Identifier: Alternative

Stressed businessman feeling desperate on crisis stock market, investment concept.

Investors with a total return objective have historically been served well by the fixed income component of portfolios, such as a portfolio benchmarked to the FTSE Canada Universe Bond Index (the Universe Bond Index), which has delivered a reliable return experience and valuable diversification to more volatile equity investments.

The experience today for investors such asendowments, foundations, target benefit plans and capital accumulation investors has been vastly different with double-digit negative fixed income returns year-to-date to May 20, 2022. This has been the result of the combination of high duration (sensitivity to changes in interest rates) and significant increase in interest rates.

This article investigates how investors found themselves in this duration trap and what options are available to limit future downside experience.

Increased Interest Rate Sensitivity

With the multi-decade decline in fixed income yields investors had become accustomed to the implications for lower longer-term fixed income returns. However, as yields declined, governments and companies took the opportunity to significantly lengthen their bond maturities when issuing new debt. In doing so, they have contributed to the increase in the Universe Bond Index duration and associated increased sensitivity to changes in interest rates.

While it made sense for borrowers to seize the opportunity to reduce their borrowing costs and lock in certainty by extending the lending period, there were few compelling benefits for investors with a total return objective to own these securities, especially in a lower yield environment.

It is a different situation for investors with liability-related objectives, such as defined benefit pension plans. The resulting dynamics significantly increased the risk of negative returns in a rising interest rate environment. The math is simple: if a fixed income portfolio has a yield of 2% and the duration is 8 years, and interest rates across the yield curve rise 1%, then the portfolio value would be expected decline by 6% (not considering the merits of active management).

Desensitized

The initial response to lower yields was characterized by a “hunt for yield,” which included the consideration of a core plus fixed income component that incorporated an allocation to strategies such as high yield and emerging market debt, and in some cases dedicated allocations to higher yielding assets.

Lower yields also triggered the decision by investors to look beyond fixed income and introduce allocations to less-liquid private markets, such as commercial real estate and infrastructure. Taken together, while this has witnessed a general reduction to domestic fixed income, in many cases fixed income still represents a sizable portion of total assets.

Investors have also had to deal with the desensitization to rising interest rates. For many years “experts” have predicted a rising interest rate environment that did not unfold. The volume of such predictions has led to many investors dropping their guard with respect to the ensuing risk.

Investors are currently experiencing some of the toughest fixed income markets in history, which combined with challenging equity markets, has seen the value of total portfolio assets significantly reduce from recent highs following the strong post-pandemic returns.

Avoiding the Duration Trap

There is still uncertainty with respect to interest rates, so what can be done to limit further downside performance from fixed income?

There are several potential considerations:

  1. Absolute Return Focus. Fixed income strategies with an absolute return focus, where the investment manager has greater flexibility. The manager is afforded greater flexibility with respect to the duration range, the ability to adopt both long and short positions in securities, incorporate higher yielding below investment grade securities, or a combination of these. Some of these strategies have managed to broadly maintain a fixed portfolio’s capital value while the Universe Bond Index has experienced double-digit declines.
  2. Total Return Objective. An alternative to 1) above is to work with your fixed income investment manager to determine a target return considering current yield opportunities. Under this approach, the extent to which there is a willingness to experience some level of downside risk will influence the longer-term total return potential.

    For smaller-sized investors, the total return objective could be achieved by allowing the fixed income manager to invest opportunistically across a range of pooled funds, such as short-term, universe, and higher yielding funds.
  3. Higher Yielding Strategies. The addition of higher yielding strategies (or increase to existing allocations) will by their nature have a lower duration compared to the Universe Bond Index, thereby reducing interest rate sensitivity. However, many of these strategies are still susceptible to negative returns as experienced year-to-date to May 20, 2022, with high yield and emerging market debt indices both declining significantly.

    Careful review of potential strategies will be required to appreciate the extent of the downside protection and diversification qualities. For example, Canadian commercial mortgage strategies in general have declined much less than universe bonds so far in 2022, although consideration would also need to be given to the less-liquid nature of these strategies.
  4. Private Market Strategies. The addition of private market strategies (or increase to existing allocations) such as commercial real estate and infrastructure offer alternative and stable sources of income, as well as providing diversification to equities and fixed income. However, investors need to be comfortable with the less-liquid nature of these assets, since they are valued on a much less frequent basis compared to public market investments.

Start the Conversation

The increased duration of the Universe Bond Index has created an environment where investors are experiencing some of the toughest fixed income markets ever witnessed. Uncertainty remains with respect to interest rates, but there are several considerations for investors to help manage the downside risk from fixed income investments. Start the conversation with your consultant or investment manager to see how your assets can be better protected.

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Connor, Clark & Lunn Infrastructure (CC&L Infrastructure) today announced the acquisition of a majority interest in Landmark Student Transportation (Landmark or the Company) – one of North America’s leading student transportation businesses. Landmark’s existing shareholders will retain a significant equity interest in the business and its current management team will continue to oversee its operations and growth.

Founded in 2010 by a group of industry veterans, Landmark provides essential student transportation services to local school districts and private educational institutions throughout rural and suburban markets in Canada and the United States. The Company has grown significantly in recent years, adding scale and a professional management approach to a relatively fragmented market. The business is well positioned for continued growth having built a reputation for excellence in both service delivery and customer responsiveness. Through its owned and managed fleet of more than 4,600 buses, Landmark safely and reliably delivers hundreds of thousand students to school each day.

“We are pleased to be expanding our portfolio of essential transportation businesses with this latest investment in student transportation,” said Matt O’Brien, President of CC&L Infrastructure. “This investment in Landmark is expected to provide CC&L Infrastructure and its clients with access to stable and resilient revenue streams contracted with a diversified customer base – adding further diversification to our portfolio and providing an attractive complement to the approximately 1.5 GW of clean energy assets that we own and operate.”

“Landmark’s leadership team has established a very successful business through their community-based approach, focus on reliable service and customer satisfaction,” added Ryan Lapointe, Managing Director of CC&L Infrastructure. “As long-term investors, CC&L Infrastructure is committed to supporting Landmark’s continued growth. We are excited to partner with Landmark’s management team and to advance forward-thinking initiatives such as fleet electrification.”

Kirk Flach, CEO at Landmark, noted, “We are excited to be working with the experienced team at CC&L Infrastructure. Like Landmark, they place a high value on employee and customer relationships, with a focus on serving the needs of our local communities. This partnership will secure a stable future for the business through a long-term ownership model. Together with Landmark’s team of professionals, we will continue to deliver our best-in-class services to the communities we serve while building on our reputation as a leader in the student transportation industry.”

About Connor, Clark & Lunn Infrastructure

CC&L Infrastructure invests in middle-market infrastructure assets with highly attractive risk-return characteristics, long lives and the potential to generate stable cash flows. CC&L Infrastructure is a part of Connor, Clark & Lunn Financial Group Ltd., a multi-boutique asset management firm whose affiliates collectively manage approximately CAD$100 billion in assets. For more information, please visit www.cclinfrastructure.com.

About Landmark Student Transportation Inc.

Landmark Student Transportation Inc. is a North American owned and operated company that provides school districts with safe, reliable, contracted student transportation services. Established by a team of industry veterans, the business provides school districts with cost-effective student transportation services with a focus on safety, reliability and responsiveness. For more information, please visit www.landmarkbus.com.

Contact:

Kaitlin Blainey
Director
Connor, Clark & Lunn Infrastructure
(416) 216-8047
[email protected]

Connor, Clark & Lunn Infrastructure (CC&L Infrastructure) is pleased to announce the completion of construction at its 200 megawatt (MW) Riverstart solar project and the concurrent closing of a US$87 million bank financing with a consortium of North American banks. In aggregate, CC&L Infrastructure has closed over $4 billion in renewable power debt financings in the Canadian and U.S. markets in recent years.

This investment forms part of a previously announced acquisition of an 80% equity interest in a 563 MW U.S. renewable power portfolio that CC&L Infrastructure, alongside Régime de Rentes du Mouvement Desjardins and Desjardins Financial Security Life Assurance Company (together, Desjardins Group), purchased from EDP Renováveis, S.A. (EDPR). In addition to the 200 MW Riverstart solar project, the portfolio includes four operating wind projects located in Indiana, Wisconsin, Oklahoma, and Ohio with an aggregate installed capacity of more than 360 MW. Each asset is fully contracted through long-term power purchase agreements with high-quality offtakers, and the portfolio provides geographically diversified exposure to three distinct U.S. electricity markets.

The Riverstart solar project is located in Randolph County, Indiana, approximately 80 miles northeast of Indianapolis. The facility, which recently entered into operations, is now the largest solar array by capacity in the state and generates energy equivalent to the average consumption of more than 36,000 Indiana homes each year.

“We are excited to announce the achievement of this important milestone and the closing of the related financing for Riverstart, the largest solar project in our rapidly growing renewable portfolio,” said Matt O’Brien, President of CC&L Infrastructure. “We would also like to thank our partners, Desjardins Group, for their support in this transaction, and EDP Renewables North America, who developed and constructed the project, and alongside whom we look forward to working in the ongoing operation of the asset for many decades to come.”

CC&L Infrastructure now owns approximately 1.5 gigawatts (GW) of renewable power globally, with more than 1.3 GW in operation. On a combined basis, these operating facilities are expected to produce approximately 4.2 million MW hours of clean energy each year – enough energy to power more than 340,000 homes and offset the equivalent greenhouse gas emissions of more than 620,000 passenger vehicles for a year.

About Connor, Clark & Lunn Infrastructure

CC&L Infrastructure invests in middle-market infrastructure assets with highly attractive risk-return characteristics, long lives and the potential to generate stable cash flows. The firm has been an active investor and owner of renewable energy assets for more than 15 years. Its portfolio includes more than 60 hydro, solar, and wind facilities totaling 1.4 GW of clean energy generating capacity globally. CC&L Infrastructure is a part of Connor, Clark & Lunn Financial Group Ltd., a multi-boutique asset management firm whose affiliates collectively manage over CAD$100 billion in assets. For more information, please visit www.cclinfrastructure.com.

Contact:

Kaitlin Blainey
Director
Connor, Clark & Lunn Infrastructure
(416) 216-8047
[email protected]

Connor, Clark & Lunn Infrastructure (CC&L Infrastructure) and its partner, Alpenglow Rail LLC (Alpenglow), today announced the acquisition of Orange Rail Inc. (Orange Rail), a recently constructed rail terminal located in Orange, Texas. The transaction further expands CC&L Infrastructure and Alpenglow’s North American rail business, which now encompasses five rail assets in Canada and the United States.

Orange Rail provides critical first and last mile rail transportation and storage solutions to a diverse base of large-scale, blue-chip customers similar to those served by existing terminal locations. The recently built project benefits from proximity to highly-attractive industrial markets and class 1 railroad access to both the Union Pacific and BNSF railroads. The facilities include a double loop track capable of handling 120 car unit trains along with approximately 600 railcar storage spots.

“Our rail operations have demonstrated their criticality and resilience over the past two years and we are pleased to grow our portfolio with the addition of Orange Rail,” said Matt O’Brien, President of CC&L Infrastructure. “We would like to take the opportunity to acknowledge our partners at Alpenglow Rail. Together we have combined a long-term investment approach and best-in-class operating model to establish an attractive portfolio of rail assets that creates value for our stakeholders, including clients, customers and employees.”

This investment is part of the ongoing expansion of CC&L Infrastructure and Alpenglow’s established partnership, which was formed in 2019 to develop and operate a diversified portfolio of rail businesses across North America. Today, the portfolio includes three assets in the U.S. Gulf Coast under USA Rail Terminals as well VIP Rail, a business that comprises two railcar storage, transloading, railcar cleaning, and switching locations in Sarnia, Ontario. In addition, the partners continue to evaluate further investments together.

“We are excited to add Orange Rail to our USA Rail portfolio,” said CEO of Alpenglow, Rich Montgomery. “Orange Rail complements our other Gulf Coast terminals, providing operational synergies and a number of avenues for potential growth, including space for the build out of additional storage capacity and the ability to added further service offerings to better serve current and prospective customers.” 

About Connor, Clark & Lunn Infrastructure

CC&L Infrastructure invests in middle-market infrastructure assets with highly attractive risk-return characteristics, long lives and the potential to generate stable cash flows. The firm has been an active investor and owner of renewable energy assets for more than 15 years. Its portfolio includes more than 60 hydro, solar, and wind facilities totaling 1.4 GW of clean energy generating capacity globally. CC&L Infrastructure is a part of Connor, Clark & Lunn Financial Group Ltd., a multi-boutique asset management firm whose affiliates collectively manage over CAD$100 billion in assets. For more information, please visit www.cclinfrastructure.com.

About Alpenglow Rail

Alpenglow Rail develops and manages freight rail businesses and related transportation assets across North America. Alpenglow Rail currently owns and operates five rail terminals strategically located in leading industrial markets within Canada and the U.S. Gulf Coast. Alpenglow Rail was founded by seasoned railroad executives Rich Montgomery, Darcy Brede, Henning von Kalm, and Josh Huster. For more information, please visit www.alpenglowrail.com.

Contact:

Kaitlin Blainey
Director
Connor, Clark & Lunn Infrastructure
(416) 216-8047
[email protected]

Historically, individual investors interested in generating safe and stable returns looked to the bond market, which performed predictably and provided investors with a comfortable and low-stress retirement. The 21st century, however, brought with it declining interest rates, lower bond yields, and little indication that the investment environment will revert to easier times.

For investors, this shift means they can no longer rely on what has worked in the past. Investors that want to grow their portfolio or draw stable income from it while maintaining a palatable level of risk need to consider other options. To help, innovative investment managers have developed “alternative” investment approaches that investors can integrate into a portfolio strategy.

In this article, we discuss what alternative investments are and provide an overview of alternative asset classes. For more information on the changing investment environment and innovative portfolio management approaches, please read our Portfolio Guide – Beyond Stocks and Bonds.

What are alternative investments?

Alternative investments refer to any investment strategy that does not take a conventional approach to investing in traditional equities or bonds. Each class of alternatives works to address some of the variety of challenges that investors face while providing diversification benefits within a portfolio and return opportunities. Real estate, private infrastructure, and private equity are the most common forms of alternatives. Others, including hedge funds, alternative income sources, and equity investments in emerging economies, are also gaining attention.

Alternative asset classes have been well-researched, their merits and value proven with institutional investors. Alternatives are commonplace in the portfolios of notable and sophisticated institutional pension funds, such as the Canada Pension Plan, the Ontario Teachers Pension Plan, and the British Columbia Investment Management Corporation.

The main barrier to alternative asset classes has been accessibility for individual investors, with minimum investment thresholds often beyond reach and no public exchange for buying and selling assets cost-effectively. With growing demand, some Canadian investment managers have embraced innovation, introducing several alternatives for potential inclusion in the portfolios of their high-net-worth investors.

What are the major types of alternatives?

There are many alternative asset classes. At CC&L Private Capital, our pension-calibre approach can incorporate the following alternative investments.

Real estate

Real estate provides stable income and return potential. However, individual investors do not commonly use it due to the value of most transactions and the difficulty associated with gaining significant diversification. 

At CC&L Private Capital, our real estate investments include over 235 commercial and residential properties across Canada. They give our clients access to a diversified source of portfolio growth and cash flow, with rent escalation clauses in lease agreements hedging inflation. Our real estate investments include office buildings, industrial manufacturing facilities, distribution warehouses, retail centres, and multi-unit residential properties – assets typically outside the reach of most individual investors.

Infrastructure

Traditional infrastructure and energy assets are a less familiar option for most individual investors, given the complexity and high cost associated with access to the asset class. Institutional investors, however, have proven the value of infrastructure investments. For investors who do not require access to their capital in the short term, infrastructure can be a lower-risk means of generating stable cash flow and long-term capital growth. Infrastructure investments have the added benefit of acting as a buffer from economic turbulence in an investment portfolio.

At CC&L Private Capital, we use ”finance, build, and maintain contracts” with proven counterparties to guide our small- and medium-sized traditional infrastructure projects (e.g., roads, rail, hospitals), renewable power generation projects (i.e., hydro, wind, and solar), and energy transmission assets.  

Private loans

Lending to private, middle-market companies is a way for investors to obtain stable interest payments secured by liens against corporate assets. It makes private loans a reasonable fixed income alternative given declining bond yields. While it is not a common asset class in Canada, it is often seen in other markets, such as the USA and Europe. Private loans also contribute to the diversity of a portfolio, providing an uncorrelated source of income.

At CC&L Private Capital, we offer private loans to middle-market Canadian companies, typically in the range of $20 to $60 million.

Hedge strategies

The use of hedge strategies offers investors enhanced diversification in their portfolios by providing an uncorrelated source of return driven by analyst insights rather than by market-driven factors.

At CC&L Private Capital, we use three distinct hedge strategies in our portfolio—Canadian small-cap equities, a range of Canadian and global bonds, and global equities—in a manner that can decrease a portfolio’s exposure to core bonds.

Private equity

Providing capital in exchange for equity in private Canadian companies can be an excellent source of potential return for investors when coupled with the oversight of experts.

At CC&L Private Capital, we utilize the team at our Banyan Capital Partners affiliate. Banyan invests in companies with a historical track record of strong operations and consistent cash flow – working with owners and managers to drive efficiencies and spur growth.

Frontier markets

Frontier markets are unclassified markets or markets that are not represented well in the emerging markets index, such as Indonesia, the Philippines, Vietnam, Ghana and Kenya. They have large and growing populations and low but increasing income levels. As incomes rise, these countries’ populations are expected to increase consumer spending on goods and services. It should increase the profitability and business maturity of local companies able to meet rising consumer demand – making such companies ripe for investment.

While frontier investments are more volatile than many other alternative asset classes, their potential for generating returns over the long term is significant. At CC&L Private Capital, we believe that adding a modest allocation to frontier markets can help improve the return potential of a portfolio. However, any investments need to be made based on a discussion of the risk and return trade-offs. 

Moving beyond traditional investment approaches

It is becoming increasingly difficult for investors to get the portfolio returns they desire using traditional investment methods in the evolving investment environment. By embracing innovative approaches to a portfolio strategy, including the use of alternatives, investors can better position themselves to achieve their financial goals while managing their risks. 

Understanding different investment options is challenging, but an experienced investment manager can help. To find out how, please read our Portfolio Guide – How to future-proof your investment portfolio.

Contact us

If you would like to find out more about our approach to alternatives or learn how we can help you grow your investment returns, please contact us. 

This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.

Wind turbines in Navarre (Spain) Renewable energy concept.

Investing in private market infrastructure assets is an effective means of generating stable cash flow and long-term capital growth. Historically, this asset class has only been available to institutional investors with deep pockets. However, in recent years investment managers have started to provide their high-net-worth clients with opportunities to invest in this asset class.

In this article, we provide an overview of infrastructure investing, how we approach it, and the opportunity for investors. For information on other alternative asset classes, please read our Portfolio Guide – Beyond Stocks and Bonds.

What is infrastructure investing?

Infrastructure investing refers to making investments in physical, or “real”, assets that provide an essential product or service that is critical to society. Infrastructure assets are varied – from roads, rail, schools, and hospitals to power generation, energy transmission and distribution, and digital infrastructure. 

Typically, attractive assets share a number of key characteristics including long lives, low competition and high barriers to entry. When combined with predictable revenue streams – often from contracts with government counterparties or counterparties with high credit ratings – this makes infrastructure investing a source of portfolio stability and return.  

Understanding the opportunity for investors

While institutional investors have long embraced infrastructure investing, it is a less familiar option for high-net-worth investors, given the complexity and high cost associated with access to the asset class. Three key benefits include:

  • Uncorrelated: Infrastructure cash flow returns have a low correlation to other asset classes. It means they do not typically rise or fall in lockstep with liquid asset classes like stocks or bonds or private asset classes like real estate, private debt or private equity.
  • Resilient: Infrastructure returns are relatively resilient to economic turbulence. Even in recessionary economic environments, infrastructure returns have been relatively stable, given their essential, and often contracted or regulated, nature.
  • Long term: Infrastructure assets typically provide steady returns over a long time. Assets usually benefit from long contract lengths of more than 20 years and the assets themselves often have even longer useful lifespans – some hydroelectric assets have reached upwards of 100 years. 

These benefits make infrastructure an attractive asset class. Incorporating infrastructure into a broader portfolio can provide important diversification benefits and may also deliver increased average returns while reducing risk. 

Another characteristic of investing in infrastructure and other private asset classes is restricted liquidity. This is because the holding period of infrastructure assets reflects the long-term nature of the investments. For investors that do not require their capital in the short term, infrastructure can be a relatively safe and low-risk way to generate income and long-term growth.  

Our approach to infrastructure investments

At CC&L Private Capital, our infrastructure investments are primarily in Canada, the US, and Chile. We expect to add infrastructure assets in other geographies over time in a measured and disciplined way. 

Our portfolio is focused mainly on small- and medium-sized traditional infrastructure projects (e.g., roads, rail, hospitals) and energy infrastructure projects (i.e., hydro, wind, and solar).

Choosing the right investment manager

We strongly believe in the benefits of infrastructure investing. That is why we invest a significant amount of our own capital in our portfolio, as with all our private market investments. It shows that we are committed to our portfolio’s performance, as we benefit alongside our clients. 

When evaluating potential investment managers, whether they have ”skin in the game” is important, particularly for alternative asset classes. Other criteria investors should consider include the stability of the investment manager’s team, the manager’s proven ability to generate returns, the direct nature of the investments and the quality and diversity of the infrastructure portfolios.

To learn more about how to choose the right investment manager for your goals, please read our Portfolio Guide – How to future-proof your investment portfolio.

Find out more

If you would like to find out more about our approach to infrastructure investing or learn how we can help you grow your investment returns, please contact us.

This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.

TORONTO, March 5, 2021—Connor, Clark & Lunn Funds Inc. (CC&L Funds) announced today the launch of the PCJ Absolute Return II Fund, a market neutral, absolute return strategy targeting long term returns similar to equities, but with less volatility and low correlation to market direction. The Fund will be offered via prospectus under the alternative mutual fund framework (Liquid Alt) and will be managed by PCJ Investment Counsel Ltd. (PCJ), consistent with a portfolio they have managed institutionally for the past 10 years.

Both CC&L Funds and PCJ are part of the Connor, Clark & Lunn Financial Group Ltd. (CC&L Financial Group), one of Canada’s largest independently owned asset management firms, and a leader in alternative investments, responsible for over $86 billion in assets on behalf of institutional investors globally, as well as individual investors in Canada.

“We have been fortunate to partner with a number of top investment advisory teams across Canada who have told us in recent years that they want the convenience of an absolute return portfolio in Liquid Alt form, but also one with a demonstrated track record of success. With the launch of the PCJ Absolute Return II Fund, we are meeting those objectives.” said Tim Elliott, President and CEO of CC&L Funds.

“We’re excited that our Absolute Return portfolio is being made accessible to a broader group of Canadian investors,” said Adam Posman, Chief Investment Officer at PCJ, “Our team has conviction in our ability to continue to generate compelling long term, risk-adjusted returns with this strategy. Given its lower volatility profile than equity markets, and the low expected returns from fixed income markets, we view the portfolio as a compelling standalone investment or portfolio diversifier.”

About the fund

Available in A and F Series, the fund conforms with the regulatory framework related to Alternative Mutual Funds.  The fund will be offered through licensed investment dealers, priced daily, with weekly liquidity, and available through FundServ.

About Connor, Clark & Lunn Funds Inc.

Connor, Clark & Lunn Funds Inc. (CC&L Funds) partners with leading Canadian financial institutions and their Investment Advisors to deliver unique institutional investment strategies to individual investors through a select offering of funds, alternative investments and separately managed accounts.

By limiting the offering to a focused group of products, CC&L Funds is able to deliver unique and differentiated strategies designed to enhance traditional investor portfolios. For more information, please visit www.cclfundsinc.com.

About PCJ Investment Counsel Ltd.

PCJ Investment Counsel Ltd. provides discretionary investment management of Canadian equity securities to pension plan sponsors, corporations and mutual funds. PCJ employs an active approach that blends an initial top-down perspective with bottom-up fundamental research focusing on stock selection and trading. PCJ manages three Canadian long-only equity strategies as well as an absolute return strategy with a focus on Canadian equities. For more information, please visit www.pcj.ca.

About Connor, Clark & Lunn Financial Group Ltd.

Connor, Clark & Lunn Financial Group Ltd. (CC&L Financial Group) is a multi-boutique asset management firm that provides a broad range of investment management products and services to institutional investors, high net worth individuals and advisors. We bring significant scale and expertise to the delivery of non-investment management functions through the centralization of all operational and distribution functions, allowing our talented investment managers to focus on what they do best. CC&L Financial Group’s affiliates manage over $86 billion in assets. For more information, please visit www.cclgroup.com.

Contact

Lisa Wilson
Manager, Product & Client Service
Connor, Clark & Lunn Funds Inc.
416-864-3120
[email protected]

In the game Monopoly, the property names all come from real places in Atlantic City, New Jersey. You might remember that four of the properties are railroads, and that one is the “Short Line Railroad”. This name is an exception because there was no Short Line Railroad in Atlantic City. The name is a contraction of “Shore Fast Line”, a railroad that did run there in the first half of the twentieth century.

In the business world, short-line railroads are the small stretches of track that spur off the main national networks. Typically, they provide first- and last-mile rail transportation and storage for their customers. There are about 550 of these short lines in the US and 60 or so in Canada, and they are usually privately owned. In 2019, the Private Client Infrastructure Portfolio joined with a team of seasoned operators in this space and purchased its first short-line rail asset in Sarnia, Ontario. Early experience in operating this asset has been positive, with financial results exceeding base case expectations.

In August 2020, the portfolio bought its second and third short-line rail assets in Louisiana and Texas, expanding the Private Client Infrastructure Portfolio’s geographic scope and further diversifying its overall portfolio of infrastructure investments. 

Short-line rail assets occupy entrenched positions with their customers and produce strong and stable cash profits. Rail is also a business that requires active management and, in return, can experience growing profits over time as well as provide protection against inflation. 

Even with the challenges of running a business during the COVID-19 pandemic, the short-line rail assets have proven to be resilient investments, due in part to short-line rail’s persistent, defensible characteristics. These include providing essential services to well-established, large-scale customers; operating in resilient markets with high barriers to entry; and having strong customer relationships, often with contracted revenues.

Infrastructure, along with real estate and private loans, are alternative assets that, where appropriate, comprise a modest part of our clients’ well-diversified investment portfolios. They can help improve the balance between the returns achieved by the portfolios and the risk required to generate those returns—which can be even more rewarding than playing monopoly and winning second prize in a beauty contest.

This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.

The biggest investment challenge today is that bond yields are near all-time lows. This means lower bond returns in the future. Equities will continue to be a source of long-term return but developed market valuations are above average. Further, the integrated global supply chain means developed market equities are more interconnected today and don’t always provide the desired level of diversification. This is where the search for alternative sources of return and increased diversification begins.

Evolution of our investment platform

Part of our job is to find sources of differentiated return and evolve our investment platform to include new strategies when appropriate. This happens when the opportunity is significant and we can find the right talent. Two years ago, we found just such an opportunity and brought on an experienced team to manage frontier equity investments. We are now making this strategy available in client portfolios.

The opportunity in frontier markets

Let’s start with a definition. Frontier markets are made up of some of the fastest growing countries in the world that are not yet considered emerging markets. These countries are located in Southeast Asia, the Middle East and Africa and are largely overlooked by global investors. We focus on buying companies in countries with large populations and rising incomes. As incomes rise, large segments of the population move out of poverty and begin to increase their spending significantly on goods and services that weren’t affordable before. Our investment team finds companies that benefit from this growth in consumption.  The companies we choose to own are very different to businesses in the developed world because they are meeting local consumption demand rather than being another supplier to global markets.

We also invest in companies that are exposed to other long-term trends exhibited by countries experiencing significant economic change. These include the benefits from urbanization, improvements in technology and access to healthcare, to name a few. These trends present investors with long-term growth opportunities. Along the way, investors are also providing much needed capital to companies that are under invested, which also has an impact on the development of these countries.

What about risk?

Managing risk in our portfolio is as much about what we don’t own as what we do own. For example, our investment universe has 8,000 companies of which we only expect to own 20-40. We start by avoiding higher risk industries and buy those companies with strong growth trends. We also focus on industries and companies with favorable environmental, social and governance (ESG) characteristics. This is an important part of our risk management process. We reward companies with strong ESG factors and engage those companies who need to improve. Once we have screened out the industries and types of companies we don’t want to own, we identify high quality companies with strong brands in large markets. Finally, we only invest in companies with experienced leadership teams and companies that we see as underappreciated by the market. Together, this helps us screen out risk in our portfolio and focus on the investments with the highest probability of success. 

The nature of investing in frontier markets is that these are developing countries which often lack a truly democratic process and strong regulations. This can’t be ignored and our research process identifies these risk exposures and adjusts our targets and ultimately the exposure to the companies in that country. For some countries, the risk is too high and we avoid them altogether. 

Adding frontier markets to a portfolio

Adding frontier markets will increase portfolio expected return and diversification. The added diversification is important because it means we can add a modest allocation to this volatile asset class without meaningfully increasing risk. This is possible because frontier markets experience volatility for different reasons and often at different times. In the chart below we show the degree to which frontier markets and other asset class returns move in relation to global equities. The lower the asset class is on the chart, the more different the returns are and the greater the benefit of diversification. 

Diversification benefit of frontier

Despite frontier markets’ low correlation to other parts of a portfolio, we recommend a modest allocation that varies depending on the portfolios’ mix of stocks and bonds. At modest allocation levels, investors can increase expected portfolio return and improve the relationship between the portfolio return and the risk required to generate that return.

Is adding frontier markets right for you?

As a firm we want to provide our clients with differentiated sources of return that will benefit their portfolios as long-term market outlooks change and new opportunities become compelling. We believe adding a modest allocation of frontier markets to a portfolio is a good option for many investors. However, the decision to change the portfolio asset mix should be made in conjunction with a fulsome discussion about the risk and return tradeoffs. We are here to help clients navigate a more challenging market environment and position their portfolio to meet their objectives while considering any unique circumstances. We can help you determine if adding frontier markets is right for you.

This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.