Canada’s fixed income landscape is foggy. A mix of slowing growth, trade uncertainty, and pending rate cuts has left investors — and their advisors — looking for clarity.

While fixed income portfolios may not be sprinting, they’re not standing still either. Opportunities exist for those taking a methodical yet active approach, says Darcy Briggs, a Senior Vice-president and Portfolio Manager at Franklin Templeton Fixed Income.

Several macro trends are shaping investor behaviour. In past years, government spending, an influx of immigration, and a housing boom “created an illusion of growth,” says Briggs. But deeper productivity and investment gaps remain. “Looking at Canada, we expect softer growth. GDP per capita is somewhat flat.”

Meanwhile, the on-again, off-again effects of U.S. tariffs, and whether the United States–Mexico–Canada Agreement will be renegotiated, are adding fresh economic headwinds. Until that gets settled, Briggs says consumers and businesses are going to “sit on their hands.”

“We may end up being one of the lowest-tariffed countries in the world when all is said and done, but we don’t have any visibility on that.”

If Canada has a quick resolution to tariffs, Briggs feels that mediocre growth might follow. If tariffs remain substantial, he says the country will face a full-blown recession over the next year. There are several paths, but Briggs feels that none are highly bullish for growth.

He expects the Bank of Canada will cut rates to about 2 percent by year-end, citing mortgage resets and indebted households as key drivers. Inflation remains a wildcard, too.

With these conditions providing the backdrop, what are the prospects for fixed income investors? In times like these, fixed income isn’t just about yield; it’s about discipline.

“Markets are remarkably comfortable with the current level of risk. We have been generally very cautious about chasing spread. We’re trying to be as disciplined as we can about credit, duration, and currency. We prefer to take a lot of little bets rather than a few big bets,” says Adrienne Young, a Senior Vice-president and Director of Corporate Credit Research, Canada, with Franklin Templeton Fixed Income.

Global diversification is key

That translates into an approach grounded in global diversification (access sectors unavailable in Canada), liquidity (act when opportunities arise), and defensive positioning (hedge selectively with derivatives).

In Canada, the bond market is smaller and less liquid, Young adds. “If other people are selling and we’re one of the few buyers, we can lock in great pricing on good-quality bonds that we might not otherwise get.”

What’s worth considering now? The short list of sectors that Franklin Templeton is overweighting includes energy (pipelines and distribution). Young touts the “contracted cash flows with high-quality counterparties.”

She’s bullish, too, on some of the resources that are important to farming and utilities (they’ll be needed regardless of the economic cycle), U.S. healthcare and industrials, and defence. Young also mentions U.S. money-centred banks, which are trading at a discount compared to Canadian banks.

This sizable investment in U.S. sectors acts as “a bit of a ballast against any correction that may affect Canadian consumer-related credit,” she adds.

In contrast, areas of concern include Canadian consumer credit, the retail and auto sectors, and credit unions (whose housing-loan books are skewed to the Toronto and Vancouver markets).

In the current environment, fixed income is generating income again. “The FTSE Canada Bond Universe yields just under 3.5%. Our preference for holding more credit than the index allows us to deliver additional yield to clients in our strategies”, says Young. That means less variance compared to some equity funds without the associated risk, offering real value.

Made-in-Canada expertise

There was a time when fixed income didn’t pay. Now, it’s a viable contributor for income and diversification, and cushioning client portfolios. “If we do have a downturn in economic activity, fixed income should still provide that buffer,” says Briggs.

While global exposure is vital, there’s no substitute for being on the ground. The Franklin Templeton team is based in Calgary, and Briggs says Canadian investors benefit from managers who understand the local nuances, whether around investors’ objectives or constraints. “You have a better knowledge of the intricacies of the marketplace. It becomes a lot more difficult if you’re removed from that.”

Rather than make major directional bets, Franklin Templeton is emphasizing a nimble posture. This measured stance enables the firm to be opportunistic.

“To benefit their clients around fixed income, advisors should think active, not passive, and diversify thoughtfully”, Young says. “Volatility demands vigilance to help smooth the ride.”

“Active management allows for better control over credit risk, interest rate risk, and liquidity risk, which can be crucial during periods of market turbulence,” says Briggs, adding that this isn’t a time to underestimate fixed income’s contribution. “Uncertainty will be with us for a period of time.”

The Franklin Templeton team believes that’s not necessarily bad for fixed income investors.

“Volatility is risk, of course. But if you’re an active manager that has been collecting liquidity — and we have — it’s an opportunity,” says Young.

She explains that sometimes certain areas of the market will go completely no bid. “That’s when Franklin Templeton can go in and say, ‘You have to sell. Well, we can buy. And here’s the price.’

“That’s an opportunity to really outperform for the investor,” she continues. “Active managers can offer you more diversification than the passive benchmark, capitalize on market opportunities, and respond to changing market conditions in uncertain times.”

Important Legal Information
This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.
The views expressed are those of the investment manager, and the comments, opinions, and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, or market.
Commissions, trailing commissions, management fees, brokerage fees, and expenses may be associated with investments in mutual funds and ETFs. Please read the prospectus and fund fact/ETF facts document before investing. Mutual funds and ETFs are not guaranteed. Their values change frequently. Past performance may not be repeated.
Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp.

This has been an excruciating year for investors who depend on the income from their investments to live. Unfortunately, the persistently high inflation, central bank monetary tightening and increasing likelihood of a recession look like they will linger well into 2023, if not longer.

Under the circumstances, it’s not surprising that flows into GICs and other cash equivalents have risen dramatically, but as an income solution they fall short. Returns remain well below the inflation rate. Lock-in requirements and penalties for early redemption or any degree of flexibility can easily leave investors with negative real returns, and the income from these investments is fully taxable.

Correlation and diversification still key

Diversification is as important for income portfolios as it is for equities, and the sources of income need to be as uncorrelated as possible. Research and asset allocation have become an exhausting, time-consuming process, so it’s no surprise that outsourcing the income component of the portfolio is becoming more popular. We suggest that one way to quickly bump up the level of income diversification is through a managed program.

20 years of income generation

One of the earliest managed programs in Canada was Franklin Templeton’s Quotential program; in fact, this year marks the program’s 20^th anniversary. Of its five globally diversified, actively managed portfolios, the aptly named Quotential Diversified Income Portfolio (QDIP) is designed to generate high, consistent income from multiple uncorrelated sources. Canadian and international fixed income assets form the core of the portfolio, but for added flexibility and performance enhancement, about one-quarter of the portfolio is invested in blue-chip Canadian and international equities selected for their income-generating  dividend yields and long-term growth potential.

While QDIP is a solid investment in its own right, the effectiveness of the portfolio ratchets up when invested through Series T.

“T” is for Tax Efficient

Taxes can eat away at the income generated from investments, especially if clients are still earning a salary or receiving significant income from other sources. All Quotential portfolios are available in Series T, which offers a predictable stream of monthly cash flow, regardless of market moves. From a tax standpoint, Series T Return of Capital (ROC) distributions are treated more favourably than interest or dividend income. Taxes on capital gains are only payable if the investment is redeemed or when the adjusted cost base (ACB) reaches zero, allowing clients to keep more for longer.

This chart shows the results of $1 million invested in QDIP in 2003. The investor wanted roughly $3,000 per month to help pay for expenses. Eighteen years later, the portfolio  was still worth over $1 million, but in the interim, it had also provided close to $800,000 worth of monthly income through ROC. Moreover, the ACB was still positive.

Franklin Quotential Diversified Income Portfolio – Series T Growth of a $1,000,000 Investment at 3.5% distribution as of September 30^th, 2022

For snowbirds and others who spend extended periods south of the border, distributions from Series T are available for Quotential Diversified Income Portfolio in U.S. dollars.

ROC on! ROC off!

For some clients, flexibility may be as important as a consistent flow of income. Series T ROC distributions can be increased or decreased on request at any time, which can be helpful in years when the client’s income or expenses are higher or lower than usual.

Showcase your value to clients

Launched 20 years ago this year, the Quotential Program offers advisors turnkey support in research, portfolio management and reporting throughout the lifecycle of the investment. Find out how our five globally diversified, actively managed Quotential Portfolios and the support offered through the program can help you free up valuable time for strengthening client relationships and building your business.

The QDIP-Series T idea was very well received in meetings we recently conducted with advisors. Not only does it reinforce with clients the concept that generating predictable, tax-efficient income from investments is possible regardless of the market environment, it’s also the type of creative thinking that clearly demonstrates the value of professional advice.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus or fund facts document before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Series T distributions are automatically reinvested unless otherwise requested. Series T may also pay a distribution that must be reinvested in December, consisting of income and capital gains. Please indicate your preference to receive cash flow immediately on the application form.

The information presented herein is for illustrative and discussion purposes only and does not constitute any offering of any security, product, service, or fund, nor does it constitute any type of investment, tax or legal advice.

Maximum target annual distribution rate on Series T varies between 5% to 8%. Investors may choose their desired ROC cash payout rate and the remainder will be reinvested.

Important Legal Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market.

Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments opinions and analyses in the material is at the sole discretion of the user.

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Equity and Fixed Income prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.

Franklin Templeton Investment Solutions, part of Franklin Templeton Canada. Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp.