Hand flipping wooden blocks from 2023 to 2024, text on table.

The start of 2023 was marked by caution, largely influenced by the prior year’s market environment that witnessed several firsts. 2022 was the first time investors faced double-digit negative returns from both equity and traditional fixed income investments in a calendar year. Many defined benefit (DB) pension plans also experienced a rapid change in their financial health, moving from deficits to meaningful surpluses despite the challenging markets. Returns in 2023 have bounced back strongly, though not without many twists and turns. This article reflects on 2023 and offers insights for the year ahead.

Interest rate surprise

The rapid rise in interest rates surprised many investors and the impact varied among investor types. Investors with a total-return goal, such as endowments, foundations and Indigenous trusts, saw portfolio market values drop in 2022 due to negative returns in both equities and fixed income. In contrast, despite negative asset returns, many DB pension plans saw their deficits replaced by surpluses as the decrease in liabilities outpaced asset declines.

Higher yields implied more favourable longer-term returns for fixed income, and discussions in 2023 shifted from the past focus of reducing fixed income allocations towards assessing the merits of increasing allocations for all investor types.

Balancing act

For total return-oriented entities like endowments, foundations and Indigenous trusts, an improved fixed income outlook was welcome. However, historical data suggests that higher fixed income yields can indicate lower equity market returns (see “crystal ball challenge” below).

Registered charities are dealing with the added impact of an increase in the minimum annual distribution quota (DQ) requirement from 3.5% to 5.0% introduced in 2023. This change could lead charities to target higher returns or accept a lower margin of additional return to meet the higher DQ.

The prospect of higher fixed income returns and potentially lower equity returns provided an opportunity for investors to reassess their asset mix strategy to ensure alignment with their goals, particularly if their fixed income allocation has been historically low or well below target allocations.

Opportunity knocks

The start of 2023 brought significant improvement to the financial well-being of many DB plans, after decades of additional contributions to counteract the adverse effects of declining interest rates and subsequent stronger growth of the liabilities compared to the asset growth. The better financial position provided an opportunity to revisit long-term asset mix strategies and risk levels.

The specific actions of DB plans depend on the plan type (e.g., corporate, university or public), actuarial liability measures that drive risk assessments, and other factors such as whether the DB plan is open or closed to new members, and plan maturity (e.g., percentage of active members versus retiree and deferred members). At a minimum, for plans that found themselves in a healthier funded position, there was a strong case for discussing the merits and trade-offs of de-risking.

While it’s unclear to what extent DB plans took the opportunity to de-risk and shift towards higher fixed income allocations, there was an uptick in fixed income search activity in the latter part of 2023, possibly indicating a trend by committees towards reassessing their asset mix strategy. However, the market roller coaster ride in 2023 was evident in both fixed income and equities. Longer-term bond yields experienced further increases at the end of the third quarter and into the start of the fourth quarter, but then yields subsequently declined leading to longer-dated fixed income investments bouncing back very strongly and achieving returns higher than major equity markets. The higher fixed income returns are likely a reflection that liabilities over the fourth quarter increased more than the assets and reduced some of the previous improvement in DB plans’ funded position.

One form of risk management that has continued unabated is de-risking through annuity purchases, especially in corporate DB plans, where the transaction can reduce the impact of DB plans on a company’s balance sheets. Many companies that chose the annuity purchase route for de-risking did so when inflation was low. Depending on the extent of built-in inflation-related pension increases, these companies might face pressure from retirees for ad-hoc pension increases given the higher inflation environment. Under a buy-out annuity, the structure is such that post-transaction there’s no longer a dedicated pool of assets with the plan sponsor for members captured under the buy-out, implying the only source of funding for ad-hoc increases would be the company’s balance sheet.

Tech titans increase market concentration

In 2023, equity returns were dominated by U.S. mega-cap stocks, particularly in the information technology sector, which benefited from investor exuberance around artificial intelligence (AI) and added to the concentration challenges of the bellwether S&P 500 Index. As shown in Figure 1, the S&P 500 Index’s top-10 holdings represented almost a third of the Index at the end of 2023.

Figure 1: Weight of top-10 holdings in the S&P 500 Index

Source: Connor, Clark & Lunn Financial Group and S&P Global Market Intelligence.

U.S. equities typically represent the largest individual component of many investors’ portfolios. Upcoming committee meetings should include discussions on the increasing concentration in the U.S. equity market. This isn’t to say the U.S. technology sector won’t continue to perform well over the next decade. However, it’s prudent to consider the benefits of diversifying the portfolio and to evaluate options for managing potential downside risks should negative outcomes unfold.

While diversification within equity markets is one option, such as leveraging the lower correlation merits of emerging markets compared to developed markets or pairing a value investment style with a growth portfolio, diversifying through fixed income and private market investments may be more advantageous. Therefore, any diversification strategy should include a broad set of investment opportunities and extend beyond equities.

Mixed experience from private markets

Over the past 10 years or so, private markets have experienced significant inflows from institutional investors. In 2023, the returns across various private markets have been mixed. Commercial real estate made most of the headlines for two reasons. First, there was the lingering impact from the COVID-19 pandemic on the office sector, leading to decreased market valuations. Secondly, some commercial real estate managers had liquidity issues, delaying divestiture requests. Other real estate sectors performed well, helping to offset office sector declines in diversified portfolios and contributing to a more optimistic market outlook for 2024 and longer term.

Private equity markets were also challenged in 2022/2023, but the forecast for 2024 and beyond is much more positive. In contrast, the infrastructure market was a standout performer in 2023 and appears well-positioned for the future. Infrastructure is increasingly seen as crucial for supporting clean energy projects and reducing reliance on carbon-intensive assets as part of global efforts to address climate risk. A successful energy transition will require extensive new infrastructure globally, focused on renewable energy sources.

The crystal ball challenge

Forecasting returns is no easy task. For example, a Horizon Actuarial Services survey of U.S. investment managers and consultants found that they significantly underestimated the strength of the U.S. equity market for the 10-year period ending December 31, 2022, and overestimated the weaker returns of emerging markets. The average annualized U.S. equity return projection was 5.9%, compared to the actual return of 12.6%. Emerging market equities were expected to return 7.5% but delivered just 1.8% (all returns in U.S. dollars).

There is, however, a historical correlation between yield levels and the outlook for equity market returns. Figure 2 illustrates the distribution of 10-year historical returns for the S&P 500. The green bars represent periods where U.S. government 10-year bond yields at the start of the 10-year period were below 3.5%, while the gold bars show returns when starting yields were between 3.5% to 5%. For example, when the yields were below 3.5%, around 20% of returns were around 17.5%. The overall average annualized S&P 500 return when yields were below 3.5% was 10.8%. Conversely, when yields were higher, such as the end of 2023, the average annualized Index return was 6.7%.

Figure 2: U.S. equity returns depending on the level of fixed income yields

Source: Connor, Clark & Lunn Financial Group.

Despite the recent decline in yields, longer-term return expectations for fixed income remain higher than what we’ve seen in a while. The level of yield at the time of writing also indicates the potential for lower long-term equity returns compared to previous strong performance.

For private markets, it is difficult to generalize since the outlook is heavily influenced by the specific strategy in which you’re invested. It’s therefore important to engage with your private market managers to understand their return expectations and assess the risk of liquidity constraints, like those recently seen in some commercial real estate strategies.

In other private markets, such as private debt, the current environment has likely enhanced its relative return potential, possibly attracting increased interest from all investor types. As noted earlier, the emphasis on energy transition to address climate risk will likely boost interest in specialized energy infrastructure strategies. Present conditions also provide an opportunity to consider more liquid, higher-yielding assets, such as commercial mortgages, that can take advantage of current higher rates.

2024: Steering through uncertainty

As your committee reviews 2023 performance, there should be welcome relief from strong positive total portfolio returns. For DB plans considering a de-risking strategy, the fourth quarter was a reminder that the opportunity to take advantage of a healthier financial position was not timeless and that there are scenarios where lower yields (and subsequent increases in liabilities) could prevail.

The top-performing market in 2023 was the U.S. equity large-cap market that was a beneficiary from the enthusiasm around AI. While the positive impact of technological innovation may persist, it’s up against a challenging economic, social and political backdrop, along with associated uncertainties. Geopolitical risks, including the U.S. election, conflicts in the Middle East and Europe, and the U.S.-China rivalry could significantly affect shorter-term market outlooks in 2024.

Given the various dynamics highlighted, ensure that committee meeting discussions focus on confirming whether your risk-return profile aligns with your objectives.

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Connor, Clark & Lunn Funds Inc. (CC&L Funds) is excited to announce the recent launch of a prospectus qualified version of the NS Partners International Equity Focus portfolio, which is now available to individual Canadian investors. The NS Partners International Equity Focus Fund is based on a similar portfolio, previously available only to institutional and internal investors.

The Fund seeks to provide investors with long term capital appreciation by investing in a portfolio comprised primarily of non-North American equities, including up to 20% in emerging markets.

To manage the fund, CC&L Funds has retained NS Partners Ltd (NS Partners) a London, UK-based manager with over 30 years of experience in managing international equity portfolios, including developed and emerging markets. NS Partners combines a bottom-up quality/growth framework to analyze companies with a unique top-down global liquidity analysis to help identify regions, countries and sectors that are expected to out and underperform, as well as whether to position the portfolio for a ‘risk-seeking’ or ‘risk averse’ environment.

“For investors allocated to large-cap global equity portfolios, there is a compelling case to make a stand-alone allocation to international equities, given the valuation and concentration issues in the large-cap U.S. equity market, and the headwind of a strong U.S. dollar. By introducing our NS Partners International Equity Focus portfolio in fund format, we can offer a compelling solution for individual investors, managed by a proven, institutional caliber investment team with a differentiated approach” said Tim Elliott, President and CEO of CC&L Funds.

“We’re excited that our International Equity Focus portfolio is being made accessible to a broader group of Canadian investors. With our proven process, a strong record on the institutional side and our talented and committed investment team, we believe this portfolio will provide an attractive solution for those seeking long-term growth from international equity markets.” said Tim Bray, President and Chief Investment Officer at NS Partners.

Both CC&L Funds and NS Partners are affiliates of Connor, Clark and Lunn Financial Group (“CC&L”), whose multi-affiliate structure brings together the talents of diverse investment teams who offer a broad range of traditional and alternative investment solutions. CC&L is one of Canada’s largest independently owned asset managers, responsible for over $104 billion in assets on behalf of institutional and individual investors.

About the fund

Available in A and F Series, the fund conforms with the regulatory framework related to conventional mutual funds offered by Simplified Prospects. The fund will be offered through licensed investment dealers, priced daily, with daily 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 investment solutions, 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 NS Partners Ltd

NS Partners Ltd is an independent investment management firm specializing in actively managed global equity portfolios on behalf of major companies, pension funds, foundations, endowments and sovereign wealth funds. NS Partners Ltd is part of the Connor, Clark & Lunn Financial Group, a multi-boutique asset management firm. For more information, please visit www.ns-partners.co.uk.

About Connor, Clark & Lunn Financial Group Ltd.

Connor, Clark & Lunn Financial Group Ltd. (CC&L Financial Group) is an independently owned, multi-affiliate asset management firm that provides a broad range of traditional and alternative investment management solutions to institutional and individual investors. CC&L Financial Group brings significant scale and expertise to the delivery of non-investment management functions through the centralization of all operational and distribution functions, allowing talented investment managers to focus on what they do best. CC&L Financial Group’s affiliates manage over $104 billion in assets. For more information, please visit www.cclgroup.com.


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

Blocks showing transition from year 2022 to 2023

The market turbulence experienced over the last several years culminated with a major downturn for both public equities and fixed income in 2022. However, the journey along the way did provide useful insights and lessons, particularly from the experiences during the height of the pandemic in 2020. This article considers the extent to which investors heeded the warning signs, or whether they were desensitized to the ensuing risks.

The international risk consultant, David Hillson, defines risk as “uncertainties that matter”. In other words, when reviewing various investment uncertainties, the key is to understand how material the consequences could be if things do not go as expected. The assessment and acceptance of risk varies among investors. This is because different investors have varying levels of risk appetite and risk tolerance.

The practical implications for investors from Hillson’s definition is to prioritize risks when deciding how to respond to them. For example, if a particular risk has a minimal impact and low probability, then you may choose to accept the risk. However, for risks identified as material and with a higher probability of occurring, you will want to act. This may include controlling the risk exposure through better portfolio diversification, or avoiding the risk altogether, if possible.

Insights from the global pandemic

In the recent market environment, the global pandemic surfaced insights and warning signs, including:

  • Further concentration of equity markets, particularly towards technology companies;
  • Increased risk of rising interest rates and potential for negative fixed income returns;
  • Governments around the world working together to manage important global issues.

Equity market concentration

There was no surprise when equity markets declined in reaction to the spread of the pandemic in the first quarter of 2020 as investors responded to the implications for the economy and the fate of individual companies, particularly those in the travel and tourism industry as the world entered various stages of lockdown. However, the speed of recovery was a surprise to most.

Aided by extensive quantitative easing, equity markets bounced back robustly, with several delivering double-digit positive returns for calendar year 2020. Some of the strongest performing stocks globally in 2020 were technology companies that benefitted from the increased reliance on e-commerce during the pandemic. However, the strong performance also led to further concentration in the major equity indices. For example, Apple, Microsoft, Amazon, Facebook and Alphabet Inc. comprised over 20% of the S&P 500 Index at the end of 2020. The impressive performance also desensitized investors to concentration risk.

US equities are typically the largest equity component in most investors’ portfolios, so the increased concentration suggested a review of overall equity portfolio construction was appropriate. For those with a bias to global large capitalization developed equity markets, where the US dominates the overall market capitalization, potential considerations included the introduction of global small cap and emerging market equity allocations.

However, diversifying the overall equity allocation to reduce US stock specific risk did not address the information technology bias, since technology stocks globally benefitted hugely from the reliance on e-commerce during the pandemic. Therefore, an assessment of the overall equity style bias was also in order. For example, value style managers are less inclined to invest in technology stocks, thereby offering a source of sector diversification.

Reducing any bias to technology and growth stocks in general would have been a benefit in 2022, since technology stocks suffered the most for the calendar year. The ups and downs of specific stocks and sectors highlights the importance of having a formal risk assessment process to discuss and address uncertainties that arise, such as concentration risk.

Risk from rising interest rates

Fixed income yields have been in decline for decades, during which time governments and companies took the opportunity to significantly lengthen their bond maturities when issuing new debt. In doing so they contributed to an increased sensitivity to changes in interest rates (duration) for fixed income indices, such as the FTSE Canada Universe Bond Index, and the associated risk of low yields combined with high duration in a rising rate environment. For years “experts” predicted rising interest rates that did not unfold, leading to investors dropping their guard with respect to the ensuing risk.

Moreover, the fixed income market experience during the pandemic simply fueled investor desensitization. In times of equity market stress, a quality fixed income portfolio with high duration can provide an important source of diversification due to an increased demand for safe-haven assets and declining rates, which has seen fixed income markets deliver positive returns when equity markets experience significant declines. The defensive nature of fixed income came through in 2020 with the FTSE Canada Universe Bond Index returning 8.7% for the year, despite the low prevailing yield.

However, the risk associated with low yields and high duration in a rising rate environment reared its ugly head in full force in 2022 with the FTSE Canada Universe Bond Index declining over 11% and the FTSE Canada Long Term Overall Bond Index declining over 21% for the calendar year.

Actions taken by investors with an absolute return goal that heeded the low yield and high duration warning signs included:

  • Adopting fixed income strategies with a capital preservation focus and less sensitivity to interest rates;
  • Relaxing the constraints on fixed income managers with the goal of generating higher added value versus traditional fixed income strategies;
  • Increasing the yield through other fixed income assets, such as commercial mortgages;
  • Investing in higher yielding non-fixed income assets, including direct infrastructure and commercial real estate.

It is a different story for investors with liability-related goals, such as defined benefit (DB) pension plans, where in many cases, despite negative returns from the pension plan assets in 2022, the decline in the liabilities was greater, resulting in an improved funded position. However, for plans using leverage within their fixed income portfolio to increase the liability hedge, the market experience in 2022 may have worsened the funded position.

Due to the asset and liability dynamics of DB pension plans, upcoming risk assessments and related discussions will likely be focused on whether the experience in 2022 has created an opportunity to take advantage of an improved funded position. For example, where the goal is to manage the volatility associated with the funded position, increasing the allocation to fixed income assets could be one risk management consideration.

Governments working together

The global pandemic showed that governments around the world can work together to manage important global issues and created expectations for greater coordination on responsible investing in general, and specifically climate risk.

The current war in the Ukraine and associated impact to the energy supply and prices, saw resource-heavy markets, such as Canada, benefit from their higher energy allocation, which helped limit the extent of market declines in 2022 compared to markets with lower resource exposure. It also highlighted the challenges of adopting a position of no fossil fuel investments within a portfolio during a period when energy was the best performing equity sector.

However, it is crucial for governments and asset owners not to be desensitized to the importance and urgency of transitioning to renewable, cleaner energy, simply based on the recent investment return experience. While the world is still heavily reliant on traditional energy sources and there is still a long way to go to reducing our carbon footprint, a continued and orderly transition to cleaner energy is essential to manage the impact of climate risk.

Looking forward

Market turbulence of the last several years has contributed to desensitizing investors to ensuing risks. Risk management does not only have to rely on sophisticated modelling; it can take different forms including a simple discussion among trustees or committee members, drawing on the insights of investment managers and consultants, and fine tuning the asset strategy and portfolio diversification. In early 2023, take time to formally review your portfolio to identify any uncertainties which may elevate the risk of not delivering on your goals.

This commentary is the first in a series in which we will profile our holdings and share high-conviction ideas in the emerging markets universe. Among the 27 countries classified as emerging by MSCI, we see a mixed bag of opportunities and challenges. Some of the constituents are candidates for an upgrade (e.g., Taiwan and South Korea), whereas a few others are on their way to being downgraded (e.g., Argentina and Pakistan). Despite facing different dynamics, the EM Small Cap universe of over 11,000 companies presents plenty of very sound investment ideas.

Indonesia is one of the countries that we overweight in our portfolio. It is the world’s fourth-most populous country, with over 270 million people spread across 17,000 islands. Indonesia enjoys strong demographic tailwinds, ongoing market-friendly reforms, massive under-penetration of multiple sectors (e.g., healthcare, real estate, consumer, and finance), a solid fiscal position, with a low debt-to-GDP ratio (36.62% in 2020), a stable current account (deficit of 0.44% in 2020), low and stable inflation, and solid FX reserves. According to the World Bank, the Indonesian economy is expected to grow by 4.4% and 5.0% in 2021 and 2022, respectively, subject to the effectiveness of the COVID-19 pandemic containment efforts, including the vaccination programs.

In early July 2021, Indonesia emerged as the new epicenter of the COVID-19 pandemic, with daily cases and deaths surpassing the levels reported by Brazil and India.[1] The country’s healthcare system is facing a horrendous challenge. The majority of its hospitals are operating at abnormally high occupancy rates due to the delta variant, as only 7% of the eligible population has been vaccinated so far. As sad as it sounds, this level is still much higher than in many other developing countries. The most recent data show encouraging progress in the infection rate, which prompted the government to begin unwinding social mobility restriction measures after a three-week implementation. Declining bed occupancy rates in some regions shows promising signs that the healthcare system is normalizing.

Although we are pure bottom-up investors, we acknowledge secular growth opportunities in Indonesia’s healthcare sector. As of 2018, the country’s healthcare spending was one of the lowest in the world, at 2.87% of its GDP, compared to India (3.54%), Malaysia (3.76%), Thailand (3.79%), the Philippines (4.40%), Singapore (4.46%), China (5.35%), Vietnam (5.92%), South Korea (7.56%), and the United States (16.89%). Indonesia’s healthcare spending amounted to IDR 404 trillion in 2017 and is expected to reach IDR 1,224 trillion in 2027, growing at a CAGR of 11.7%. Indonesia ranks among the lowest in the region in terms of the number of hospital beds per 10,000 people (11 beds), compared to Malaysia (18), Singapore (26), and China (47). It also has the lowest number of doctors per 1,000 people among the Association of Southeast Asian Nations (ASEAN) countries.

Private players dominate the hospital industry. In 2017, there were 2,776 hospitals in Indonesia, comprised of 1,009 public and 1,767 private hospitals. Presently, there are seven major private players: Siloam International Hospitals, Mitra Keluarga Karyasehat, Sejahteraraya Anugrahjaya Group, Sarana Meditama Metropolitan, Awal Bros Hospital Group, Hermina Hospital Group, and Ciputra Development. The sector is expected to benefit from rising disposable income in Indonesia in the long term. However, Greater Jakarta and a few other of the most populous areas are already relatively well penetrated by hospitals. However, the population living in the most underpenetrated regions do not have similar purchasing power, implying that healthcare operators should accept a different kind of economics. Another challenge for them is the shortage of doctors in regional hospitals. Specialist doctors can only graduate from government medical colleges in Indonesia. As a result, the healthcare system welcomes only 700-800 graduates annually, with half of them going to public hospitals. A brand-new hospital needs 30 to 40 specialists. The ongoing universal healthcare reform also adds uncertainty. As a result, most hospital chains are reluctant to expand outside of population centers. Therefore, we believe there is a better way to capitalize on that massive opportunity.

One of our holdings offers the key to solving that issue. Prodia Widyahusada (PRDA IJ) is the pioneer in private independent clinical laboratories in Indonesia, with the most extensive network and largest market share. It was established in 1973 by a group of idealists with a background in the pharmacy business. Prodia’s unmatched track record, strong brand, and long-term relationships with healthcare industry stakeholders provide a sustainable source of referrals and scientific breakthroughs. The company is the only independent clinical lab with the College of American Pathologists accreditation in Indonesia, which is considered to be the highest certification in the clinical lab industry worldwide.

In 2020, Prodia performed approximately 14 million tests for 3.1 million patient visits. The company has a solid operational track record, with the number of visits and revenue per visit growing at a 5.4% and 2.8% CAGR over 2016-2020, respectively. It provides the most comprehensive range of clinical lab tests catering to the needs of a broad client base. Key types of routine tests include lipid profile, hematology kidney function, liver function, thyroid panel, glucose, HbA1c, urinalysis, coagulation testing, and endocrinology panel. Since its inception, the company has focused on innovation and introduced many clinical laboratory tests and technologies in Indonesia. The main types of non-routine tests include nutrition panel, trace element testing, vitamin D testing, autoimmune panel, molecular-genetic testing, and osteoporosis panel. Non-routine tests contributed 20% of total revenue in 2020, up from 16% in 2018. Genomic testing contributes 25% of non-routine tests revenue and grows at 30-40% annually. The price of Prodia’s new genomic sequencing tests’ range from IDR 7 to 10 million or 10 to 15 times the average revenue per visit. Benefiting from its pricing power, the company was able to raise prices by 5-10% annually from 2014 to 2020. Prodia’s fixed costs account for a high proportion of expenses, underscoring its operating leverage.

Prodia leverages a scalable hub-and-spoke business model, whereby specimens are collected across multiple locations for delivery to a local clinical laboratory or the Prodia Referral Lab Services for centralized clinical laboratory testing. This way, it can ensure superior quality and reliability, as well as economies of scale. The spokes facilitate deeper penetration within regions, strengthening the brand and driving higher volumes. The efficiency of a clinical laboratory improves with increasing test volumes, making automated tests less expensive and labs more cost-efficient. Outlet expansion generally requires light capital investments, as the testing equipment is provided by vendors free of charge, as long as Prodia purchases raw materials for testing from them. Moreover, specimen collection is made by qualified nurses and not doctors.

According to IQVIA, Indonesia’s private independent lab market was worth IDR 4.5 trillion in 2019 (20% of the total diagnostic market size). It grew at an 8.3% CAGR over from 2017 to 2019 (compared to 9.1% for Prodia). The non-routine test market is expected to grow at a 9.4% CAGR from 2018 to 2024. Prodia’s market share is 39.2% in 2019 (compared to 38.8% in 2018), larger than the following five players combined, at 33.9% (Kimia Farma, Pramita, Parahita, BioMedika, and Cito). Moreover, Prodia faces almost no competition in non-routine tests.

Its growth strategy is based on introducing new tests, including next-generation diagnostic technologies, and expanding the network via both physical and digital channels. Prodia is developing an omnichannel presence. The pace of new physical lab openings will likely slow due to the focus shift on digital services via Prodia Mobile. The app is a game changer, providing clients with many functionalities. They can book and pay for tests, choose the point of collection, track results, and share them with a specific clinic or hospital. The clients’ response has exceeded management’s expectations. In 2020, Prodia acquired 30% of new patients through its Mobile App, primarily millennials. Digital revenue accounted for 0.6-0.7% of total sales in 2020, growing by 67% year-over-year, while management expects it to expand by more than 100% in 2021. The company’s pace of growth is poised to accelerate on the back of rising disposable income and increasing awareness of preventive healthcare. Prodia demonstrates high profitability and cash-flow generation; it has a pristine balance sheet, with net cash accounting for 18% of its market capitalization.

The company is run by a professional and experienced management team with a strong track record in delivering superior growth and innovation. Andi Wijaya, the Chairman and co-founder, continues preaching relentless focus on innovation and service quality. A group of co-founders maintain 75% ownership of the company.

Prodia has a very strong ESG profile, which is well presented in its comprehensive sustainability report, published annually. The CEO and chairman roles are separated. Two out of five directors are independent. The company demonstrates substantial diversity, with two out of five female directors and four out of five female executives, including the CEO. Prodia has established green infrastructure to improve efficiency and conservation of energy and water resources. It manages the medical and non-medical waste in a responsible manner. In collaboration with Indo CorAlliance, Prodia carries out a coral reef revitalization program on Nusa Penida, Bali. The company is actively involved in other projects aimed towards improving the well-being of Indonesians. It funds scholarships and grants for researchers.

Low stock liquidity has been a well known concern for investors in this story. However, because of the quality growth profile of the company, we believe that multiples will expand given its consistent quality growth profile and attractive valuation relative to global peers.

The COVID-19 pandemic has multiple effects on Prodia. In the short term, non-essential test volumes are negatively impacted by the social restriction measures. At the same time, the pandemic drives new revenue streams, including PCR testing, pre-vaccination check-ups, participation in independent vaccination programs, post-vaccination antibody testing, and blood viscosity testing for COVID-19 survivors to detect blood clot risks. This demand might be sustainable even beyond 2022, as the world adapts to a new normal.

We believe that Prodia offers attractive exposure to the secular growth in an underpenetrated healthcare market, being an industry leader, leveraging its recognized brand and most extensive network, and led by an experienced management team with a strong track record in delivering consistent growth and innovations.

[1] https://www.nytimes.com/2021/07/17/world/asia/indonesia-covid.html

In typical fashion, markets have reflected opposing sentiments – uncertainty and optimism. On the one hand, the worry associated with the pandemic and on the other, optimism fueled by a resurgence in activity and strong government support. Our portfolio management and asset allocation teams have been busy, first and foremost, protecting capital during the market decline and then shifting positioning to benefit from the recovery. As we look forward here are some areas of opportunity we see as we manage client capital through a challenging time. 

Revisiting equity exposure for a changing environment

Some investors might conclude that mega-cap stocks in Canada and US are the only place to be. Companies like Shopify, Facebook, Amazon, Microsoft, Apple and Google had very strong returns and our portfolios benefited from owning them. However, the recovery in stocks has broadened beyond these names. For example, in late 2020 we saw a resurgence in companies that were hurt most from lockdowns. With new vaccines these companies got a new lease on life. Throughout the year our teams took profits by selling some of the mega-cap stocks and buying companies likely to benefit from a post-vaccine world. This includes buying leaders in the travel and leisure industry. This may be hard to imagine at this point of COVID fatigue, but remember markets are always looking forward.

Late last year investors also began to favour areas that are more cyclical like value stocks, small-cap and emerging markets. These areas of the market were laggards earlier last year and have now risen above the pack. We were positioned for this shift in leadership by having a strategic allocation to value stocks and tactically buying small-cap and emerging earlier in the year. Today we are overweight equities in client portfolios with a bias to global small-cap companies. We believe we will benefit from a strong earnings recovery as more businesses reopen and stimulus remains a strong tailwind. We have also continued to increase our weight in emerging markets companies and recently launched a frontier equities strategy. As we look longer-term we believe these asset classes will be important sources of return in portfolios. 

Bond investing in the wake of a pandemic

Our positioning in bond portfolios also reflects that the worst appears to be over. Yet we are not in the clear and safety is important in a bond portfolio. The challenge, however, is that the tradeoff for safety is low yields. Current yields remain lower than they were before the pandemic and central banks are inclined to keep them low. Our bond portfolios are positioned to improve yield by investing in high quality corporate and provincial bonds. We also believe that government stimulus will result in rising inflation expectations. This has led us to own real return bonds which will benefit from this trend. Finally, we have positioned the portfolio to benefit if the recovery stalls and bond yields fall. This is a prudent offset to other positioning and helps protect capital should the economic recovery falter. 

As we look to strike a balance between safety and income, we have also been adding to high yield bonds that carry a much higher yield. The focus here is on strong credit research to avoid companies that may not be resilient if economic recovery stalls. 

Fertile ground for alternatives

Private market alternatives have been an attractive addition to portfolios for some time. These assets can be generally characterized as having strong returns, coming mostly from income and relatively low volatility. This combined with added diversification makes private market alternatives appealing on a long-term basis. The tradeoff for accessing these characteristics is reduced liquidity and the time it takes to deploy capital into new assets. Recently, however, we have been able to put more client assets to work in these strategies. Within our infrastructure portfolio we completed the purchase of four operating wind assets and one construction-stage solar project in the US. These assets have strong expected returns and benefit from fixed price contracts for the energy produced. Not to mention this now brings our renewable power generation to 1.4 gigawatts, enough energy to power more than 320,000 homes.  

Within our direct real estate portfolio we have completed our first purchase in the residential apartment sector. Historically residential has generated more stable returns and income compared to other property types like retail and office. We expect our allocation to this property type will increase.

Our positioning

The bumpy road to long-term performance

Building wealth for the future requires discipline, thorough research and a process for managing risk. The opportunities that are most attractive today are assets that can benefit the most from the economic recovery. Yet we also need to recognize that the road to recovery from here will be bumpier than what we’ve experienced so far. To manage this risk we continue to be broadly diversified while tactically tilting the portfolio to the areas of the market with the greatest opportunity. 

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.

Markets reached new highs in 2020 in the face of a global pandemic. This leaves some asking if this is sustainable.  Continued growth depends on improvements in the economy, company earnings and government support. The good news is that we have seen advances on these fronts over the last several months. However, markets have high expectations for 2021 and any shortfall may result in a setback. Here are three areas we are looking to see progress on in 2021:

1. Markets and the economy become more connected

The global economy had a terrible 2020 but equity markets delivered strong returns. This disconnect is quite normal when a cycle comes to an end and a new one emerges. The reason is that the economic data provides an assessment of where we were, while the market is focused on a brighter future. Looking forward we need to see continued improvements in the economy and believe market returns may be more modest- reflecting a more normal outlook as opposed to a strong recovery. Of course, these improvements don’t happen in a straight line and fluctuation in the economic recovery will cause volatility in markets.

2. Earnings will need to move above pre-pandemic levels

As economic activity increases in 2021, overall business earnings should continue to recover. Globally, earnings are expected to rise and surpass pre-pandemic levels in late 2021. This isn’t good for equity markets- it’s a requirement!  This is because the current market level already reflects this earnings recovery in the form of higher valuations. If this outlook falters, it may lead to a temporary decline in markets. 

3. Government support is a necessity

The recovery we have experienced has been largely the result of unprecedented government spending, zero percent interest rates and bond-buying by central banks to heal credit markets. Going forward, government spending will be the dominant tool for managing the recovery. We are looking for a continued willingness of policymakers to run sustained supportive policy until there can be a transition to private-sector spending and investment.

What does this mean for your portfolio?

An improved outlook for the economy combined with uncertainty argues for portfolio diversification. At CC&L Private Capital, we have built diversity within our asset class strategies and across our investment platform. Diversification across traditional and alternative asset classes will be even more important as we look ahead. In 2020 we increased investments in private market assets like infrastructure. We also began to offer frontier market investments to our clients and increased exposure to emerging markets. This broadens portfolio diversification and positions our clients well for the future.

Often after discussing our market outlook, a client will ask, what should I be doing? For long-term investors, sticking to your existing strategy (while we manage the rest) is almost always the best advice.  This year we would add to this sage wisdom and say now is a really good time to revisit your asset allocation to ensure that you are balancing risks while achieving the long-term return necessary to meet your financial objectives.

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.