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PART TWO: Fixed Income Fund Opportunities for 2020

Alexandra Gorewicz's picture

open pdf version“Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies.”

So why do central banks keep reaching for the elusive 2% inflation target? The simple answer is “because they are legally required to so do.” For the better part of the last decade, world leaders (except maybe Donald Trump) have been content to take a back seat to monetary policymakers. They allowed central banks to do the heavy lifting because it meant that interest rates would fall further, spur rallies in global risk assets (and their re-election chances!) and make it cheaper to issue new government debt. This, in turn, enabled governments the world over to throw fiscal prudence out the window (except maybe in Germany) and go on deficit spending sprees, without any consequences! Why should governments pay for the privilege of borrowing money? Investors, particularly those in Japan and Europe, should pay governments for the “privilege” of lending them money via negative interest rates.

Sadly, this absurd development is unlikely to change anytime soon. For proof, look no further than Europe. The September report, “Challenges ahead for the European Central Bank: Navigating in the Dark?” published for the ECON committee of the European Parliament is comically tragic. The paper accuses the ECB of having a poor grasp of where “neutral rates” should be, of having outdated models about how the economy actually works, and of facing prospects of diminishing marginal returns on their conventional and unconventional policies. Put another way: the ECB has no clue what it is doing. Yet despite such a scathing analysis, the paper states: “We also urge the ECB to be ready to apply all the tools at its disposal if the economic situation deteriorates (quantitative easing, generous refinancing operations, forward guidance, etc.) and to start thinking about other potential tools if the current ones are insufficient (e.g. helicopter money, etc.).”1 Put another way: the ECB has no clue what it is doing, but it should keep doing what it is doing (and then some) if the economy worsens! Clearly political developments are as absurd as monetary policy ones. 

“Courage is knowing what not to fear”

From my comments above, it is clear that global monetary policy is on hold. Given that we expect the world’s economic overcapacity to persist in the foreseeable future, we do not expect central banks to take interest rates higher. More explicitly, we believe that the U.S. Federal Reserve, the ECB, the Bank of Japan, and others (including the Bank of Canada), will keep interest rates at current levels (or lower!) until at least the end of 2020. And we are confident that this position is supported by politicians who are skeptical that monetary policy is effective but are keen to encourage more unconventionality if economic growth and inflation rates fall further. This setup – very low rates yet low growth – makes markets feel uneasy about taking risk, because pundits have repeatedly claimed that we are in the late stages of the current cycle for the last five to six years. And, yet, central banks found ways to extend the cycle each year. 

While we do not expect the Canadian investment-grade bond market to return 9% again in 2020 (we expect something closer to 2-4%), we believe that existing geopolitical trade tensions, global manufacturing slowdown, and long-term structural challenges are underpinned, over the next year, by exceptionally loose global monetary policy, which has a bias towards further easing. This means already tight credit spreads can continue to tighten (so, expensive corporate bonds can become more expensive) and already low interest rates can continue to move lower (so, expensive government bonds can become more expensive). The implications for domestic investors are the same as those for foreign investors: to hit your return targets, you must continue to take risks, but government bond yields can fall further. This means they will continue to add protection in your portfolio! Thus, we believe 2020 will reward portfolio diversification and the following three Signature fixed-income strategies will outperform traditional Canadian bond funds in such an environment. 

Signature Core Bond Plus Fund 

This portfolio is designed to provide negative correlation to stocks – similar to a traditional Canadian bond strategy - but with a higher yield to address the current low-rate environment. The higher duration on government bonds held in the portfolio are complemented with allocations to higher yielding asset classes that are part of Signature’s core competencies such as high yield bonds, emerging market bonds, U.S. agency mortgage-backed securities and preferred shares. Gone are the days when “core fixed income” was a combination of Canadian government bonds and investmentgrade corporate bonds. Today, with its diversified set of return drivers, this enhanced fixed-income strategy should be considered the core fixed-income solution for Canadian investors. 

Figure 1: Signature Core Bond Plus Strategic Asset Mix, as of December 31, 2019 

Signature Core Bond Plus Strategic Asset Mix, as of December 31, 2019

Yield to Maturity 3.14%
Duration 8.3
Average Credit Quality A

Sources: Signature Global Asset Management, Bloomberg Finance L.P. 

Signature Corporate Bond Fund

This portfolio is designed to generate high-yield like returns with Canadian bond market risk (or volatility), leading to better risk-adjusted returns compared to traditional fixed income indexes. Security selection within and allocations between high-yield and investment-grade corporate bonds are adjusted ahead of turns in the business and credit cycles to drive returns, generate income, and protect principal. 

Figure 2: Signature Corporate Bond Fund Strategic Asset Mix, as of December 31, 2019 

Signature Corporate Bond Fund Strategic Asset Mix, as of December 31, 2019

Yield to Maturity 5.30%
Duration 4.83
Average Credit Quality BB+

Sources: Signature Global Asset Management, Bloomberg Finance L.P.

CI Global Unconstrained Bond Private Pool 

This is a new pool that we launched at the end of 2018. This benchmark-agnostic strategy aims to generate positive, GIC-beating returns across the business cycle. With a “go-anywhere” approach, it is carefully constructed to diversify exposures across a broad suite of fixed-income asset classes to ensure positive, consistent returns. 

Figure 3: CI Global Unconstrained Bond Target Allocations, as of December 2019 

CI Global Unconstrained Bond Target Allocations, as of December 2019

Yield to Maturity 4.86%
Duration 2.75
Average Credit Quality BB+

Sources: Signature Global Asset Management, Bloomberg Finance L.P.

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1. Challenges ahead for the European Central Bank: Navigating in the Dark?

Sources: Signature Global Asset Management, Bloomberg Finance L.P. 

 

IMPORTANT DISCLAIMERS

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. 

This document is provided as a general source of information and should not be considered personal, legal, accounting, tax or investment advice, or an offer or a solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this document is accurate at the time of publication. Market conditions may change which may impact the information contained in this document. All charts and illustrations in this document are for illustrative purposes only. They are not intended to predict or project investment results. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Investors should consult their professional advisors prior to implementing any changes to their investment strategies.

The opinions expressed in the communication are solely those of the author and are not to be used or construed as investment advice or as an endorsement or recommendation of any entity or security discussed. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Investors should consult their professional advisors prior to implementing any changes to their investment strategies.

Certain statements contained in this communication are based in whole or in part on information provided by third parties and CI Investments Inc. has taken reasonable steps to ensure their accuracy. Market conditions may change which may impact the information contained in this document. Certain statements in this document are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “intend,” “plan,” “believe,” or “estimate,” or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what CI Investments Inc. and the portfolio manager believe to be reasonable assumptions, neither CI Investments Inc. nor the portfolio manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

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Published January 27, 2020

We welcome your comments and questions for the Signature team and will respond as soon as possible. Please note that all comments are reviewed for their relevance to the topics discussed in the blog, and that comments may be edited.

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