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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.

April 2018

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Keith Patton

Global Head of Unconstrained Fixed Income

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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.

Why Invest in BMO GARB?

  • Access to a global universe of bonds – opportunity for higher returns relative to traditional Canadian bonds
  • Strategic allocation to shorter-dated securities – providing greater portfolio protection by reducing the impact of cyclicality
  • Flexibility – ability to generate returns in both a positive and negative market environment (including rising rates) through short or negative duration
  • Diversification – both within corporate bonds and among overlay strategies to improve risk/return profile
  • Core focus on capital preservation – greater risk avoidance than traditional bond funds and alignment of outcome

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.

Disclosures

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

The BMO AM Global Absolute Return Bond Fund aims to deliver a positive return regardless of market conditions over any one-year rolling period but such a positive return is not guaranteed over this or any time period. Capital is at risk and on sale of shares in the Fund an investor may receive back less than the original investment

Important information about the Fund is contained in the offering memorandum including, a detailed description of the Fund’s investment objectives, investment strategies and portfolio metrics. This document pertains to the offering of the funds described in this document and in the Information Memorandum only in those jurisdictions and to those persons where and to whom they may be lawfully offered for sale, and only by persons permitted to sell such Shares. Eligible purchasers will need to qualify as “accredited investors” and “permitted clients” under applicable Canadian securities laws.

This document has been prepared for information purposes only and should not be construed as a solicitation for, or offering of, an investment in securities in any jurisdiction where such offer or solicitation would be prohibited. While the information contained in this document is believed to be reliable, no guarantee is given that it is accurate or complete. This document is not, and under no circumstances is to be construed as an advertisement or a public offering of the Shares described in this document or the Canadian Offering Memorandum or Information Memorandum in Canada. No securities commission or similar authority in Canada has reviewed or in any way passed upon this document or the merits of the Shares described in this document or the Canadian Offering Memorandum or Information Memorandum, and any representation to the contrary is an offence. Prospective investors are advised to read the offering memorandum and to consult with an independent financial advisor prior to making any investment decision based on this document.

BMO Global Asset Management is the brand name for various affiliated entities of BMO Financial Group that provide investment management, retirement, and trust and custody services. BMO Global Asset Management comprises BMO Asset Management Inc., BMO Investments Inc., BMO Asset Management Corp. and BMO’s specialized investment management firms. Certain of the products and services offered under the brand name, BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations.® “BMO (M-bar roundel symbol)” are trade-marks of Bank of Montreal, used under licence.

®/™Registered trade-marks/trade-mark of Bank of Montreal, used under licence.

BMO Global Asset Management is the brand name for various affiliated entities of BMO Financial Group that provide investment management, and trust and custody services. BMO Global Asset Management comprises BMO Asset Management Inc. and BMO Investments Inc. Certain of the products and services offered under the brand name, BMO Global Asset Management are designed specifically for various categories of investors in a number of different countries and regions and may not be available to all investors. Products and services are only offered to such investors in those countries and regions in accordance with applicable laws and regulations. BMO Financial Group is a service mark of Bank of Montreal (BMO).

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Exchange traded funds are not guaranteed, their values change frequently and past performance may not be repeated.

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Commissions, trailing commissions (if applicable), management fees and expenses all may be associated with mutual fund investments. Please read the ETF facts, fund facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

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