Bonds Unbridled:
The Right Side of
Rising Rates

As increasing volatility and rising rates cast doubt and uncertainty in the minds of investors, Keith Patton discusses an innovative, active strategy that truly moves the needle for Canadian Financial Advisors, offering clients steady returns with significantly reduced risk, and a smoother performance path – an entirely necessary de-risking solution for your toolkit in this environment.

The Need for Flexibility in the Bond Market

The reality is that the vast injections of liquidity we’ve seen by central banks worldwide since 2009 are beginning to be unwound – spelling an uncertain environment for bonds where the risk of rising yields, negative returns, and diminished capital gains is quite high. Clearly, now more than ever, Advisors – and their clients – need a way to address these concerns within their fixed income allocations.

As markets transition to more normalized monetary policies and rates continue to rise, it’s imperative that investors seek fixed income strategies that have the ability to manage throughout the business cycle, with a flexible, dynamic approach that promises access to other forms of return drivers while controlling risk. A solution that enables the bond manager to look beyond Canadian borders, and to anticipate and manage risk, ultimately delivering the diversification and stability that we traditionally associate with bonds.

BMO AM Global Absolute Return Bond Fund (BMO GARB) offers this solution, and allows investors that have grown accustomed to strong returns in recent years (whether from equities, credit funds or even government bonds) to de-risk amid an increasingly volatile market environment, without being forced to resort to cash, which offers minimum value at present.

A Compelling Solution: BMO GARB

The key differentiator to BMO GARB, particularly for Canadian institutional investors, is our simple, unconstrained approach, which effectively means we can move to geographies, sectors, or securities that we believe won’t be under pressure from either falling prices in corporate credit, or rising yields – adapting to ALL market conditions, while seeking to generate consistent bond returns.

The true beauty of the strategy is that – unlike a traditional fixed income fund – BMO GARB has the flexibility to go short, so we’re able to extract and harvest the credit premium, but at the same time, we have the flexibility to reduce duration to negative, so that we can actually benefit from rising yields to preserve capital.

The way we accomplish this is by starting off with a core portfolio where we look to purchase an attractive yield from global credit markets, focused on shorter-dated securities (to reduce the impact of cyclicality) and on a high level of diversification. The importance here is that we’re not simply buying bonds for a speculative purpose; rather, we are lending to companies that are always issuing – names we believe have longevity and can give us our money back. The portfolio therefore has a low turnover rate, designed to reduce transaction costs, which directly benefits the client. The result is a diligent, well-constructed, fully diversified beta core.

This initial low-duration core is then supplemented with macro overlays, adding value through global anomalies (e.g., interest rates, currencies, etc.) that allow us to manage risk through the cycle. For example, if we expect interest rates to rise, we will use derivatives – cheap, liquid and efficient to implement – to move duration from the neutral position to negative, literally removing rate risk for a short period of time, and allowing us to re-enter once the sharp movements have passed. Since the launch of the strategy in summer 2016, BMO GARB has sustained three clear periods of interest rate shocks (including President Trump’s election), and each time, its performance has fared significantly better than the Canadian bond market due to its dedicated – and primary – focus on capital preservation.

Aligned with Your Client’s Needs

Ultimately, through BMO GARB, Advisors are delegating their asset allocation decisions to world-class, experienced, fixed income professionals with the ability to navigate complex market dynamics and the insight required to make tough market calls, such as when to reduce risk. Because no single strategy works all the time, responsibility for weighting the macro overlays resides with a strategic allocation team composed of independent investment experts in global interest rates, currency, and credit, and liability-driven investments (LDI). The team dictates how much interest rate or credit risk is appropriate at any time, while adhering to overall risk portfolio parameters.

The greatest advantage is that we’re much more aligned with our clients’ needs than a traditional benchmark-constrained product, whose primary concern is to outperform a broad-based index. Instead, we’re focused on delivering our stated cash +4% target, over a business cycle, to investors without any opportunity limits and providing that necessary protection against down markets.

In fact, the core portfolio, from where roughly half of the Fund’s returns are derived, is composed of more than 250 well-diversified, short-to-medium-term corporate “crossover” bonds – a sweet spot for investors, also known as the space where issues are downgraded (or upgraded) between investment grade (BBB) and sub-investment grade (BB). While many index-based strategies choose to focus either on BBB or BB bonds, many also have guidelines in place that prohibit them from owning a crossover bond that has been downgraded – yet another differentiator and value-add for an active, flexible manager like BMO Asset Management. Similarly, we can move interest rate risk to an area like Europe, where rates have not been rising, and where our confidence is higher compared to the U.S., rather than constrain ourselves to a specific market.

Strategy and Skill: Preparing for What’s Ahead

The major challenge for fixed income investors looking ahead will be the inevitable transition from extraordinary measures to a new world where we have less quantitative easing and more fiscal policy support. During this time, it is prudent to be active and aware, positioning for different relative growth and central bank policies, and understanding precisely when to implement hedges, and when to lift them.

We remain confident in our long-term views of rising rates, and that pressure on credit spreads will come through, which means BMO GARB will continue with its low-duration approach, overlaying tactical macro strategies – and our sharp skills – to add alpha and manage risk.

As we move forward, we actually expect to see increasing volatility in the marketplace and starker divergence across countries, giving us greater scope to lever our global perspective and source value-add fixed income opportunities – making BMO GARB an ideal de-risking vehicle for every well-constructed portfolio in today’s climate.

To learn more about BMO AM Global Absolute Return Bond Fund, access the materials below, or contact your Regional Sales Representative.