Storm Clouds On the Horizon: What Asset & Investment Managers Are Preparing For
We believe everyone by now knows that inflation has seeped into the economy, shortages of certain manufactured goods persist, interest rates are rising, and as a result, the equity markets have soured after two years of incredible growth. With that as the backdrop, we reached out to a number of our investment and asset managers to hear about how these conditions are affecting their funds and what they are doing in response. Spoiler Alert: it’s not all bad, but it may get worse before it gets better.
What impact has inflation had on your business / fund(s) / portfolios? What, if anything, are you doing organizationally to adjust to it?
“Inflation has been a challenge as we have experienced rising construction across all real estate development projects. The cost of delivering new buildings today is equal to the market price from just two years ago. Thus far, rents have generally risen by more than enough to keep up with rising construction costs. We are concerned about how much more rents can rise in the multi-family sector before tenants are priced out without wage inflation. We are including larger contingencies in budgets and being hypersensitive to current market news regarding lease rates in competitive projects.” – John Courtliff, CEO, ICM Asset Management
“Invico Diversified Income Fund (“IDIF”) has a target allocation of 30-50% to energy working interests and royalty positions and, as at the end of Q1 2022, an actual allocation of 38%. This direct exposure to commodities acts as a natural hedge against inflation. For our fund our energy exposure has helped combat the inflationary pressures, and economic constraints felt in the marketplace. Due in part to the continued strength of North American energy fundamentals and the portfolio’s exposure to oil and gas production, IDIF announced an additional distribution for unit-holders of record as at March 31, 2022, and will continue to provide additional distributions above our regular payments based on energy revenues being maintained at or near current levels. IDIF hopes to continue to provide an ongoing hedge against inflation for unit-holders and provide additional income through the foreseeable future. Lastly, IDIF has implemented further hedges on our energy assets through the end of 2023 as a means of prudent risk management to ensure we can make distributions in excess of it’s hurdle rate. As such, we anticipate this will allow further additional distributions in 2022.” – Jason Brooks, President, Invico Capital Corporation
“Inflation has had an indirect positive impact on the Pavilion portfolios. Large parts of the mining and minerals Flow-Through portfolios are in the “battery metals” space which has been a source of inflation. Another large part our portfolios is in the precious metals space which is an area that is traditionally considered to be an inflation hedge.” – Dan Pembleton, CEO, Accilent Capital Management, Pavilion Funds
What impact does rising interest rates have on your business / fund(s) / portfolios? What, if anything, are you doing organizationally to adjust to it?
“This is generally positive for the opportunities we provide financing on, given that traditional bank loans are becoming more expensive. In fact, the spread between our target loans with interest rates greater than 10% and bank terms we are seeing in the marketplace has never been this narrow. In addition, with the rise of interest rates, our investment team is negotiating floating rate loans when underwriting new opportunities, which will generate additional yield as rates continue to rise.” – Jason Brooks, President, Invico Capital Corporation
“Heading into 2022, we not only decided to increase our cash allocation to protect our portfolios against rising interest rates, but held the duration on our fixed-income holdings lower than the benchmark to limit the impact of rising interest rates. This lower duration provided our portfolio with better relative performance as shorter duration assets work as natural protection in such an environment.
With short term lending rates rising, money markets are finally offering a more meaningful yield as for a long time this offered very little return. We are using an ETF strategy to earn a yield on our cash holdings while maintaining a high degree of liquidity and safety. This strategy will increase cash yield as the Bank of Canada confirms the expected interest rate hikes.” – Jay Bhutani, President, Raintree Wealth Management
“So far we haven’t seen a tremendous impact on our private businesses held in the portfolio. We offer a very good yield to our investors and have a large built-in spread between what is offered and what the portfolio generates in earnings. However, we have started to work towards lower purchase prices on our new acquisitions and/or basing more of the purchase price on an earn-out arrangement to spread our risk to be shared with the vendors. Further, we have just arranged a $100 million financing at a fixed yield so we are comfortable with increased rates in the market.” – Brad Nathan, President, Lynx Equity Ltd.
Are you concerned about an impending recession? What, if anything, are you doing organizationally to prepare for it?
“We are managing on the portfolio on the basis that an impending recession is likely. Within our lending portfolio, we are careful not to extrapolate recent increases in land values and historically high commodity values well into the future. We are being conservative on both fronts to maintain a strong margin of safety within the security position of our portfolio of loans and by using normalized operating margins in financial projections. From a Macro perspective, there are several positive influences that provides a level of protection to Canadian Agriculture including the non-discretionary nature of the demand for agricultural outputs (food) and strong government support (both domestically and internationally). We believe, these factors provide some insulation to full impact of a potential recessionary period.” – Shawn Bustin, President, Agriroots
“We are mindful that inflation and interest rate hikes may lead the economy to recession. Our portfolios included strategies with low correlation to the overall markets, such as long/short and multi-strategy funds that can generate positive returns despite declining equity returns. This lower correlation can offer protection if worsening economic conditions transpire. This portfolio strategy has already contributed to lowering the volatility of our funds and limited drawdowns in times of market stress.” – Jay Bhutani, President, Raintree Wealth Management
“Concerned, not yet. Paying close attention, absolutely. In commercial real estate, we feel that services/experiences remain in demand and that there is still pent-up demand among consumers in the wake of the pandemic. Whether this will be sufficient to counteract the decline in demand for goods and the accumulation of inventories remains to be seen. With recent dispositions of real estate assets in our portfolio, the fund is cash rich. We intend to be opportunistic with upcoming acquisitions and ensure that we retain a higher cash balance in the event that the outlook becomes gloomier and we either need the cash for our existing portfolio or to acquire opportunistically in a changing market environment.” – John Courtliff, CEO, ICM Asset Management