In Q4, the Picton Mahoney Fortified Income Fund Cl F returned 0.87% and the Picton Mahoney Fortified Income Alternative Fund Cl F also returned 0.87% underperforming the blended benchmark composed of 75% ICE BofAML Global High Yield Index / 25% ICE BofAML Global Corporate Index (TR) (Hedged to CAD). Defensive positioning and portfolio hedging were the primary drivers of the underperformance in the quarter. This positioning benefited the portfolio (Picton Mahoney Fortified Income Alternative Fund Cl F) on the year with 9.2% outperformance against the benchmark.
During the fourth quarter, we saw tremendous volatility across asset classes as the market began pricing in the peak in inflation and an eventual pause and pivot from the U.S. Federal Reserve (the Fed). The government bond market was violently flat as the U.S. Ten Year Treasury yield was only up 4 bps at the end of the quarter, but traded in a 93 bps range from the October 21st highs to the December 7th lows.
Risk assets including corporate bonds performed very well during October and November and then gave back some performance in December as global central banks reinforced a hawkish tone. Despite the Fed’s messaging, the interest rate market is pricing in a terminal rate of just below 5% and ~50 bps of rate cuts in the second half of 2023. There seems to be inconsistency with the level of optimism implied by equities and credit spreads while monetary policy remains uncertain and the rate market appears to be pricing in a higher chance of an economic slowdown.
We continue to observe some encouraging signs of inflation rolling over, however we also see a risk that the Fed would rather be a quarter too late instead of a quarter too early and therefore may need more conclusive evidence of inflation coming down before we get a more substantial shift in policy stance. Global central bank policy, particularly Japan, also remains uncertain.
Despite the macroeconomic risks, with yields on corporate bonds at March 2020 levels and trading at the highest level since 2009, there is a compelling opportunity to buy high-quality short duration credit. However, given the uncertainties, we believe it is critical to maintain a hedged long/short approach as we enter 2023.
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