Eric: Marc Andre, it’s great to have you with us today. Thanks for joining us.
Marc Andre: Happy to be here.
Eric: So we’ll start with the first question. We all know it’s a cha—challenging environment for bond investors and bonds are a significant part of the retirees’ portfolio. Um, so how can retirees get the maximum out of their fixed income exposure?
Marc Andre: There are two main benefits of, um, of adding bonds in a diversified portfolio. The first benefit I’d say is to earn a reasonable level of, uh, of income. Uh, the second benefit I would call it more of a, uh, portfolio insurance, whereby should, uh, an economic catastrophe occurs and there’s a strong recession and equities are down, typically, uh, central bankers will respond, bring down rates, and you’re going to see capital gain coming from, uh, the fixed income part. So, so, those are the two benefits.
When we look at the, uh, situation today, uh, and, uh, you know, looking back again(?) a year ago, central bankers, uh, brought rates at very low levels to deal with COVID. Uh, as the economy reopened, the bank came back, we started to see a little bit more, um, uh, inflation pressures and central bankers didn’t need to keep, uh, rates at, uh, emergency levels, so brought, uh, rates up quite significantly.
So, where we’re sitting today is high-quality fixed income now is providing investors with a level of income that has not been seen in 14, 15 years. So, so, the income is back, I guess, into fixed income, uh, and should a recession occurs, well, central bankers will now have the capacity to bring down rates to restimulate the economy.
Eric: So, I guess the next logical question is how can retirees get income without taking too much risk?
Marc Andre: There are three risks in fixed income. Uh, the first one I would call the interest rate sensitivity. So, as rates go up or down …
Eric: Yeah.
Marc Andre: … you have short-term mark-to-market movement, uh, in your bonds. The second risk is more of a spread, uh, credit spread and volatility risk. Uh, as the market again goes up or down in, in, uh, in risky assets, there’s an impact on how much investors are asking for, you know, the credit spread risk. Uh, and the third risk is a default risk, so that’s the worst one. So, I’d(?) say(?) losing your income.
Uh, so those are the three main risks, and, uh, given where we are today, uh, in(?) basically, the economy and central bankers have brought rates a lot, uh, they want to control or slow down demand so that the offer of services can keep up with all that demand, uh, we think the economy is going to slow down, uh, and rates now, as I mentioned earlier, uh, the income has gone up.
So, for now, I’d say investors, uh, want to take on a little bit of a [sic] interest rate risk and a little bit of spread risk, but don’t—you know, not necessarily the time to take on default risk. As the economy slows downs [sic], valuation readjusts a lot. Um, taking on default risk eventually at, kind of, better, uh, timing will bring investors equity-like returns, uh, with, uh, you know, uh, pretty good, uh, downside protection.
So, so, right now maybe a bit more defensive and as the market evolves, uh, taking on a bit more spread risk and default risk down the road.
Eric: Okay. So, if investors were to add credits within the, their allocation, what are some of the pitfalls that they should be aware of?
Marc Andre: Well, I guess the lower the, uh, credit quality, the higher the default risk. By default, you’ll have a higher correlation to risky assets in the economy. Uh, so that’d be one pitfall. The second one, though, if you stay too high risk, well, I guess the level of income is not as much as when you stretch(?) down, uh, and you have a bit more interest rate sensitivity. So, finding a partner or navigating, uh, between those two pitfalls, uh, and being active, uh, so reducing duration, uh, when it makes sense, uh, or increasing your allocation, uh, to a higher quality, uh, prior to the fixed income market, before the market goes down. As the market goes down, I’d say you want to, uh, you know, allocate more to what went down more.
So, so finding a partner that can be active, uh, is I think quite important for, for investors.
Eric: So, Marc Andre, uh, when you talk about high yield bonds, aren’t they just junk bonds? So, I’d be curious to know what’s the difference and also, what’s your outlook on credit?
Marc Andre: Uh, both are identical. Uh, the high yield is basically companies with a, uh, rating-agency rating of Double B+ or lower (inaudible) all their way down to Triple C. So, that’s the same thing as junk bonds; just a different terminology.
Investment-grade bond is Triple B- and above, so all the way up to, uh, the Triple A.
With respect to the evolution of those two markets over the past few decades, I’d say that the high yield, uh, market or junk bond market has evolved significantly. Um, for example, when I started my career, uh, in the late ‘90s, uh, Triple C’s, uh, were a much larger part of the high yield market, and, and by default Triple—Double B’s, so the higher quality, uh, high yield was a smaller portion. I think around 30%.
Today, the composition of Double B is 50%. So, the credit quality has improved significantly.
On the flip side, when you look at investment grade, so Triple B- or above, Triple B- in 30 years or 25 years ago represented 18, 20% of the Canadian market. Similar, uh, in the U.S. Now it’s 50%. So, high yield credit quality has improved. Whereas, uh, on the investment grade, it has deteriorated.
Eric: For pre-retirees and retirees that are thinking of actually adding credit to their retirement income portfolios, how would you recommend they go about it? Because doing it by themselves might not be the most prudent thing.
Marc Andre: I agree with that. So, finding a partner that has a track record, uh, and capacity, uh, to navigate through the cycle is, is quite important.
For investors right now, uh, that want to, you know, get access to more income, uh, by going credit, uh, and don’t want to use alternative solutions, so higher quality, shorter duration, uh, product is, is quite compelling, uh, given where we are. For example, we have our, uh, Dynamic Discounted Bond ETF, uh, and our Dynamic, uh, Investment-Grade Floating Rate, uh, ETF. So, those are a very high quality, shorter duration that are providing investors with return streams that have not been seen in, in more than a decade.
So, so, pretty decent level of income without taking on too much risk even if there’s a recession. Uh, for investors that have, uh, the appetite, uh, to, uh, look at alternatives, so we have our Dynam—Dynamic Credit Absolute Return Strategy, uh, that is very flexible. Again, low sensitivity, uh, to interest rates, uh, provide investors with high, mid-single digit return right now, uh, that can basically navigate well through environment, where, uh, overnight rates stay maybe a bit higher, uh, and the economy a bit slower, this strategy can provide a different stream of, uh, return, uh, for retirees.
Eric: Marc Andre, thank you very much for being with us today. Great insights and looking forward to see you soon.
Marc Andre: Thank you, Eric.
