Positioning fixed-income portfolios

Despite uncertainties about monetary policy, the fixed-income landscape is ripe with opportunities, says Aaron Young, vice-president of global fixed income with CIBC Asset Management. 

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Ahead of the Bank of Canada’s upcoming interest rate announcement on Wednesday, Young said recent economic data support a cut. For example, Canada’s growth rate in the first quarter came in at a slower than expected 1.7%.

If the central bank does cut rates, “the market has priced a good chunk of it in,” he said, “in terms of government bond yields on the short end.”

A hold scenario would lead to continued curve inversion, he noted.

As things stand, “We kind of sit in that unusual position of having an inverted curve where [you] can actually get more yield being shorter in the curve versus taking more term risk,” he said. 

This situation represents “backwards opportunities,” he said — those that wouldn’t be available in a highly efficient market.

For example, short-term government bonds yield more than 4%, he noted. “We’re happy to clip that coupon [at the short-end of the yield curve] as kind of a baseline return for our portfolios,” he said.

Further, as short-term bonds mature, investors have capital readily available for market opportunities, he said.

Young also noted that the Federal Reserve appears to have more leeway to maintain current interest rates longer due to stronger macroeconomic indicators. With potential rate divergence between Canada and the U.S., he suggested shorter-term U.S. agency mortgage-backed securities.

“The size of the U.S. agency MBS market eclipses the size of the entire Canadian government bond market,” Young said.

“Against this backdrop, we can actually own those bonds at a higher yield than we get in Canada.”

In long-term bonds, Young highlighted U.S. Treasuries. “Again, we get a yield pickup going into a much more liquid, larger market,” relative to Canada, he said.

In corporate bonds, he cited global systemically important banks (GSIBs), which have “gone through the deleveraging of the great financial crisis, and now offer really attractive yields that can compete with what we can get here in Canada,” he said.

Lastly, Young touched on key elements to keep in mind for investors allocating to private debt. Most private debt in the market is floating-rate debt, he noted, which performed well in recent years. But the underlying companies will have higher financing costs going forward.

He suggested choosing private debt managers with proven resilience through cycles, with robust underwriting infrastructure. 

Looking ahead, Young was optimistic overall about the role of fixed income in investment portfolios. 

“We think long-term fixed income rises back to the role it has in the past, to play as an income generator for clients, as a lower volatility asset class, and as a place to add value through active management,” he said.

This article is part of the Advisor To Go program, powered by CIBC Asset Management. It was written without input from the sponsor.