Middlefield Canadian Income (MCT) has announced its annual results for the year ended 31 December 2020, during which it outperformed its benchmark, despite the chaotic market conditions. During the year, it provided NAV and share price total returns of -7.2% and -2.3% respectively, both of which are ahead of its benchmark’s return of -8.5%. MCT increased its exposure to select Canadian-listed securities during the second half of the year and finished with approximately 85% of its investments allocated to Canada. MCT’s manager says that the Canadian economy entered the pandemic from a position of strength, which has helped support bold policy responses to protect businesses and consumers.
The Canadian response to COVID
In November 2020, the Canadian federal government announced it will spend $100 billion to help the nation recover from the pandemic – the largest economic relief package since the Second World War. The wide-ranging plan includes targeted relief for hard-hit business sectors, investments in the healthcare sector and distribution of vaccines. The vaccination rollout is advancing with Johnson & Johnson’s becoming the fourth to receive approval from Health Canada, prompting the Province of Ontario to accelerate its timeline for administering at least one dose to all willing citizens by June.
MCT’s manager says that the government’s fiscal stimulus measures are further supported by the attractive structural characteristics of the Canadian economy. Canada’s banking system is well-capitalized and has proven resilient over previous economic crises as well as the COVID-19 pandemic. The manager also comments that Canada possesses a highly educated work force and is home to one of the world’s most robust information technology industries, and that the TSX has become much more diversified over the past 10 years. For example, Energy and Materials, in aggregate, currently represent 25% of the TSX compared to 47% in 2010. Over the long-term, the manager believes that Canada will benefit from increased economic diversification and an increase in immigration.
Biden – a major shift in US politics
MCT’s manager says that the election of Joe Biden as US President represents a major shift in US politics. It says that the new Administration has made an early impact, passing a U.S.$1.9 trillion coronavirus relief bill which includes extra unemployment benefits, rental assistance, COVID-19 vaccination funds and direct payments. Biden is calling this the “first step in a two-step plan to build a bridge to the other side of the crisis.” The second step will involve major investments in infrastructure, with a particular focus on clean energy. While Democrat control raises the possibility of more regulation and higher taxes to fund these initiatives, MCT’s manager expects the presence of a number of independently minded senators on both sides of the aisle will mitigate the risk of sweeping tax and regulatory changes.
MCT well positioned to benefit from the economic rebound in 2021
MCT’s manager says that, notwithstanding its focus on high-quality dividend paying entities, MCT is well-positioned to benefit from a rebound in global economic activity in 2021 while providing some stability against potential market volatility. It says that sectors and industries that underperformed in 2020 as a result of strict lockdown measures and travel restrictions should perform well as the world moves past the pandemic. Real Estate and Financials, the two largest sector weights in the portfolio, experienced outsized negative impacts from the pandemic in 2020 and significantly lagged the broader market. The manager views both sectors as attractive in 2021 due to their high dividend yields and potential for substantial capital appreciation.
Manager’s view on real estate
The manager says that the Canadian Real Estate sector generated a total return of -8.7% in 2020, reflecting the extremely challenging and unpredictable operating environment for many property owners. However, the returns within the various sub-sectors varied widely. Retail and office REITs generated total returns of -21.3% and -26% due to forced store closures and mandatory work from home orders. In contrast, industrial REITs, whose tenants include logistics and distribution companies, generated a total return of 13.8% during the year as a result of the growth in E-commerce. The manager says that industrial REITs should continue to benefit from steady rental rate increases in 2021 and beyond due to the ongoing adoption of E-Commerce and the mounting imbalance between growing demand and limited supply of new warehouse space. While MCT continues to hold industrial REITs, the manager has recently increased its exposure to more cyclical real estate issuers. Many well-capitalized, high-quality retail REITs focused on suburban open-air shopping centres continue to trade at significant discounts to their net asset values, despite near-perfect rent collection, robust development pipelines and success in renewing leases at higher prices. Due to the arrival of multiple highly effective vaccines, together with a low interest rate environment and ongoing government stimulus, MCT’s manager expect these companies to outperform with the recovery in economic activity.
Increased exposure to financials
In Q2 2020, MCT’s manager began to gradually increase its exposure to Financials as it became apparent that Canadian households would largely emerge from the pandemic on a solid footing. From approximately 10% of the portfolio in April, Financials finished the year representing nearly 30% of the Fund, making it the second largest sector weighting behind Real Estate. In light of their relatively high capital ratios, low payout ratios and discounted valuations, the manager concluded that Financials were an extremely attractive way to leverage the expected growth in economic activity. This thesis began to play out in the latter part of the year as the Canadian Financials sector generated a total return of 16.7% during the fourth quarter, led by core portfolio positions such as Bank of Nova Scotia (+26.4%), Bank of Montreal (+26%) and Toronto Dominion Bank (+18.1%). Canadian banks beat estimates by an average of 17% in the final fiscal quarter of 2020, driven primarily by ongoing performance in their capital markets and wealth management businesses. The manager says that it remains positive on the sector given the relatively elevated levels of household savings as well as the steepening of the yield curve which should support the profitability of their loan book.
Utilities – the third largest weighting
Utilities finished the year as MCT’s third largest sector weighting. Its exposure to the sector is concentrated in companies focused on renewable power generation, which the manager says provides both high levels of income and the potential for capital appreciation. BloombergNEF, a research organization dedicated to the energy industry, expects more than $35 trillion in clean power investments by 2050, making this a very attractive investment sector over the long term in the manager’s view. It says that Canada is home to several world-class renewable power producers, including Brookfield Renewables (BEP), which has installed capacity of more than 20 gigawatts (GW) across five continents and is planning to build 1GW of new capacity every year. BEP generated an impressive total return of 79% in 2020 and was one of the Fund’s top performing stocks. Northland Power (NPI), one of the Fund’s long-held core positions, generated a total return of 73%. NPI is the world’s fourth largest offshore wind company by installed capacity and plans to more than triple its generation base by 2025. The manager says that, notwithstanding risks such as rising interest rates and increasing competition for renewable power projects, the long-term growth prospects for Canadian renewable power producers remains extremely attractive.