NexC February Commentary

 Market Backdrop

February began with a continuation of the rally that started the year. However, political and policy uncertainty crept into the picture over the course of the month and drove a pullback in risk assets.

The steady economic improvement in the US prompted concerns of an early Fed exit from Quantitative Easing (QE), especially after a slightly hawkish read of the Federal Open Market Committee (FOMC) minutes. The impending sequestration deadline at the end of the month added to investor anxiety. Uncertainty surrounding the outcome of Italian elections coupled with weak GDP data across the Euro-zone caused sovereign yields to widen and European indices to underperform. China reported positive data prints, however the announcement of a liquidity drain caused a downdraft on fears that the People’s Bank of China would be less accommodative going forward. The US dollar rallied strongly, causing the Canadian dollar to weaken nearly 3%. Overt central bank actions to devalue domestic currencies prompted speculation of currency wars between nations. This was highlighted by the continued Japanese effort to weaken the yen in order to re-flate their economy. Finally, the commodity complex saw weakness highlighted by the sell-off in gold and oil on the back of stronger USD and a slower outlook for global growth.

Fund Commentary

After launching on Feb 20th, the NexC portfolio generated positive returns for the month of February. We purchased 40 dividend-paying equities to create the initial portfolio, of which 18 stocks were US-based and 22 were Canadian. The portfolio is diversified across 11 sectors, with Health Care and Materials slightly underweight and Financials slightly overweight, reflecting the availability of stocks that meet our dividend and fundamental quality criteria.

Over the course of the month, Telcom and Financials were the drivers of return. In the Telcom sector, BCE, Telus and Rogers all performed very well. In the Financial sector, Bank of Montreal and Great West Lifeco outperformed. Overall, Canadian market indexes outperformed US markets, and that tailwind was reflected by outperformance of our Canadian exposures. We experienced pockets of underperformance, particularly from weakness in tobacco names and idiosyncratic volatility in our Cablevision position due to higher than expected impacts from hurricane Sandy. Sector diversification and name diversification served us well in containing the drag from any underperformers.

The NexC portfolio is not utilizing leverage at this time. We will re-assess the use of leverage in coming months based on continued positive performance trends. We also expect to make use of covered call overwriting, but did not do so in February because we expected increased volatility and higher price levels that will provide a good entry point. The majority of US dollar currency exposure is currently hedged using forward contracts, but residual US exposure benefited from US dollar strength in February.

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