Behind the lines in North American fixed income

Paul Borean's picture

For all the focus on political wind changes, one constant in the background is that there is limited appetite for additional monetary stimulus across major developed market central banks. Fiscal and monetary policies have linkages, with changes in one having cyclical implications for the other. We briefly examine some highlights from the North American policymaking sphere, including aspects of how we are presently positioned in light of the balance of risks to the outlook.

Positioning at a glance

The following tables provide a high level summary of the positioning in our Signature Canadian Bond Fund strategy compared to its benchmark the FTSE TMX Canada Universe + Maple Bond Index.

Source: Signature Global Asset Management.
* The portfolio has a neutral USD hedge ratio of 80%


U.S.: gaining confidence

Looking first at the U.S. situation, one notable complication in the monetary to fiscal policy handoff is the U.S. administration’s two-handed approach to market reactions to their policies. On the one hand, it wants to keep the U.S. dollar soft enough relative to other currencies to support some rebalancing on the trade front, while at the same time proposing protectionist measures that risk having the opposite effect on the currency. Another concern is the Fed’s own communication challenges. The committee has struggled to consistently achieve clarity in its missive to the market, and this situation is unlikely to improve with two voting member positions currently vacant and another three awaiting turnover.

Taking this backdrop together with improving cyclical conditions, we argued in our recent Global Fixed Income webcast (see highlights here) the window of opportunity for the Fed to raise rates may be smaller than the committee believes. Regardless of whether the Fed agrees with this assessment, the committee has another quarter worth of mandate consistent U.S. data flow in hand, along with favourable financial conditions. Accordingly, various Fed speakers have announced their comfort with continuing on the tightening path in a more vocal fashion, with North American bond markets repricing lower accordingly (bond prices fall as the level interest rates rises).

We have been keeping overall North American fixed income duration in our Signature Canadian Bond Fund and Signature Tactical Bond Pool strategies underweight relative to their benchmarks (the FTSE TMX Canada Universe + Maple Bond Index and the FTSE TMX Canada Universe Bond Total Return Index, respectively), as developed government bond markets are generally susceptible to reassessments of Fed rate expectations, given the policy implications for other markets.


Canada: the tightrope walk must end

Where do U.S. machinations leave a small open economy like Canada? In short, between a drawn out rebalancing and recovery, and a suite of prospective U.S policy changes that threatens it.

Historically what has been good for the U.S. economy has tended to exert positive knock-on effects in Canada, but the U.S. policy cocktail may not be so friendly this time. To highlight some examples, lower U.S. corporate taxes and lighter

regulation in isolation could lead to deterioration in Canadian competitiveness, impeding the positive influence these measures likely would have on demand for Canadian exports, some 3/4 of which are currently destined for our southern neighbours. Protectionist U.S. trade measures would make matters worse, hindering the long awaited reorientation of the domestic recovery and hurting Canada’s growth prospects and underlying inflation outlook. For the Bank of Canada, this combination points to an uncomfortable wait on the sidelines for greater clarity. In the interim, the Bank seeks to lean against a tightening of financial conditions - as markets have priced in a slow cyclical recovery as Canada gradually emerges from the throes of lower energy prices - while at the same time aiming to not exacerbate rising consumer indebtedness and hot real estate markets. The country’s fiscal policymakers are also feeling stuck, with the government having already put forward stimulus measures of its own, there is less room remaining to combat a potential new economic shock. Clarity on how to respond to U.S. initiatives will likely still be lacking when the government tables its next budget later this month, again suggesting a preference for waiting.

Placed in the context of rising global rates, the carry focused aspects of the Canadian fixed income strategies may have their day while policymakers remain inclined to not rock the boat, but will offer limited consolation when this fragile status quo ultimately breaks, especially with credit spreads in sub-sovereign government and investment grade corporate bonds near the tight end of the cycle range. Investors should ready their plans for an inevitable shift in the outlook: toward an economy that gradually recovers unimpeded and warrants a tighter policy stance or another negative shock that demands further easing.

The yield curve exposure in our Signature Canadian Bond Fund and Signature Tactical Bond Pool strategies is aligned to deal with such considerations, being bulleted and thus still quite responsive to market rallies despite the overall underweight duration position relative to their respective benchmarks as noted above. In terms of credit spread exposure, we remain overweight investment grade corporate credit and underweight government agency debt.

Source: Bloomberg, Signature Global Asset Management
* Includes provincial, municipal, government agency and supranational entities
** ILB refers to inflation linked bonds


Inflation: large adjustment, in need of follow-through

Back in August of last year, we aired our concerns about a cyclical shift to a more inflationary environment and the potential inflation implications of the U.S. political agenda, most notably protectionist measures. To express this view, we had gradually accumulated positions during the second half of 2016 in U.S. TIPS across our Signature Canadian Bond Fund, Signature Global Bond Fund, and Signature Tactical Bond Pool.

These concerns manifested more firmly in market pricing following the U.S. election. The timeline for implementation of the proposed U.S. policy changes is now becoming increasingly clear to markets, and it is likely to be lengthy. Our allocation to TIPS has captured the one-time large readjustment of inflation expectations, though there is a risk that these assets may not perform as well relative to nominal bonds going forward, particularly should U.S. policymakers fall short in delivering on their plans.

Given this balance of risks, we have pared back the size of our TIPS allocations across our strategies accordingly, though we retain meaningful exposure to the asset class. TIPS positions have merits beyond serving as a medium for expressing inflation views. During the current season, the carry on these instruments can be quite favourable relative to nominal government bonds, while modest concessions are made in terms of liquidity and correlation to risky assets (see our blog titled Inflation protection in the fixed income markets for more general information on inflation linked bonds). We see this important portfolio diversifier continuing to produce benefits for the portfolios, and its size will be managed tactically to make the most of these benefits.

Source: Bloomberg, Signature Global Asset Management


Drivers of performance and future developments

Further to the duration, yield curve, and TIPS allocation positioning discussed earlier, the following tables provide an  in depth look at how performance has been generated over the first two months of 2017, how it fits into the fixed income suite at Signature, and a brief look ahead to future updates.

As of February 28, 2017, the Signature Canadian Bond Fund  has outperformed the FTSE TMX Canada Universe + Maple Bond Index by 0.24% over the year to date (this relative performance and breakdown below is expressed gross of all fees and taxes). Duration and yield curve positioning, corporate credit spread and inflation linked bond exposure have all contributed positively to this performance, while residual exposure to a weaker U.S. dollar provided some offset.

Source: Bloomberg, Signature Global Asset Management
Quarter-to-date and year-to-date as at February 28, 2017.


The fixed income markets will remain choppy amid the ongoing monetary to fiscal policy handoff, and we continue to actively manage our exposure to different drivers of fixed income performance to navigate this challenging environment (see our Tactical Bond Strategy Update from September for more on the fixed income levers we utilize to achieve various objectives). Our April update will examine highlights from our Signature Tactical Bond Pool and emerging markets strategy.

Source: Bloomberg, Signature Global Asset Management


An overview of the counter cyclical fixed income suite offered by Signature


Standard performance data – As at February 28, 2017

Fund Code Fund Name YTD% 1YR% 3YR% 5YR% 10yr% Since INception Inception Date
CIG 7226 Signature Short-Term Bond Fund Class F 0.5 0.9 1.3 1.5 2.3 3.2 11/17/00
CIG 726 Signature Canadian Bond Fund Class F 0.9 1.5 3.2 3.0 4.0 4.7 07/17/00
CIG 4345 Signature Tactical Bond Pool Class F 0.9 1.8 N/A N/A N/A 2.5 12/17/15
CIG 129 Signature Global Bond Fund Class F 0.2 -3.9 5.1 4.8 4.9 3.9 07/17/00


Disclaimer: This commentary is published by CI Investments Inc. It is provided as a general source of information and should not be considered personal investment advice or an offer or solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this commentary is accurate at the time of publication. However, CI Investments Inc. cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. This report may contain forward-looking statements about the fund, its future performance, strategies or prospects, and possible future fund action. These statements reflect the portfolio managers’ current beliefs and are based on information currently available to them. Forward-looking statements are not guarantees of future performance. We caution you not to place undue reliance on these statements as a number of factors could cause actual events or results to differ materially from those expressed in any forward-looking statement, including economic, political and market changes and other developments. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return include changes in unit value and reinvestment of all distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

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