While low interest rates have been driving the bond discussion for years, the conversation has changed suddenly in recent weeks. Economic growth and inflation expectations have spiked, pushing up bond yields and lowering returns for fixed income across the board. The quick turnaround has left some investors with questions about the potential impact on their fixed income portfolios.
In this blog post, I explain the change in expectations, what's driving the shift and how we've positioned MD's portfolios in response. And, of course, I'll share my thoughts on what could be next for interest rates and fixed income down the road.
What's going on?
While bond yields have slowly been on the rise, the last two weeks has seen that trend accelerate, with a massive increase. Just one year ago, U.S. 10-year bonds stood at 0.5%. Fast forward to today and the yield on those same bonds has risen to 1.5%. Since rising yields correspond with falling bond prices, the change has brought lower returns for fixed income after several years of positive returns.
What's causing the change? Optimism for the most part. As investors see light at the end of the tunnel and progress against the pandemic continues, inflation is expected to make a comeback. Commodity prices are also moving up based on expectations of improving growth and demand – a trend that was exacerbated by the catastrophic shutdown of the energy grid in Texas. Additionally, government policy continues to support growth and consumption, with more to come as the U.S. seeks to pass a US$1.9 trillion stimulus package.
What we've done
While returns on fixed income were robustly positive last year, we have positioned our portfolios with an expectation that bonds will provide a lower return going forward as interest rates modestly increase. Capital preservation remains the goal of our fixed income exposure. To support that, we've reduced duration (the sensitivity of a bond's price to changes in interest rates) in Canadian fixed income. We've also reduced exposure to domestic government and corporate bonds in favour of exposure to foreign fixed income, especially higher yielding corporate credit.
What does this look like? We've reduced our exposure to Canada's provincial bonds (i.e., Ontario and Quebec) in favour of U.S. corporate bonds issued by Kraft Heinz, Netflix, and Uber. This change provides additional income and helps to cushion the negative price impact as interest rates rise.
We entered 2021 with our portfolios tactically positioned for a rise in bond yields. After the Georgia senate election runoff and positive vaccine announcements, we further reduced our portfolio's duration exposure and have benefitted from having a reduced interest rate risk exposure. We retain a more modest, yet still underweight to duration exposure today.
We also recently launched the MD Platinum™ Global Private Credit Pool which provides access to an opportunity that is usually reserved for institutional investors and offers higher potential returns, investment risk that is lower than stocks and comparable to traditional fixed income and has unique diversification benefits. For certain investors, it could be an important tool for augmenting returns and ensuring capital preservation, especially in the current environment.
Can we expect this spike to endure? Probably not. While interest rates will likely trend upwards (slowly) for the next 12-to-18 months, we do not believe they will move meaningfully or sustainably higher. There are still plenty of headwinds for global economic growth. Unemployment remains high and there is still uncertainty about COVID-19 variants and the pace of the vaccine rollout. All this is likely to temper investor enthusiasm for heightened inflation expectations and a further increase to bond yields in the months ahead.
For more information about interest rates, bond yields and our positioning, please contact your MD Advisor*.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.
The information contained herein provides key information about the respective MD Platinum™ funds and is not intended to be taken by and should not be taken by any individual recipient as investment advice, a recommendation to buy, hold or sell any security, or an offer to sell or a solicitation of offers to purchase any security. The Platinum funds described in this document are subject to additional terms and conditions set out in the Platinum funds’ operative agreements and regulatory suitability requirements as considered by the MD Private Investment Counsel Portfolio Manager. The Platinum funds’ operative agreements will also set out additional information about the investment objective, terms and conditions of such fund, tax information and risk disclosure that are a material terms regarding a fund. Any investment in a fund would be speculative and would involve significant risks. The information and strategies presented here are not suitable for U.S. persons (citizens, residents or green card holders) or non-residents of Canada, or for situations involving such individuals. Employees of the MD Group of Companies are not authorized to make any determination of a client’s U.S. status or tax filing obligations, whether foreign or domestic. The fund is intended for individuals that are discretionary managed account clients of MD Private Investment Counsel, an operating division of MD Financial Management Inc., which provides investment counselling services.
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