This year could present some of the same challenges that fixed-income markets have encountered since 2008, says Steve Locke, lead manager of the $1.2-billion Mackenzie Sentinel Bond and senior vice-president at Toronto-based Mackenzie Financial Corp.
"The market is reflecting a lot of the same underlying fundamental problems that have been in place over the last three years," says Locke. "It's reflecting the longer-term need to deleverage the developed economies, of which Canada is a part, although it's more focused around the U.S. and Europe. It is a long-term problem and will cause a lot of cross-winds for investors."
As a result, interest rates are likely to remain in a low range for a few years. "It's even been forecast by the policy-makers," says Locke, referring to comments by Federal Reserve chairman Ben Bernanke that interest rates may remain low until late 2014.
"This shows us how deep the problem is -- and how little they are worried about inflation returning," says Locke. "As bond investors, one thing we worried about is inflation. But it's likely to be a sideline issue for now. Deleveraging is resulting in a disinflationary environment."
Still, Locke watches for opportunities and takes advantage of short-term spikes in interest rates. "Even a hike of 50 to 100 basis points can produce a dent in returns in the bond fund, within the investment-grade space. The way we mitigate the risks is by managing the duration and yield-curve exposure." (Bond prices tend to move in the opposite direction of interest rates.)
In the summer of 2010, for instance, Locke shortened duration by about three-quarters of a year, in expectation of rising rates due to Quantitative Easing 2, the Federal Reserve's economic-stimulus plan. "That move dampened the impact of rising yields, which did occur."
Another strategic move is a 50% weighting in corporate bonds -- twice the exposure of the benchmark DEX Bond Universe Index. Corporate bonds pay higher yields than government securities and thus offset any impact of rate hikes.
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By anticipating and adjusting to market conditions, Locke and his colleagues steered the flagship Mackenzie Sentinel Bond to a second-quartile return last year. The 3-star rated fund returned 7.5% in 2011 with Locke as co-manager or lead manager, compared with 7.2% for the median Canadian Fixed Income fund. On a two-year annualized basis, the Mackenzie team, including Locke, produced a 6.7% return, matching the category median.
A Toronto native, Locke is an 18-year industry veteran. After graduating with a BA in economics from York University in 1992 and an MBA from the Schulich School of Business in 1994, Locke landed a post as credit analyst and bond trader at Metropolitan Life.
"I gravitated to fixed income in business school," recalls Locke. "It was a combination of the mathematical bent and macroeconomic focus that really appealed to me."
After four years at Met Life, Locke joined Royal and Sun Alliance Insurance Co. of Canada, and its investment-management subsidiary, Agilerus. As a portfolio manager Locke focused on investment-grade bonds that were held in general insurance funds, pensions and segregated funds.
In 2003, Locke was hired by Howson Tattersall Investment Counsel Ltd., which managed the Saxon funds. Two years later, he became lead portfolio manager for all fixed-income mandates, which grew to about $8 billion in assets. In 2008, when the firm was acquired by Mackenzie Financial, Locke joined the Sentinel team.
In May 2010, Locke became co-lead. Thirteen months later, in June 2011, he was appointed head of the fixed-income team, which currently oversees about $15 billion, including money-market funds.
Locke heads a six-person team that has a focus on corporate bonds, which require more bottom-up analysis than government bonds. "The top-down view is important for managing duration. Understanding companies and their merits are keys to managing the corporate credits," says Locke, adding that he works closely with Felix Wong, a former Howson Tattersall alumnus.
Corporate issues are limited to 1% to 3% of the portfolio. However, individual government bond holdings can go up to 7%.
The duration of the bond fund is six years, versus 6.8 years for the index. "We shortened it at year-end because of the lower yields on longer-term government bonds," says Locke. "The decline in yields was significant and a little over-done, reacting to fears in the global marketplace."
Locke is also co-manager of the 4-star rated Mackenzie Sentinel Income Series A, a balanced fund with a fixed-income tilt. The bond portion, which represents about 65% of the $1.3 billion in assets, is almost identical to the holdings in the flagship bond fund, with the exception of a small allocation to high-yield bonds.
Looking ahead, and given the uncertainty surrounding Europe, Locke would not be surprised if yields fell further. "If we had significant turmoil in Europe, we would likely see another drift down in government bond yields," Locke says, noting that the running yield for the flagship bond fund is about 2.75%, before fees. "But it does get harder to produce significant drops in yield from these levels."
