It is remarkable to think, but over the past twenty five years, while Canadian equities offered a return of 8.34%, Canadian fixed-income delivered “equity-like” return of 7.75%. Decades of declining interest rates have kept the price of older, higher-coupon debt high. The difference between equity and fixed-income returns has not been as wide as common investing assumptions suggest.
But according to a fascinating new white paper from NEI Investments
this unique era of over-performance from domestic Canadian fixed-income is at an end. Rates can’t go any lower. Total returns on Canadian fixed income are set to bottom out at a much lower levels of return. Those looking to maintain a piece of their portfolio in fixed-income need to get a new plan in place—NEI offers an option.
In a recent interview with WP tk, Daniel Solomon, chief investment officer with NEI, explained the inner workings of a new global fixed-income fund the company recently launched. The concepts driving the creation of the fund are worked out in the paper, which makes for interesting reading (find it here
Those familiar with fixed income will argue that global yields on average are just 1.7%, a rate for lower than Canadian fixed income. So why bother evacuating the Canadian market for globally-based securities? According to Solomon the answer is in active management that can avoid those places on the global fixed-income map where yields are radically lower—in a word, avoid Japan. “People will ask, why go global if yields are so low? Well, I came from banking….banks tell you don’t lend to people who spend more than that make. Simply by avoiding Japan total global yield is higher,” says Solomon.
Turns out, getting global fixed income right is a matter of finding the right investments, and that is a matter of active management. “We believe this is one place where active management really works,” says Solomon. There is a vast universe of fixed-income securities across the globe, spanning corporate and government debt of varying duration. Managing the five different facets of global fixed-income investing--country selection, currency selection, sector allocation, credit research as well as duration management and yield curve positioning--is the key to getting this play right. Actively managing these five facets can increase total return.
When it comes to sectors, “If emerging market debt is doing well, we’ll have more of that, if corporate debt is the place to be, we will have more there,” says Solomon. In terms of currency risk, active management can turn currency shifts--that can be negative for return--into an opportunity. “You have to hedge that risk. If you can hedge, you can lower risk. But you don’t have to hedge all the currency risk. Our approach is to hedge some of that risk, but also make some yield on currency shifts,” says Solomon.
In terms of duration Solomon points out the fund is much shorter in duration than many funds, meaning there is less credit risk. By getting the sector and security selection right, there is “more risk-adjusted yield than in the benchmark....I always stand firmly on the side of active management. You need someone who can come in and balance these five dimensions. You don’t get a rebate for someone who doesn’t have a view on currency. If you can’t do all five dimensions go passive,” he says.
Solomon says the fund has rapidly become one of NEI’s most successful products. Seeded with $100 million of the company’s own money, it has rapidly attracted another $100 million.