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Helen Hayes Hi, I'm Helen Hayes, Head of iShares Canada, and I'm here today with Rachel Siu, Head of Canadian Fixed Income Strategy at BlackRock, to discuss the evolving world of fixed income, new opportunities in this space and what might be coming next. Hi Rachel, thank you so much for joining us today.
Thank you for having me, Helen, it's great to be here.
Rachel, let's start out with the Bank of Canada and the Federal Reserve rate cut expectations. I think they've really changed in recent months. In Canada, we're expecting rate cuts this summer, but in the US, we've been very data dependent. And we've been, I think through really thinking through are we going to be higher for longer? We saw April US CPI numbers and that narrative has now changed again. We saw the first miss in the last six reports, which again I think has the market speculating that we could see rate cuts in the US in 2024. Rachel, has anything changed from your perspective regarding monetary policy?
As you said, Helen, I think the outlook is very much data dependent. But having said that, the bigger picture hasn't really evolved in our mind. We do think that the conditions are set for developed market central banks to start cutting policy rates in the second half of 2024. In Canada, as you alluded to, the story has been more clear in that the path towards a 2% target has been more steady. But we've been seeing inflation print showing that deceleration trend in pricing pressures, which is what the bank is really looking for. Economic indicators, whether it's GDP growth, whether it's employment numbers, also show the moderation in the economy more broadly. The picture in the US has been more mixed, right. They are less rate sensitive as an economy relative to Canada, and as a result, the progress towards inflation coming down has been slower, more gradual and more uneven. Having said that, we do think we are trending towards the direction maybe more unevenly than initially expected, but we do think the fed can start cutting rates in the second half of this year. But overall, I think it's important to keep in mind that the pace will be gradual in terms of rate cuts across developed markets.
In our recently published Global Insight piece, No Time to Yield, one of the key takeaways has been that yields are higher today than they were 20 years ago. If inflation indicators, Rachel, continue to fall in, and central banks start cutting policy rates as you've outlined, this time of elevated cash rates might be drawing to a close. What does this mean and how can financial advisors really help their clients navigate this environment?
First, I think it's important to acknowledge that investing in cash or staying in cash is an active decision. And as you indicate, cash yields are poised to come down right as central bank start cutting policy rates, and we do think that investors should start reconsidering that active decision and instead redeploy capital back into fixed income. In fact, when you look at historical performance in the periods during rate pauses, which is the period that we're in now, and during the rate cut cycle, bonds tend to outperform cash. And when you look at historical performance in particular, yields tend to move ahead of policy decisions. So if you wait for the first rate cut, there is a possibility that yields might have already moved ahead of that. And so we do think this is the time for investors to reconsider their portfolio allocation, to lock in these higher yield levels available in fixed income today and also participate from a price return standpoint when yields do start moving lower.
Rachel, the world of fixed income investing has seen a lot of change in the past couple of years. Late last year, Government of Canada two year bond yields reached their highest level since the global financial crisis. What are you seeing as the most compelling opportunities in fixed income today?
Really has been a very remarkable regime change in terms of the amount of income or yield that you're able to get from global bond sectors, even compared to just a few years ago. And we do think that this is a compelling time for investors to allocate to high quality bond parts of the market without needing to extend too much risk. So right now, we do think that in a position for building one portfolios, you can stay in high quality, stay in core parts of fixed income, like XBB, the iShares Core Universe Bond Index ETF, which allows you to get broad exposure to the Canadian investment grade bond market, accomplish very compelling levels of yield, and start allocating a little bit more to duration as we are poised to see interest rates come down from here.
Rachel, despite the highest yields that we've seen in the past 20 years, many investor portfolios are still underweight fixed income. Is that now starting to shift, and should investors be thinking about that as cash yields are set to drop, investors, I think, need to start revisiting their asset mix to cover the under allocation to bond. How do you think investors should be considering the role of fixed income against their investment objectives?
Yeah, cash did a nice job, I would say, in protecting to the downside during a year like 2022 when we saw drawdowns across multiple asset classes. But in this environment, as you indicated, we do think that investors should rethink the role of fixed income and go back to the fundamentals of what the objective of having bonds is in your overall portfolio mix. Number one, we do think equity diversification is a key role that bonds can play, right? Having duration through something like XBB, our Core Universe Bond Index ETF allows you to protect when equities sell off, or where there is a risk off market move. The RBC Target Maturity Bond ETFs also allow investors to pick their spots on the curve and allocated duration where they want in a more precise manner. The second objective for fixed income, we think, is capital preservation. So, providing you with stability through a different market environment and we think that shorter duration exposures like XSB, our short term bond index ETF, does allow investors to to meet that objective. And then lastly, income, right, fixed income can deliver income again at these compelling yield levels that we're seeing in particular in investment grade corporate bonds like XEB, providing you high quality exposure to Canadian issuers, while delivering attractive income levels.
How can investors use bond ETFs to step out of cash, Rachel, and get back into fixed income? And how do you think about the role of index and active bond ETFs in a portfolio construction context?
We do see that increasingly bond ETFs are becoming an important part of the portfolio construction toolkit for all types of investors, whether it's institutional to wealth. And we do think there is a role for both index and active bond ETFs to play different roles. Index ETFs can play that core building block as your portfolio, given they're low cost, efficient and provide ease of access for investors who are looking to build out exposures across bond sectors. And we do think that active ETFs can pair very nicely alongside those core building blocks, especially when it comes to being more tactical in specific parts of the market, whether it's from a credit standpoint or from a rate standpoint, and also providing access to those typically harder to access parts of the bond market.
Rachel, where are we seeing investor demand in terms of fixed income ETF flows this year, and what are key industry trends that you're focusing on?
We have been seeing a clear shift, I would say, of flows where in 2023, they were very much focused on short duration or cash alternative types of exposures into fourth quarter and building the momentum in this year into more fixed income core allocations, aggregate bond type of ETFs. And we do think this shift demonstrates, I think, the demand for investors to allocate out of cash and move back into fixed income and adding back to duration. Across the RBC iShares complex, we've seen very sizable flows into XBB as well as XLB, which is our long term bond index ETF, I think, reflecting the investor interest in extending duration, right, taking advantage of the opportunity set that we see today, we've seen about 2 billion across those two products in the last year or so. And the RBC Target Maturity Bond ETFs as well have really seen a lot of continued demand from investors who are looking to add duration and also be more precise in terms of lining up their cash flow needs with these bond maturity ETFs that very much feel like an individual bond. And so we do think there is that clear trend moving back into fixed income, adding into core allocations and extending duration as well.
Rachel, there's been a lot of innovation in the fixed income space. How are bond ETFs resonating with investors and what do they offer versus traditional bonds.
Bond ETFs really have transformed investing in fixed income through the different benefits that they offer to investors, whether it's low cost, efficiency, diversification, strong performance, as well as importantly, liquidity for fixed income, really has allowed different types of investors to incorporate bond ETFs as a critical part of how they build fixed income portfolios.
Yeah. It's amazing. I mean, people used to have to go to an institutional bond desk to get access. Now it's really changed.
Exactly. The ease of access, I think, really has been a game changer in terms of on ETF adoption across investors.
And people can get any kind of exposure they want using bond ETFs.
That's right. I think it really allows them to be more precise when it comes to selecting sectors credit as well as duration as well.
Rachel, thank you so much for joining us today and for shining a light on the recent evolution of fixed income investing. As always, it's a real pleasure to speak with you.
Thank you so much for having me, Helen.
To learn more, please visit RBC iShares.com.