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Geopolitical conflict and rising inflation dominated the discourse throughout 2022, leading to financial market turbulence. Yet the world economy continued to grow as the pandemic transitioned to its endemic phase. At Letko Brosseau, colleagues reunited back at the office for the first time in over two years, in-person meetings took place, and domestic and international business travel resumed.
There is much debate regarding the trajectory of the global economy, and we acknowledge that the current environment is beset by uncertainty. However, we remain cautiously optimistic. The portfolios are reasonably valued and well diversified. We continue to advise patience in the face of volatility. As we pause and reflect on the highlights of the prior year, we also take this opportunity to share with you our expectations for 2023.
Following a robust economic rebound in 2021, the past year began with expectations of a return to post-pandemic normalcy. Putin’s invasion of Ukraine in February, however, triggered the largest refugee crisis in Europe since World War II and sent economic shockwaves throughout the world. The conflict drove food and energy prices higher and caused headline inflation to reach levels not seen in 40 years. Meanwhile, rising wages and low unemployment led to continued robust demand. This confluence of factors brought an end to the era of extremely loose monetary policy. The Bank of Canada and the Federal Reserve initiated the fastest pace of monetary tightening in their history, hiking benchmark interest rates from near-zero levels to 4.25%. Other global central banks followed suit.
In 2021, we wrote about the impact ultra-low interest rates have on inflating the prices of certain assets. Exceptional monetary policy measures over the past decade, amplified by stimulus injected during the pandemic, led to record-high bond valuations. In addition, we pointed out that the use of low discount rates to value company earnings expected long into the future was a major reason for some stocks reaching elevated multiples. As interest rates began to climb, long-duration bonds, excessively valued stocks, and speculative investments, such as cryptocurrencies, suffered massive declines.
Our investment strategies held up well during a year marked by volatility, in large part due to our exposure to commodity and defensive sectors, shorter maturity fixed income securities, and the avoidance of companies trading at rich valuations.
Based on our long-held view that interest rates were significantly and artificially depressed, we eliminated our exposure to long-term bonds over the last decade. We believed yields would inevitably rise and bonds had virtually no chance of ultimately delivering returns above the low rates they offered. We, therefore, substituted this exposure with shorter-maturity bonds. Despite our short duration, our overall bond returns have beaten the index by a significant margin over the last 1, 2, and 3 years and outperformed over 5- and 10-year periods. Our strategy contributed positively to the performance of our balanced portfolios by successfully protecting them from the significant recent losses seen in long-duration fixed income securities. This conservative approach also allowed us to overweight equities which have performed much better than bonds over the last 15 years.
Total returns of most market indices were negative in 2022: the S&P 500 total return was -12.2% in Canadian dollars, the S&P/TSX -5.8%, MSCI World Index -12.2%, FTSE Canada Universe Bond Total Return Index -11.7%, and MSCI Emerging Markets -14.3%. During the same period, our portfolios saw considerably less volatility than market indices and delivered returns well ahead of their respective benchmarks: Canadian Equity (1.0%), Global Equity (0.2%), Global Balanced (-1.0%), and Emerging Market (5.7%).[i] Of note, the RBC Investor & Treasury Services Pooled Fund Survey, an independent survey of funds available to Canadian institutional investors, ranked our Emerging Markets Equity Fund in the first percentile for each of Q3 2022, 1-year, 2-year, 3-year and 10-year performance periods, among a pool of 30 other emerging market funds.
In an aim to provide our clients with an informed perspective on our portfolio strategy and other financial market topics, we enhanced the depth and breadth of our communications. During the year, we continued to release our monthly “Portfolio Update” letters and quarterly “Economic and Capital Markets Outlook” publications. In addition, we published topical research notes, including our wide-ranging Net Zero Research series, and launched the 2022 edition of our Investor Forum in September featuring Letko Brosseau portfolio managers. In the future, we plan to expand our digital communications with videos and webinars to keep you abreast of our views in a timely manner.
You may have noticed that Letko Brosseau appeared on the pages of the business news throughout the past year, voicing our position with respect to a worrying trend towards declining investment in Canadian public companies by domestic pension funds. In 1990, Canada’s pension plans allocated around 28% of their total assets to Canadian publicly traded equities and by 2020, this figure had dropped to around 4%.
This development is not healthy for our country’s economic well-being. We believe the first step to remedying this issue is awareness. As such, we formally launched our Invest in Canada campaign in the first quarter of 2022.
We contacted politicians, the leadership teams of Canada’s largest companies, think tanks, journalists, professors, union heads, and other community and business leaders to highlight this troubling trend. Canada is rich with opportunity, with favorable demographics, a tolerant, well-educated and diverse population, an expanding economy with moderate debt levels, abundant natural resources, modern infrastructure, and world-renowned educational institutions. We passionately believe Canada is a great place to invest and it is time that Canadians’ savings play their proper role in forging Canada’s future.
In addition to advocating on domestic issues, we ensure that our portfolio companies behave with the highest standards with respect to environmental practices and social issues. Sustainable investing is seamlessly integrated into our research process, and our portfolio managers are leading the charge on environmental, social and governance (ESG) issues. As such, we are signatories of the United Nations Principles for Responsible Investment (UNPRI), an international network of investors working to support responsible investment practices through the incorporation of ESG factors into investment decisions. As a UNPRI signatory, we are required to report on our responsible investing practices annually. We were delighted to receive our latest assessment report from UNPRI which showed an overall score of 85%. Our assessment in each of the three individual areas evaluated by UNPRI, together with the median score from all reporting UNPRI signatories from around the world, was: Investment & Stewardship Policy 87% (60% median score), Incorporation of ESG Principles in Listed Equity Investing 95% (71% median) and Proxy Voting 64% (54% median).[ii]
On the client services front, we successfully launched a secure client portal at the beginning of 2022. Clients now have access to an online platform that allows them to access information about their accounts, including the ability to consult balances, view transactions, details of their investments and their portfolio’s evolution. We are committed to adding new features to the portal that will enhance the client experience. Most notably, we aim to give clients the ability to access their statements directly on the portal in the months ahead. If you have not already activated your client access, we invite you to contact your client servicing team.
As we detail in our latest Economic and Capital Markets Outlook, the ongoing monetary policy tightening cycle remains the main factor behind a weaker global economic outlook entering 2023. Nevertheless, inflation has begun to trend downward in several major economies, a sign that policy rates may be nearing the terminal point of this current cycle. While we acknowledge the world economy is on a slowing trajectory, the balance of risks differs across regions. The economies of the U.S. and Canada remain resilient, largely due to strong labour market fundamentals and accumulated household savings. Europe is at a higher risk of recession than other regions due to the continued negative effect of the war in Ukraine on energy prices. Elsewhere, China’s relaxing of COVID-19 restrictions will provide a meaningful boost to domestic growth, with positive spillovers on the global economy. On balance, emerging market growth is expected to remain broadly stable in the year ahead.
We recently took the opportunity to shift some of our fixed income exposure to high-quality corporate bonds as yields rose above 5%. However, within balanced portfolios, our investment strategy continues to favour equities over fixed income securities. Our global equity portfolios trade at attractive valuations of only 9.8 times 2023 earnings and offer an average 3.7% dividend yield. We are confident that our investment approach, which emphasizes companies chosen for their strong business franchises, top management, growth characteristics and sensible valuations, will continue to generate value over the long term. As a firm, we have remained disciplined in our approach in all economic cycles, even during periods of market dislocation. Since 1988, the first full year of data following the firm’s inception, we have generated a compounded annual return on total assets of 11.3% for investors. This is equivalent to C$34.3 billion in cumulative gains, roughly comparable to the market value of Manulife, a leading Canadian insurance company.[iii]
As noted above, we aim to continue providing clients with an informed perspective throughout the year. As such, we are excited about the release of the next installment of our Net-Zero Research Series which is scheduled for Q1 2023. In this second report of the series, we will explain the main sources of emissions from electricity generation, the technologies that exist today to reduce these emissions and the solutions required for the utilities sector to transition to net-zero by 2050.
On the business initiative front, we are launching an expansion of our emerging market strategy to the U.S. institutional market. This will be undertaken in partnership with Arrow Partners, a New-York based third-party marketing firm, whose strong track record and distribution network will greatly facilitate our penetration of the U.S. market. Having ranked in the first percentile for emerging market performance in the most recent RBC Investor & Treasury Services Pooled Fund Survey, we believe this is an opportune time to establish this partnership and offer our emerging market strategy to U.S. pension plans and endowment funds.
On a final note, we are delighted to announce that Letko Brosseau’s Board of Directors welcomed two new members, Mr. Jean Gattuso and Ms. Nathalie Francisci, increasing the total number of directors to seven.
Mr. Gattuso spent 34 years at Lassonde Industries Inc., a Canadian agri-food company, where he assumed the role of President and Chief Operating Officer in 2004. Under Jean Gattuso’s stewardship, Lassonde grew revenues from $250M to $2B in 2021 and became a leader in the manufacturing and marketing of juices, drinks and specialty foods in North America. He is also co-president of Transport Canada’s Supply Chain Task Force.
Ms. Francisci is the Executive Area President, Eastern Canada at Gallagher, one of the world’s largest insurance brokerage, risk management and consulting firms. She brings more than 25 years of experience in executive search and talent management to Letko Brosseau. Ms. Francisci is also a board member of Innergex.
We are confident their wealth of knowledge and experience will be a valuable addition to our firm.
We thank you for entrusting us with the responsibility of investing on your behalf.
All of us at Letko Brosseau wish you and your families joy, good health and prosperity in the new year.
SENIOR VICE PRESIDENT
VICE PRESIDENT - INVESTMENT SERVICES
VICE PRESIDENT - INVESTMENT MANAGEMENT
VICE PRESIDENT - INVESTMENT MANAGEMENT
VICE PRESIDENT - OPERATIONS AND CFO
[i] Performance results reflect the reinvestment of dividends, income and other earnings and are presented net of all foreign withholding taxes. Reclaimable withholding tax refunds are recognized when received. The benchmark is fully invested and its returns include the reinvestment of dividends, income and other earnings and are presented net of withholding taxes. Performance results are presented before management and custodial fees but after trading commissions.
Composites and benchmarks information:
[ii] Additional details on the three individual areas evaluated by the United Nations Principles for Responsible Investment (UNPRI):
[iii] Represents the net gains on all assets for all mandates under management from January 1, 1988 to December 31, 2022.
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The information and opinions expressed herein are provided for informational purposes only, are subject to change and are not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. There is no representation or warranty as to the current accuracy of, nor liability for, decisions based on such information. Any companies mentioned herein are for illustrative purposes only and are not considered to be a recommendation to buy or sell. It should not be assumed that an investment in these companies was or would be profitable. Unless otherwise indicated, information included herein is presented as of the dates indicated. While the information presented herein is believed to be accurate at the time it is prepared, Letko, Brosseau & Associates Inc. cannot give any assurance that it is accurate, complete and current at all times.
Where the information contained in this presentation has been obtained or derived from third-party sources, the information is from sources believed to be reliable, but the firm has not independently verified such information. No representation or warranty is provided in relation to the accuracy, correctness, completeness or reliability of such information. Any opinions or estimates contained herein constitute our judgment as of this date and are subject to change without notice.
This presentation may contain certain forward-looking statements which reflect our current expectations or forecasts of future events concerning the economy, market changes and trends. Forward-looking statements are inherently subject to, among other things, risks, uncertainties and assumptions regarding currencies, economic growth, current and expected conditions, and other factors that are believed to be appropriate in the circumstances which could cause actual events, results, performance or prospects to differ materially from those expressed in, or implied by, these forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements.
Past performance is not a guarantee of future returns. All investments pose the risk of loss and there is no guarantee that any of the benefits expressed herein will be achieved or realized.
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