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HOLLAND BLOORVIEW INVESTOR CHALLENGE

Money managers showed resilience in third-quarter's 'whiff of rising rates' Add to ...

The market did an about-face in the third quarter, reversing the fortunes of the winners and losers of the first half and scrambling the opportunities for a trio of money managers trying to generate profits in support of children with disabilities.

The three are participants in an investment challenge to raise money for the Holland Bloorview Kids Rehabilitation Hospital, which is the largest facility of its kind in Canada. Its mission is to improve the lives of children living with disabilities.

To that end, three fund managers each started with $25,000 donated by their respective firms.

Each is managing that money on behalf of Holland Bloorview over the course of the calendar year, with all capital and investment gains going to the hospital. Additional donations of cash or securities can be made to each manager’s Investor Challenge fund at hollandbloorview.ca/investorchallenge.

The first half of the year was dominated by crude oil, from the winter crash in energy prices to the subsequent swift recovery. The third quarter, however, saw the prospect of rising interest rates and bond yields come back to the fore, as rate-sensitive stocks sold off in favour of cyclical sectors.

Here is how each manager fared amid the big shuffle.

The manager: Stephen Carlin, managing director and head of equities at CIBC Asset Management

The fund: Renaissance Canadian Dividend Fund

Dividend stocks in general are among the most vulnerable to a rising-rate environment, as higher bond yields make income equities less attractive by comparison.

But Mr. Carlin has built in some insulation to upward pressure on yields, in part through exposure to financials stocks, particularly life insurance companies.

Lifecos are among the few segments of the market that benefit from higher yields, generating returns on reinvested premiums. Higher yields also tend to have a positive effect on bank profit margins.

The midpoint of the year saw bond yields begin to rise as the market came to expect the U.S. Federal Reserve to hike rates in December. The wisdom of extraordinary monetary stimulus came under scrutiny more generally.

“I think we’ve reached the point of diminishing returns,” Mr. Carlin said, referring to perpetually low interest rates. “We’re beginning to see more and more discussion around using fiscal policy to help stimulate.”

That shift in sentiment dragged down rate-sensitive and precious-metals stocks in the third quarter, while Canadian bank and lifeco holdings lifted Mr. Carlin’s returns on the sector.

The fund posted a third-quarter return of about 5 per cent.

The manager: Bryan Pilsworth, president and portfolio manager, Foyston, Gordon & Payne

The fund: FGP Canadian Equity Fund

This year has seen a gradual recovery of risk sentiment after the winter correction, which, in the third quarter, increasingly favoured sectors more positively exposed to economic growth, Mr. Pilsworth said.

“There’s been modest improvement. Oil markets are coming back into balance. The financials of the world have a lot of challenges, but the Canadian banks and lifecos are managing to show earnings growth. There’s employment growth in Canada and the regulators seem to be cognizant of the housing risk,” he said.

“And there’s a whiff of rising rates.”

If global growth can remain resilient at albeit modest rates, investors could continue to be drawn toward cyclical sectors.

“Because rates are so low, even a small move in long-term interest rates has big ripple effects in the equity markets,” Mr. Pilsworth said.

Both financial and energy sectors in Canada beat the index in the third quarter, which helped lift this fund’s total return over those three months to 6.2 per cent.

And while the materials sector was a third-quarter laggard, one of the Mr. Pilsworth’s biggest winners was Teck Resources Ltd., which rose by nearly 40 per cent.

“It was a painful hold on the way down, but we stuck to our guns.”

The manager: Barry Allan, president and chief investment officer, Marret Asset Management

The fund: Marret Tactical Energy Fund

The rebalancing of the energy market took a small step in the third quarter, after taking a giant leap in the second.

While crude oil prices were largely flat over the third quarter, default expectations diminished moderately.

This fund was specifically designed to profit from the recovery of the high-yield energy space. When the price of oil collapsed, expected defaults on energy credits hit extraordinary highs.

Last quarter, sentiment improved dramatically and the estimated default rate plunged, resulting in a return of 15 per cent for Mr. Allan’s fund.

“It’s broadly played out the way we anticipated, which is reasonably rare,” Mr. Allan said.

While the recovery was concentrated in the second quarter, there is still upside to capture, he added.

“I would describe the sector as being fairly valued now. It’s no longer cheap. But I expect it to move into overvalued territory, as the people still underweight energy finally capitulate.”

The fund posted a return of 3.5 per cent in the third quarter.

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