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Ruth Saldanha: We've had an interesting couple of weeks for the equity market with COVID-19 causing central banks to reevaluate and cut interest rates, which has led to ongoing equity market volatility. But what about the fixed income space? With rates being cut, what should you do to protect your portfolio? And where could you look for yield? Sue McNamara, Vice President of Fixed Income at Beutel Goodman Investment Counsel is here to discuss this.
Sue, thank you so much for being with us today.
Sue McNamara: Thank you for having me.
Saldanha: The Fed and Bank of Canada both have cut rates because of the coronavirus. But before we get into that, the virus itself has caused a lot of volatility for equity markets. What do you anticipate to be the long-term impact on the fixed income side?
McNamara: Well, it's really difficult to say exactly what the impact will be because we don't know what the impact of the virus will be. But I think it's pretty safe to say that rates are going to be lower for longer. And certainly, that's what the fixed income markets are pricing in. And despite the fact that both the Bank of Canada and the Federal Reserve have gone 50 basis points, both markets are factoring in that they're going to continue to cut rates. Obviously, to the extent to which they cut rates will depend on how serious the spread of the virus comes. But history has shown that every time the Federal Reserve has gone into a meeting with an emergency cut, they have cut at the next meeting. So, history is on the side that this is more of an easing cycle than it is necessarily emergency cuts. So, I think your base case for this is that interest rates are going to stay low and that, you know, the Bank of Canada was very dovish today. So, they and together with the Fed have said that they will continue to ease as they see necessary. And when we don't have a lot of inflation, it gives them a lot of tools in their toolbox for monetary policy. But that being said, we're also going to need something fiscal from both federal governments.
Saldanha: So, we are in a low interest rate environment, which is likely to continue. Where are you seeing some of the risks right now and where do you see pockets of value on the other side?
McNamara: Yeah, I mean, it's very difficult right now because where the markets are telling you where we're going with the central bank is continuing to ease, there's not a lot of value that you might see within duration curve unless the economy or the spread of the virus starts to be different to what markets are expecting. And those are the – always you see those opportunities in that the central banks and the markets when they're at odds, never get it right. So, either the central banks come to where the markets are, the markets come to where the central bank thinking is. So, we don't see that value right now, because we're kind of in accordance with what the central banks are thinking. But that could be an opportunity later on.
And it's similar with corporate bond spreads in our thinking that we don't see the opportunities now. In fact, we see the risks. We think that corporate bond spreads are too tight. They've widened a little bit since the spread of the virus and the fear but haven't widened enough that we think that they should widen. Part of the widening has been reflective of softer earnings, but there may be another leg up. So, on our credit team, we've just added some new members and we've been doing a tremendous amount of work adding new names to our approved list. And what we're looking at is kind of building up a treasure chest of names that we can deploy when credit spreads start to widen and when we see those opportunities. Because the one thing we know when you have these credit spread widening events is everything widens at the same time. There's no differentiation between sector, between rating, between names, between even duration. So, that just – you have kind of like a rising tide lifts all boats. And that creates tremendous opportunities because there's dislocation of value. So, really, a lot of the work we're doing right now is to be able to take advantage of that credit spread widening events. So, it's not necessarily that we see a tremendous amount of value in the fixed income market right now. But we're positioning for when we get those opportunities, because we don't get those opportunities very often.
Saldanha: So, does it make sense for retail investors to consider high-yield options like, say, junk bonds right now?
McNamara: I think it does. I think it does have a place in your portfolio. I think it's just how you manage that risk. And junk bonds may be a little bit more of a 1980 scare term for these types of investments and the high yield market has grown significantly. I think what I would say is, where you want to play high yield is with an active manager and not with a passive manager. I'm not here to dump on ETFs. But understand the concerns that – the two main concerns I would have with a high yield pure ETF fund is, one is on the liquidity front. High yield bonds traditionally are not as liquid as other bonds. And if you have a run on markets like we had last week, where there's $4.2 billion pulled out of bond funds, and particularly corporate and high yield funds, that's a lot of money to have be going all one way. And so, there could be liquidity concerns that you're selling into a falling market, and ETFs are price takers.
The other concern you have is, sometimes to offset that what an ETF or a passive manager would do will buy the highest weighting in the index. With a highest weighting in a debt index it's usually the heavily debted company. So, that's not necessarily the best company because it means they have the most debt outstanding. So, we would advocate that while high yield definitely does have a place, it just should be one that it was more actively managed. And you can get a lot of interesting situations in high yield. As I mentioned before, they could be companies that are turnaround stories that are going to get upgraded. In Canada, we have a really interesting investment in the hybrid bonds. So, these are bonds that are issued by investment grade companies, but they are unsecured, and they are lower in the capital structure. So, if your rating is BBB mid, there's usually a two-notch difference to your hybrid bonds. So, it can be BB+. So, the way I like to look at this, you can get high-yield spreads and high-yield yield from an investment grade type company. And the way that we look at a company when we do our research is, our bottom line is, we don't think the company is going to go bankrupt. So, we're very comfortable investing in any part of the capital structure. So, we like kind of opportunities like that in high yield.
Saldanha: Thank you so much for joining us today, Sue.
McNamara: Thank you very much for having me.
Saldanha: For Morningstar, I'm Ruth Saldanha.
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