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Transcript - Fixed-Income Investing in a Rising Rate Environment Webinar


David Keenan: Hello and welcome to this evening’s webinar: Fixed-Income Investing in a Rising Rate Environment. My name is David Keenan and I will be your moderator for the evening. I’m a Portfolio Manager with MD Private Investment Counsel and I’ve been with MD for almost 10 years.

The main presenter tonight is Wesley Blight, who is a Portfolio Manager within the Investment Management and Strategy team based in Ottawa. Wesley’s responsibilities include being lead Portfolio Manager for the MD fixed income and balanced products, including the Canadian Equity Segregated Portfolio within MD Private Investment Counsel. Wes joined the Investment Management and Strategy team in 2009 and has been with MD since 2004. Wes previously worked for a large financial Institution in Ottawa and is a graduate of the University of Ottawa, and his industry designations include the CIM, the FCSI and he also holds the Chartered Financial Analyst designation.

In terms of tonight’s agenda, we will be looking at:

  • Bond Basics
  • Yield 101
  • What’s Happening in Bond Markets?
  • Why Bonds?
  • Why Always?
  • General Strategies to Help Investors Achieve Fixed-Income Returns
  • How MD Seeks Rate-Adjusted Returns in Fixed Income

I will also add if you have a question, please feel free to use the question and answer box and direct your question to all panellists. If you’re not able to use the Q&A box, please send an email to And please feel free to submit questions throughout the presentation. Once we have finished the presentation we will answer as many of your questions as possible and we’ll also email a link to the recording as soon as it’s available on our website.

First of all, to give a little bit of background about MD: MD has been in existence for more than 45 years. It’s the number 1 most trusted wealth management company in Canada for Canadian physicians. And in MD Investment Counsel we have over $21 billion in assets under management, which makes us the largest non-bank owned private investment company in Canada.

In terms of a little bit more of MD by the numbers, we have over 300+ wealth advisors and experts across Canada. We have over 100,000 clients and we have more than $44 billion in total assets under administration, and approximately half of that amount are assets under management for MD Private Investment Counsel clients.

So with that background, we’re now going to move to bond basics and I’m going to hand over to Wes to start the presentation for a brief tutorial on the background of bond basics.

Wesley Blight: Great, thanks David, appreciate the introduction. I’m just on slide 9 right now. And before we get started, I want to make you familiar with a number of common terms that are associated with bond investment. Bonds are a way to raise money in the capital market. You can take the Government of Canada as an example. We’re in our 150th year, and this summer there’s going to be a series of very expensive fireworks across the country. In order to raise money to pay for those fireworks, the Government of Canada will issue debt.

In this instance, our example suggests that the Government of Canada will be raising $100,000 in debt. That becomes the face value or the size of the bond issue and then they’re going to be paying a 5% coupon. That’s the interest rate paid by the bond issuer to the bond holder.

In this example, the Government of Canada has raised $100,000. They’re going to be paying a 5% coupon. That equates to an annual payment of $5,000. At the end of five years, when this particular bond in our example matures, the issuer repays the face value to the bond holder, and in the interim we’re able to enjoy successful fireworks.

Moving on to slide 10, Credit Rating Agencies, they’re the ones who provide insight into the likelihood that an issuer will default. There are three firms that are globally dominant in this space. There is S&P, which is Standard & Poor’s, there is Fitch and there is Moody’s. They dominate bonds in the global market and they represent approximately 95% of all credit rating agencies’ worth.

Now in our Government of Canada example, the Government of Canada is deemed to have the highest willingness and ability to repay their bond obligation. And consequently, the credit rating agencies have said that they have the best credit rating at AAA.

Now there are also bonds that are rated lower than BB. So they could be BB, B, CCC, those are considered to have a higher risk of default and that’s either via a lack of willingness or ability to repay their debt obligations. Those non-investment-grade or high-yield issues typically pay higher coupon rates as they have a higher probability of default.

David Keenan: So we know that bonds have a term, a coupon rate and a face value. Wes, can you go on and explain the concept of bond yield for us?

Wesley Blight: Absolutely. So we’re up to slide 12 now. I think of yield as a measure of compensation for owning a bond. Thinking back to our Canadian Government example, the bond is paying a coupon of $5,000 and divided by $100,000 par value, that has a yield to maturity of 5%. However, in the secondary market, the price that another investor is willing to pay for that bond determines its value. In other words, the price of the bond will move up and down, depending on other investor’s willingness to buy that bond and as a result, with the bond increasing or decreasing, its yield will also move. Say for example, the price of the bond falls down to $90,000.

The yield here increases to 5.5%. As an investor, you’re still going to receive the $5,000 coupon payment, even though the bond is now only worth $90,000 on the secondary market. So when you hear the words “yields on 10-year bonds went up,” that’s also saying that the value of those bonds went down.

On the next slide, you can see a quick snapshot of the relationship between bond price and yield. Now when prevailing interest rates fall, most older bonds, bonds that are already out there, become more valuable and that’s because they had been sold in a higher interest rate environment and typically have higher coupons than what the current issues are paying. Now investor’s holding those bonds can sell them at a premium on the secondary market. And we’ll show this on our next example on slide 14.

David Keenan: Wes, would it be right to say then that there’s a direct inverse relationship between the value of bonds and the movement of a cut in interest rates?

Wesley Blight: That is a fantastic way of summarizing this. Yes, there is a direct inverse relationship between interest rates and bond prices.

David Keenan: Excellent, thanks.

Wesley Blight: Now there’s also a wide variety of factors that can cause a bond price to change. So just what you mentioned, if interest rates fall, but you still own a bond that’s paying a higher rate, you’ll typically see the bond price increase. So that makes our $100,000 investment in the Government of Canada bond example more valuable. As interest rates fall, its value in our hypothetical situation may increase to $110,000. At that point in time, the yield has declined from the 5%, down to 4.54%. Now, as an investor, we have the choice to either continue holding the bond and receiving our $5,000 payments, even though the yield for continuing to hold that bond has declined, or we can sell that bond for a tidy profit.

There’s a common term that is used to evaluate the sensitivity of a bond’s price to changes to interest rates, and that’s duration. Duration is the weighted average of the present value of a bond’s cash flows, so those are future cash flows, which includes both the series of regular coupon payments—so in our example, the $5,000 that we’ll receive on an annual basis—plus the much larger payment at the end of the maturity for that bond, which is the face value being repaid back to bond holders. So our Government of Canada bond was issued with a five-year term to maturity, but that isn’t the bond’s duration. It’s typically a little bit shorter than the full maturity term. In relating that to interest rates, as I mentioned, it is a measure of sensitivity, the change in interest rates. The higher that a bond’s duration is, the more sensitive its price will be to changes in interest rates.

Wesley Blight: It is. Typically, bonds that have longer maturities will typically have more duration than bonds that have a higher yield. If they have the same maturity date, one with a higher yield would be a little bit less sensitive to interest rate risk, so its duration may not be as high.

David Keenan: Excellent, thanks Wes. So looking at what’s happening in bond markets, we’re living through very interesting times in terms of politics, the economy and the markets. Can you give us your insight, Wes, as to what’s happening in bond markets?

Wesley Blight: Absolutely, happy to do so. For more than 30 years, bond prices have been in a highly favourable environment and that’s a direct result of global interest rates having continually declined since the early 1980s. Interest rates today are in fact so low that the chief economist from the Bank of England put together a historic plan. And it looked at the last 5,000 years of interest rates. Now this is obviously a lot longer than anyone’s investment time horizon, but I do think that’s it’s important to show that today’s interest rate environment is at the lowest point it’s been for the last 5,000 years. But that really isn’t the unique attribute in that 5,000 year history of interest rates. The unique attribute is back in the early 1980s

In 1981, September, a Government of Canada 10-year bond had a yield of 17.66% and that’s a true anomaly in that bond yields hadn’t historically been at those heights in the last 5,000 years.

Since that time, we’ve had a steady decline of interest rates and the price return for bonds have been strongly positive. Now today’s interest rate environment is so low that there are even regions of the world where the interest rates are actually negative.

On the next slide, slide 18, we’re seeing the U.S. experience and this is specifically the federal funds rate. The U.S. Federal Reserve has rapidly reduced their lending rate since the early 1980s, but even more explicitly during the global financial crisis. And the intent behind that was to make it cheaper for companies to borrow and in turn stimulate their economy.

Now our chart shows that more recently, the federal funds rate has started to increase and I think the key consideration is what happens to bond investors when rates start to go up? And that’s what we’ll focus the rest of our discussion on. We’ll provide an overview of the macroeconomic environment. We’ll continue to talk about some of the key terms and tendencies in bonds. And then we’ll look at those corresponding investment implications.

David Keenan: Now Wes, that’s a dramatic drop in historical interest rates. Is that also a reflection of the low inflation environment we’ve been living through?

Wesley Blight: It’s a direct correlation. When you think about the yield curve, and we’ll show this a little bit later on as well, the yield curve is an indicator of economic expectations going forward and by virtue of it being an indicator of economic expectations going forward, it’s also an indicator of inflation expectations going forward. Typically what we’ll see is a yield curve that’s upward sloping, with an expectation that economic growth in the future’s going to be faster than it is today. It also means that inflation expectations are going to be higher than they are today as well.

And the second point that I think we should make about inflation expectations is that both—all central banks around the world really—the U.S. Federal Reserve and the Bank of Canada, in order to maintain economic stability, they have a target rate for inflation. So as inflation comes down—so it’s kind of a measure of economic growth—as inflation comes down, the interest rates will also come down in that central banks are looking to provide more stimulus into the economy when inflation is too low and they’ll look to increase interest rates when inflation is too high.

In Canada, inflation has come down, so economic growth has not been that strong. Inflationary pressure has not been that strong, and the path for the Canadian interest rate, the key overnight lending rate from the Bank of Canada, has followed a similar profile to what the U.S. Federal Reserve’s key lending rate has. And with low oil prices making it hard for the oil producing regions in Canada to sustain economic growth, and many Canadians carrying elevated debt, tacked on top of the low inflation profile, I think those three components are providing the rationale for why Canada’s central bank has maintained very low interest rates, really since the global financial crisis, and then we even saw a lowering of Canada’s overnight lending rate back in 2015 directly in response to oil prices having declined.

David Keenan: Is this about to change in the Canadian context, Wes? We have the Governor of the Bank of Canada, Stephen Poloz, recently stating that the economy is in good health and that lower interest rates have had the desired effect of stimulating the economy.

Wesley Blight: Good question. I think similar to what the U.S. is going through right now, the prospect for higher interest rates in the future has increased. Part of the reason for that is just as you mentioned, the economy is in a little bit better health than it had previously been perceived to be. Labour growth has been improving and some of the difficulty that was realized from previous drawdowns of oil prices is now moving behind us. And I think the other component that is important is the interest rate differential between U.S. Federal Reserve policy and the Canadian central bank policy in that the interest rate differential between the two can’t be that high. So as the U.S. Federal Reserve is increasing their rate, at some point in time, the Bank of Canada should follow suit, otherwise the consequence of not doing so will drive the Canadian dollar below where the Bank of Canada would be comfortable with it being. So I do think that prospectively, we’re going to see higher interest rates in Canada, but the path to those higher interest rates is probably still quite slow and the increase is going to be more moderate than what we’ve realized in the past.

David Keenan: OK, thank you.

Wesley Blight: Maybe what we’ll do is we’ll flip over to bond yields. Bond yields and interest rates are highly tied together but a little bit different. Bond yields have similarly followed interest rates down over the last 30 years. And with interest rates now starting to increase, and, I’d say far more importantly, with the expectation that they’re going to increase, existing bonds with lower rates that are currently trading on the secondary market are starting to sell at more of a discount than what they were in maybe the third quarter of 2016. And that’s reflected on the right-hand side of slide 20, where you can see that bond yields have started to increase more recently.

David Keenan: Given what we know about the inverse relationship between bond values and interest rates, can you tell us, Wes, why rise in rates can be a good thing for investors?

Wesley Blight: Absolutely. I think the best thing to do here is stick with our example of a Government of Canada bond. These, along with other investment-grade government bonds, are really at the core of most Canadian bond funds. And although some of the value for these bonds can decrease in the short term, there is a long-term positive. And what I mean by that is that any short-term capital losses on fixed-income investments merely set up the potential for higher future returns. If you think about how you’re being compensated as a bond investor, you keep getting a coupon payment made to you from the bond issuer. That doesn’t change, unless of course the bond issuer has defaulted, but because that doesn’t change, it gives you the opportunity to reinvest those proceeds into other bonds that are now paying you a higher yield at higher reinvestment rates. I believe that’s why over the long term, having higher interest rates as a bond investor do good from a return perspective.

I think what we can talk about now is maybe really narrow in on some examples of why I think that’s a good thing. Realistically, yield to maturity acts as kind of a proxy for the total return that you’re going to receive as a bond investor through to the remaining term for the bonds that you hold. And you can see that on slide 23, the benchmark yield to maturity for each one of the funds and pools that we’re showing here is lower than the recently realized return. What that means is that we have historically realized a rate of return that is stronger than our current yield. And our current yield to maturity acts as a proxy for what you should expect as a fixed-income investor going forward. The other thing that I think is important here is that we’ve actively positioned all of our funds and pools to generate a higher yield to maturity versus our benchmarks. What that means, very similar in concept, is we should expect, over an investor’s time horizon through to the expected term to maturity for each one of these funds and pools, we should expect a higher rate of return than what our benchmarks are able to generate.

David Keenan: In the past few years, Wes, we’ve been in somewhat of a bull market for bonds, so I think it’s probably fair to say that we shouldn’t have the same expectations going forward.

Wesley Blight: 100% true David, yes.

David Keenan: Excellent, good. Given what we know about the likely direction of interest rates, the question is should we always have bonds in a portfolio? Tell us, Wes, why bonds? Why always?

Wesley Blight: Great question. One that we’ve wrestled with a number of times within the Investment Management team, and I think the slide that does a fantastic job of explaining this is slide 26. And I think it really gets back to the preservation of capital. The purpose for holding fixed income is when equity markets correct, and this is true across all portfolios, when equity markets correct, typically what happens is fixed income acts as an offset to diversify the portfolio. And I really like how this chart frames this concept in that cash, at the bottom of the pyramid, has the lowest expected return, it also has the lowest amount of expected risk. And what I think about is that the value of your cash holding isn’t rising or falling tremendously at any given point in time, and that’s regardless of how other asset classes are performing.

Fixed income offers more risk, but as compensation for that additional risk it offers more return.

And equities often offer even more risk and even more return; however, the pattern for when equities rise and fall are not typically correlated, meaning they’re diversifying the portfolio, helping to smooth the investor’s portfolio performance across different market environments.

Using an example on the next slide of both Canadian equities and bonds, you can see the two circled areas are times when equity investors would normally get nervous. That is when equity markets have gone down quite significantly. In some investors, that nervousness may cause them to sell out of their equity positions at what would perhaps be perceived as a maximum time of pessimism. However, a balanced investor who holds both bonds and equities is getting some combination of these two lines within their returns. In other words, they’re not getting the big swings or the big drawdown of a pure equity position.

Over the fullness of time, that drawdown for equity will likely correct. We believe it will correct. But when you’re thinking through the puzzle and perhaps reacting to some of that drawdown or that volatility, the investor may be incented to remove their assets at an inopportune time and not actually realize the benefit of that corresponding recovery. And our job as investment managers is to really help our clients find the right strategy and stay invested. Our performance then aligns the expectation to realized results. So we set an expectation, we make sure that our clients are on the right strategy. We talk to them about what they should expect from that strategy and then when realized results align with that expectation, we’re reducing the risk of a client removing themselves or an investor removing themselves from the right strategy for meeting their needs.

Actually, I’m going to skip a slide. We’re going to move all the way ahead to slide 28. This shows real world returns based on a study of investors in the U.S. And I think it helps to answer the question of why a volatility or reduction is so important for helping investors stay on the right strategy. And it’s really a comparison of the returns for the average U.S. investor on the right-hand side versus individual asset class indices.

Now with access to actively managed products and all sorts of information, the average investor over a 20-year period has only managed a return of 2.5%. Now that’s underperforming each of the asset classes listed on the left-hand side, including a balanced portfolio, and perhaps even more importantly, including inflation. So the point here is that in order to realize the investment benefit of a higher rate of return from any of these individual asset classes, you need to stay invested. And minimizing the risk of divesting, I think, is reducing volatility and making sure that you’ve got bonds acting as an offset to promote stability in your portfolio. That’s truly valuable.

David Keenan: It really looks like bonds significantly reduce the volatility in a portfolio and it’s amazing to see that the average investor barely beats inflation over time, so it really does pay to remove the emotion from investment decisions.

Now we’re going to talk about ways to generate returns with fixed-income investments in this challenging environment we’re living through.

Wesley Blight: Perfect, David. Just as you said, we know that the return expectation for bonds is lower than what’s been realized in recent history. But even though we have a lower rate of return expectation, we still need to hold bonds within our portfolio. So knowing both of those things, what are some of the tools that we have in our exposure in order to add value? And within various bond portfolios there are a number of strategies that we can deploy to generate higher returns while making sure that the risk exposures are appropriate for every investor. And depending on the investment mandate, we have the latitude to manage the duration of bonds, so that’s the sensitivity and changes in interest rates. We can also position our portfolio across different points of the yield curve. We’ll show that in a couple of slides. And we can also allocate the different types of bonds. For example, we can continue to follow exclusively our Government of Canada example or we can deploy to high-yield corporate bonds which have higher default risks but also pay higher yields. We can look at investment-grade corporate bonds from across the globe, sovereign bonds from across the globe, so those are government bonds, including both emerging market and developed market bonds.

We’ll describe these types of diversification and then demonstrate exactly how they’re used within our funds. One of the tools that’s available to bond investors is on slide 31, and that helps us to manage fluctuations in value coming from interest rate changes and that’s duration. The longer duration bond prices, as I mentioned earlier, are more sensitive to changes in interest rates, whereas short duration issues are less sensitive. And while bond prices are rising and falling over time, an investor who holds a bond through to maturity, assuming that issuer doesn’t default, gets the principal or par value back regardless of the behaviour of that bond price. It’s the investment time horizon.

For investors it is to ensure that the average maturity of their holdings is aligned with their investment time horizon. So if a bond price falls, doesn’t default, it will recover and that concept, in my view, is recognized as a pull to par phenomenon.

The next slide shows just a couple of quick points about how the slope of the yield curve works. And as I mentioned earlier, it’s been a good leading indicator of economic activity as well as inflation expectations. And because the yield curve summarizes where investors think interest rates are headed, it also helps to provide some indication of how they expect to be compensated for lending money across different periods of time.

Here on slide 33, we’re using the Canadian Government bond issuance to show what yield curve positioning actually means. A normal yield curve is upward sloping, where longer maturity bonds offer the highest yield, where shorter maturity bonds offer the lowest yield. Now the opposite of this normal yield curve is called an inverted yield curve, where longer maturity bonds offer a lower compensation or a lower yield than shorter maturity bonds and that would really be considered an abnormal event. Not something that we would normally expect to see in the yield curve.

In managing our funds in pools, we deploy strategies that capitalize on the expectation of a short-term movements in the shape of the yield curve. For example, we would use a bullet strategy to highly concentrate our exposure at one point on the yield curve. Our barbell strategy would focus on an allocation to the short end of the yield curve and another concentrated allocation on the long end of the yield curve.

And then finally, a laddered bond portfolio strategy would kind of invest equally in bonds maturing on an annual basis. So that staggered portfolio with bond maturities would realize, let’s say at the end of year one, you take the one bond that was invested for a one-year period and it matures. You’ve reinvested at the long end of your laddered portfolio and then you continue to roll down the curve as maturities and time goes on. And those are three standard tools in a bond manager’s toolkit.

David Keenan: Wes, regardless of which strategy we use, it looks like we could still benefit from a yield perspective by having longer term bond exposure.

Wesley Blight: Over the fullness of time, yes, keeping in mind that as you increase your maturity profile, you’re also increasing your interest rate risk. You need to make sure as an investor that your investments are directly aligned with your time horizon. If you only have a three-year time horizon for your investments in order to realize your objective, then I wouldn’t recommend going further out the yield curve, meaning having higher maturities if you don’t have the time with your investment strategy to manage through the interest rate sensitivity. Does that answer your question, David?

David Keenan: Yes, absolutely.

Wesley Blight: Good. Maybe we’ll go ahead to slide 34, where we’re showing different types of bonds. This includes corporate high-yield bonds, emerging market bonds and convertible bonds. Now convertible bonds, you haven’t heard me mention yet. Those are bonds that have the option to be converted into equity shares, so they’re really thought of as a hybrid investment. And the graphs that we’re showing here are based on 23 years of data from [1994] through until 2017. And it separates returns, both the right-hand side to the left-hand side, looking at different environments. On the left-hand side, we’re looking at the experience of each of those four types of bonds in a rising interest rate environment and we’re looking at on the right-hand side, their average experience in a falling interest rate environment. And you can see that bonds that have more credit risk are less affected by rising interest rates than U.S. government bonds. And it kind of hearkens back to what I was saying earlier in that if you’ve got a bond that has a higher yield, they’re a little bit less sensitive to changes in interest rates than a bond that doesn’t have as much yield. But one strategy in a rising interest rate environment is to diversify your holdings away from holding merely Canadian and U.S. government bonds, and introducing different types of bonds that have higher credit risk and are offering enhanced income through more yield. Now depending on your goals and timeline, this could mean a lot of diversification away from predominantly Canadian government bonds or it can mean just a little bit.

David Keenan: I think the key point there, Wes, is that with some diversification, we can still have positive returns in a rising interest rate environment.

Wesley Blight: Yes, that is exactly the point there.

David Keenan: Excellent, good. So I’ll move to the next slide, which is How MD Seeks Risk-Adjusted Returns in Fixed Income. And I’m really interpreting this to mean how and where do we find these opportunities?

Wesley Blight: The vast majority of all of our fixed-income funds and pools are invested in Canadian investment-grade bonds, but we have taken a piece out of the previous slide that we just talked about where we recognize that there is benefit of diversity. And we think that in order to improve the risk return profile of our fixed-income funds and pools, we should truly be looking at a global opportunity set to try and add incremental value. And what we’re doing there is we’re enhancing the income while still maintaining an appropriate amount of capital preservation. And to do this, what we’ve effectively done is we’ve reduced our exposure to Canadian bonds, which historically have been 100%—we’re now using the example in the MDPIM Canadian Bond Pool—our Canadian investment grade exposure is down to 82%. We’ve increased the diversity by introducing what we describe as an opportunistic mandate, which includes both foreign investment grade and non-investment grade.

And on the right-hand side from a yield perspective, you can see that we’re enhancing the income and also are increasing our interest rate protection in a rising rate environment by doing that, in that the domestic mandate, so that’s the Canadian investment grade mandate, is only generating a yield to maturity of 1.76, whereas the opportunistic mandate is dramatically over and above that yield to maturity profile at 3.21, providing a pool yield to maturity that is higher than the benchmark.

Now depending on the market conditions that we expect to encounter, and well within what we’ve described and defined as clear risk objectives, we’ll actively change our allocation to the opportunistic mandate in order to make sure that we’re well-positioned for the market environment that we expect to encounter.

On the next slide, it really describes how we went about calibrating the appropriate allocation to both the opportunistic mandates, so the opportunistic asset classes overall, as well as each of their individual components. And what we did here is that we spent a lot of time trying to understand what the downside risk, so the worst possible scenarios for each one of these asset classes, would be on a relative basis to what we had from a Canadian perspective. And by looking at that risk lens, we’ve limited ourselves to only 7% high-yield corporate bond exposure within the Canadian bond pool. And I’m saying that’s the riskiest possible allocation we’re willing to have within the high-yield corporate bond, then the next riskiest possible allocation there is emerging market bond, so we’ve kept that at 6%. And then the next riskiest asset class would be global investment-grade bonds, we’ve capped that at 8%. However, at that point the risk of all the opportunistic asset classes put together is too risky compared to what we would get from just the domestic investment grade mandated. So we’ve capped the overall opportunistic asset class exposure at a maximum of 20% within the Canadian Bond Pool, 22% within the MDPIM Canadian Long Term Bond Pool and then 15% within the Short-Term Bond Fund.

And I think the next slide, 38, is really my favourite slide in the entire deck. And what this shows is that as we increase our allocation away from the Canadian domestic investment grade exposure only and increase our allocation to the opportunistic asset classes, the expected volatility, which is a measure of risk, declines. We’re actually reducing risk by increasing the opportunistic allocation, so increasing the diversity. And at the same time we’re increasing the yield that we’re able to generate. At the end of the day what we’re providing our bond investors with is that enhanced income with more diversified risk exposure.

David Keenan: That’s real interesting in a way because it seems a little bit contrary that we can reduce risk by investing in what may be considered riskier assets. I assume that relates to those assets having less than perfect correlation?

Wesley Blight: Correct, yes. Correlation is exactly the right way to think about it. And what that means specifically is that if you’ve got your Canadian investment-grade bonds moving in a specific direction, say down, as a result of a rising interest rate environment in Canada, it doesn’t mean that the opportunistic mandates will also be similarly moving down. And the reasons for that is that we’ve got exposure to non-Canadian investments, where the interest rate environment in those countries may be moving in a different direction than what we’re experiencing in Canada. It also includes exposure to issues that have a higher yield, which is providing additional compensation, so less sensitivity to changes in interest rates. And as we’re managing our portfolio, I had mentioned that we set up the maximum exposure we would ever have to our opportunistic mandates at any given time, using the Long Term Bond Pool as an example, we wouldn’t have more than 22% in the opportunistic mandate at any point in time, but today we only have an exposure of 13%. And the purpose in doing that is that today we don’t have a high enough conviction that the risk of moving away from more of our domestic investment grade exposure is going to provide us with the expected return that is aligned with the risk exposure from doing that. And you can see on slide 39 that across the board we have not allocated away from domestic investment grade exposure to our maximum opportunistic allocation.

David Keenan: Given that we’re currently below our maximum risk allocation, Wes, what triggers would cause us to move closer to that maximum risk allocation?

Wesley Blight: I’d say there are multiple things. One, we would like to see a clearer trend for the future direction of infrastructure. So yes, I think there’s a high probability that we’ll see a moderate increase for interest rates in Canada over the next couple of years, but that direction of interest rates hasn’t yet been fully clarified. I think two weeks ago we were in an environment where there was a high probability of interest rates actually having to decline. This week, we will also look for improved stability from the European economy and stronger consistency of economic growth in both the U.S. and the Chinese economy before we would look to increase our exposure to these markets.

David Keenan: Excellent, thanks for explaining that, Wes.

Wesley Blight: I think the next slide really kind of puts this in holistic context for what fixed income means from a portfolio perspective. So the balanced income portfolio has more than 1,000 bond holdings, and part of the reason why you may question that is we’ve been told as investors that there is such thing as over-diversification; however, in fixed income that doesn’t really make as much sense. And what I mean from that perspective is that if we’re targeting a yield of say 3% from a fixed-income perspective, we can get a single bond that will give us a yield of 3%. Or, we could go out and buy 100 different bonds that also provide us with a 3% yield. And what I’m really getting at is that the upside, so the terminal rate of return in fixed income is known from the outset. You know what you’re upside is going to be. It’s not like equities where you make an investment and then depending on the success of that company you may earn a very high rate of return. The rate of return on fixed income, the maximum rate of return you’re going to receive, is known, it’s fixed. It’s understood. But the purpose of a fixed-income perspective is to increase your diversity as much as you can while still ensuring that you’ll still have a high probability of meeting your target yield. In my example, if that one bond defaults and that’s the only one you hold, you’re likely to lose a significant portion of your par value. But if you hold 100 bonds to get you to the same upside and you have one bond that defaults, the impact to the rest of your holding is very muted.

Now the largest parts in this portfolio of fixed income for the MD Precision Balanced Income Portfolio, or our MD Bond Fund, that’s 44%. And the MD Short-Term Bond Fund is close to 13%. And each of those funds have the latitude to invest in opportunistic fixed-income asset classes which includes high-yield and foreign bonds, but must reinforce the purpose of that diversity is to make sure that we’re managing the downside risk and ensuring that we’re still providing that capital preservation and reduced volatility with the equity components of the portfolio, so that the return profile of that portfolio is aligned with expectations so that our investors stay on the right strategy. But we also have a small fixed-income portion that’s invested in the Strategic Yield Fund within the Balanced Income Portfolio and that employs multiple yield generation strategies that offer even further diversity to the fixed-income portion of the portfolio as well as the portfolio overall. And that provides an all-in-one investing solution so that you’re building a lot of sophistication into the structure, so you should have confidence that it’s going to meet your expectations going forward.

And we’ve shown that bond prices can fluctuate as a result of interest rate changes changing and also as a result of corporate bonds moving up and down so that the price changes on the secondary market.

We’ve also demonstrated the importance of bond holdings for most investors, but what we haven’t done is talked about one of our unique fixed-income investments that really focused on the needs of risk-averse income investors and that’s on slide 41. And that’s our MD Stable Income Fund. This is issued by the MD Life Insurance Company and it’s intended for investors that still have a mid- to long-term time horizon, but the fund is uniquely positioned for capital preservation and it’s focused on providing investors with a stable $10 unit value, so that unit value is not intended on fluctuating while still delivering an elevated interest rate income.

I think that brings us to our conclusion on slide 42. Our fixed-income mandates are built specifically with well-managed risk exposures and that’s really paramount for realizing our desired investment outcomes. And while we prefer to invest in high-grade Canadian bonds, we recognize and will take advantage of opportunities to enhance our return from foreign as well as non-investment-grade bonds. And the purpose is to align the realized results with expected outcome. There should be no surprises and our fixed-income fulfilment should help investors be confident to stay on the strategy that’s right for their needs.

David Keenan: Excellent, thank you for that, Wes. That was very comprehensive. I just wanted to identify the fact that MD partners with leading asset managers across the globe for our patented MD Precision approach. And we look to provide the best in class solutions to all of our clients on both the equity and the fixed income side. I’d like to thank everybody for joining us this evening. We will open up to questions. If we don’t get to your question, we’ll follow-up with you in the next couple of days and a recording of this session will be sent to you via email as well. And if you have any other questions, please feel free to connect with your MD Advisor or contact the MD office nearest to you. So with that said, I’ll open the floor to questions.