This week we talk to Barry Allan, President, CEO Chief Investment Officer and Founder of Marret Asset Management (a subsidiary of CI Financial) and manager of the First Asset Enhanced Government Bond ETF (FGO). There are several asset classes where it just makes more sense to pay a bit more for an active approach versus a passive index-based approach. Fixed income is one of those areas due to the expectation that bond yields may stay low for decades to come. I’ve copied the following quote from Marret’s website:
“Fixed income portfolios have benefited from 30 plus years of falling interest rates. During most of this time, passive “buy and hold” programs delivered returns in line with investors’ objectives. Today these traditional portfolios are challenged: both highly exposed to rising rates while priced for ultra-low yield. Marret’s core-alternative mandates are not reliant on falling rates. Our active management looks for pockets of value within credit markets, while using active risk management to hedge unwanted market risks. Volatility may be reduced, producing a smoother return stream through different market environments.”
Depending on the point of the economic cycle, tactical emphasis in an actively managed fixed income portfolios will make significant changes. There are three primary focuses in fixed income portfolios. 1. Credit quality 2. Duration (interest rate risk) and 3. Shape of the yield curve. Marret shifts the type of exposure they have in the portfolio depending on what part of the economic cycle we are in. In the late cycle expansion phase, lower quality credit (high yield), preferred shares, emerging markets and asset backed securities. When the economy is strong, credit spreads tend to narrow and so there is better total returns in corporate bonds than safer government bonds.
At the peak of the cycle, when the central banks are actively trying to slow the economy and fight inflation pressures, short duration (less interest rate risk) and floating rate notes (adjustable coupons) offer better capital preservation and growth potential.
Once a recession hits and the central banks shift a tightening bias towards an easing bias, Long-term high-quality government bonds offer the best returns. Early in the recovery, as the Fed is cutting rates, focus turns to the shape of the yield curve and the belly (3-7 year) part of the yield curve tends to perform best adjusted for risk compared to the same duration as a barbelled (2 & longs) position due to the rapid steepening.
In terms of types of holding between government and corporate, they will put limits on exposures, so all eggs are never in the same basket so to speak.
The universe of Canadian Bonds is made up of about 35% federal government debt and about 35% provincial and mortgage backed debt (CMHC). Corporate is about 29% and municipal is a little over 1%. A big focus of the FGO active strategy is credit exposure, but they will also shift interest rate risk by moving from having all floating rate short-term debt to very long-term government bonds with a eye to what part of the yield curve also provides the best bang for the buck in terms of risk adjusted returns.
With yields having declined so much over the past 35 years, the Yield to maturity of the world index (about $50T) is a little over 2%. After tax and inflation, the entire world of debt has a negative real return meaning you are worse off every year having fixed income in your portfolio. This might be the biggest issue retirees will face in the coming decades. Traditional (passive) fixed-income investing will disappoint investors.
The risk of the bond market as measured by duration (sensitivity to changes in interest rates) rises as yields fall. A duration of 7 means a 1% change in interest rates will see a 7% change in price. We now have close to the lowest yields and the highest risk investing in passive bond portfolios. Viewers need to understand how appropriate fixed income is for their portfolios in terms of preserving capital. Especially as we head into a recession phase in the coming years. FGO might be an ETF to look at including in your portfolio’s fixed income exposure. The management fee (55bps) is high compared to passive ETFs (~10bps), but the value delivered should more than makes up for it.
Learn to Sleep at Night in a Bear Market
The previous Investor’s Guide to Thriving tour wrapped up on December 1st 2018. Aptly named “How Long Can a Bull Market Run?” we may have received our answer. The market printed the worst December since the Great Depression – bringing most of the major indices officially into bear market (-20%+) territory. Markets have rebounded in January as they always do after steep declines, but we are likely in the early phases of a bear market where average corrections are closer to 30% and extreme corrections are more than 50%. If this is case, we haven’t seen the last of market volatility and a downward pattern of lower highs and lower lows. Many people are surprised at this phase because it can take some time for the fallout to move from Wall Street to Main Street – showing up as a recession. Job markets are relative robust still and Central Banks are still talking about raising rates. Markets are forward looking and generally anticipate economic downturns, so even as rates continue to rise, employment appears to be strong, and many companies are still posting record earnings – you should be paying attention to the growing cracks in the system.
Larry will take the audience on a more detailed tour of past bear markets to see what we can learn about how this next one might compare. Will it be a gentle panda or a deadly grizzly? Can we hope for a soft landing due to aggressive government policy? How would we recognize a market bottom – when the next major bull market might begin? Why not go to cash or put all your money into a GIC right now? There are many questions to ask – and while (spoiler alert) we don’t have a crystal ball to give you the definitive answers, Larry can show you how to navigate a bear market so that you will use it as an opportunity rather than something to fear. Using some of his favorite indicators and techniques, you will learn how to use a tactical approach to trading, and strategic asset allocation (including the use of gold, real assets, and other non-equity vehicles), to help keep your portfolio within your emotional comfort zone – while avoiding costly emotional mistakes. Success in difficult markets is both a science and an art, so Larry will also discuss the psychological aspect of managing portfolios under stressful conditions.
You will take away from this live presentation a timely perspective on how to approach your investments in 2019 and beyond – along with actionable ideas to help strengthen your portfolio, and even a few tools and resources to use at home.
Click here to register for free and as always we ask for volunteer donations to one of our two favourite charities. Children’s cancer research at the Sick Kids Hospital and Alzheimer’s and dementia research at the Baycrest Hospital.
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Now, let's discuss the concepts mentioned in the article you provided.
Active vs. Passive Approach in Fixed Income Investing
The article mentions that there are certain asset classes, such as fixed income, where it may be more beneficial to use an active approach rather than a passive index-based approach. This is because fixed income portfolios have historically benefited from falling interest rates, which have delivered returns in line with investors' objectives. However, with the expectation that bond yields may stay low for decades to come, traditional passive portfolios are challenged as they are highly exposed to rising rates while priced for ultra-low yield.
Marret Asset Management, the manager of the First Asset Enhanced Government Bond ETF (FGO), takes an active management approach in fixed income investing. They look for pockets of value within credit markets and use active risk management to hedge unwanted market risks. By doing so, they aim to reduce volatility and produce a smoother return stream through different market environments.
Tactical Emphasis in Actively Managed Fixed Income Portfolios
Marret Asset Management adjusts the type of exposure in their fixed income portfolio based on the point of the economic cycle. They focus on three primary factors: credit quality, duration (interest rate risk), and the shape of the yield curve. Depending on the phase of the economic cycle, they shift the portfolio's exposure accordingly.
During the late cycle expansion phase, they may increase exposure to lower quality credit (high yield), preferred shares, emerging markets, and asset-backed securities. When the economy is strong, credit spreads tend to narrow, making corporate bonds more attractive than safer government bonds. At the peak of the cycle, when central banks are actively trying to slow the economy and fight inflation pressures, they may shift towards short duration (less interest rate risk) and floating rate notes (adjustable coupons) for better capital preservation and growth potential. In a recession phase, long-term high-quality government bonds offer the best returns. Early in the recovery, as the central bank cuts rates, the focus turns to the shape of the yield curve, with the 3-7 year part of the yield curve tending to perform best adjusted for risk.
Types of Holdings in Canadian Bonds
The universe of Canadian bonds is composed of various types of debt. Approximately 35% is federal government debt, 35% is provincial and mortgage-backed debt (CMHC), 29% is corporate debt, and a little over 1% is municipal debt. Marret Asset Management puts limits on exposures to ensure diversification and avoid having all eggs in one basket.
Yield to Maturity and Passive Fixed-Income Investing
The article mentions that with yields having declined significantly over the past 35 years, the yield to maturity of the world index is a little over 2%. After tax and inflation, the entire world of debt has a negative real return, meaning that fixed income investments may result in a loss of purchasing power over time. This poses a challenge for traditional (passive) fixed-income investing, which may disappoint investors.
Risk of Passive Bond Portfolios
The risk of passive bond portfolios, as measured by duration (sensitivity to changes in interest rates), increases as yields fall. A duration of 7 means that a 1% change in interest rates will result in a 7% change in price. With yields currently near their lowest levels, investing in passive bond portfolios carries higher risk. It is important for investors to understand the appropriateness of fixed income in their portfolios in terms of preserving capital, especially as the economy heads into a recession phase in the coming years. The First Asset Enhanced Government Bond ETF (FGO) may be an ETF to consider for fixed income exposure, despite its higher management fee compared to passive ETFs, as the value delivered may outweigh the fee.
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