Using short-term bonds to capture elusive yield

Jean-Francois Giroux, Portfolio Manager, Manulife Investment Management, explains secret sauce behind its bond ETF and how it combines systematic and active approaches

Using short-term bonds to capture elusive yield

This article was produced in partnership with Manulife Investment Management.

More yield in a low-yield environment is music to investors’ ears – and that’s what the Manulife Smart Short-term Bond ETF (TERM) aims to do.

Launched just over a year ago, the short-term bond ETF aims to deliver a higher yield than a broad short-term bond index, while matching the risk profile of that index. The fund seeks to achieve this by combining a systematic and active management approach and it’s seen impressive growth in a short period of time, with TERM surpassing $700 million1 in AUM in its first year, evidence of how attractive the short end of the curve is to investors.

Jean-Francois Giroux, Portfolio Manager, Manulife Investment Management, said: “we build the whole portfolio by optimizing sector and curve positions to get more yield. We use security selection to create this optimized portfolio that targets the same volatility of a broad short-term bond index.”

Active management is critical in creating a portfolio that doesn’t look like the index. Being active means the fund managers are constantly asking: what are the different securities and sectors that can deliver more for investors, and where can the ETF position itself on the curve to get more yield?

Given its exposure to short-term bonds, the ETF was not impacted by the Bank of Canada’s more aggressive-than-expected approach to QE tapering and rate-hike schedule. TERM’s exposure to corporate bonds provided an additional buffer to this. Giroux added: “In some ways, the market probably overreacted and is pricing in even more rate hikes than the Bank of Canada might have said, so that really provides an attractive level for entry into TERM.”

Giroux expects a busy year in 2022, with jittery investors and markets hanging on every word the central bank says with regards to rate-hike timings. But he sees it as an opportunity. With a corporate spread able to mitigate volatility and “too much being priced in by both the market and Bank of Canada”, he believes TERM represents excellent value.

The fees for the ETF are attractive; TERM has a management fee of 0.20%. It has the advantage of an efficient, systematic approach and the added value of being actively managed. By using a systematic approach that has proved successful for other strategies, mostly on the institutional side, Giroux and his team aim to deliver “an actively managed fund, but in a very efficient way”.

One of Giroux’s first steps in building a portfolio is filtering out illiquid securities by taking out old issues. These tend to not only be less liquid but also trade at a deep premium, meaning a greater potential for losses in times of distress. He explained: “They are filtered out from the start and are not part of the investable universe. When there is a good opportunity, we like to participate because sometimes there’s a concession that's built into the price that's issued. So we will favour new issues versus old, for sure.”

Advisors have been attracted to the ETF because of its tight bid-ask spreads (the possibility to trade as close to fair value as possible). It’s been the core of its success, Giroux added, and is achieved by selecting high quality, very liquid securities, and engaging with market makers to ensure tight markets.

TERM is overweight in communications and industrials2, where there is a good risk-reward balance. Financials are also attractive, with a great pool of liquidity; a vital trait for the ETF’s profile and something advisors constantly ask about. Another potential issue is the effect of high trading volumes. But Giroux said: “It's been a fantastic year and working with our market makers, it's been smooth. We're a big shop and we’re used to dealing with big volumes on a daily basis, so we have good relationships and good trading platforms that allow us to track this market in a very efficient way.”

1 As of October 31, 2021. AUM is in Canadian dollars.

2 As of October 31, 2021.

Jean-Francois Giroux is a Portfolio Manager with Manulife Investment Management responsible for the portfolio management of liability-driven investments (LDI) ― including goals-based investment solutions ― and fixed-income index mandates in Canada.

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