Markets continued to rally in April, supported by better-than-expected Q1 earnings. The Fund’s NAV generated a total return of 1.9%, beating the TSX Composite and benchmark returns of 0.8% and 1.8%, respectively. The British Pound appreciated 2.2% relative to the Canadian dollar, weighing on returns to U.K. investors.
Cyclical and value sectors represent the majority of the Fund’s portfolio. Despite technology and growth stocks outperforming in recent months, we believe the longer-term outlook for the Fund’s core investments remains attractive. We have entered a period of higher inflation and higher interest rates which bodes well for companies that can continue to grow their earnings and dividends. The current setup has similarities to the early 2000s – the aftermath of the dotcom bubble when inflation was elevated, rates were rising and the TSX Composite outperformed the S&P 500 in eight out of ten years.
Canada’s growing tech sector is making it an increasingly attractive country for investment as the Toronto-Waterloo corridor has grown to become the second largest tech hub in North America, trailing only Silicon Valley. The country’s world-class universities, such as the University of Waterloo and the University of Toronto, continue to attract foreign students from around the world and serve as a breeding-ground for top tech talent. Many large U.S. tech companies, including Microsoft, Google and Apple, have opened large offices in Toronto to capitalize on the growth. Although MCT does not own any technology companies directly, its holdings are benefiting from the spillover effects of tech’s rise. These include attracting skilled workers, foreign direct investment, and growing consumer demand.
We expect interest rates to remain near current levels over the next several quarters with the Bank of Canada neither hiking nor cutting short-term borrowing rates. The Bank of Canada expects Canadian inflation to reach c. 3% by mid-2023 and return to its 2% target by 2024. Lower interest rate volatility should support Canadian equities, particularly in sectors that have been impacted by the rising rate environment.
Real estate continues to be a large overweight exposure and is a sector where we have strong conviction. Unlike US REITs, where fears of credit losses and loan defaults are elevated, debt and liquidity levels remain very healthy. In Canada, commercial real estate (CRE) lending is dominated by well capitalized large banks, life insurance companies and pension funds which compares to the US where loans from regional banks and commercial mortgage-backed securities are more common. After a muted 2022, debt issuance by real estate companies accelerated in Canada during the first quarter with unsecured debentures issued totalling CAD$1.4 billion. In addition, we believe the main concerns with CRE relate to the office market and the Fund is not invested in any office REITs. Having said that, office properties in Canada are largely concentrated in well capitalized pension funds, life insurance companies and global private equity firms. These owners are very disciplined in their leasing discussions due to their long term investment horizons. As a result, Canada is not likely to experience the level of distress in the office sector currently occurring in the US. It is important to note that other property types, including our core exposures to industrial, multi family and grocery-anchored retail continue to be on very solid footing with Q1 2023 results either meeting or exceeding estimates.
