I hope you are all coping well with colder weather and shorter days! The third quarter of the year has wrapped up, and markets have largely been positive. That said, inflation fears are becoming more real every day, so we can’t take our eye off the ball.
In this Issue:

  • Markets – Realizing Inflation Fears 

  • Canadian Equities – Capturing the EV Transition

  • U.S. Equities – Game on!

  • Global Equities – Producing What the World Needs
  • Fixed Income – Balancing Two Key Risks

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The dominant theme markets are focused on this quarter continues to be inflation. We have been discussing the onset of inflation throughout the year and the data continues to show it is here, with Canadian monthly inflation hitting 4.1% at the end of September – levels not seen since the early 2000s. We don’t expect this to change going forward – continued economic stimulus combined with pandemic-related supply chain issues are increasing costs to consumers, meaning inflation is here to stay for some time and will likely continue to increase. 
Inflation can’t be avoided – it affects equity markets, fixed income markets, and makes your cash worth less every day. That said, some investments are hurt by inflation more than others. Some key things to avoid in an inflationary environment: 

  • Companies with a large debt load, 
  • Companies that don’t have pricing power, 
  • Companies that aren’t currently profitable, 
  • Long-term government bonds. 
To manage inflation, we need to focus on companies that can pass increasing costs on to customers without losing market share. Doing so insulates a firm’s profits from inflation, which can then be passed on to investors in the form of dividends. Growing your dividend stream is one of the best things you can do to make up for everything in the world becoming more expensive. 
For a deeper dive on how to position your portfolio for an inflationary environment, continue reading below. 
One theme we have talked about a lot (and will continue to talk about going forward) is companies that are well-positioned to help build the future and benefit from major global shifts, all while making money today. This is always an important concept when analyzing businesses, but it’s that much more important in difficult markets, such as one facing significant inflationary pressures. 

One Canadian Company is consistently a phenomenal example of exactly this: Magna International.
Making Money Today
Magna is an automotive parts manufacturer with facilities all over the world, building an entire range of parts from door handles to electric powertrains and performing complete vehicle assembly. They supply nearly every automaker in the world and have the manufacturing expertise to assemble complete vehicles from well-established automakers like Mercedes-Benz and BMW, as well as for newer entrants like Fisker. 
Building The Future
The world is moving towards electric vehicles and this trend is being increasingly accelerated by government legislation globally. Magna stands to benefit from this for multiple reasons. They build components for Internal Combustion Engine (ICE) powered vehicles, as well as complete drivetrains for Electric Vehicles (EVs). The switch to electric vehicles won’t occur overnight – the middle ground in the transition away from ICEs and towards EVs is Hybrids. And you guessed it – Magna builds hybrid drivetrains and components as well.
On top of that, Magna builds an entire range of products that are “Powertrain Agnostic”. Whether your car is internal combustion-powered, a hybrid, or electric, you still need components like seats, lights, body panels, door handles, mirrors and parking sensors. Magna builds a whole range of products that are necessary for all types of vehicles.  
As the world moves towards Electric Vehicles, Magna is extremely well-positioned to benefit from every step of the transition from ICEs to EVs. Finally, Magna doesn’t care who wins in the electric car industry – they supply everyone. Between their wide range of products and massive customer base, Magna remains a great example of a business that is positioned to build the future AND make money today. 
When entering an inflationary environment, it’s essential to own growing businesses in growing industries. 
As an overall industry grows, it can provide a tailwind for the existing leaders in that space. One great example of this is the Gaming Industry. Believe it or not, the Gaming industry is now bigger than the movie and music industries combined. Not only is it currently larger, but it’s also growing faster!  
Trends Driving The Growth
There are several trends benefitting the growth of the Gaming industry. Covid provided a predictable boost, but other factors are going to continue driving growth: 
Next Generation Consoles
We have come a long way when it comes to the computing and processing power of gaming consoles, and the latest generation consoles (the Microsoft Xbox Series X and the Sony PlayStation 5) are the most powerful ever sold. To take advantage of the new, more powerful consoles, customers need to buy new games that are optimized to take advantage of the new power. Companies like Activision Blizzard and Electronic Arts have been investing heavily in these new games over the past few years. Much of the development has now been done, but the game makers are just about to start seeing profits flow as the new games are released. 
E-Sports is currently a $1.5 billion industry and rapidly growing. In 2020, there was a 70% increase in the number of eSports viewers in the US, with viewership predicted to hit 26.6 million monthly e-sports viewers in the U.S. this year. This trend existed pre-covid – The 2018 “League of Legends” World Championship held in Korea drew in over 100 million viewers – more viewers than the Superbowl! Gaming and eSports are truly global, and with multi-million-dollar prize pools, attention is being paid to eSports all over the world. The growth in eSports provides new ways for game makers to earn revenue – through media rights, ticket sales, sponsorships, and advertising deals.
Growing Profits
For those who play (or whose kids play), you’ll know that the spending doesn’t stop once you’ve purchased a game. Game makers have been expanding the way they can extract revenue through their games, primarily through
subscription models and microtransactions. Microtransactions are small add-ons that can be purchased in-game to give the user special abilities, added features or new content. Microtransactions are often only a few dollars but are frequently sold in bundles that can add up quickly.

Subscriptions allow players to pay a regular fee to access games, live competitions, and additional content. Microtransactions allow users to purchase virtual items for small amounts of money. Often, these items are bundled together and required to purchase if players want to advance or be competitive in a game. These microtransactions are now included in virtually every new game, and are a major driver of revenue, especially on mobile apps.
The Titans Of Gaming

Our U.S. and Global portfolios own some of the absolute industry leaders:

  • Microsoft
  • Electronic Arts (EA)
  • Nintendo 
  • Activision Blizzard
These are dominant businesses in a rapidly growing industry and well-positioned to provide continued growth, even in an inflationary environment.  
One way to manage inflation risk when buying companies is to own dominant producers of products the World just can’t live without. Some recent additions to our Global Portfolio are great examples of companies doing exactly that: 
Cementing Future Growth
One product the World simply cannot live without is cement – one of the most used building materials on the planet. Holcim, a recent addition to our Global Portfolio, produces more cement than anyone else globally. Each year Holcim produces over 415 million tons of concrete – that’s enough to build 52 Hoover Dams every year! The Swiss company has an over 100-year track record of executing massive infrastructure projects, including the construction of the Suez Canal in Egypt.
Beyond leading the world in cement production, Holcim produces some of the cleanest cement in the world. Holcim is a leader in the decarbonization of cement – drastically reducing emissions by creating concrete recycled from rubble that absorbs carbon in the production process. Holcim is targeting net zero emissions by 2030. Given the projected increase in post-covid global infrastructure spending and increasing environmental standards, Holcim is very well positioned to manage inflation by generating future growth. 
Powering a Greener Future
Another good example of something the world needs, and where demand is increasing dramatically is Renewable Energy. Not unlike the transition to electric vehicles, this significant global shift is backed by strict government legislation all around the globe. Individual governments have set increasingly aggressive carbon reduction targets, and entire industries are making net-zero carbon pledges.

In order to deliver on these big promises, the world needs to generate more power from renewable resources, and that’s exactly what the Italian company Enel is doing. Enel is currently the largest developer of renewable power in the world and is at the forefront of the transition to clean and renewable energy. It is truly a global business, selling gas and electricity to more than 70 million customers, in 50 countries, across 5 continents. Enel powerplants generate electricity using:
  • Wind 
  • Solar 
  • Geothermal 
  • Hydroelectric 

Enel is the global leader of a rapidly growing industry that the world just can’t live without. This is a great example of a business that will be able to grow far faster than the rate of inflation for decades to come. 
We know inflation is here, and we also know inflation will eventually lead to higher interest rates. Market-set interest rates, set by investors buying and selling bonds such as the 10 Year U.S. Treasury Yield, have already begun to rise – a sign that benchmark rates (set by central banks, like the Bank of Canada or the Federal Reserve) will also rise at some point in the future. These rising rates have already had a negative impact on many bonds, as evidenced by recent performance.
When rates rise, 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. Some bonds are more exposed to interest rate risk than others. The bonds most exposed to interest rate risk are those often viewed as the safest – long-term government bonds. That means investors may be unaware that the “safest” portion of their portfolio is actually at risk. 
Managing Bonds in A Rising Rate World
One way to manage interest rate risk is to take none at all – by buying floating rate bonds. Floating rate bonds have interest payments that rise and fall with rates, so they don’t bear any interest rate risk. 

Another way to minimize interest rate risk is to take credit risk instead. Credit risk is the risk that the borrower (bond issuer) defaults on payments and can’t pay you back. Bonds with more credit risk tend to have much higher interest payments and shorter terms-to-maturity than government or floating rate bonds. This combination of a higher payment and shorter lending period results in less interest rate risk.  

To manage credit risk, we need to: 

  • Ensure the company has sufficient, reliable cash flow to make the loan payments.  
  • Demand significant collateral and other protective covenants to reduce the likelihood of default. 
  • Only take credit risk when we are adequately paid to do so! 

Good fixed income management requires a constant balance of both interest rate and credit risks. Recently, we have been adding to floating rate bonds to ensure our bond portfolios are well-positioned for an inflationary, rising interest rate environment. 
Gregg Filmon, MBA, CIM,

Gregg Filmon | President
t: 204-949-1723
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