A Tour of the Signature Short-Term Bond Fund

Paul Borean's picture

Throughout the era of highly accommodative monetary policy that has endured over much of the last decade, a core fixed income solution is still viewed by many investors as the key source of diversification for portfolio risky-asset exposures. This preference has held even during a regime where bonds’ correlations with risky assets have not always behaved as one would expect.

The implication in practice is that when typically negative Canadian bond and equity return correlations do not apply, as they have at points within the last few years (see plot below), the degree of interest rate sensitivity of portfolio fixed income holdings becomes a point of concern. Fixed income allocations cease to provide the intended portfolio insurance if interest rates across the curve are rising alongside a sell-off in equity markets.

Short-term fixed income portfolios can be beneficial for filling this niche, reducing the return hit to portfolio fixed income holdings during periods when interest rates are rising across the curve, while still providing some risky-asset diversification benefits when equity market returns soften and typical negative return correlations hold. 


Source: Signature Global Asset Management, FTSE Russell, Bloomberg 

In the following, we briefly highlight some further compositional differences between short-term and broad fixed income exposure in the Canadian context, and discuss Signature’s approach to short-term fixed income investing, including recent performance and positioning.

Different from broad fixed income exposure

There is a wide gap in the overall interest rate sensitivity of short-term bonds relative to the broader Canadian fixed income market, represented here by the FTSE/TMX Canada Short-Term Bond Index (“Short-Term Index”) and FTSE/TMX Canada Universe Bond Index (“Universe”) respectively. The duration of the Short-Term Index is just over one-third of that of the Universe, making its returns less exposed by approximately this amount to a given shift higher in the level of interest rates. In addition, the Short-Term Index exposure is limited to issues ranging from 1 to 5 years to maturity, while the Universe spans the whole maturity spectrum from 1 year onwards, entailing different interest rate volatility exposures, which can vary materially at the various points across the yield curve. 


Source: Signature Global Asset Management, FTSE Russell, Bloomberg


Source: Signature Global Asset Management, FTSE Russell, Bloomberg

Beyond the raw interest rate risk, there are also noticeable divergences in credit composition between the two market segments. More specifically, the Short-Term Index exhibits a sort of barbell in issuer content compared to the Universe, carrying a larger presence of federal and corporate paper and a much lesser quantity of provincial debt (see bottom plot above), partly reflecting the preferred habitat of the issuance programs of these various bond issuers. The quality of the corporate credit in the Short-Term Index also displays a notable tilt toward higher-rated names, with some 10 percentage points less BBB-rated paper compared to the Universe (see the two plots below).

Given these variations in the beta exposures between short-term and broad fixed income markets, actively managing shorter-term fixed income portfolios requires a different approach.


Source: Signature Global Asset Management, FTSE Russell, Bloomberg


Source: Signature Global Asset Management, FTSE Russell, Bloomberg

Short-Term Bond Portfolio Positioning at Signature

In the interest of maintaining diversified exposure within the Signature Short-Term Bond Fund (see our blog titled “Portable beta in modern fixed income design” for more about this framework), we have spent much of the year carrying exposure across the US term structure, with these positions being reallocated primarily from 5-year maturity Canadian bonds. Our US investments include USD investment-grade emerging-market sovereign debt, agency mortgages and inflation-linked bonds, and we retain positions in such issues today. Although some of these US assets range beyond the typical 5-year longest maturity of instruments in our benchmark, we have managed this exposure to be mindful of the balance of risks around taking positions in longer-dated US bonds relative to shorter-term Canadian bonds, as well as any credit risk and residual currency exposure, after accounting for hedges in the latter.

Our inflation-linked bond positions were scaled back during the first nine months of the year, in part to limit exposure to their underperformance relative to US nominal benchmark bonds, but also to take advantage of the outperformance of US duration relative to the Canadian market. In addition, once much of the adjustment higher in Canadian yields prompted by the Bank of Canada had taken place, we took Canadian duration moderately higher mainly via purchases in 5-year maturities. This added duration also helps provide some insurance against a potential softening in credit-risky assets, which have performed admirably relative to Canadian government benchmark bonds year-to-date.

Heading into the final month of the year, the short-term bond portfolio has shifted duration close to its benchmark, though the portfolio remains short in the 3- to 5-year area of the Canadian yield curve. Within the spread product arena, in addition to the US asset positions highlighted above, we remain overweight corporate and provincial credit and underweight Canadian government agency debt.

Source: Signature Global Asset Management

Appendix: Signature Short-Term Bond Fund Performance Analysis

The Signature Short-Term Bond Fund advanced by 1.34% year-to-date as of November 30, 2017, outperforming the FTSE/TMX Canada Short-Term Bond Index (the portfolio benchmark) by 0.81%. The total return outcome of the portfolio was primarily driven by the net compression of corporate credit spreads, and to a lesser degree government credit spreads, with a modest offset coming from the rise in Canadian interest rates.

On a relative-to-benchmark basis, duration and yield curve positioning was a key contributor to portfolio alpha, benefitting from an underweight duration position in 5-year maturity Canadian bonds, both outright and relative to the US, amid a hawkish shift from the Bank of Canada during the second quarter and two rate hikes being delivered in the third quarter. In the spread product arena, overweight positions in corporate credit, US agency mortgages and emerging market spreads were all beneficial for alpha, with corporate credit registering the largest alpha contribution. Please refer to the table below for a detailed breakdown of the performance.


Source: Signature Global Asset Management, Bloomberg. Class F returns net of fees are disclosed below.


Source: Bloomberg, Signature Global Asset Management
As of December 12, 2017
*First Asset Long Duration Fixed Income ETF is an exchange-traded fund managed by First Asset Investment Management Inc. Signature Global Asset Management, a division of CI Investments Inc., acts as portfolio advisor.

 

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 commentary 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. Unless otherwise indicated, the indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do 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. First Asset Investment Management Inc., manager of First Asset Long Duration Fixed Income ETF, is an affiliate of CI Investments Inc.

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