Hello and welcome to The Download. I'm your host, Dave Richardson, and it is always a happy day when our guest is Sarah Riopelle, who manages Portfolio Solutions at RBC Global Asset Management, among many other things. You're heading to Hong Kong, you were saying?

Yeah, I fly tomorrow and I'm going to spend next week in Hong Kong and the week after in Tokyo just visiting our investment teams there.

Will you do a turkey in Hong Kong?

No, Peking duck maybe? Is that the equivalent?

Well, I like the goose there. So you're more of a white meat turkey fan?

Maybe, yes. I actually don't eat a lot of turkey. I eat a lot of mashed potatoes and gravy.

Okay, well, that's good. Everyone's got their thing, but Thanksgiving dinner is always special, and we look forward to it. Just like we look forward to your appearances here. There's so much happening in every area of the market, and you have to look and be aware of everything that's going on. We usually have a little cadence we follow here with your appearances. We start with the economy and then flow through the different assets and then take a look at what you're doing in the portfolio. So, when you're looking economically, what are you seeing as this war drags on and Fed hikes rates and you've got lots of infrastructure going on in Canada and all kinds of things? What are you thinking about? What's most important?

Yeah, all that. The economy has delivered really solid growth this year despite the headwinds that you talked about. So despite the war in Iran, rising interest rates questions about the AI boom— that's one that you didn't mention— US tariffs and elevated inflation. And so growth has been supported by fiscal stimulus as well as the spending on AI and the associated productivity gains that we're getting out of that. So if you just look at US AI CapEx, it's contributing 0.5% to 75 basis points to US GDP on its own. So it's really helped to support growth. Looking forward, what are we looking at? Well, economic environment is probably going to remain reasonably supportive should all of these trends continue. We expect stronger productivity growth from AI going forward as it's more widely adopted by businesses and consumers alike. The consumer makes up the bulk of economic demand. And the good news is, at least for now, that spending growth is holding up well despite high energy prices and rising borrowing costs and high inflation elsewhere. You mentioned Canada. Some recent positive economic developments in Canada worth noting. Foreign direct investment rose to its highest level in a decade last year. We had the Canada Investment Summit recently. A lot of institutional investors announced sizable investment pledges as part of that summit. And Canadian banks talked about lending commitments to support that as well. And then the recent corporate tax cuts to incentivize new business development are all positive for the Canadian economy. Risks to the outlook are always there, something we always have to be aware of. Prolonged war in Iran, sustained rise in government bond yields— which we'll probably talk about in a minute when you ask me about bonds— doubts around the durability of the AI investment cycle. A lot has happened. We have to think about where we go from here. But bringing all that together, our base case is that major economies around the world will avoid recession and continue to grow over the next year.

Yeah, I didn't mention AI because it's actually SI now. It's superintelligence. You might not have heard about the renaming. Hard to keep track of all this renaming that's going on, right?

There's a joke in my house. The AI tool that I use on my personal phone, we've named him Kevin. And so anytime anything comes up around my house, I'll say, oh, you know what, I'm just going to ask Kevin. And the joke is that he's actually more useful than my actual husband. But don't tell my husband that.

He's a good golfer?

Kevin is not.

I'm actually stealing the AI term for this podcast. Because this podcast is about affable intelligence. You're a great example of that.

I was going to say, you're very affable.

I like to be affable, but I'm chubby. Chubby people are generally fairly affable. Isn't that what they say? Jolly, more than affable? But you know what's not jolly?

Bond yields.

Bond yields. No one likes that or the way they're rising. Or do we? What are your thoughts?

Well, it depends if you want to look at it as a risk or an opportunity. And so, yeah, we've seen government bond yields rise to their highest level in decades. A few key factors that are driving that increase. Central banks have begun that tightening cycle in that effort to compete against inflation pressures stemming mostly from the war in Iran with respect to energy prices. Investors are concerned with elevated fiscal deficits. Corporate bond issuances surged as the AI hyperscalers are tapping into debt markets to raise capital. And then the Fed raised its policy rate by 25 basis points in mid-September. So that's contributed as well. That's their first rate hike in 3 years. We think it's more likely the start of a modest mid-cycle adjustment rather than a large tightening cycle. The market is looking at 3 more hikes from here. Our base case is actually we only think we're going to see one more hike from here. We’ll have to see whether or not the market comes towards our view or not. The most pronounced adjustments in fixed income markets have occurred at the long end of the yield curve versus the short end. And we believe this has set up a pretty appealing opportunity for fixed-income investors. That goes back to what I mentioned a moment ago. It depends if you see this as a risk or an opportunity. We actually are buying bonds at these levels. We've been underweight fixed income for quite some time and we've now moved that to a neutral position over the last couple of weeks in that we've been buying bonds. Our model suggests that sovereign bonds have improved return potential with diminished valuation risk at these levels, particularly if inflation moderates as we anticipate. The war in Iran should be resolved at some point, hopefully over the next year, reducing the upward pressure on energy prices. And so I believe that any significant increase in yields from here is likely not to be sustained. It seems like a good buying opportunity here. Like I said, as a result of that, we moved 50 basis points out of cash and into fixed income, neutralizing our bond exposure within the asset mix.

As we've talked with some other guests, it’s incredibly important to highlight for investors— and you're an example of an investor who's buying bonds. We tend to roll everything around the 10-year US Treasury. It's the most important bond and you'll see that number quoted everywhere. I can buy a 10-year US Treasury yield at 5.25%. And that's a nice yield, especially with elevated valuations in equity markets and strong performance for a number of years. And if I'm looking for income, it pays me a nice income. And if yields go down from here, then I get the price return along with a nice coupon. And then if yields go up, well, it's different when yields go from 1% to 2% versus 5 to 6%, it's not as big an impact and I'm being paid to hold. So it's kind of a nice scenario, which not surprisingly, you're ahead of a lot of the market on this.

Yeah, we talk about diversification all the time. They also provide a good buffer in the event that the equity markets do sell off in the future. So you have to add that to the mix of the discussion as well as to whether or not it's a good place to buy bonds in here too.

Yeah. And so that's what you're doing in bonds stocks. What are your thoughts on equity markets? And I imagine which markets we're talking about.

True. So we've had a pretty remarkable run. Let's focus on year to date. It's been mid-teens gains across global indices. And since I was on the podcast a couple of months ago, equities have actually seen some volatility from macro factors that we were talking about earlier, the escalation in the war in Iran, higher oil prices, heightened inflation expectations, Fed's new rate hiking cycle. But the selloffs have been fairly contained, and the markets continue to be supported by the robust earnings outlook surrounding mostly AI-related investments. So there is one recent pattern worth highlighting, which is some volatility between the surface. So the broader index level is holding up, but we're seeing some movement within the cycle in some of the names beneath the surface with some divergence in how sectors are performing as investors are trying to tease out who is going to be the AI winners and the AI losers. So something to keep watching. Looking at broader market trends, though, leadership has flipped back to mega-cap technology stocks away from smaller and value-oriented companies that were leading over the summer. And that's probably because of that climb in interest rates is weighing broadly on some of those businesses. Across the regions, strength is showing up in the US, Japan, and emerging markets. Seeing some wavering in Canadian equity markets over the past couple of months, but perhaps that'll change with some of the discussions we just had around the Canadian economic tailwinds that are coming. European equities have actually especially underperformed so far this year, given that region's proximity to the war in the Middle East, as well as the lack of exposure to the AI theme that we're seeing in some of the other areas of the market. With stocks at record highs, valuations are at elevated levels. So returns from here are really going to depend on the durability of corporate profit strength and investors' continued willingness to pay a premium for that expected growth. So valuations and earnings, as always, are key, but both of those pieces really have to be aligned to generate strong returns from here. That said, the outlook for profits, we think, is compelling. Analysts are looking for a sizable 34% EPS increase in this year with another 15% next year. So that looks to be pretty supportive. And because of all that background, we're still keeping a small overweight in equities in the asset mix, keeping an eye closely on valuations. One of my colleagues likes to use the analogy that we stay at the party but stand by the door. And so that's what we're doing with our equity weight at the moment. And elevated bond yields are offering an attractive alternative for sure. The low recession risks keep us tilted towards equities in the asset mix, at least for now. And then regionally, we still favor North America and Asia in our asset mix, underweight Europe, and neutral in emerging markets.

That's an important factor. The big picture asset mix where you're a touch overweight in equities and you've been adding bonds, but there's lots going on beneath the surface. There are areas that you want to be overweight. And because of the war and at the advent of the war, the world shifted. And again, if I'm looking at Europe— so I'm underexposed to AI and I've got no oil— that's a bad place to be while the war's going on. That could shift very quickly, but where you're positioned right now, and you're always active in the underlying different asset classes where different types of bonds, different duration of bonds, different types of equities— maybe some equities that are a little less risky because, as you say, you want to still be there but close to the door— you're making a lot of moves underneath the surface as well, right?

Yeah, exactly. And those don't all necessarily show up when you're looking at the top-level performance of the fund. There's all that stuff that's going on under the surface to drive those returns within the funds. A lot of active decisions happening on a day-to-day basis to make sure that we're always positioned to take advantage of opportunities in the market.

I've asked most of the other guests— I don't think I've had a chance to ask you this, and I know you have an opinion— about the shift we're seeing in Canada towards a more business-friendly environment. You mentioned the foreign direct investment, which has accelerated lots of money being spent on big projects to unlock some of Canada's potential. Again, we don't get into politics here. We just think of the policies and how the policy flows through into better economic performance, and that better economic performance in theory should lead to higher profitability down the road. Are you optimistic about these policies and how it'll play out in the Canadian economy and Canadian markets?

Yeah, absolutely. I think that Prime Minister Carney is doing all the right things that he needs to to support the Canadian economy in the face of some risk with respect to tariffs and their negotiations with the US. And I think as Canadians, we're very proud of the stance that he's taken against the US government. Again, we're not going into politics here, but we need to stand up in the face of that risk, and he's coming up with strategies that will help to support the Canadian economy in the face of that. I'm pretty proud with the direction that we're going.

That would be the thing. You get a trade, you get a resolution around the USMCA, calm down some of the tariff stuff, and you get a resolution in the war in Iran. And the winners and losers in equity markets could change very quickly, would they not?

Yeah, absolutely. I think Canada could benefit quite significantly from that shift in sentiment too.

Overall, Sarah, you've made a couple of little tweaks around adding some fixed income, take advantage of these higher yields. It doesn't even need to really be a call that we've peaked in yields. It'd be nice if it did, but it doesn't need to be there. But anything else you see on the horizon that you're going to be taking a look at and maybe again, some big picture or smaller picture changes in the portfolios?

So yeah, so there's lots going on in the portfolios. One other thing I wanted to talk about for a minute today was the alternatives positions within the portfolios. With this rise in bond yields and some of the pressure on some of the bond positions in the portfolios from a return perspective, I was wondering how our alts positions were performing. And they're actually doing very well, generating positive returns during this period, and that's exactly what we want them to do. The reason we add alternatives to the portfolios is for those diversification benefits, because they're negatively correlated to the traditional asset classes. So we own illiquid assets in real estate and infrastructure, and then we also have liquid alternatives with the BlueBay Alternative Return Bond Fund. And we have a new allocation which we just added since the last time we talked, and that's the Qube Market Neutral World Fund, which we added through July and August. And we actually funded that from fixed income. And so it's generated a pretty strong return relative to where we funded it from. And so, this area of the portfolio has been a key contributor to returns, offsetting some of that pressure during this rising bond yield environment. And we're going to continue to build our alternatives in the portfolio. There's a number of other strategies that we're looking at at the moment for potential inclusion in the portfolio. I expect to have more to say on that topic in the next few quarters.

And to educate new listeners, when you say alternatives, what does that encompass? We got stocks, bonds, and where would this fit in terms of types of assets?

The traditional asset classes are cash, stocks, bonds. And alternatives would be a 4th asset class that we blend in there. As I mentioned, alternatives are divided into liquid and illiquid. There's a lot of different things that you can put into those buckets. Absolute return type strategies, they can be risk modifying, they can be return enhancing. On the illiquid side, it's real estate, private equity, private debt, mortgages, infrastructure, a lot of those real assets, that type of things that you can invest in. For us, we have a real estate fund which invests in buildings and shopping centers. We have an infrastructure fund that invests in power developments and shipyards. And so it's putting some of those types of strategies within the portfolios to just, as I mentioned earlier, enhance those diversification benefits.

Excellent. We're always looking for broader diversification. What a lot of people forget, and in the markets that we've had over the last several years where investors have been rewarded really as much as anything for taking on as much risk as they possibly can. You can ignore risk and you've been rewarded for it, but that is not normal. In my investor roadshow this year, I'm calling the presentation The Risks You Don't Know You Have. But a portfolio manager like yourself and the real value you bring is that risk management is at the forefront of what you do. And sometimes that makes what you do seem boring through a period like this, but through a whole cycle, you appreciate the value of risk management and awareness of risk and return and how they work together. Am I off base or is that something that you feel quite a bit given what you do, the kind of boring portfolios that you manage relative to some of the high-flying, exciting stuff out there?

Well, you say boring. I think they've generated pretty good returns over the last several years.

I say that facetiously. They're not boring. They're about as exciting as you can get with the levers and things that you're involved in. It's just that some people go, that's just boring.

A boring balanced portfolio.

And they're wrong.

For us, it's not just about return. It's about how you get there and the journey. So we're trying to generate risk-adjusted returns and steady and consistent returns. Because I think our clients would feel much more comfortable with their investments if they can have a steady upward sloping straight line, as opposed to a really volatile line that goes up and down and up and down. That gives them anxiety and makes them think, when we're on one of the down parts, are we going to go back up? So they get really nervous about that. But if you can just show them steady and consistent returns over the long term, that's going to keep them comfortable and keep them invested. And so that's what we're focused on delivering for our clients.

Obviously you need to get good returns in your portfolio, but an element of getting those good returns is being invested in the first place. That's where the experience matters because if the experience forces you to panic and sell or move away from the asset mix which you need to deliver the results that you want, then you're not invested and then you run the risk of falling short. So, you need the returns but there's a behavioral element to achieving your financial goals. And consistent good performance and the experience you have is a big part of that.

Absolutely. Clients need to be willing to give up some of the upside in order to manage the downside. You shouldn't always be chasing the best returns in the market because when the market does correct— as we all know, markets go in cycles, they're not going to go up all the time and when they do correct, it's going to swing you back the other way pretty significantly and it's going to hurt when it happens— so I would much rather take a bit less of the upside in order to manage my downside so that I can deliver those more consistent results for clients.

That's a philosophy that works. Unfortunately, some people look at it and go, well, that's boring. I'd like to have a little bit more excitement. Well, that's what you're seeing when the markets are going up. When the markets are going down, it's not as exciting anymore. It's pretty painful.

We could talk about those bucketing approaches. If you want an exciting part of your portfolio, then take 5 or 10% of it and go do some exciting stuff with it. But I think the core of it should be in a multi-asset diversified global portfolio so that you can withstand those market downturns.

And you start to think of the range of investments that you've got in your portfolios. I mean, it's crazy. No individual could sit there and put together portfolios that look like yours.

Think about the alternatives positions we just talked about. The infrastructure fund and the real estate fund. Individual investors would have a hard time accessing those types of strategies on their own. The benefits of these portfolios is that we give you access to that. And then we also manage those exposures on your behalf. Our biggest balanced fund has, I think, 39 underlying holdings, all in different asset classes, regions, bond strategies, alternative strategies, you name it. And we actively manage every single one of those positions every single day. It's amazing the breadth of exposures that you get within one of these types of portfolios.

We had Jennifer Shillaci on recently and talked about how you want to go buy a shopping mall. Well, most people don't have that kind of cash lying around. And then, you buy the shopping mall and you've got to rent out the stores. You got to keep the tenants in and you got to clean it and do all the things. Pave the parking lot. So it's not necessarily an easy or fun thing. Bottom line, most people don't have the assets to do it, but they can contribute into your fund and get that access as the assets or cash are pulled together. And that's a huge advantage because you want to have that diversification in your portfolio and you just can't do it on your own.

Yep, exactly.

So, Sarah, thanks again. Always love your visits because you pull it all together in your actual job and when you come on the podcast as well. Have a safe and enjoyable and productive trip to Asia, Hong Kong and Tokyo. I'm very jealous. But I'll be thinking about you as I stuff down my turkey and stuffing, as I stuff myself, literally, over the weekend.

Well, I hope you enjoy it and Happy Thanksgiving.

Same to you, Sarah. Take care.