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Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.

For today’s soundbites, we speak about multi-sector bonds with Terry Moore, vice president of T. Rowe Price Group and the portfolio specialist in the company’s fixed income division. We started by asking what he makes of current markets and how he’s fine-tuning his holdings.

Terry Moore (TM): Today’s market is interesting because valuations are generally on the richer side of long-term fair value for most assets, mainly because of three things: the tremendous global monetary stimulus, the fiscal stimulus from around the world, and the vaccine rollouts. At the same time, there are no obvious imminent reasons for asset valuations to suddenly cheapen. But there could be some unexpected bumps in the road. So, we have balanced our portfolios from a risk perspective to a more neutral allocation, where we’ve been trimming some sectors that have had significant gains, such as U.S. and European high-yield corporate bonds, investment-grade corporate bonds, and agency mortgage-backed securities. Now on the other side, we’ve been adding to what we call the Covid laggards or rebound reflation trades, such as certain parts of the U.S. securitized credit market, some emerging market corporate bonds and even U.S. taxable municipal bonds. And lately we’ve been adding global sovereign bonds. This is the so-called dry powder in the event that there is one of these bumps in the road.

Why he’s looking closely at bank loans.

TM: Bank loans are an interesting asset to us because they are effectively high-yield paper but they sit higher in the capital structure than high-yield corporate bonds. And because of this higher level of credit protection, the yield on bank loans is typically lower than the high-yield corporate bond yield. But recently they’ve converged. So, we think the bank loans start to look attractive today. Additionally, bank loans, they’re floating rate notes, which means their yields adjust with the margin over short-term LIBOR [London Interbank Offered Rate] rates. Bank loans are not penalized if five-year or 10-year interest rates were to rise. So, as we get to the other side of Covid and we get positive economic growth and inflation—and, yes, I said inflation—then longer maturity interest rates should rise, which in turn will adversely affect long-duration bonds.

What regions look good right now?

TM: We’re favouring countries today such as Korea, Israel, Australia, Malaysia, Chile – all are levered to the expected global growth rebound. Now we don’t see a lot of inflationary pressure or central bank tightening in some of these countries, but real yields — bond yields adjusted for inflation — they’re generally higher than in Canada. Canada’s 10-year real yield is negative 1%. But Malaysia, for example, offers a positive 70-basis-point real yield. And Indonesia’s real yield is over 3%. So, there are opportunities globally to add some value, even on the government bond side.

What should Canadian fixed income investors keep in mind?

TM: Now, the Canadian corporate bond market, as we all know, is heavily weighted towards energy and financials. So, we believe that widening the opportunity set as much as possible can help investors find higher yields and sources of return that are less correlated with the Canadian bond market. Now this has the benefit of both increasing the portfolio return while also reducing portfolio volatility, and that’s the true benefit of diversification.

Why an active approach to bonds makes sense right now.

TM: As mentioned, the 10-year Canadian government bond yield is around 1%. But important for us to keep in mind, is that the duration of the core-bond universe has extended to about eight-and-a-half years. So not only is the yield pretty paltry, but if interest rates were to, let’s just say generally rise by 1%, the bond math on that is a price return of about negative 8% or so. That’s a big risk to consider. So, if an investor goes with a passive portfolio, they own that full duration risk. But an active portfolio may be able to reduce that duration risk either by buying shorter duration assets, hedging some of the duration risk, or buying less-correlated bonds from other countries. Globally we have a divergence of interest rate cycles, a divergence of monetary cycles and credit cycles, and all of that means that active global bond managers, they have more tools to navigate a rising interest rate market.

And finally, what’s his key message to Canadian bond investors?

TM: With rock bottom Canadian bond yields, the time is right to embrace a global multi-sector bond investment and seek higher returns from the wider opportunity set, while also potentially reducing portfolio risk and volatility.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life.

Our thanks again to Terry Moore, vice president of T. Rowe Price Group, and portfolio specialist in the company’s fixed income division.

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