By Canada Life | May 5, 2023
On the call, Mackenzie Investments Fixed Income Team gave an overview of their active, flexible approach to the asset class, as well as their forecast for the rest of 2023. Read on for thoughts on fixed income from Konstantin Boehmer, Senior Vice-President and Portfolio Manager, and Mark Hamlin, Vice-President and Portfolio Manager.
What’s in this article:
Global fixed income markets had one of their worst years in more than a decade in 2022, as central banks confronted rising inflation with decisive actions in monetary policy. These actions come at a cost, with more difficult conditions for businesses and consumers raising the likelihood of a recession. Now, the focus is on what could be next for investors as the economic landscape continues to shift.
Interest rate hikes take time to ripple through the real economy. It’s why the team believes a significant part of the adjustment has yet to happen. This will likely shift the focus from concerns about inflation to weaker growth. They see three broad narratives for what may lie ahead:
- Soft landing: growth slows enough to bring inflation under control without causing economic turbulence.
- No landing: a strong U.S. economy leads to inflation stabilizing at levels above targets, forcing central banks to take their foot off the brake to avoid a recession.
- Hard landing: an economic crisis develops, potentially related to a bank-induced collapse of confidence, which could cause deflation and a recession.
The effects of central bank policies aren’t felt uniformly around the world. Canada led the other G10 nations in hiking rates, and the team estimates that the Bank of Canada (BoC) is likely near the end of the current tightening cycle. The speed of the BoC’s hikes is partly why it paused the hikes in April. Other factors include the make-up of Canada’s economy, which is more vulnerable to rate changes due to the importance of the housing sector.
Still, Boehmer pointed out that Canada’s fixed income market is quite attractive. Canada has a significant amount of debt that’s generally on the shorter side, which creates opportunities when rates rise quickly. In the longer term, Boehmer noted there are structural stories that investors should be watching which make Canada a great place to invest.
Outside Canada, the bigger picture is already looking brighter than last year. The year began with yields between 1 to 2%. They increased dramatically by the end of February, creating a buffer against the types of losses we saw during the market selloff in 2022. At the end of March, yields for investment-grade asset classes had reached between 4 to 6%.
Yield is only half the story for possible returns, with price being the other. Since the risk of substantial price depreciation has mostly been factored in by the markets, investors can now start to benefit from these much higher yields. This “see-saw” effect, where price contributes so much to outperformance, means that fixed-income investors need to have a longer-term view, Hamlin said.
The difference in yield, or credit spread, between corporate bonds and risk-free alternatives – like government bonds – is widening. This means investors looking to balance returns and protection need to focus on diversifying their fixed income allocation through active management. Modern markets demand flexibility and thinking outside the box to achieve this balance.
One example Hamlin brought up on the call is the team’s attention to the inverted yield curve. They are confident it will dis-invert, whether because of lowered rates, investors buying up assets with a shorter duration, or other factors. The timing may be uncertain, but they see such dislocations in the market as opportunities and where they can distinguish themselves as active managers.
The team seeks a holistic understanding of fixed-income markets by combining macroeconomic, quantitative and fundamental credit research methods. They develop investment themes by integrating their research process with market perspectives, which include technical factors and valuations. They use risk posture to determine credit bias, duration positioning and hedging strategies. Finally, sector allocation and security selection help them assess relative value among sectors and securities. Analysts also engage with companies on material risks.
The timing and difference in policy actions by central banks across the world is creating big opportunities. “We’ve actually rotated from one country to the next,” noted Boehmer. They provided a brief overview of their portfolio positioning on the call. Overall, they’ve shifted towards a more conservative investment strategy with a focus on investment-grade holdings and reduced exposure to loans and non-investment-grade securities. Many headwinds and tailwinds simply can’t be predicted, which is why keeping a long-term view and a focus on diversification is critical.
Developed markets
- Canada: long duration
- U.S.: neutral-to-long duration
- Eurozone: work to be done by central banks to contain inflation, which raises duration risk
- Japan: short Japanese bonds given its action on inflation has heavily lagged behind other developed markets
Credit
- With current downside risks, they’ve adopted steady, neutral positioning to help clip extra yield
- A positive environment for high-grade fixed income, especially corporate bonds, with short duration
Emerging markets
- Quick to get inflation under control, and in terms of opportunities, second only to places like Canada
- For example, Brazil’s double-digit interest rate and lower inflation (high-yield environment) creates opportunities when rates are cut
Talk to your Canada Life wealth wholesaler today to find out how you can put Mackenzie Investments’ fixed-income approach to work for your clients through a variety of funds on the Canada Life™ shelf. You can read more about their approach in this article from Wealth Professional, featuring Portfolio Manager Konstantin Boehmer.
Watch this event on-demandThe views expressed in this commentary are those of this investment manager as of April 13, 2023, and are subject to change without notice. This commentary is presented only as a general source of information and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide tax or legal advice.
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