The path to economic recovery is littered with known unknowns and unknown unknowns. While it is critical to recognize and respect these uncertainties, it is also important to take stock of what we know.
 

• June is notable for the large numbers of bonds maturing and paying coupons, resulting in a robust inflow of cash into credit markets
• Corporate debt funds have experienced record inflows over the past weeks, adding to the cash to be deployed into the market
• After the recent flood of deals, the summer (and potentially second half of the year) should offer some respite and time to digest the new issuance thus far
• The Bank of Canada continues to inject liquidity through various programs
• The Bank of Canada Corporate Bond Purchase Program adds further stability and confidence to credit markets
• Credit has lagged the recovery in equities
• Canadian credit has lagged US credit since March and is now cheap on a relative basis

 
Thus barring any virus or macro-related shocks, the expectation is for Canadian credit to continue to perform over the summer months. Given the portfolio’s running yield and the tailwinds for corporate debt, there is potential for the Fund to fully recover sooner than our initial expectations.

 
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“All we need is just a little patience.”
Guns N’ Roses

First and foremost, we hope that you and your family are safe, healthy, and coping well during these difficult times.

One of the most frequently used words of this period is ‘unprecedented’.  Accordingly, we are going to break precedent from our usual commentary format.  Rather than the usual drivel that fills these pages, this month we opted for a summary of the carnage in the corporate bond market, and a review of our portfolio and strategy going forward.

The Ugly.

Corporate Bond Market Summary.

While COVID-19 has taken equity markets on a rollercoaster ride, corporate bonds experienced an unabated sell-off through most of March.

The two major drivers:
 

• Credit risk. With businesses shutting down across the globe, the creditworthiness of corporations has declined, and the risk of delinquencies has increased
• Liquidity premium. A scarcity of cash in the financial system has banks, institutions, and asset managers selling high-quality corporate bonds to raise the cash for their immediate needs (regulatory requirements, margin, collateral, fund redemptions etc.)

 
The net effect was a sharp widening of credit spreads, with short-dated corporate bonds being the hardest hit.

Credit Spreads.

The credit spread is the premium on a corporate bond over government bond yields.  This spread is comprised of default risk and a liquidity premium.
 

• The default risk reflects the probability that the corporation will be delinquent on its debt obligations and will vary from company to company
• The liquidity premium represents the ease and costs of selling an asset and converting it into cash. For example, disposing of a property can be a lengthy and costly process, as opposed to the relative ease and low transaction costs of selling a stock

 
The COVID-19 Effect.

The table and graph below offer some illumination into the magnitude and speed of the virus’ impact on credit markets.

Indicative Canadian 5y Credit Spreads.
 

We have fielded several questions about how the current experience compares to 2008.  The major differences are the underlying causes and the speed of the sell-off.
 

• In 2008, the concern was that the banks would fail and take down the financial system with them. Today, the shock to spreads is due to the global economy unexpectedly and suddenly being put on pause
• The credit spread widening of the Great Financial Crisis occurred over several months. During the current crisis, we experienced approximately ¾ of the 2008 move within four weeks

 
Canadian Investment Grade Corporate Bond Spreads.

While increased default risk has contributed to higher credit spreads, the majority of the move has been driven by the need for liquidity i.e. selling of corporate bonds to raise cash.

The Liquidity Problem.

Everybody either wants or needs cash at a time when it is a scarce commodity.
 

• Businesses and individuals are drawing down on their credit lines
• Banks are experiencing funding pressure
• Financial institutions and pensions are required to post more margin and collateral against their positions
• Asset managers need cash to fund redemptions

 
To raise the cash to meet their immediate obligations, market participants sell ‘cash proxies’.  The most popular assets to sell have been high-quality, shorter-dated investment-grade bonds and commercial paper.

As per the graph and table below, this created a more pronounced spread widening in less than 2-year maturities.

Canadian BBB Spread Curves.

Indicative 3-month Credit Spreads.
 

The Bad.

The Fund Performance.

With the Fund concentrated in higher-quality, short-dated bonds, the sell-off in this space led to mark-to-market losses.
 

• These losses are due to marking down the prices of our corporate holdings and are not the result of permanent capital loss due to default
• Hedges through short positions in credit derivatives partially offset the rise in default risks within corporate bonds but were ineffective against the increase in liquidity premiums
• While we were net sellers of credit exposure through February, we did not anticipate moves of this magnitude and velocity
• Despite running much lower than normal exposure, the magnitude and speed of the widening in credit spreads led to a net return of -16.3% for March

The Good

The silver lining with credit strategies is that while spread widening leads to losses, it does also result in increased portfolio yields and opportunities for recovery and outsized returns in the medium term.
 

• The losses are mark-to-market and as long as the issuers don’t default these losses can be recovered
• Given the Fund is concentrated in higher-quality issuers, the risk of portfolio defaults remains low
• The dramatic widening of credit spreads has resulted in a substantial increase to the yield on the portfolio
• The sharp sell-off has created dislocations and opportunities that we, as active managers of a small fund, can capitalize on
• Central Bank and government stimulus are supportive of investment-grade bond markets

 
Our Portfolio.

Below is a high-level summary of our portfolio as of March 31, 2020.  For a more detailed breakdown of exposures and metrics, please refer to the appendix of this document.
 

• Portfolio Yield: 13.5%
• 99% Investment-grade
• Average Term to Maturity: 1.87 years
  • 44% matures within 12 months
  • 92% matures within 3 years
• Net 5y Credit Leverage 1.5x
• Total Long Credit Exposure 5.6x (not including hedges)
• Largest issuer exposures: BMO, TD, and Bell Canada
• Largest sector exposure: Banks
• Energy exposure
  • Only exploration and production exposure are two positions in Canadian Natural Resources which mature in 2-months and 4-months, respectively. The remainder is in pipelines and midstream issuers
  • 43% of the energy exposure matures within 4-months
• In good standing with prime brokers with a significant excess margin
• Liquidity through bonds maturing every month for both deployment and portfolio de-levering

 
The Opportunity.

Although volatile markets present several enticing opportunities, we feel few offer the attractive risk/reward profile of investment-grade credit.
 

• Wide credit spreads mean high-quality assets offer extremely attractive yields and potential for price appreciation
• Central Banks have rolled out programs that already exceed those employed in 2008 in both scope and scale. Many of these measures are aimed at improving liquidity in the markets
• The Federal Reserve and European Central Bank have extended Quantitative Easing to include investment-grade corporate bonds, and the Bank of Canada has enacted similar measures for provincial bonds and commercial paper
• Large-cap companies that are integral to the economy should benefit from fiscal stimulus and government support
• A significant recovery in equities is not a prerequisite for high-quality credit to perform

 
The Timing.

To paraphrase legendary credit investor Howard Marks’ recent memo:

‘The bottom’ is the day before the recovery.  Thus, it’s absolutely impossible to know when the bottom has been reached…ever.  Even though there’s no way to say the bottom is at hand, the conditions that make bargains available are materializing.

In the medium-term credit markets typically recover faster than equities.  But we anticipate the short-term moves will be slower and more gradual in credit.  This gives us a greater opportunity to adjust exposure and participate in more of the upside.

Our Strategy.

Keep It Simple Stupid.
 

• With bonds maturing every month, we look to capitalize on the dislocations in high-quality credit while maintaining financial flexibility should even greater bargains emerge
• As markets stabilize, use new issues to enter positions at deep concessions
• Focus on high-quality issuers and sectors that will survive and thrive in the long-term. Given the current opportunity set, there is no need to be heroes and venture into lower-quality debt

 
Final Thought.

In times like these, often the greatest commodity is patience.  Patience with self-isolation, your family, long line-ups at stores, and the slow internet.

Thankfully, given the nature of our strategy, the patience we require is not of the Warren Buffet 5-10 year nature, but more like that of a millennial with a one to two-year investment horizon.

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Appendix

For portfolio metrics please see below.

Fund & Performance Summary

“It’s a mess, ain’t it, Sheriff?”
“If it ain’t, it’ll do till the mess gets here.”
No Country for Old Men

A big and often underappreciated part of any epidemic is fear.  The basic emotion (Eckman, 1992a) that invokes extreme instinctual reactions that can either protect us or cause further harm.

In their 2008 paper, Epstein et al. argued that behavioural changes driven by fear need to be factored into epidemiological models. The authors divided the at-risk population into three categories: ignorers, hiders, and fleers. If we all ignore the problem, lo and behold, the disease spreads until we all get infected.  Hiding and self-isolating contribute to containment while fleeing from infected regions exacerbates the problem.

Unfortunately for us, flight is a very natural response. In 1994, half a million Indians fled the city of Surat to escape a supposed outbreak of pneumonic plague.  To this day, controversy exists as to whether any confirmed cases occurred.

Predictably, economic epidemiology assumes people act rationally to achieve an optimal outcome.  COVID-19 could test this assumption.  After several weeks of ignoring the risks, a spike in cases outside of China has seen investors flee the markets to hide in cash and government debt.

As we write, equities have fallen nearly 20%, and 10y government bond yields in the US and Canada are sitting at 0.43% and 0.39% respectively.

The panic is a product of uncertainty. At this stage, there is a very short list of known knowns, a long list of known unknowns, and an unknown list of unknown unknowns.

Let’s begin with what we know, or at least can infer thus far.  The medical and public health experts seem to agree that the number of cases will increase and that an effective vaccine will take time to develop.  Amongst economists, there is consensus that the virus will hurt economic growth and that central banks and governments will deliver both monetary and fiscal stimuli as countermeasures.

As for the unknowns, underlying this long list are questions about the magnitude and severity of the problem.  There is still a lack of understanding around the transmission of the virus, mortality rates, and whether it will recede or persist.  There are also questions over the containment measures various countries will take and the efficacy of these responses.  While the Chinese model appears to be working, few nations have the same combination of authority and competence to deal with an outbreak.

From an economic perspective, the containment playbook of ‘hiding’ results in a rather unique predicament of creating both a supply and demand shock.  A supply shock is occurring because factories are being shuttered which is disrupting the flow of production from raw material to finished goods.  A demand shock is occurring because fewer people are flying, going on cruises, and venturing out to social gatherings such as movies, entertainment events, restaurants etc.

In a classic recession, demand is lower than supply, so central banks lower interest rates to incent consumers to borrow money and spend.  But rate cuts will do little to reopen factories or return people to work.  Inventive fiscal policies such as programs to boost confidence and keep credit flowing will be required to protect the economy.  The question is whether any of these measures can prevent empty factories, restaurants, and shops from causing empty earnings.  As such, this is an unprecedented event with no visible timeline, making it impossible to quantify the economic impact.  Nonetheless, many pundits are taking guesses.  To steal a line from Howard Marks, there are as many forecasts as there are forecasters.

The added wildcard to this already uncertain situation is investor psychology, which can quickly shift from fear to greed and back again.  Such swings can be fast and furious as information and misinformation circle the globe in a matter of minutes.  Thus, while we don’t know the path the virus will take nor the economic damage it will cause, we do feel it is reasonable to assume that markets will continue to be volatile until the scourge stops or infects us all.

The Fund

Credit was not immune to the virus-infected sell-off.  By the end of the month, investment-grade spreads were generically wider by 13 bps in Canada and 20 bps in the US.

For some time, the Fund has been conservatively positioned with the portfolio concentrated in higher-quality, short-dated securities.  Around 97% of our positions are investment-grade with a focus on issuers with the resilience to withstand a recession. Furthermore, almost half the securities mature in less than one year, with 32% coming due over the next six months.  The cash from these maturities rapidly decreases the amount of leverage employed, thereby providing the manager with a tremendous degree of flexibility to take advantage of dislocations.

As active traders, we have been working within this portfolio structure and dynamically managing our exposure.  Last month, we felt that spreads were underpricing the coronavirus risk, in particular within credit derivatives.  Accordingly, we built a decent short position in the CDX credit indices (IG & HY), as a hedge for the macro uncertainty.  We also reduced higher-beta corporate bond holdings and positions with greater than 4y to maturity.

Our hedges blunted and offset the losses from corporate bond holdings leaving us relatively unscathed during the sharp market decline.  Thus despite the weakness in spreads, the Fund finished the month in the black.

As of February 29^th, 2020

The Algonquin Debt Strategies Fund LP was launched on February 2, 2015. Returns are shown on ‘Series 1 X Founder’s Class’ since inception and for ‘Series 1 F Class’ since May 1st, 2016 and are based on NAVs in Canadian dollars as calculated by SGGG Fund Services Inc. net of all fees and expenses.  For periods greater than one year, returns are annualized.

Credit

For the typically boring credit markets, the widening move of today and the last two weeks has been dramatic.  Whether this trend continues and where all-in corporate yields and spreads settle will depend on the severity and duration of COVID-19.  At this stage, it’s just too early to know. Not only is the path of the pathogen unpredictable, but the damage it has caused thus far is also still unknown.  There is still lots of information and data that needs to come to light before gaining clarity on the longer-term implications.

In the shorter term, we expect investors to react to any new developments in the story.  The upshot of this extreme volatility is that assets can become available at attractive prices.  Not all economies, sectors, and companies will be equally affected (or infected) by the virus.  Indiscriminate selling by index funds, ETFs, and portfolio managers experiencing outflows, can lead to interesting dislocations and opportunities.

We feel it’s too early to look for value in lower-quality issuers, so our focus remains on companies that have strong balance sheets to weather a long period of sub-par economic growth.  There is still too much fear and uncertainty to become aggressive.  Currently, any news of more cases is met with the selling.  It would be a reassuring sign to see markets go from fleeing to ignoring reports of further outbreaks and cities being locked down.

Based on the current sentiment and the complex nature of the situation, defence remains our highest priority. With that in mind, we continue to maintain hedging positions and adjust our exposures dynamically as new information becomes available.  Fear, irrational behaviour, and wider credit spreads will create some enticing opportunities, but for now, defence is the best offence.

Rates

As policymakers at all levels grapple with how to manage the disruption beset by COVID-19, both the Federal Reserve and Bank of Canada chose to deploy their weapon of choice as each delivered a 50 bps rate cut with the promise of more to come if warranted.  The Federal Reserve’s move came as the first emergency cut since the financial crisis of 2008.

Sovereign bonds responded by pricing in another 100 bps of cuts.  Furthermore, long end yields are setting new historic lows as traders bet that deflation risks are rising.

With the speed at which information travels today, yields will remain volatile for the foreseeable future as traders react to new information.

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“Success is not final; failure is not fatal:  It is the courage to continue that counts.”
Winston S. Churchill

While our newborn, Fixed Income 2.0, has been getting a lot of attention lately, it was our firstborn that recently celebrated its fifth birthday.  On February 2^nd, the Algonquin Debt Strategies Fund completed five years of active trading.

As proud parents, we marvel at how our baby has grown and wonder where the time has gone. And like most child-rearing experiences, it has been a rollercoaster of ups and downs, sleepless nights, and soiled diapers (no names divulged).

To celebrate, we thought to share some of the lessons learnt from our first five years of parenting.

It’s a Small Business.

One of the first great challenges our partnership faced was changing the toner in the printer.  Thankfully, Mr. Greg Jeffs rose to the occasion, earning him the first-ever Employee of the Month Award.  This incident was a simple example of the resources we took for granted working at large institutions and of all the little things that go into running a small business.

Progress is a Process.

Moving our office from a kitchen cupboard to a walk-in closet, to a hotel suite.  Growing from three bank refugees to a team of nine misfits.  Embracing and accepting that everything is a continuous work in progress and subject to constant improvement.

Ignorance is Bliss.

Not knowing the entirety of what we were getting ourselves into turned out to be a blessing.  Building an asset management firm is a daunting, overwhelming, and intimidating adventure. Being ignorant meant we worried less and simply handled problems as they arose.  Had we known then what we know now, we might have never taken the plunge.

Laugh Hard and Often.

Humility and a good (or very bad) sense of humour are necessary to survive.  Building a business is a continuous stream of steep learning curves, mistakes, and rejection.  The best cure has been to have fun along the way and to laugh at ourselves and each other (often).

The Most Important Thing.

The hardest and most important thing is assembling the right mix of people to work together and complement each other.  We founders are very fortunate to have surrounded ourselves with incredibly talented individuals that compensate for our gross incompetence.

But the team goes beyond ourselves and employees of Algonquin to include our extended family of investors, service providers, peers, and supporters.   As we have often said, it takes a village to raise a fund.  And we would like to take this opportunity to remind our village of the gratitude we feel for all the help and support we have received along the way.  Thank you.

The Fund

The new year picked up where 2019 left off, with issuance well received by bond investors flush with cash, and credit spreads continuing to grind tighter.  That was until January 22^nd when the coronavirus infected financial markets.  The risk-off tone saw Canadian credit spreads give back their initial gains to finish flat on the month, with higher-quality names outperforming. Energy names were in particular focus as oil prices (WTI) plummeted -15%.  South of the border, fears over the coronavirus coupled with a large supply of issuance saw spreads generically higher by 9 bps at month’s end.

New issue supply on both sides of the border was much higher than normal, with the general trend towards longer-dated deals as corporate treasurers took advantage of the rally in interest rates and low all-in yields.   In Canada, $9.5 bn of primary deals were completed with the financials leading the charge.  BNS, RBS, CWB, Coast Capital, BMO, and John Deere all issued in the domestic market and even Morgan Stanley did a $1bn Canadian maple deal. Other notable transactions were Pembina’s $1bn and Brookfield Properties’ $500mm deals.  The US market was inundated with a ‘wall’ of supply with $45bn of US HY and $150bn of investment-grade debt hitting the books. Of note was Canadian convenience store and gas station champion Alimentation Couche Tard placing its deal south of the border.

The Fund was well-positioned for the rally through the first two-thirds of the month, and we were quick to reduce exposures and increase hedges in the face of epidemiological uncertainty.

As of January 31^st, 2020

The Algonquin Debt Strategies Fund LP was launched on February 2, 2015. Returns are shown on ‘Series 1 X Founder’s Class’ since inception and for ‘Series 1 F Class’ since May 1st, 2016 and are based on  NAVs in Canadian dollars as calculated by SGGG Fund Services Inc. net of all fees and expenses.  For periods greater than one year, returns are annualized.

Credit

Being the worrywarts that they are, fixed income managers started the year with a long list of things to be concerned about.  Coronavirus was not one of them.  A humbling reminder that the future is indeed unpredictable.

Prior to the looming pandemic, credit markets were in good shape.  New issue supply was easily digested as portfolio managers still had cash to put to work. The technical backdrop of low inventory and supply coupled with ample cash holdings remains intact.

But there is a fly in the ointment.  Fears that the coronavirus will put the world in recession have resulted in a deeper yield curve inversion which exerts upward pressure on credit spreads.  The uncertainty of the virus has put nearly everyone into a holding pattern.  Given the unpredictable nature of the epidemic, we have elected to maintain financial flexibility and adapt as the situation develops and unfolds. If the pace of transmission and fatalities increase, markets will react negatively, but with the significant stimulus being added globally, signs of progress on the virus front could be met with a strong relief rally.

Rates

Domestic bond funds had a great month.  After rising in December, rates fell between 20 to 30 bps (depending on tenor).  Most of the move was fueled by the Bank of Canada’s perceived pivot towards easier monetary policy.  Fears that the pandemic would further chill the economy pushed feverish traders to at one point price in at least two cuts by the central bank.

Without a doubt, the coronavirus has the potential to severely crimp global growth.  The Chinese government has introduced stimulative measures to ameliorate the problem, however, the efficacy of these actions remains unknown. Yields have priced in central bank cuts, however, whether they take action really depends on the magnitude and persistence of the virus.

We don’t believe the Bank of Canada or Federal Reserve will move aggressively until there is a clearer picture of the economic damage.  If the virus proves to be short-lived, the amount of stimulus being added by the Chinese government to bolster its economy could end up reflating other economies as well.  As a result, expect sovereign yields to be volatile as traders adjust rate cut expectations in response to emerging information.

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“We have long felt that the only value of stock forecasters is to make fortune-tellers look good.”
Warren Buffet

Our minds inherently loathe uncertainty.  Not knowing what to expect is unnerving, as it threatens our primary instinct to survive.  Perhaps this explains and underlies our affinity for prophecies and predictions.  A source of comfort amidst the unpredictable future.

At this time of year, there is no shortage of such prophecies.  Bold calls from politics and sports to fashion and technology.  And of course, the usual smattering of financial forecasts of investment profits for 2020.

Most of these predictions are based on extrapolations of the present and the past, based on the logic that history doesn’t necessarily repeat but rhymes.  And given the immense computational power and data available, there is growing confidence in these forecasts.

But given the narrow range of these investment predictions, we suspect some overconfidence on the part of financial pundits.  After all, markets are unpredictable and subject to bouts of volatility, making accuracy in foretelling the next twelve months very difficult.  We would much rather make our bold calls for the year 2050.

Although it might seem counterintuitive, predicting long-run asset returns is far easier than forecasting them in the short run.  If you want to know what fixed-income will generate, a simple approach is to look at the information available from tradeable securities.  A Government of Canada 30-year bond yields 1.7%, while one issued by Hydro One yields a lofty 3.0%.  Thus, one can easily build a portfolio of long bonds that should earn 2-3% per annum for the next three decades.

Relative to the past 50 years, this return spectrum might seem rather low and depressing.  But we will note that the high interest rates of the 70s, 80s, and 90s were an anomaly.  Based on data from the Bank of England the range for interest rates from 1870 to 1970 was 2-5%.  So while today’s climate of ultra-low yields is in sharp contrast to recent history, it is not too far out of whack from the previous centuries.

When it comes to equities, there are unfortunately no cheats like in fixed income, via long-dated securities.  Fortunately, Professor Randy Cohen of Harvard University does offer a rather elegant and simple approach using a few key metrics.  The theory is that long-run equity gains are a function of GDP, inflation, and dividends.  With an expected inflation rate of 2% (observable in 30-year real return bonds), expected real GDP growth of 2% (based on demographics), and a dividend yield of 3% or so, one can conclude that equity returns will fall in the range of 5% to 7% over the next few decades.

Based on the above, an investor running a basic 60/40 portfolio can expect gains of 4% to 6% before fees and expenses.  While we look forward to being judged in January 2050 on the accuracy of these calls, we understand that such long-term forecasts don’t offer the amusement of single year predictions.  But instead of wasting time on guessing what the market will deliver, we thought we would offer far more valuable insights:

* Vancouver will see plenty of rain and the mosquitos will be bad in Winnipeg this summer
* After the Maple Leafs recent bout of success, Toronto fans will be planning a parade
* Greg Jeffs will be one year older (allegedly)
* Interest rates will go up, and down, and up, and down and … (we couldn’t resist an investment call)
* We will all lose 10 lbs

Now that we’ve armed you with our ‘pearls of wisdom,’ we wish everyone a prosperous, healthy, and happy 2020.

The Fund

The holiday season is typically quiet with credit modestly performing on a lack of supply, thin liquidity, and lighter dealer inventories driving the usual Santa Claus rally.  With the headwinds of US/China trade, USMCA, and Brexit moved to the back burner (for now), the seasonal grind tighter turned into a more pronounced rally with investment-grade credit spreads lower by 8 bps in Canada and 12 bps in the US.

CIBC, BNS, RBC, Crombie, Welltower, Smart Centres, Telus and Shaw took advantage of the positive tone to raise debt.  Even National Australia Bank returned to the Canadian market after a long hiatus with a Tier 2 capital deal.  Despite the unusually large amount of supply for a December (> $10 bn), the deals were well received by buyers flush with cash.

The continued performance of credit coupled with yield earned allowed the fund to end 2019 with a strong return of 1.05% (F Class 0.94%).

As of December 31^st, 2019

The Algonquin Debt Strategies Fund LP was launched on February 2, 2015. Returns are shown on ‘Series 1 X Founder’s Class’ since inception and for ‘Series 1 F Class’ since May 1st, 2016 and are based on  NAVs in Canadian dollars as calculated by SGGG Fund Services Inc. net of all fees and expenses.  For periods greater than one year, returns are annualized.

Credit

After a difficult 2018, credit markets experienced strong performance in 2019.  Domestic spreads were 45bps better on the year, while US spreads moved in an impressive 58bps.

Looking at the month ahead, after the holiday lull, new issue activity is expected to pick up.  US estimates for January supply are in the area of $125-130 bn.  Getting estimates for the domestic market is tougher, but we think issuance will be in line with historical norms (i.e. $7bn).  The appetite for new deals remains robust as portfolio managers have healthy cash piles to deploy, and in particular, demand for BBB paper remains strong.

The main headwinds that dominated the stage last year (China-US trade, USMCA, and Brexit) have receded, but a new protagonist (US-Iran sabre-rattling) has made an entrance.  We don’t believe either side desires an open conflict.  However, we are aware that accidents do occur.

The Fund has plenty of dry powder on hand to take advantage of the opportunities that are sure to arise when the deal flow materializes.

Rates

The Federal Reserve is expected to leave rates unchanged later this month as they continue to observe the impact of previous cuts.  US treasury yields should remain range-bound for several more months until a clear trend in GDP and/or inflation emerges.

The Bank of Canada remains on edge as the domestic economy appeared to falter in December.  Worries about whether the data was merely a blip or the beginning of a trend will keep yields anchored at current levels until the question is resolved.

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“It was time to raise the bar higher, or lower if you’re doing limbo.”
Frank Edwin Wright III (Tre Cool)

In limbo, the bar has been set, or more appropriately lowered, to an astonishing height of 8.5 inches.  On September 16^th, 2010, Shemika ‘The Limbo Queen’ Charles contorted and shimmied her way to this incredible world record.  Given the physical limitations on how low one can go, she has left the competition very little wiggle room (pardon the bad pun).

Much like the limbo bar, people once thought the ultimate lower bound for interest rates was zero.  After all, the bar can’t be on the floor, and who would lend money at a loss?  But with over $17 trillion of debt trading at negative yields, one of those notions has been firmly dispelled.

Harkening back to the days when wealthy nobles (and Scrooge McDuck) incurred costs to store and protect their pools of gold, European clients now even pay banks to keep large deposits.

The fact remains that money can’t exist in the ether, and it needs a home.  And since stuffing cash under a mattress has practical limits, today, many are willing to pay governments, banks, and select corporates to store it in their houses.

That negative rates can exist and persist is a confirmed reality.  But many unknowns remain, including whether they can migrate to Canada.

The list of explanations for sub-zero yields is long and varied.  The most frequently cited culprits are central banks, inflation (or the lack thereof), demographics, regulations, and pessimistic outlooks for the future. Given the number and diversity of theories, including some entertaining conspiracies, it appears the reasons for negative rates are not fully understood.

At this point, what we can conclude is that a strong precondition is central bank action.  Thus far, negative yields have only occurred in jurisdictions where central bankers have taken the overnight rate below zero.

So, what motivates them to push overnight rates into negative territory?  The theory is that lower rates stimulate borrowing and spending, and the lower they go, the greater the degree of economic stimulus delivered.  Although there were concerns about the impact of sub-zero rates on the banking sector, for the most part, theorists felt the pick up in demand would offset this drag.

While hypothetical debate can be a lot of fun, nothing beats empirical evidence.  And thus far, the experiments in Japan and Europe have revealed a number of unintended consequences.

Rather than promoting an increase in consumer spending, the opposite is happening.  Ultra-low yields mean people need to save more for retirement.  And since the introduction of negative yields, European savings rates have increased.  Low yields also push savers to take more risk to reach financial goals, encouraging less prudent investments and reducing resilience in stressed markets.  These issues extend beyond the individual and include pension plans, which might be forced to reduce benefits or raise contributions.  The combination of these factors has weighed on consumer spending and consumption.

Low interest rates also reduce the return hurdle for new projects and investments, which allows for all manner of dubious schemes to be funded.  Similarly, minimal debt servicing costs allow zombie firms, who would otherwise be insolvent, to continue to exist.  This comes at the expense of healthier companies gaining more market share and reinvesting profits to increase productive capacity.

Accommodating monetary policies have also had political implications.  The ensuing rapid rise in asset prices has disproportionately benefited the rich and furthered the ‘wealth divide’.   With the rising tide of low rates not lifting all boats, we are witnessing an increase in political risk and social unrest (i.e. gilet jaunes, Hong Kong, Chile, Brazil, Hungary, Italy, Brexit, Trump…).

The staff at the Bank of Canada are analyzing these mixed results from the Japanese and European experiments.  As a consequence, we suspect they are more reluctant to move into negative territory than they would have been several years ago. Fortunately for them, Canada enjoys a couple of factors that ought to reduce the need to do so.

Population growth is hovering around 1.4% per year (thanks to flexible immigration policies), while growth in Europe is barely positive and is slightly negative in Japan.  The federal government also has the willingness and flexibility to run deficits and employ fiscal stimulus. Thus, reducing the reliance on monetary policy as the only tool to fight off a recession.

While there is no doubt that negative yields are still part of the Bank of Canada’s playbook, given the above factors coupled with empirical evidence thus far, the bar to go lower has moved a little higher.

The Fund

The largest single focus for the market remains the state of US/China trade negotiations.  Optimism around a Phase 1 deal helped propel risk assets higher, with broad credit indices rallying by 7 bps in Canada and 5 bps in the US.

High cash levels in domestic bond funds and light bank inventories meant a robust demand for new issues.  For the most part, deals performed well, with investors even piling into the unloved auto sector (Ford, GM and BMW all successfully tapped the market).  Other interesting deals, to name a few, included offerings from Ventas, Morguard, Saputo, Capital Power, and Inter Pipeline.

Amidst the rally in credit, the performance of the provincial sector was notable.  Typically, provincial spreads move in the same direction but with a smaller magnitude than corporate credit.  Last month, they matched the pace of corporate spread tightening.

The Fund was well-positioned for the rally in spreads and benefitted from investments in outperforming securities.

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As of November 29th, 2019

The Algonquin Debt Strategies Fund LP was launched on February 2, 2015. Returns are shown on ‘Series 1 X Founder’s Class’  since inception and for  ‘Series 1 F Class’ since May 1st, 2016 and are based on  NAVs in Canadian dollar as calculated by SGGG Fund Services Inc. net of all fees and expenses.  For periods greater than one year, returns are annualized.

Credit

Looking to year-end, conditions appear to be in place for the frequently observed ‘Santa Claus’ rally in credit.  There is good demand for quality paper, dealer inventories are light, and although the new issue market will still be active with banks and financials reporting, the deal window normally closes in the third week of December.

From a fundamental perspective, US corporate earnings have looked okay so far, in spite of a substantial slowing in revenue growth. Strength was unsurprisingly concentrated in defensive sectors such as utilities and health care, with poor results in the energy and auto sectors.  The expectation is for muted earnings growth to continue in the near term.

On balance, we expect a steady grind tighter in spreads into early January barring any hiccups with the US/China Phase 1 trade deal.  We will maintain a reasonable risk posture while remaining very aware that liquidity will decrease as the month progresses, which means unfavourable surprises could create added volatility.

Rates

The Federal Reserve should be content to observe how the economy responds to the recent cuts.  The timing and direction of the next move are highly dependent on how the US/China trade negotiations turn out.  Until further clarity on this matter, US treasury yields will remain in a narrow range.

The Bank of Canada seems to be having a little trouble determining where to place the bar for a rate cut.  Having seemingly tilted towards monetary stimulus, the Bank has recently walked back expectations a little bit.  Judging from their recent comments, they too are having trouble gauging the impact of trade tension on the economy.  As a result, expect heightened volatility in yields as traders adjust forecasts after each data release.

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“If you think this has a happy ending, you haven’t been paying attention.”
Ramsay Bolton

 In the game of thrones, you win, or you die. In the game of loans, death is unlikely, but great pain and suffering could be in store for some players.

Fuelled by strong investor demand, the leveraged loan market has doubled over the last decade, and by some estimates, has reached USD 1.4 trillion.  The rapid growth of this space has led to fears of excess and imprudence. Such concerns even garnering the attention of global leaders at the October G20 meetings.

As risk appetite for lower-quality debt wanes and cracks appear in what is suspected to be a fragile market, should we be heeding the choruses of ‘winter is coming’?

For the unindoctrinated, leveraged loans might sound like an esoteric Wall Street invention, but they are simply loans.  The leveraged aspect comes from the borrowers: companies encumbered with lots of debt or poor credit history, and private equity firms financing leveraged buyouts, share purchases, and dividends.

Given the riskier nature of these debtors, the loans are typically rated BB- or lower and pay a relatively high spread over a benchmark interest rate (i.e. LIBOR).  And in a world of ultra-low yields, this extra return potential has enticed investors and spurred parabolic growth in loan issuance.

Behind much of this demand are Collateralized Loan Obligations (CLOs), home to over half of the outstanding issues.  CLO managers bundle loans together and then slice and dice them into various tranches.  The seniority of the tranches dictates the order in which investors get paid from the underlying loans, thus offering different risk/reward profiles.

This structuring process and the term itself might sound eerily similar to the much-maligned CDOs of the Great Recession. But unlike their notorious cousins, CLOs outperformed most sectors of the high-yield market and skated through 2008 with relatively few losses.

The ‘winter is coming’ crowd will point to many reasons as to why this time it will be different.

Not only has the loan market gown considerably, but there has also been a loosening of underwriting standards or covenants.  Of the over $700 bn of new loans issued in each of 2017 and 2018, estimates have over 80% being covenant-light, compared to less than 20% in 2007.  This means fewer restrictions on the borrowers and fewer protections for the lenders.

The concerned camp will also add that the credit quality of the issuers has decreased.  Pre-crisis, over 50% of loans were rated BB, whereas today, the majority are single-B or lower.  Perhaps most concerning is that almost a third of outstanding loans are rated B-.  The particular relevance of this rating is that it is only one notch above CCC, with most CLOs contractually limited to holding no more than 7.5% of CCC debt.

With fears of slower growth (if not a recession) ahead, there is a rising concern that downgrades will hit the sector, pushing more loans over the CCC cliff, resulting in forced selling by CLO managers.  The problem then becomes identifying potential buyers.  The usual cast of characters is money managers without onerous constraints on what type of debt they can own.  But these folks are seeing outflows, as ‘hot money’ becomes weary and leery of low-quality credit.

With the buyers of last resort in retreat, a rise in defaults and restructurings is imminent.  While this may seem ominous, in and of itself, it is a healthy and long-overdue process of trimming the excess fat.  For most of us, the big question is the impact this could have on other parts of the market (i.e. high-yield).

Given the complexity and opacity of the space, it is difficult to assess the risk of contagion.  If the rest of the economy holds up, the defaults and restructurings could occur over longer periods.  In such a case, the pain can be contained.  However, if some other exogenous shock or crisis unfolds, causing capital to flee to safety, then the risk of an unleashed dragon-like scenario grows significantly.

The Fund

October often sees a bifurcation in temperatures between Canada and our neighbours to the south.  Last month, credit markets followed the weather pattern with a much colder climate north of the border.  While US investment-grade spreads were tighter by 5 bps, the domestic market was broadly unchanged, with BBB spreads widening a few basis points.

US credit was supported by a light amount of issuance combined with strong inflows into investment-grade funds (likely some of the cash flowing out of lower-quality investments).  In Canada, the new issue supply was more robust as large deals from RBC, CCDJ, Fortified Trust, Enbridge Inc, and ENMAX came to market.  There were also plenty of infrastructure-related deals from the likes of Vancouver Airport, BC Ferries, Brookfield Infrastructure, and CN Rail. Finally, there were small but interesting deals from Sienna Senior Living and Allied REIT.  By Hallowe’en, the tally was over CAD 8 bn, making it the second busiest October on record.

In issuer-specific news, Allied REIT was upgraded to Baa2, as Moody’s rewarded the company’s progress in deleveraging and strong operational performance.  Moving in the other direction was Ford, which was downgraded to BBB- and sits on the cusp of falling to high-yield.  Despite the restructuring issues that face the auto sector from declining sales, Ford spreads actually rallied on the downgrade as investors were relieved that the company maintained an investment-grade rating.

With weak economic data and geopolitical tensions (Brexit, Syria) to start the month, the Fund was defensively positioned and relied largely on the carry portion of the portfolio to generate a conservative return of 0.39% (F Class 0.32%).

Credit

November should see a reasonable spike in new supply south of the border, as companies get past quarterly earnings and rush to get deals placed before US Thanksgiving.  Canadian issuance should also pick up, but the forward calendar looks very manageable, with the market in a position to digest the new deals.

Demand for investment-grade credit, especially BBBs, remains very strong.  The domestic market also has a significant number of corporate bond maturities and coupon payments due, with roughly CAD 10 bn/month in November and December.  With dealer inventories sitting at moderate levels, portfolio managers will rely on the new issues as a means of putting this cash to work.

Typically, the run to year-end provides a seasonal tightening of credit as issuance pauses from December to mid-January, and dealer inventories get depleted. Also, with the odds of a no-deal Brexit now very low, and the US and China playing ‘nice’, the backdrop for credit into the new year is constructive.  But with the scars still fresh from last December’s massacre in risk assets, there is the possibility of increased volatility on any late-year macro surprises.

Rates

Bond traders were treated to a rare event with both the Bank of Canada (BoC) and Federal Reserve (Fed) having rate-setting meetings on the same day.

The BoC got things going in the morning by opening the door to lower rates.  They expressed concern that global trade tensions were negatively affecting the economy and barring an improvement in data, monetary stimulus would likely be required.  As such, we think that unless GDP improves, the odds are good the BoC cuts rates by 25bps in January 2020.  Sovereign bond yields responded by moving 15 bps to 20 bps lower over the last two days of the month.

The Fed, on the other hand, delivered another 25 bps cut (bringing the total cuts to 75 bps) but signalled that a pause was in order.

Both central banks maesters have done an admirable job in anchoring rate expectations for the next quarter or two, which means yields will ebb and flow in a rather narrow range.

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“If you consider the contribution of plumbing to human life,
the other sciences fade into insignificance.”
James P. Gorman (CEO Morgan Stanley)

The repo market is often referred to as the plumbing of the financial system.  And much like the plumbing in your house, it functions in the background unnoticed, that is, until something goes wrong.

That something wrong happened last month, with financial institutions finding a clog in their funding pipes.  As a result, boring old repos made headlines and sparked fears of systemic problems in the plumbing infrastructure.

This has many asking what the heck a repo is, what happened, and how worried we should be.

Repo is market slang for a repurchase agreement.  It is a common type of short-term borrowing where the underlying ‘collateral’ is government securities.  In a typical repurchase agreement, a financial institution sells government bonds to raise cash today and agrees to buy them back tomorrow.  The next-day repurchase is at a higher price, which implies an overnight interest rate referred to as the repo rate.

Usually, the repo rate is marginally above the central bank overnight rate (i.e. low 2% range at current levels).  But on September 17^th, it spiked to 10%.  Despite the opportunity to earn large premiums on overnight cash, financial institutions were unwilling or unable to lend to each other.

As with most clogged pipes, it was due to a confluence of factors building up over time.  A growing deficit has meant a greater supply of US Treasuries.  And with the Fed pulling back from their purchasing program in 2017, the slack has been picked up by the banks, where primary dealers are forced buyers.  Since 2008, the amount of US government debt held by commercial banks has tripled.

Often these purchases are funded through the repo market.  Consider a bank buying Treasuries and then selling them in a repurchase agreement to raise the cash.  The following day they enter into a new repo and thus continuously borrow the money to finance their purchase.  This is an extension of the old bank game of ‘borrowing short and lending long.’

In September, these factors came to a head and created an imbalance in the demand and supply of cash.  On the 16^th, a large amount of new Treasury purchases settled, and money was due.  At the same time, companies were making withdrawals from banks to pay taxes.  This left more Treasuries sloshing around the system than cash on the other side.

In such crunches, there is usually money tucked under the mattress in the form of reserves. And while the $1.3 trillion in storage at the Fed seemed sufficient, the cash was not being lent out.  On closer inspection various regulations have made the cash immobile.  As JP Morgan CEO Jamie Dimon noted, the banks ‘have a tremendous amount of liquidity but also have a tremendous amount of restraints on how they use that liquidity.’

So the Fed had to step in and play the role of plumber and get the pipes flowing with an injection of cash.  This took care of the immediate issue, with more permanent solutions being explored.  Some of the options up for discussion include the Fed administering a standing repo facility, a revival of Treasury purchasing programs, and changes to regulations, i.e. allowing banks to treat Treasuries and cash as equal for reserve purposes.

For those of us scarred by 2008, all of this has an unnerving familiarity.  But for all the noise that repos made last month, the impact to rates, credit, and equity markets was negligible.  Banks are better capitalized and stronger than a decade ago, and the funding crunch was the result of immobile money, not the lack thereof.

So while nerds and traders debate the nuanced impacts this could have for bank inventories and liquidity, the rest of us needn’t get our underwear in a bunch.  Unlike the financial crisis, there is not a lack of confidence in the banking system.  The pipes needed some maintenance and attention, but we don’t see the need to rip apart the entire plumbing.

As they say in the army, “it’s the bullet you don’t hear that will get ya.”  So perhaps the incident last month serves as a welcomed warning shot of a design flaw in the post-crisis system.  If not remedied, a blocked pipe could create unnecessary panic in fragile markets.  Thankfully, central bankers and regulators are working to ensure the repo market operates smoothly.  Unlike in poker, when it comes to plumbing, a flush beats a full house.

The Fund

Rumours swirled in August about a tidal wave of issuance to come in the fall.  September didn’t disappoint, as corporate treasurers, thrilled with the prospects of cheap financing, lined up to issue debt.  The final tally registered as Canada’s fifth-largest supply month with approximately $14 bn of new corporate bonds issued.

Videotron broke the record for the largest domestic high-yield deal at $800 mm and used the proceeds to retire existing bank debt.  Gibson Energy (recently migrated from high-yield to investment-grade), Pembina, Transcanada, Brookfield, GTAA, Equitable Bank, VW, Bell Canada and BNS also came to market last month.

As we had anticipated, cash levels had been building up in fixed income portfolios, and the flood of supply was met with even greater demand.  Portfolio managers were left disappointed with their new deal allocations and were forced to scramble in the secondary market for scraps.  Overall, credit spreads narrowed approximately 4 bps (5 bps in the US), which is remarkable given the volume of deals.

We were well-positioned to selectively participate in new deals and to capitalize on the trading activity around the new supply.  Active trading, the general performance of spreads, and carry contributed to a solid gain of 1.02 % (0.91% F Class) in September.

Credit

Concerns of looming issues in credit markets are resonating with investors, who are becoming far more discerning about who they finance.  Stelco couldn’t do a bond deal even with a hefty 9% coupon. Meanwhile, WeWork saw their bonds drop 25% and $40 bn trimmed off the company’s valuation in just a few weeks.  People reconsidered whether a negative cash-flow company is truly worth the same as, say, Caterpillar.  The message is clear.  Investors are no longer willing to throw their hard-earned money to finance speculative companies (debt or equity) that rely on miraculous growth or at the very least, a strong economy.

While the investment bankers will be whinging about how their bonuses will be affected, the rest of us should be pleased that investors are finally showing some discipline.  This could lead to a slight increase in defaults as investors refuse to bail out poorly run companies.  Oddly enough, we think this could be a good sign.  While defaults will raise some fears, the increased pressure means corporate executives will be forced to focus on strengthening their balance sheet ahead of a downturn.

With the ongoing fall issuance calendar and the overhang of trade, Brexit and some lousy economic numbers, we don’t believe aggressive exposure is warranted.  We will continue to hold our modest position, which allows us some flexibility to exploit opportunities that arise from a market sell-off.

Rates

Purchasers of sovereign debt experienced a bit of ‘buyer’s remorse,’ as markets reassessed how low central banks need to take rates.  As a result, the Canadian 5y yield increased by 22 bps in September after having fallen 27 bps in August.  The markets see-saw as investors attempt to decipher the economic data and geopolitical risks.

On the one hand, economic growth is slowing as business and consumer confidence wanes.  But if the US and China reach a deal (any deal really) and the UK and Europe work something out, central bankers will be reluctant to add further stimulus in hopes that growth rebounds.

Both the Federal Reserve and the Bank of Canada are treading a fine line with the trade war.  First, there is the ever-changing dynamic in the trade negotiations.  Then there is the uncertainty of the impact and overhang from the loss of business confidence that this spat has created.  And since progress on these issues is painfully slow, central bankers would like to keep some firepower in reserve.

Given that most central banks around the world are currently biased towards lowering rates, we think that sovereign yields will remain anchored within a well-contained range for the balance of the year.

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