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2nd Quarter 2012 Market Commentary – Fixed Income

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The second quarter witnessed continued global economic turmoil. Euphoria near the end of the quarter was a product of the Federal Reserve’s Operation Twist and the acceptance of a common banking supervisor in the Euro Zone.

Operation Twist along with the Federal Open Market Committee (FOMC)’s unwillingness to raise interest rates before they are pressured to lower the Fed Funds rate, reinforces our continued desire for longer duration bonds.

A Euro-wide banking supervisor and the ability of the European Stability Mechanism (ESM) to recapitalize banks, eases concerns about the banking sector; however, the deal still requires ratification, and is only a small fix to a larger problem in the region.

Although the risk of Greece and other less stable countries (such as Spain and Italy) leaving the Euro has been marginally reduced, the region is in a constant state of flux. The most realistic scenario continues to be an eventual breakup of the union; however, it could be lead by the exodus of a stronger and more stable member – leaving the weaker members as the new monetary union.

During the second quarter, our fixed income portfolios maintained a cautious duration and yield curve exposure due to a potential back-up in interest rates.

Given our main interest rate exposure is in corporate bonds and in around the 5-year area of the yield curve, the bond portion of the fixed income model was somewhat insulated from the gyrations of the bond market. We were able to substantially outperform with gross year-to-date return of 4.62% for the Core Bond Model Portfolio and 4.41% for Pension Bond Model Portfolio, versus the DEX Universe Total Return of 2.03%.

Our Preferred Share Model Portfolio was impacted by higher than normal preferred share issuance in the quarter, with 12 issuers raising approximately $2.3 billion, with activity highest in May – driven by some degree of fear in financial markets not functioning due to a potential Euro union breakup.

Of note for the quarter was the earnings miss by Canaccord Financial Inc. Going forward, we continue to hold Canaccord (CF.PR.A) in our model as we believe the contribution of Collins Stewart Hawkpoint (their wealth management acquisition in the U.K.) will be positive to their more volatile Canadian operations, and do not believe their dividends are at risk as the latest quarterly loss was an anomaly.

With Operation Twist extended to the end of the year, the FOMC currently has dry ammunition to lift the economy in the event of a prolonged period of economic malaise.

The Bank of Canada has been given reason to remain on the sidelines given the recent tightening of mortgage lending standards. The combined effect of the stricter mortgage lending rules translates roughly to a tightening of mortgage rates by 100 basis points. The benefit here is two-fold; a stronger banking system and an indirect policy tightening.

For the balance of the year, we will be monitoring the opportunity of extending the duration of our bond portfolios from its current duration of 4.8 & 5.4 years (TriDelta Core & TriDelta Pension Portfolios) to around the 7.0 year area, which will likely enable us to benefit from a flatter yield curve, while keeping our corporate bond weights intact.

Edward Jong
VP Fixed Income, TriDelta

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