The Manager's Commentary - May 2011

The chart below describes one of the most persistent, pervasive, and powerful trends in modern investment history. Since the early 1980s, interest rates have been in a virtually uninterrupted descent, represented here by the 30-year US Treasury Bond yield. This benign environment has carried at least two important implications. First, because rate declines boost the values of already-issued bonds, fixed income investors have enjoyed a halcyon existence, with their portfolios having been rarely put offside by an uptick in rates. Second, as rates have fallen, the periodic willingness of both professionals and individuals to take on risk has increased.

With the perception that safer alternatives no longer provide a satisfactory yield, investors have become increasingly apt to allocate assets further out the risk spectrum; at the same time, the cost of taking on leverage to pursue these strategies has grown cheaper by the year. This confluence of conditions undoubtedly contributed to the financial detours of the past decade, which include the tech bubble, the subprime crisis, and now the significant amount of speculative capital flowing into commodity markets. As mid and long term rates plummet to historic depths, the belief that yields will reverse their long march down has become so widely held that pundits and amateurs alike regularly express this view as an unquestionable certainty. While we don’t make specific predictions as to future interest rate levels, we do keep an eye on their general trend when building our equity risk and asset allocation models. Despite the vocal chorus calling for a secular upturn in rates, we have yet to witness evidence of such a reversal. In fact, yields have taken a fresh turn down in recent days, following the release of lackluster employment data in the US and the reemergence of sovereign debt concerns in Europe. While we are vigilantly avoiding investment themes driven principally by speculative or “risk-on” money flows, we do not yet view rising rates as a likely near term impediment to investment grade bond portfolios or to the shares of reasonably priced, cash flow producing companies.

Dixon Mitchell Investment Counsel
May 31, 2011