I hope you have been enjoying the summer of re-opening! Across Canada, restrictions continue to be lifted and life is slowly returning to what we remember as normal. We are still living with uncertainty as the Delta variant spreads, but we have all been through much worse!

Throughout the second quarter of 2021, we have seen some great business results and some great investment performance. That said, markets have been volatile as uncertainty around inflation dominates media coverage.  

In this Issue:

  • Markets – Inflation is Here, How Do We Manage it?

  • Canadian Equities – Capacity for Dividend Growth

  • U.S. Equities – Passing Costs on to Customers

  • Global Equities – Benefitting From the Construction Boom
  • Fixed Income – Shifting Back to Quality

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The dominant theme markets are paying attention to right now is inflation – the invisible force that erodes your purchasing power over time. During the second quarter of 2021, inflation pushed to its highest level in 10 years.  
This is partly because inflation has been very low over the last decade, but the main driver of the increase is the record amount of stimulus pumped into the global economy throughout 2020. In response to Covid lockdowns, governments and central banks around the world embarked on stimulus programs, the size of which have never been seen before. The stimulus was necessary to keep the economy alive, but as we begin to move past Covid, one of the consequences of the incredible stimulus is the onset of inflation. Now that inflation is rearing its head, the concern isn’t necessarily the current rate, rather, much of the concern is centered on the uncertainty of how far it will increase, and how long it will persist.

You cannot hide from inflation. The force is felt by consumers, businesses, and financial markets alike. Central banks can manage inflation by raising interest rates over time, and that comes with a suite of other risks for companies and assets with lots of debt, as discussed in previous notes. At an individual level, there are some ways to mitigate the inflation risk on your investment portfolio:
  • Own businesses that can consistently grow their profits and their dividends faster than the pace of inflation,

  • Own businesses that can pass increasing costs on to customers,
  • Own businesses that can benefit from rising interest rates,

  • Own the few businesses that can actually benefit from inflation.
See below for more detail.
We’ve been talking about the Canadian Banks a lot in 2021,
and for good reason.

As we’ve covered in previous notes, the Canadian Banks are making more money now than they were pre-pandemic. Beyond that, they are sitting on more deposits than ever before – deposits that can be lent out as loans. Finally, banks benefit from a rising interest rate environment – a 0.1% increase in interest rates can yield as much as $5.3 billion in added net interest margin. Put that all together, and the Canadian Banks are extremely well-positioned to grow their dividends not only this year but well into the future.

Growing dividends is one of the most effective ways to manage inflation. 
To fair well in an inflationary environment, the best businesses can pass their increasing costs on to their customers. FedEx is an excellent example of a company that has been doing exactly that. From 2009 to 2021, FedEx has increased its average shipping rate by 83%. Over the same period, inflation increased by 26%. The fact that FedEx has been able to increase its shipping rates so heavily and not lose market share is a great example of a business that can produce inflation-protected cash flow. Over time, that cash flow is returned to investors through dividends, buy-backs, and share price appreciation.  
On the theme of growing dividends, our U.S. Dividend Growth focused mandate has been living up to its name! From July 2020 to July 2021, the 22 businesses in that mandate have grown their dividends an average of 13.7%.  
Finally, we own two U.S. businesses that can actually benefit from inflation. Visa and Mastercard are payment processors – they collect transaction fees every time you tap or swipe your card. If all your bills go up because of inflation, so do Visa and Mastercard’s revenue. The companies have no additional costs associated with the added revenue, so inflation can actually be profitable for these two world-class businesses. 
For our Global holdings, Ashtead Group has been leading the pack. Through its ownership of Sunbelt Rentals, Ashtead Group is a global leader in equipment rentals, renting everything from heavy earthmoving equipment to scaffolding, to Acrow (specially built modular steel bridging), and everything in between. The Company can support projects from residential home building to massive infrastructure projects, as well as providing equipment for large events such as concerts and music festivals. Ashtead Group has a huge global market share – it is the number one or two equipment rental company in Canada, the U.S., and the U.K.

In the short term, Ashtead Group is benefitting directly from the construction and home building boom, specifically in the U.S. They are seeing stronger demand in their Events segment, as group gathering limits are removed and large events are happening, with many more planned for the future. In the longer term, Ashtead Group is very well positioned to benefit from growth in global infrastructure projects. We are excited about what’s to come for the Company.
Finally, we own many other companies that are benefitting from the construction boom in both the short and long term, such as Techtronic Industries (TTI). TTI produces a range of high-quality tools and products from brands such as Ryobi, Milwaukee, and Hoover. These are critical to the homebuilding industry, as well as the Do-It-Yourself segment – both of which have been booming. 

As these firms benefit, they are sure to see growing earnings as we move forward – a key tool to managing inflation.
The fixed income story of 2020 was the big shift away from floating-rate notes into high-yield bonds that were deeply discounted. The big shift was driven by a unique opportunity – as Covid took hold and markets sold off, credit spreads (the premium paid to investors for buying high yield bonds instead of government bonds) took off. We took advantage of this by aggressively buying high-yield bonds because we were paid to do so. This big shift worked out incredibly well, resulting in a 2020 return of +21.9% for the Canso Corporate Value Mandate.

Now, as we enter the third quarter of 2021 amidst global re-openings, economic recoveries, and the onset of inflation, market conditions have changed. Those credit spreads have now narrowed – investors are not being compensated as generously for owning high-yield bonds. As these conditions shift, so do our holdings. Recently, we have reduced the high yield weighting from 80% to 60% to protect client capital.
As mentioned above, increasing inflation eventually leads to rising interest rates. When interest rates rise, most bond prices fall. This is essentially because a 30-year bond paying 1% interest becomes much less attractive to own when you can buy the same 30-year bond paying 2%. This is known as interest rate risk. Floating Rate bonds have no interest rate risk because as interest rates rise, the interest rate paid by the Floating Rate bond also rises. Much of the funds moving out of high yield bonds have moved into Floating Rate Notes for exactly this reason.
Given the recent shifts, you can have complete confidence your fixed-income dollars are well-positioned for 2021 and will continue to shift as markets do.   
Gregg Filmon, MBA, CIM,

Gregg Filmon | President
t: 204-949-1723