Hello and welcome to The Download. I'm your host, Dave Richardson, and it is an exciting day. We're going to talk to our good friend in London, Soo Boo Cheah. What's the best way to describe you, Soo Boo? You're a kind of a bond guru, a fixed-income guru. Would that be the best way to describe you?

No, Dave, you're giving me way too much credit. I'm a student of the bond market, except I've been around for a quarter of a century doing bonds.

Doesn't that all add up? If I look up the guru definition in the dictionary, doing something for a long time with a certain degree of expertise and knowledge, that would be a guru, wouldn't it?

I'll take it, but there's also a definition of insanity, right? Doing the same thing over and over again and expecting a different outcome.

Why don't we say a senior portfolio manager of fixed income who is extremely humble about his background and expertise. I've worked with Soo Boo for those 25 years, for that quarter of a century, and Soo Boo has an immense knowledge of fixed income markets, and I've learned so much from him over the years. And I know our listeners, mostly in Canada, would benefit from hearing what Soo Boo has to say about the bond market. I'm sure you'll sprinkle in some bond market history. I know as a young investor, growing up, I've invested in a lot of stocks, and I've tracked the stock market probably to a moderate extent, and sometimes heavily, for over fifteen years. When you're younger, bonds don't seem that exciting. Now that I'm older, bonds seem extremely exciting. And I think Soo Boo is going to say they're a little more exciting than they've been in a while where we're right now. But I always find Soo Boo can fill me in on just a historical perspective of the markets that we're in, the economic circumstance we're in, how different parts of the bond market respond to those things. So Soo Boo, after an incredibly long introduction, it's great to have you with us.

Well, I think this podcast is over. You pretty much covered everything, Dave. What else are we going to talk about?

Well, why don't we get into it? Let's talk about what's driving the bond market today. What are the things that you're looking at and what do you think is really moving the market? What should investors be thinking about in terms of what's moving the market?

Well, before that, I'll just say that it has been a great pleasure knowing you all these years, and we're still continuing learning together. And let's see that we can get better as we progress, right? To answer your question specifically about what's been driving the bond market, in the top of the mind for investment, particularly the bond investor, it has been inflation. It has been a key driver. And any press, anything that you read is all about it. It all started from the inflation, and then it started coming down from there onwards. So a bit of a history, we saw the elevator up in inflation in 2021 and 2022. Now we're on the escalator down phase, and this escalator down takes time to shakeout. So for those who are looking for inflation to return to normal rapidly, it seems to be disappointing. On and off, whether it’s the auto insurance, whether it’s health, whether it’s the service inflation, or occasionally energy shocks. This is like slowing downtrend in inflation, actually. But recently, we got a good news. Last week, the CPI release. For the first time ever for a while now, we have the negative month-over-month print. Then this negative print is coming from all fronts. It's coming from core goods; it's coming from core service inflations. It's also coming down from energy. All dragging down the headline. Which means it gives greater confidence that perhaps this shakeout phase could pick up pace. This is why we’ve seen bond yield dropped in the market, rapidly. What investors are waiting for is next week, the PCE measure, which is on the actual spending, the inflation measure on a fixed basket, and that's the Fed preferred measure next week. This is what the investors are waiting for. But as I started by saying that the shakeout phase in investment in looking for the inflation to fall. But it's never a smooth line. One number doesn't mean it's a trend. So this is what I think that investors are waiting for. That's why we're not seeing the bond rally around that 4.2% in the US 10-year yield in terms of a Fed expectation. It probably introduced half a more easing that is pricing for the end of this year. Before the CPI, we're looking for two cuts in the Fed. Now we're looking for two and a half cuts from the Fed by this year end.

We've talked a lot about this with Eric Lascelles. We had him on a couple of weeks ago, and we were looking at the data, I guess at that point, which was really reflecting what had happened in May. Now we're waiting for the data in June. We got the CPI last week, which was a good number. First time, as you say, month over month negative. But we now have the PCE, that big number that the Fed looks at, and then we have to see how things shakeout. I think one of the other things that Eric mentioned to me, I was going back and forth with him over email, that after the CPI report out of the US, the odds for a cut by the Bank of Canada in July went up as well. So maybe they're going to sit and wait a little bit longer to see what the Federal Reserve does in the US. But at least for the last three months or so, the news has been getting better and better. So you pull all this together, the drivers, how does that set your expectation for the bond market, Soo Boo?

Can I touch on a bit on what you just talked about, the macro? Because yes, one number is not necessarily making it a trend, but as a long-term investor, we start thinking about it. The falling trend as I mention this shakeout phase. As a long-term investor, you know that the falling trend is largely expected. We just need to see it sustain. That's one thing, the inflation side. But if you start looking from the economic side, the US economy is doing fine still. That is the other thing. Which means that you're looking for a cut from the Fed. It's not a done deal. It may be a cut pricing, but it's not like a sequential large cut or anything and we should keep that in mind. You touched on Canada, which is brilliant because the US may be in a situation that's different from other economies that are sensitive to a short-term risk. Canada and Europe are highly sensitive to the spike in the interest rate because it fits quicker into the economy. They have been seeing slower growth, and those economies might be vulnerable. And then this is what we see, the cuts from the Bank of Canada and the ECB, and the fact that it’s on hold. But the one thing we need to think about, the way I describe that, yes, this may seem like a start of an easing cycle, but bear in mind that this easing cycle is more like the central bank wants to reduce the rates from this restrictive level. It's almost like an easing on the inflation break, but by no means, they're hitting the growth accelerator. So that is more on the macro. So if I come back and answer your question, like an expectation for bonds. The first thing we need to recognize, if you want a big rally in bonds, you need the central bank to commit to many cuts, which is not what we have right now. Or you will need a financial shock, which is not what we're seeing at the moment. There are signs of that, but it's not there. For us, our operating assumption has been the easing cycle is here, which means that it caps how high the yield could go. But by no means it's telling us at the end, it's going to fall rapidly. So that's the first thing that I want to highlight. And then when you look through bond yield across the developed world. Let's use some long-term fair value because we're long-term investors. We look at Canada, Europe, Japan. They're all in the long-term fair value range. US is the only one that seems to be slightly on the high yield on the fair value side. So that's the great news for bond investors, because on the higher yield, it means that you have a better yield, it means that you have the better return going forward, which is the key pillar of why you own bonds. Are you yields? Are you income? Our best-case expectation is for a coupon-type of return with potentials of modest gain, if you come down from here a little bit. As I said, you rarely stay at the fair value for long. Which is bringing the next pillar: price gain. When you have yield drops in the bond space, you have price appreciation. And then you will see even a bigger gain in this high-quality bond in a recession scenario or the financial shock scenario, which is the third pillar: diversification benefit or the portfolio insurance features in a balanced portfolio. So on all three counts of why we own bond, income is there, the price gain potential is there, and then the diversification feature is there. So what I'm saying here is that bond has value. A bond portfolio has value right now, the high-quality bond portfolio. We could even look at it from a different angle. It's a bond investor peace of mind. When you buy bond insurance, when the bond yields are high, that lowers your insurance premium because investors receive the income if there is no financial accident, but they receive a big payoff if you have a financial market shock or a turmoil. In the meantime, it allows investors to sit in a liquid bond to buy attractive price asset. All in, bond has value at this stage.

You did a tremendous review that I've been sharing when I've been doing speeches with investors that shows how the risk return and how the odds tilt in your favor once you get a US 10-year treasury yield above 3.5%. And when you look at the period going forward, your chance of above-average returns goes up and your chance for really poor negative turns goes down dramatically. In fact, it almost disappears. And that's essentially what you're talking about here. When we get to this point in the cycle, with the Fed now talking about lowering — they haven't lowered and we don't know how much they're going to lower — but as you said, that cap on rates or how high rates could go is capped at this point. That's what creates this advantage in terms of giving you more upside than downside risk and makes it attractive, along with all those other reasons that you invest in bonds.

Yet at this time, you could sit there and wait, and you have income on your side because yield is high.

And income is good. That gives us the government world. But as you said, as we go into different types of bonds — if we go into corporate bonds or even high yield bonds or bonds that are outside of the developed world — is that an attractive market in this environment, or do we want to stay a little safer still right now than adding risk? And are we being rewarded for any additional risk we're taking?

Yes. What I'm saying up to this point is related more to the high-quality bond portfolios. And then what we have seen is, at this moment, we want to stay away from the high-risk segment in the bond market and for a couple of reasons. In terms of risk compensation from, let's say, high yield and EM, they are providing very little in their own history. But all in, the yield level is still high. But because it's a risk compensation, it's low. As such, if you think of someone whose portfolio is chasing after income or yield, you could actually get decent yield without taking on extra risk. For us, our preference is to be on the safe side, and this is what we have been deploying, the safety strategy across most of our portfolio. In the bond fund, global bond fund, the short-term global bond fund. They are all low on the credit risk at the moment compared to what we typically run. Dagmara was in town last week, and we had this conversation among our team on one of the new risks that we have identified, which can potentially be quite risky and that people don't talk a lot about. We heard a lot about the private credit. The leveraged loan market has been well-developed. They cushion the credit market as well. We see such a tame credit spreads, and then because the whole market has changed. We take this as a potential risk for the portfolio construction. Here is what we think about. If you look at high yield and EM in isolation, whatever is remaining in this public market, the quality is good. Typically, they're good. Because they're not so good when issued in a different market, more opaque, less liquid market. Then eventually, when economies are slowing, the zombie corporations could no longer finance, and eventually, those losses have to be recognized. When those losses have to be recognized, that means they'll be marked. And then one thing leads to another, it may and may not, but the risk of the credit cycle downturn is very high. The risk is there. So now, what happened with high yield and EM? Why are we being defensive? On their fundamentals, there’s merits that this issue will be better in terms of credit profile, but because there will be the collateral damage. When we think about the asset allocation, that portfolio has a lot of illiquid stuff like the private credit, leveraged. In the credit downturn cycle, what do they need to do? They need to reduce risk in the portfolio. Because they are so illiquid, what do you do? You go to the next best thing you could sell, which is public high yield and EM. Not because public high yield or EM are bad on their own, but because they are the collateral damage that people sell — what they could sell. And then this is where we think the next phase of risk, if we ever go to a credit downturn cycle, this market may suffer. As such, for all our portfolios, we are light on those two strategies, and we're waiting for a better opportunity to accumulate those better assets if we ever get to that point.

Right now, there's not a lot of reward for taking more risk. There is some true risk in the riskier part of the market. That's what you've just been explaining very clearly. What you'd like to wait for as an investor is to see if those problems arise — which they could, if we have an economic shock or slowdown — and then you'd be able to accumulate those higher risk pieces at better prices, which gives better returns to your investors.

Exactly. This is what we talk about, the high-quality bond, like say, portfolio insurance. That is the insurance features we talk about. For now, stay on the safe side, stay strategic. Once you get the opportunity to accumulate something for the next cycle, that's where we're waiting for those opportunities.

Yeah, the ultimate reason that you take more risk in a portfolio, whether it's more risk in stocks or more risk in different parts of the fixed income or bond markets, is you want to be rewarded for that. A reward comes with taking on extra risk, but at different points in the market, the reward you get for taking on that extra risk is just not enough to rationalize taking the risk. Say I want to go parachute jumping. I go to this really professional firm. I know I'm taking a risk, but very clearly, as I'm working with them, as they're explaining to me how to set up my parachute and how everything's going to work, they're very detail oriented. They're fantastic. Everything they do is perfect. And so, I might take that risk. I go to another company where they're just like, hey, just throw this on your back. We're just going to go and jump. Don't worry about it. Everything's fine. I'm still going to get the same thrill, the same upside of the parachute jump, but I'm taking on a lot more risk going with that company that's not doing all of their due diligence and taking care of me as much as the other company. So you know what? Maybe I'll just wait until that other company either gets better or I'll just go with the company that I feel more confident in. That's what you're thinking about when you start to get out into the riskier part of the bond market or riskier part of the stock market. Am I being rewarded for that risk? If I'm not, maybe I won't take it. And then, of course, for some people, they just say, well, I don't want to jump out of an airplane and do a parachute jumping anyways. That's where we stay in more conservative investments. And that's where you're positioned right now. We should really get to a couple of other issues in the bond market that I think are really interesting right now because they're in the election cycle, and we're in the election cycle in the US and many places around the world. And we're not hearing a lot from either candidate in the US in particular about managing debt. Yet, coming out of COVID, we have a lot more government debt than we've ever had before all around the world. How is this going to impact the bond market as we look into the future?

Yes, those have a long-term implication in terms of portfolio construction. Dave, can I just add a point to what you just said? About the example of the parachute, from a portfolio construction standpoint, it's okay to be greedy, but don't be greedy all the time. There are times you should be greedy, and there are times that you should not. So this is one of those times we think that it's okay for us to be slightly greedy, but not overly greedy. There are better times for you to be greedy. So coming back to your questions on the debt implications, we said that neither of the candidates talks about the debt loss in the system. So there are two schools of thought that I want to put out. And this is not something that happens overnight. The first school of thought is that, because of rising debt levels, it tends to lead to higher interest rate because the higher debt load needs more financing to service the debt. Therefore, it's a higher issuance of bonds. Therefore, investors require high risk premium to own bond. The curve needs to be steep, and then level of rates should be higher, which is a case for higher or higher-for-longer. So that's one school of thought. This is what the popular press wants to project. Then you can also have the other school of thought, which says: it’s not necessary. The higher debt may actually lead to lower rates. High stock of debt is what we're having right now. These are accumulated debt. When you accumulate debt, it means you borrow. We already borrow from the future. This is why we get our stuff into the current stage because we already borrow from the future growth, which means that the growth going forward ought to be lower. When you have a lower growth, you need to have a lower rate expectation because the investor will need to stay in even more because of the ever-rising precaution savings, and you expect central bank to be in the market with repression measure to make sure there's no collapse in our banking system, because the banking system will rely on government bond as collateral. So you actually have these two schools of thought. They are on the opposite spectrum. For us, I think both of them have a merit on their own. For us, in terms of portfolio construction, there is a shorter term and there's a longer term. We should keep in our minds that these forces are playing. But in the meantime, we should be thinking about how we play this merit to what we manage on a much shorter-term basis, which is that the central banks are on the easing path. Recognizing that, easing path means that the lower rates across various points of maturity ought to expect. But thinking of this long-term implication means that the long maturity yield may not fall as much as the shorter term. So therefore, we are coming back to our point about the overall position. We like neutral to long duration for most of our mandate. And then just bear in mind this long-term effect here, we should always constantly review and challenge the hypothesis.

And that's really where perhaps the view has changed a little bit over the last several months. As this debt has continued to be accumulated, this idea that maybe long-term rates aren't going to fall too much through this cycle. In the US, we always use the US 10-year as that benchmark, and we're at 4.2%. At some points we may have been under the impression that those rates could fall to the 2.5% range, but it doesn't look like they're going to get there through this cycle. A lot of these factors that you've been discussing are really driving the idea that they just can't come down that far.

Yes, that's right. Again, this will take time to shake up. So you probably stick to wait the probability, and then that is one of a segment that you do not want to put a lot of capital on. And then knowing that the payoff may not be as great. It’s the shorter maturity part of the yield curve that we know will be mostly driven by a central bank easing path.

Okay. Then again, you just summarized your positioning of the portfolio, but let's go through that again. We've talked about where we are in terms of government, but any corporate bonds at all? And where do you like the corporate bonds in terms of your positioning right now?

In corporate bonds, we like investment grade, and then we like the investment grade in Canada and Europe. The segment we like better is the shorter maturity corporate investment grade, in Canada and Europe, simply because they have a better break even. You have a better chance, better odds, keeping the spread provided by this instrument. And then you also get the potential, the windfall, the gain from the drop-in rates. And then when we get to the stage of the drop-in interest rate, those are likely to benefit more than the longer maturity counterpart.

So again, not a time to go parachute jumping or getting greedy in the riskier parts of the market. And a good time to stay a little bit more conservative because you're being rewarded there and you're getting good yields. You're getting good coupons on those shorter-term bonds already. So why not take advantage of that without taking that additional risk?

I call it sensibly greedy.

Sensibly greedy. Well, that's fantastic, Soo Boo. Again, great summary of everything and the positioning and what you're thinking about. And I think everyone's seen the occasionally greedy, sensibly greedy, but always humble, Soo Boo Cheah. Soo Boo, thanks for joining us today.

Great. Thank you very much for having me here, Dave.

And as things progress through the summer, we'll check back with you in the fall, hopefully, if you've got some time then.

Okay, we'll definitely do that. Thank you.