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Investors focused on the day-to-day gyrations of the equity markets may be missing an underappreciated opportunity in the bond market. With their current income and capital gains potential, coupled with a more stable level of risk, bonds are a must-have for any portfolio.
“I think there are a lot of opportunities right now,” says Crista Caughlin, fixed income portfolio manager at Mawer Investment Management. “Just higher rates alone, or the higher level of yields, has made fixed income as an asset class more attractive today than it has been for decades.”
The bond market’s success is almost always tied to the overall economic landscape. Bonds have an inverse relationship to interest rates. When the cost of borrowing rises, bond prices usually decline. But returns from maturing bonds can also be reinvested into new bonds that offer higher yields.
“If you’re looking at macro indicators, there are a number of things lining up that would suggest it’s the right time to move to bonds,” Ms. Caughlin says.
Interest rates were low for years, and borrowing was cheap and easy, a situation that has come to a halt. Interest rates, inflation and monetary policy now mimic the late 1990s, making bonds even more appealing. They offer investors growth without the drama of the stock market.
As a general rule, bonds also tend to outperform stocks in a recession, and an economic slowdown is still a possibility in Canada. “Our view has been that it will be challenging to orchestrate a soft landing and get inflation back to target, on a consistent basis, without some sort of growth slowdown or job losses,” Ms. Caughlin says.
Bonds are often marketed as a low-risk portfolio diversifier. They can offer income and capital gains through exposure to a broad array of fixed income markets, sectors and issuer types.
Taking advantage of these opportunities requires an active, research-oriented approach, says Brian Carney, fixed income portfolio manager at Mawer Investment Management. He says that’s what can separate the superior from the average, generating returns in excess of the broad market while providing peace of mind for investors.
“If you’re in a GIC and locked in, or you’re in an ETF [exchange-traded fund] that’s just mimicking the market, you’re subject to the ups and down of the market without the ability to outperform through security selection.”
Mr. Carney says it’s important to employ fund managers with the skills to identify mis-priced securities in the market. That takes insights into the direction of interest rates, or variations in security valuation due to changes in the credit quality of an issuer. At Mawer, the fixed-income team can tap into a 40-person research group. The ability of fund managers to rapidly alter the complexion of a portfolio, through changes in duration or credit quality, can dramatically affect the outcome for investors.
Mawer recently introduced its second active fixed-income vehicle, the Global Credit Opportunities strategy, managed by Mr. Carney. It operates alongside Mawer’s long-standing Canadian Bond strategy, managed with an active approach by Ms. Caughlin. Global Credit is an unconstrained mandate, with the flexibility to invest in securities issued by companies across all rating categories, within major developed credit markets around the world.
The largest bond market is in the United States, followed by Europe, and then peripheral markets including Canada. Accessing those markets through a global fund gives investors more opportunities than they would have in a fund confined to the Canadian market.
“The corporate market outside Canada exceeds US$20 trillion,” Mr. Carney says.
While you have to do your homework when picking fixed income, he adds there are always opportunities regardless of the economic cycle, and there are benefits to not being as heavily weighted in equities within holdings.
“When it comes to your portfolio, you don’t want to have all your eggs in one basket. You don’t want to own just Amazon and the six other big tech stocks,” Mr. Carney explains. “And while we’ve gone through a period where the income component on these investments has been very small, now we’re at a point where yields are attractive. A U.S. 10-year bond is around 4.3 per cent, and a Canadian 10-year bond is around 3.65 per cent.”
There’s also increased capital gains potential on fixed-income investments should inflation drop back to 2 per cent.
“Additionally, when you move from government bonds into credit products, you’re getting an incremental yield that’s even more attractive,” Mr. Carney says.
Disclaimer: This publication and its contents are for informational purposes only. Information relating to investment approaches or individual investments should not be construed as advice or endorsement. Any views expressed in this publication were prepared based upon the information available at the time and are subject to change and possible correction. In no event shall Mawer Investment Management Ltd. (“Mawer”) be liable for any damages arising out of, or in any way connected with, the use or inability to use this publication appropriately.
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