Spring 2019: Fixed income is still important
Patrick Ercolano, Ian Taylor and Wesley Blight, Assistant Vice Presidents with the Investment Management and Strategy team here at MD, chat about the evolution of MDs fixed income solutions and the opportunities that investors should be excited about.
Patrick: With a historically low bond yield environment in traditional bond markets, this quarter we wanted to focus on the evolution of MD’s fixed income solutions and the opportunities that exist. I am here with Ian Taylor, co-Portfolio Manager of the MDPIM Strategic Yield Pool and Wesley Blight, Portfolio Manager for MD’s Canadian fixed income and balanced solutions. Fixed income is not always the most exciting topic but I know both of you are finding some opportunities in the fixed income markets that investors should get excited about.
Q: Ian, Emerging Market debt is an asset class you recently wrote about for the MDM.ca blog. Can you tell me a bit more about this asset class?
- Picture you are a student; your income is likely sparse and earning potential is probably the only argument to prove credit worthiness when seeking a loan. As a result, the amount that can be borrowed is often limited and borrowing rates are typically higher.
- Laster, as you acquire assets, pay your bills and build credit history, you improve your credit worthiness. Eventually borrowing becomes easier and more affordable. This virtuous cycle is often what emerging market economies experience when turning to the market for financing. It is also what makes it an interesting asset class from an investing perspective.
- Some would be surprised that over the last 20 years, the premium for investing in emerging market debt relative to developed market debt has been greater than the premium from investing in emerging market equities relative to developed market equities.
Q: Ian, as co-PM of the MD’s Strategic Yield products, how are you investing in Emerging Market debt?
- Traditionally, emerging markets have issued debt in U.S. dollars to make it more attractive to foreign investors. However, that virtuous cycle we described at the beginning of this article means they've become increasingly credit worthy. That's made local currency debt more compelling for investors.
- We should also consider the diversification benefits—50% of the MSCI Emerging Market Equity Index is dominated by just three countries in one region (Asia) . If you look at US dollar or local currency emerging market debt indices, no country represents more than 10% of either index.
- In the MD Strategic Yield Fund and the MDPIM Strategic Yield Pool, we invest in both U.S. dollar and local currency emerging market debt with a strategic allocation of approximately 15%.
Q: Wes, our investors would be interested to know more about how some of your mandates take advantage of these opportunities. What sort of opportunities are the Canadian fixed income mandates investing in?
- We focus on providing clients with income, capital preservation, and reduced portfolio volatility.
- Our preference is to invest in high quality Canadian issues, but we source added value from a dynamic allocation to global exposures
- Thinking about the mandate’s investment objectives, generating an elevated income is the easy part. Simply purchase bonds that pay a higher coupon. There are lots of opportunities to do this outside of Canada and we take advantage of them through both country and corporate bond exposures
- Emerging market bonds are a great example of higher yielding opportunities; however, we also recognize they generally have a greater risk of more significant drawdown and even default.
- When allocating to Emerging Market positions, our primary focus is on capital preservation and we meet this risk objective by:
- Limiting the maximum exposures to all global bonds, EM country issuers, and individual bonds;
- Maintaining dynamic exposure
- Diversifying our exposures and maintain low position sizes (Gives us the flexibility to change our allocation and mitigate the risk of a specific issuer contributing to performance decline).
Q: Wes, can you give us an example or two of the types of investments?
- We’re in a supportive economic environment for high-quality Emerging Market country bonds to provide an attractive yield and total return potential vs. our preferred Canadian bonds and, we have only modest exposure to bonds issued by high quality countries while avoiding countries with deteriorating fundamentals
- Indonesia is a good example of a high quality country where we’re comfortable maintaining a position today
- They have strong fundamentals with GDP growth above 5% and only muted inflation.
- Their government has instituted credible policies and their central bank has maintained a 6% key policy rate since November last year.
- With a stable to improving back drop, we’re able to pick up attractive relative value in a country that yields ~7.5% for their 10-year issue.
- Our positions in Indonesian bonds are rated investment grade and the recent performance for both the bonds and the country’s currency has provided a direct added value to our Canadian fixed income mandates.