An 'exceptional environment' for fixed income investors going forward

This article was featured in Wealth Professional.

At first glance, times are challenging. Inflation is elevated, interest rates are rising, and stocks are beaten up. But fixed income investors have been urged to look a little deeper at what Roshan Thiru describes as an environment offering opportunities. Thiru, Head of Canadian Fixed Income at Manulife Investment Management, told WP the Manulife Yield Opportunities Fund team’s investment philosophy is resilient. From the sovereign debt crisis of 2011, the commodity meltdown of 2015, and the COVID-19 pandemic. With that track record, Thiru is confident his team can successfully manage the fund through the 2022 global rise in inflation.

Addressing the latest test, the Manulife Investment Management Fixed Income team, which draws from talent globally, concluded that central banks’ efforts to normalize monetary policy would trigger increased volatility in both rates and the risk markets. Since mid-last year, their message has been consistent: that they were concerned about rising rates and skeptical about stock market valuations. The fund, therefore, began 2022 with an equity allocation of approximately 13% (net of put options), bond duration that was reduced to two and a half years (compared to five and a half during the pandemic), and a “sizeable” allocation to cash.

Thiru said: “Ultimately, the ferocity of the shift in the yield curve was more than what we had anticipated. Nevertheless, because of our investment philosophy and process, we were well positioned to take advantage of market opportunities, and we are confident our investors will likely benefit from the decisions that we have taken, going forward.

“We've got a long track record of exploiting inefficiencies in the market and generating alpha through active management. The fund has performed well relative to its peers¹ and in periods like this we endeavor to set it up for future success. During times of market dislocation, things get cheap, including high quality bonds. You buy them at distressed prices, and the bond issuers have a contractual obligation to pay par at maturity – so we capture yield and capital appreciation”.

Thiru believes inflation has likely peaked and the next 18 months will see it come down meaningfully as supply chain issues dissipate over time and countries learn to live with COVID. This, he added, is a huge tailwind for bonds, which have been sent spiraling with negative returns, because of inflation fears.

The fund, which aims to deliver a 5-7% return, per annum, over three-to-five-year periods, is underpinned by a robust bottom-up research process which, through fundamental analysis, identifies companies that have sustainable business models, that can generate stable cash flows and are managed by leaders who are good stewards of capital. “Crucially, that gives us visibility into the businesses and investing companies. When the markets offer them at great prices, our clients are set up to benefit through that over the long term time horizon.”

He added: “In our view it's a very attractive environment for fixed income investors. Why wouldn’t we take advantage of it? The conditions could be ripe for a successful outcome for investors in our fund.”

We believe a calm temperament and discipline are key to success in this environment. “You don’t want to chase yield or valuations. Instead, buy when cheap, sell when expensive”. Of course, that’s easier said than done but it’s the foundation of the Manulife Yield Opportunities Fund.

Thiru notes that the company’s overall risk culture has been essential to the fund’s successful performance record. “It’s also a firm which has deep global resources and scale, including a global ESG team, and a sizable Canadian investment team guided by portfolio managers who have decades of experience”. Thiru and colleagues also have skin in the game and are invested along with clients “in a meaningful way”.

The fund’s approach to adding value can be boiled down to three words - valuation, volatility, and flexibility. Portfolio Managers and Analysts are keenly focused on valuations, wait for volatility to present opportunity, and maintain flexibility to capture those opportunities. Risk is managed at a high level using four factors - asset allocation; duration management, currency management; and derivative hedging (using put options to protect the portfolio).

Thiru has one message for investors: In our opinion now is a good time to consider bonds. He explained: “Investment grade corporate yields are at levels we haven't seen since 2009, government yields are at levels we haven't seen in over a decade, and non-investment grade bonds are offering cycle-high yields. You can't be passing on the yields that are currently offered by the bond market; it just doesn't make sense.”

While volatility is unlikely to suddenly vanish, Thiru embraces this as a necessary part of the equation for the fund aiming to deliver on its objectives. He urged investors to stay focused and avoid the temptation of fixating on short term performance.

“Time is a bond-manager’s friend” he said. “We think the fund is well positioned to deliver on its objective. The opportunity sets are pretty good, we are still sitting on some cash, so we believe we are very well placed. My last message? In our opinion, now is a good time to buy bonds.”

1 Peer group for the fund is the Global Fixed Income Balanced category (3-year – fund outperforms 89% of peer group, 5-year – fund outperforms 90% of peer group, 10-year – fund outperforms 91% of peer group