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Terms and conditions for Canada

by  Dagmara Fijalkowski Jul 8, 2019

In this video, Dagmara Fijalkowski, Head of Global Fixed Income and Currencies at RBC Global Asset Management, discusses the continuing relevance of fixed-income in today’s low-rate environment. She also explains how active management and global diversification can add value in fixed income portfolios.

View transcript

How is monetary policy shaping the fixed income environment right now?

We are at an interesting point in the monetary policy cycle. Between December 2015 when the Fed delivered its first interest rate hike and December last year, monetary policy had been fairly straight forward. The Fed was increasing the Fed Funds rate, and also shrinking its balance sheet. Over the course of three plus years, or three years, interest rates were increased by 225 basis points, so, quite significantly. However, by the turn of the year, the communication from the Fed started shifting, they indicated more flexibility and patience, they were looking at weakening economic data and adjusting to it.

That was interpreted by the market as indicating that the next move from the Fed will be cuts. And here is a big discrepancy between what the Fed is telling us, future hikes… although they seem to be slowly backing out of those, but they’re still suggesting future hikes. And the market, which is pricing increasingly more and more interest rates cuts. We have been siding more with the market, but there is plenty of uncertainty. What we feel quite comfortable with is that when the yield curve flattens, what it often indicates is that the monetary policy tightening cycle is behind us, that the Fed has delivered the last hike. And from that perspective, it’s natural to look after a shorter or longer pause, towards interest rate cuts. That’s not a negative environment for fixed income.


As yields remain near 40-year lows, is fixed income still relevant for investors?

I hear that concern from investors and question quite often. Interest rates have been on a steady decline for the past 40 years, and often investors expect that since they are now near these 40-year lows when they imagine a future scenario they think about a mirror image. We assign a quite low probability to such development. We think that since rates bottomed in 2012. 10-year yields in U.S. have actually been trading in the 1.5% to 3% range 95% of the time. So that’s quite a well contained range at the bottom.

It’s good to remember that there are historic reasons why interest rates have come to these lower levels and they may stay at lower levels for extended periods of time. Two of these reasons, to give you an example, would be that central banks have been pursuing that inflation targeting policy and have actually tamed inflations quite well. And the second reason would be demographics, especially in developed market countries, aging population mean also that growth and inflation potential is lower. But that’s historic perspective. But when we think about interest rates we also think about the geographic perspective.

So, when we look at Barclays Global Aggregate Bond universe, 20% of bonds in that universe trade with negative yields mostly Japanese and European bonds. But when you are a North American investor, and you invest into these securities on a currency-hedged basis, your yield actually is higher than Canadian or U.S. yield in many cases. And that’s going to be the case as long as short-term rates in Canada and in U.S. stay higher than Japanese or European rates. We expect that to continue for a while.

There’s also another example that combines these historic and geographic perspectives, and that’s an example of Japan, where 10-year yields have been below 2% for 20 years, and only once during these 20 years Japanese investors in bonds had negative total return during that year. So, while questions about the role of fixed income in portfolios, and the future path of interest rates keep popping up, we believe that as long as inflation remains under control, fixed income is going to play an important role in investors’ portfolios.


Is there an opportunity to generate alpha through active management of fixed income?

Interestingly, I think actually there is more opportunity to generate alpha in fixed income now than at any time during the past 20 years. Even if you look at just the decade since the financial crisis, the fixed income market has increased both in breadth and depth. If you look at the outstanding stock of global government and corporate bonds, it increased by 60 trillion dollars. That’s three times the size of the U.S. economy. That’s a lot of choice. In addition to that, the number of issuers in the global fixed income markets doubled over the decade to over 22,000 issuers. More currencies are floating and freely tradable and cost of trading, both in fixed income and in currencies has declined. So we have the right amount of resources, with a deep analytic team, we believe that active investors can make important decisions that are going to contribute to value-added and alpha in fixed income portfolios.

Disclosure
This report has been provided by RBC Global Asset Management (RBC GAM) for informational purposes only and may not be reproduced, distributed or published without the written consent of RBC Global Asset Management Inc. (RBC GAM Inc.). In Canada, this report is provided by RBC GAM Inc. (including Phillips, Hager & North Investment Management). In the United States, this report is provided by RBC Global Asset Management (U.S.) Inc., a federally registered investment adviser. In Europe, this report is provided by RBC Global Asset Management (UK) Limited, which is authorised and regulated by the UK Financial Conduct Authority. In Asia, this document is provided by RBC Global Asset Management (Asia) Limited, which is registered with the Securities and Futures Commission (SFC) in Hong Kong.

RBC GAM is the asset management division of Royal Bank of Canada (RBC) which includes RBC GAM Inc., RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, RBC Global Asset Management (Asia) Limited, and BlueBay Asset Management LLP, which are separate, but affiliated subsidiaries of RBC.

This report has not been reviewed by, and is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the above-listed entities in their respective jurisdictions. Additional information about RBC GAM may be found at www.rbcgam.com.

This report is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. The investment process as described in this report may change over time. The characteristics set forth in this report are intended as a general illustration of some of the criteria considered in selecting securities for client portfolios. Not all investments in a client portfolio will meet such criteria. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information.

Any investment and economic outlook information contained in this report has been compiled by RBC GAM from various sources. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by RBC GAM, its affiliates or any other person as to its accuracy, completeness or correctness. RBC GAM and its affiliates assume no responsibility for any errors or omissions.

All opinions and estimates contained in this report constitute RBC GAM’s judgment as of the indicated date of the information, are subject to change without notice and are provided in good faith but without legal responsibility. Interest rates and market conditions are subject to change.

Return estimates are for illustrative purposes only and are not a prediction of returns. Actual returns may be higher or lower than those shown and may vary substantially over shorter time periods. It is not possible to invest directly in an unmanaged index.

A note on forward-looking statements This report may contain forward-looking statements about future performance, strategies or prospects, and possible future action. The words “may,” “could,” “should,” “would,” “suspect,” “outlook,” “believe,” “plan,” “anticipate,” “estimate,” “expect,” “intend,” “forecast,” “objective” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance. Forward-looking statements involve inherent risks and uncertainties about general economic factors, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement made. These factors include, but are not limited to, general economic, political and market factors in Canada, the United States and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological changes, changes in laws and regulations, judicial or regulatory judgments, legal proceedings and catastrophic events. The above list of important factors that may affect future results is not exhaustive. Before making any investment decisions, we encourage you to consider these and other factors carefully. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility.
Recorded on: June 4, 2019