Rising rates offer chance to reset portfolios
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The prospect of rising interest rates will present new opportunities to investors, especially those who have taken a more conservative position to this point, says Brian Kloss, a portfolio manager with Brandywine Global Investment Management.
“This is going to provide an opportunity to reset portfolios,” he said, advising fixed-income investors to focus their attention on increasingly shorter duration bonds and callable securities.
Kloss has already removed 30-year bonds from his portfolio, and now favours maturities as low as two to four years. He said he also looks for opportunities in callable bonds — fully expecting them to be called early.
This is part of a three-pronged strategy to minimize interest rate sensitivity: shorting futures of bonds from developed market safe havens, reducing cash bonds in his holdings, and moving toward very short durations.
As global economies begin to recover and interest rates edge upward, Kloss has also turned his attention to commodity-related instruments in the housing and travel sectors.
“We’ve got a pro-cyclical bias. So, we’re looking at basic materials, capital goods, and companies that have pricing power,” he said. “We believe the bond market is telling us there’s going to be growth. And we’re trying to capture that growth through what we think is going to be at a demand for the reopening of the economy.”
Housing and airlines
Housing will continue to do well, he predicted, and the dearth of new housing in major metropolitan areas has prompted him toward the residential mortgage-backed security market — particularly non-agency paper, which he said offers greater rewards than agency paper.
Kloss noted several opportunities in home-building trades. He likes Tronox Inc., a Connecticut-based paint company involved in titanium dioxide products. He’s also bought Virginia-based Beacon Roofing Supply Inc., and he recommends reputable home builders such as Texas-based D.R. Horton Inc. and Pennsylvania-based Toll Brothers Inc.
Kloss also predicted a strong recovery for airlines, seeing strength in their secured bonds.
“We’ve taken a reasonable risk by going into secured paper, versus unsecured paper,” he said. “If the recovery does open, as we believe it will, we may even want to move out of the secured paper and go down into a lower piece of paper in the capital structure.”
In Canada, he likes Air Canada. In the U.S., he said, he’s predisposed toward Southwest Airlines Co. first, and then to Delta Air Lines Inc. With particular strong economic activity, he said he could be persuaded to buy what he deems to be a riskier security, such as American Airlines Group Inc.
Bank of Canada
As for how the Bank of Canada could steward the expected growing economy, Kloss expects a continuation of its traditional approach to monetary policy.
“They’re talking about potentially starting to taper first and then maybe a normalization of rates. [That’s] very different than what Jerome Powell and the U.S. Federal Reserve are doing. They’re being much more accommodative, taking a much more of a wait-and-see approach, and letting interest rates run a little bit hotter,” he said.
A stronger-than-expected recovery in Canada could push the Bank of Canada to contemplate raising rates before its stated target of 2023. The BoC could raise in 2022, Kloss predicted.
The bottom line for vigilant investors, he said, is that a recovering global economy with attendant rising interest rates will bring opportunities.
“We think rates will go back up. If you can go into this — and have gone into this — with a more conservative positioning, we’re going to have the opportunity to reset our fixed income portfolios, and really capture what we think are going to be, real attractive levels in the next [few] quarters,” he said.
“We would just argue to be active, be dynamic, and be very flexible in your fixed income allocation.”
This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.
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