Portfolio manager Mark Carpani faces the same challenges as your average fixed-income investor: how to wring out the maximum possible returns in a low-interest-rate environment without taking on too much risk.
“Rates are low and it is challenging but we do have a credit focus and an absolute total return focus,” says Mr. Carpani, senior vice-president of fixed income for Ridgewood Capital Asset Management Inc. of Toronto, whose Ridgewood Canadian Bond Fund won a 2021 Lipper award in the Canadian fixed-income category.
The fund’s performance has been flat over the past year and has a three-year annualized return of 5 per cent, according to Morningstar data as of Oct. 31.
His strategy has been to seek out the superior returns that corporate credit offers, with approximately two-thirds of assets coming from corporate debt with the remainder in government debt.
“Credit, and corporate bonds, have been the place to be vis-à-vis government bonds” over the past three years, with the exception of the short but severe market crash in March 2020, he notes.
A bet on real estate through the pandemic, in the form of commercial mortgage-backed securities, might sound risky with downtown office towers virtually emptied out overnight. However, Mr. Carpani says, “you really need to do your homework,” given some of those securities had suburban office space that easily rode out the pandemic while other real estate categories such as industrial and apartment buildings were largely unaffected.
The fund also loaded up on debt issued by insurance companies and Canadian banks, which have recently opted to offer limited recourse capital notes – a hybrid security that pays interest as opposed to dividends – rather than their traditional reliance on preferred shares.
“Real estate was good, financials were wonderful,” Mr. Carpani says, adding they were the biggest contributors to the fund’s recent success.
An emerging worry for fixed-income investors today is sharply higher inflation and the prospects of higher interest rates being rolled out by the central banks of developed countries. The key questions are whether the current spike in inflation is a temporary glitch that has come with a reopening global economy and will central banks be dovish or push aggressively with a series of rate hikes.
“It all comes down to how central banks are reacting and how they are looking at inflation and growth,” says Konstantin Boehmer, co-head of fixed income and portfolio manager at Mackenzie Investments in Toronto.
He notes that last month there was “an initially fairly hawkish tilt” led by the central banks for England, Canada and New Zealand but that there has been a moderation since that time by other central banks such as the U.S. Federal Reserve.
“My interpretation of this is that while inflation is high, uncomfortably high and above their level of what they think they can tolerate, they don’t want it to force their hand,” says Mr. Boehmer, who manages the Mackenzie Core Plus Canadian Fixed Income ETF, which won a 2021 Lipper Award in the Canadian fixed income category.
The ETF is down 2.6 per cent over the past year, as of Nov. 12, according to Morningstar, and has a three-year annualized return of about 5 per cent.
He agrees with the central banks’ conclusion that the current record-setting inflation “will take care of itself” and moderate although it will likely be higher than it has been in past years. He expects inflation to fall to 4 or 3 per cent next year from the current rate of about 6 per cent.
“The emphasis and eyeballs should be more placed on growth and the labour market because that is still the missing component for them to raise rates,” Mr. Boehmer says.
He advises investors to be looking for the next big story, which he pegs as economic growth that appears to have lagged the rising of inflation and higher market valuations.
“The next story should be on growth and how that probably should pick up a little bit over the next three months,” he says.
A more negative view of inflation is held by Fidelity Investments portfolio manager Geoff Stein, who believes the market “continues to misprice the risk of inflation and that the inflationary pressures displayed in recent months will be more persistent than anticipated.”
Mr. Stein, based in Boston, is one of a trio who manage the Fidelity Global Income Portfolio Series F fund, another 2021 Lipper Award winner. The assets have been adjusted in the past few months to reduce their equity holdings in the belief that stocks are expensive and markets could be roiled by higher interest rates.
The fund has lower-than-benchmark exposure to Canada citing high household debt levels and higher asset allocations to inflation-sensitive commodities such as gold and energy.
The fund is up about 9 per cent over the past year and has a three-year annualized return of nearly 8 per cent and a 10-year annualized return of just over 7 per cent, according to Fidelity.
In the end, Fidelity is betting on inflation and higher rates.
“The key question is whether inflation is transitory or structural,” Mr. Stein says. “There are certainly transitory factors are play, given base-level effects, however, from a more structural view, shelter and wages are increasing, which are large components in the inflation measure.”