Jon Chevreau, Q1: Do you believe active management makes more sense in the fixed-income space versus the equity space? Perhaps it makes sense in both?

Jon Durst: There are merits to active management in both equities and fixed income; however, I feel recently, it has been a heavy skew towards active fixed income in this current market environment, and for many reasons. Early in March 2020, we saw a 50bps cut in interest rates by the Fed in the US: it was the first unscheduled rate cut since 2008 and the biggest cut since the financial crisis.  There also appears to be a strong consensus on the street that rates will be “low for longer” going forward.  If you own a passive fixed income strategy, the goal is to minimize tracking error to the index and what it cannot do is to adjust or try to anticipate any type of market events, like interest rate changes or changing company fundamentals.

This can certainly be a worrisome event for most advisors if they buy their own bonds directly or passive fixed income products covering different sectors/regions, as they have to scramble and figure out if they should continue with the same fixed income allocations in their portfolio, as the onus of making any changes to their portfolio will be on them.

Active managers with years of experience can focus solely on their investment mandates and can adjust to different types of market events, such as shape of the pandemic recovery or the consequences of the Democrats winning the 2020 US elections.

Outsourcing in this market environment and buying active fixed income exposures that align with your client’s outcomes will hopefully provide a calming effect that is certainly needed.  Not to mention, active fixed income ETFs in particular are now often priced very similarly to passive indexed products, which is even more important in this low rate environment to help maximize clients cash flow.

Jon Chevreau, Q2: For income-oriented retirees, do you generally see more opportunity in corporate or government bonds?

Jon Durst: I do see more opportunity in corporates debt, as the yields are higher, they also tend to be less sensitive to interest rate movement, but the risk level and volatility do tend to slightly go up.

A passive aggregate bond strategy that encompasses both corporate and government debt in Canada yields around 2.55%, a pure passive Canadian government bond strategy at 2.11%, and a passive Canadian corporate strategy around 2.77%.  On the other hand, for example, an active Canadian corporate strategy FLCI – Franklin Liberty Canadian Investment Grade Corporate ETF, yields 3.12%. An active manager can select certain bonds over others, perhaps looking for higher coupons and/or YTMs, or overweighting certain sectors that will benefit from the pandemic trade or the Biden Presidency.

Jon Chevreau, Q3:  How much exposure should Canadian investors have in US and international bonds and through what vehicle? On that note, what is your stance on currency hedging?

Jon Durst: We do need to think outside of Canada; even from a fixed income perspective, Canada’s total debt in comparison to the world is about 3-4%.  Also, there is no tax incentive to buying solely Canadian debt, unlike the Canadian Dividend Tax credit provided on distributions from Canadian equities.  There are many fixed income opportunities to take a look at – a solution based option via a Canadian Core Plus strategy is one – where you would still keep 70-75% in Canadian bonds and have an active manager select the 25-30% in the US and/or globally.  You could also consider a more broad-based global aggregate option, having the portfolio manager look for opportunities from a global stand-point, which offers the PM a lot of flexibility to diversify geographically and from a currency perspective.  Yields in different countries can vary significantly which can create a lot of opportunity for higher yields and capital appreciation, not to mention diversification benefits.

In terms of buying a pure-based exposure – in other words, buying direct US, EAFE or EM debt, either by purchasing individual bonds or a managed product — I find most advisors are still tippy toeing into pure US, EAFE or EM debt spaces: most still maintain a home country bias and the complexity of selection, weighting, and trading these exposures is difficult, to say the least. Those that see the value in investing outside of Canadian debt usually outsource this complexity by using active fixed income strategies that provide access to the US/Global exposure, in addition to Canadian bonds.

I am for 90-100% in currency hedging fixed income exposures.  With interest rates and yields being at historical lows, another level of worry should not be placed on how the global currencies are going to perform relative to the CAD$, especially in fixed income, which is supposedly the conservative component of a client’s portfolio.  In my opinion, currencies should be hedged out as much as possible in fixed income.

Jon Chevreau, Q4: Your blog back in February compared bond funds to GICs. Do you see a role for both and in what proportion?

Jon Durst: In this environment, it can get even trickier: do you really want to lock into GICs for a certain period of time at a certain rate? Or want to be nimble and have liquidity? It’s a question on how to balance stable income that is locked in (currently at historically low rates) and/or including a short term bond strategy that can yield a little more in this environment and provide liquidity in the event of a requirement. I am beginning to see a fair number of advisors who have started to allocate to short term bonds funds as client GICs mature. Usually cash, GICs and short-term bond funds make up about 5-10% of a clients portfolio, but GIC investors are being compensated very little, so short term bond funds are being used for those with a higher need for income, and cash now being used for those with a 100% capital preservation requirement (not taking inflation into the equation).  GICs appear to be losing some steam.

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