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Is Global Fixed Income Dead?

Despite interest rate volatility and inflation risk, Keith Patton explains that trendlines in the bond market are promising, especially with a global, diversified approach.

May 2021

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Keith Patton

Global Head of Unconstrained Fixed Income

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Key Takeaways

  • Bonds continue to remain a critical diversification tool for investors
  • Global strategy offers wider opportunity set than Canada only
  • Multi-sector strategy is benchmark agnostic and can focus on market

Traditional bond allocations have come into question recently due to higher interest rate volatility. Does this mean that fixed income is dead?

KP: No, absolutely not. Fixed income still provides very attractive income and upside potential for capital gains. However, achieving this without unnecessary volatility has become more challenging in the low interest rate environment. The Global Multi-Sector strategy is one solution to this headwind. We can avoid being dragged into longer dated securities, so getting hurt by rising yields or increased volatility in government markets is not something we typically encounter. In addition, the ability for us to look for opportunities globally, across multiple markets and sectors, is key to our success – we’re not just locked into one marketplace or one specific asset class, enabling us to focus on where market anomalies exist.

Should Canadian investors choose a global strategy or domestic fixed income?

KP: Well, this is always an interesting dilemma. Domestic fixed income can, and should, form a part of a portfolio to balance out riskier equity and credit assets. However, when it comes to finding a wider opportunity set for the growth side of the portfolio, global will always be preferred. Of course, there are some great managers in Canada, but diversification can become a major challenge – specifically at the issuer level. For instance, the Canadian bond market has roughly $2 trillion in assets and fewer than 250 non-government issuers, smaller in size to the high yield market ($3.3trn – 1522 issuers) but with much less diversification across issuers. These markets are tiny compared to the $82 trillion global investment grade market, with over 3,000 non-government issuers. Our strategy seeks to build a robust bottom-up portfolio, diversified across many factors from across the breadth of global fixed income markets.

Can you talk to some of the recent changes made to the BMO Global Multi-Sector Bond Fund, including debt purchases in consumer and financial sectors?

KP: Sure. There has been a lot of focus on the increased amount of BBB securities in investment grade markets and the risk of companies being downgraded to high yield (BB) - “fallen angels” – as a source of real volatility in the portfolio. We actually believe that as the economic environment improves and vaccines roll out, we might see an improvement in the upgrade-to-downgrade metric. And so, we've started to increase our weights to the BB sector to take advantage of a potential reversal in this ratings-drift.

Kraft Heinz, for instance, was downgraded last year to high yield but we expect it to benefit from an improving credit backdrop and potentially move back into the investment grade universe. Similarly, Netflix is a BB issuer but has benefited during Covid and is expected to build on this success.

That said, on the Financials side we've focused on a well diversified allocation of higher quality, global names, such as HSBC, Barclays, JP Morgan rather than some of the smaller regional companies.

With the second and third waves of COVID cases, there’s been concern about fixed income performance in emerging markets. What is your outlook for EM bonds?

KP: I think the initial stages of the COVID crisis and particularly the vaccine roll-out has been pretty bad for emerging markets. Going forward, however, we expect this underperformance to wane as the global economy gradually gets back to normal. For example, some exporters will benefit from the stimulus-induced growth we're going to see in the US and soon in Europe. Similarly, the recently proposed increase in IMF’s Special Drawing Rights (SDR) allocation of $650 billion could help boost reserves for many of the more vulnerable countries in the world. At the same time, strong oil prices have benefited a handful of Middle Eastern issuers. To benefit from this lagging of the original credit story, we’ve increased weighting to several EM names on the expectation of improvements not only in the sovereigns, but some of the corporates as well.

Keith, one last question. We like to end by asking about interesting reads that have shaped the way you think. What would you suggest for our Advisor audience?

KP: Before I give my book recommendation, there are two academic papers which I think are absolutely essential to understanding how policymakers are going to approach fiscal policy in the next decade. The first is Public Debt and Low Interest Rates[i] by ex-IMF Chief Economist Olivier Blanchard, which argues that the days of extraordinary monetary policy lifting economic growth seem to be over, and that we need to pass that baton to fiscal policy. This was backed up by a discussion paper from economists Jason Furman and Larry Summers called, A Reconsideration of Fiscal Policy in the Era of Low Interest Rates[ii]. On a more lighthearted note, I'd recommend Three Cups of Tea by Greg Mortenson and David Oliver Relin - an inspirational book that shows the power of thinking in different ways and challenging the norms of the day.

[i] Public Debt and Low Interest Rates, Olivier Blanchard, Peterson Institute for International Economics (PIIE)

[ii] A Reconsideration of Fiscal Policy in the Era of Low Interest Rates, Jason Furman & Lawrence Summers, A Presentation to the Hutchins Center on Fiscal & Monetary Policy, Brookings Institution and PIIE

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