Middlefield Canadian Income (MCT) has announced its annual results for the year ended 31 December 2023, during which it provided NAV and share price total returns of -1.4% and -10.7% respectively, underperforming its benchmark’s total return of 3.9%.

At the beginning of 2023, inflation was falling faster in Canada than in the US, and the US Fed’s monetary policy was more restrictive. In response, MCT’s manager increased the portfolio’s exposure to Canadian equities to 100% . However, in June 2023, longer-dated government bond yields were rising and the Bank of Canada surprised markets with an increase in overnight lending rates, causing rate sensitive stocks to sell off. MCT’s manager therefore decided to rebalance the portfolio with the aim of mitigating market volatility, while maintaining dividend income, and the exposure to Canadian financials was increased from 21% top 29% in the fourth quarter, putting its exposure in line with that of the benchmark.

Against a backdrop of higher borrowing costs, MCT reduced its net gearing from an average level of 19.5% over the first three quarters of 2023 to 13.5% at the year end. Borrowing costs have started to decrease and the board believes that gearing is warranted as the expected total exceeds the borrowing costs but says it will continue to monitor the spread between interest expenses and the portfolio yield.

MCT’s board has approved an increase in the total dividend by 0.1p for the year, bringing the total dividend to 5.2p per share. Quarterly dividends of 1.30p per share were paid, which represented a 2% increase in the quarterly dividend rate for the prior year. MCT’s revenue earnings per share totaled 5.57p for the year, reflecting a dividend coverage ratio of 1.07x (down slightly from the 2022 year’s coverage ration of 1.16x but up from 2021’s 0.95x).

MCT’s manager notes that PE ratios are their lowest for 25 years, resulting in the TSX’s dividend yield versus the S&P500’s being at a record high of 2.3x. In an effort to dampen portfolio volatility, MCT has averaged an underweight position in energy, which was the top-performing sector in 2021 and 2022 and this has impacted MCT’s five-year relative performance numbers. The fund’s exposure to energy was increased so that it was in line with the benchmark’s at the end of 2023, for both pipelines and energy producers.

The manager says that recessionary risks have abated in recent months, largely due to the resilience of consumer spending and tight conditions in the labour market. With the global economy looking increasingly set for a soft landing with slowing but positive growth, this bodes well for the portfolio’s exposure to Canadian cyclicals such as energy and financials.

The manager expects inflation to keep edging down although notes that the war in the Middle East has elevated the risk of supply chain shocks. However, it thinks that Canada is uniquely insulated from these given its proximity to the US. It thinks that if the conflict becomes drawn out this may cause investors to seek hedges to inflation and Canadian equities could attract inflows as a result.

The manager remains constructive on the outlook for Canadian real estate in 2024. Following a tough couple of years, Canadian REITs could be very well positioned to outperform if interest rates continue to come down as expected.

Energy security is an increasing issue and Canada’s oil and gas reserves rank in the top five globally. And Canada could benefit from increased demand for energy imports from other nations. The trans mountain pipeline, which is expected to come online if the second quarter of 2024 will provide western crude oil producers with an additional 590,0010 barrels per day of crude transportation.