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SVP, Senior Portfolio Manager and Head of Global Fixed Income & Currencies at RBC GAM®
Even though interest rates rose over the past few years, they are still near historical lows, which means that government bonds alone are not sufficient for diversifying and providing income. To get fixed income truly working for clients, advisors have the choice to diversify with a more comprehensive approach to fixed income, including global and higher yielding bond issues, as well as a sound currency management policy and active currency overlay.
Investment Executive sat down with Dagmara Fijalkowski, SVP, Senior Portfolio Manager and Head of Global Fixed Income & Currencies at RBC Global Asset Management®, and Karen McNally, Vice President and Head of Investment Solutions at RBC Global Asset Management, to discuss how fixed income investors can succeed in the current environment. Their ideas are clearly resonating with advisors and investors across Canada given the success of the recently launched suite of RBC Fixed Income Pools.
Q: Let’s set the scene for readers. How is monetary policy shaping the fixed income environment today?
Fijalkowski: Between the fourth quarter of 2015 and the end of 2018, monetary policy was on a clearly marked tightening course. By the beginning of 2019, however, the U.S. Federal Reserve Board (Fed) started indicating patience regarding future interest rate increases. Interestingly, both equity and fixed income markets have responded positively to this development.
These days, there is a discrepancy between what the Fed and fixed income markets are telling us about future monetary policy. While the Fed indicates further hikes are likely, the shape of the yield curve suggests that investors believe the tightening cycle is complete. We also lean towards that interpretation.
Q: Given the complexity of the current environment, what are some of the challenges fixed income investors face?
Fijalkowski: I think it is reasonable to assume that the low interest rate environment combined with a long period of low volatility has resulted in some investors making less-than-prudent capital allocations. One example might be meaningful flows into passive fixed income products. During periods of low volatility, investors tend to be rewarded indiscriminately, even without doing any meaningful credit analysis.
Going forward, the environment is likely to be more difficult. Skilled active managers who have been doing thorough credit analysis have planted the seeds for future outperformance. They are positioned to harvest that work during periods of volatility and risk aversion.
Q: So, how can active fixed income investors generate alpha?
Fijalkowski: We strongly believe that the role of fixed income investments is critical to adding value. Today, there is much more to fixed income investing than calling interest rate directions. It involves a complete understanding and ability to navigate global, corporate investment grade and high yield bonds, as well as emerging markets bonds and currencies.
Monitoring multiple markets allows investors to take advantage of lower correlations, less than perfectly synchronized credit cycles, and differences in monetary and fiscal policies across various countries.
In fact, we believe there are more opportunities to generate alpha in fixed income today than in the past decade because of the significant growth of fixed income markets – the amount of government and corporate bonds outstanding globally went up by US$60 trillion. That is three times the size of the U.S. economy. The number of issuers doubled to over 22,000. More currencies are floating, and the trading cost of currency hedging and currency exposure has come down.
With the right resources and a disciplined approach to both strategic and tactical asset allocation, the opportunity to generate alpha in fixed income is outstanding.
Q: Some investors may be cautious of investing in corporate and global bonds. How do you manage risk when investing in higher yielding credits?
Fijalkowski: Having a robust process is essential. For us, that means starting with team-based intensive fundamental credit analysis, performed by seasoned analysts who have been through multiple credit cycles.
Investments are based on a detailed review of the issuer, including the issuer’s management team, competitive position, and financial metrics and policies. Investments are then evaluated against the anticipated return profile given the current price, upside-downside characteristics and recovery prospects.
Diversification is an important consideration. For example, we place limits on sector concentration and the amount of lower-rated companies within a portfolio. The objective is to create a well-diversified portfolio consisting of higher-quality, high yielding companies. Importantly, whether we look at an individual bond or a portfolio, the amount of risk taken must be proportional to the opportunity.
Vice President and Head of Investment Solutions at RBC GAM®
Q: Since these insights are clearly resonating with advisors and investors, can you explain the genesis of the RBC Fixed Income Pools?
McNally: As you can tell from Dagmara’s comments, managing fixed income is an increasingly complex proposition in today’s environment. The feedback we received from advisors is that it is becoming more challenging to manage fixed income inside client portfolios. We saw the need for an all-in-one solution where advisors can gain easy access to global bond markets. That was the genesis of RBC Fixed Income Pools: an option that allows advisors to take advantage of a much broader set of fixed income opportunities.
Q: Why do you think the Pools have been such a success?
McNally: We worked alongside advisors from the beginning to make sure that we built portfolios that worked for them, and helped them address real challenges as they build client portfolios. In bringing them to market, we were really looking to solve an industry pain point.
Q: What are some final thoughts you would like to leave with advisors regarding RBC Fixed Income Pools?
McNally: With RBC Fixed Income Pools, investors can tap into nine fixed income teams around the world with more than 150 portfolio managers, analysts and traders. We recognize that investors have different preferences for risk and reward expectations, so rather than coming up with a one size fits all solution, we built three separate options for investors with different risk preferences and profiles. We are also able to extend our fee leadership in the industry and take advantage of our size and scale to price the Pools at the same low management fees that we apply to our core fixed income funds.
Fixed income investing is getting increasingly complex. For those that work in the space every day on a global level, an active team approach with significant resources and experience can uncover many opportunities to generate income and diversify a portfolio.
This article may contain forward-looking statements about a fund or general economic factors which are not guarantees of future performance. Forward-looking statements involve inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement. All opinions in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility.
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