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For today’s soundbites, we discuss the risks and opportunities presented by rising interest rates with Brian Kloss, a portfolio manager with Brandywine Global Investment Management. We talk about sectors that will benefit, and the state of consumer savings, and we started by asking how he protects his portfolios from rising rates.

Brian Kloss (BK): How we’re protecting portfolios right now is by reducing duration. And that can be done two ways — short Treasury futures. So, you can use developed market safe havens such as a Treasury, a Canadian bond, a bund, or maybe a U.K. gilt to take that interest-rate sensitivity out of your portfolio. And then the other thing you have to think about is reducing the actual cash bonds that you own. At some point, it may behoove you to actually have a very-short-duration portfolio. And what I mean by that is that they have maturities that are two, three, four years from today, or that are callable at this point and we expect them to be called, so that you’re not going to be hit by any of these rising rates that we’re talking about today.

What sectors he’s inclined toward right now.

BK: We believe the bond market is telling us that there is going to be growth. And we are trying to capture that growth, through what we think is going to be in demand for the reopening of the economy. We’ve got a pro-cyclical bias. So, we’re looking at basic materials, capital goods. We believe housing will continue to do well. There’s been a dearth of housing. The lack of supply, especially in areas outside of some of the large metropolitan areas. So, we’ve actually taken a position, both in securitized markets, as well as in basic materials, roofing companies, homebuilders, paint. So, you want to be in the TiO2 [titanium dioxide] producers. You want to be in roofing supplies. Companies like [paint company] Tronox, which is a TiO2. You want to think about Beacon [Roofing] Supply from a roofing perspective. And you want think about some of the actual home builders, whether they are D.R. Horton or Toll [Brothers]. We’re really trying to capitalize on the strength that we’re seeing in the market.

Why airlines have caught his eye.

BK: We are playing the economic reopening of the global economy, so some of that has been in airlines. We do think that we have to be very cognizant of the risks within the airlines. They’re not all created equal. Within Canada, we are predisposed to owning Air Canada. In the U.S., we’re predisposed to owning Southwest [Airlines Co.], followed by Delta [Air Lines]. And if we do really see the economy opening, maybe an American Airlines or something along those lines.

About the state of consumer savings.

BK: We think the consumers have very strong balance sheets. In the U.S., we believe the consumer balance sheets is probably in some of the best positions they’ve been in, in quite some time. They have de-levered. We think that the savings rate has increased and there’s going to be a proclivity to spend. So, what we’re trying to capture is some of that spending.

How the Bank of Canada is likely to respond.

BK: We believe the Bank of Canada is taking a more traditional approach to monetary policy. And what we mean by that is they’re talking about potentially starting to taper first and then maybe a normalization of rates. 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. Canada does operate with a slight lag to U.S. economic recovery, which is a very good thing. So, if the U.S. economy is going to post nominally high single digits this year, we should expect a fairly strong economic recovery in Canada. So, that probably pushes the Bank of Canada to actually start to contemplate raising rates, and it could be before 2023. It could be into 2022.

And, finally, what rising rates could mean to investors?

BK: We would actually argue that it provides opportunities. And if you’re active and have a strong view of how it’s going to play out, this is going to provide an opportunity to reset portfolios. Again, this is all assuming that our base case is that we’re going to have a growing global economy. We think rates will go back up. If you can go into this, and have gone into this, in a more conservative positioning, we’re going to have the opportunity to reset our fixed income portfolios, and really capture some, what we think are going to be, attractive levels in the next — I don’t know if it’s a quarter, two quarters, or three quarters. We would just argue to be active, be dynamic, and be very flexible in your fixed income allocation.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Brian Kloss, portfolio manager with Brandywine Global Investment Management.

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