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A historical context
September 2007 is regarded by many as the beginning of the global financial crisis. However, despite the initial market sell-offs, the performance of most asset classes were turbo-charged in the decade that followed, given that it ushered in an era of ultra-loose monetary policy. For example, on 30 September 2007, the 10 year UK gilt yield stood at 5.02%, fast forward ten years and that yield is now just 1.37%. For fixed income assets in particular, this has resulted in gilts delivering a total return of 79% over that period, while sterling corporate bonds returned 85%.
We have characterised post crisis monetary policy as a tide incessantly coming in over the last decade, pushing up the prices of all assets, not just fixed income. However, we began to see more nuances emerge in the market in 2016, which suggested that the tide was about to turn. This began in June 2016, as experiments by the European Central Bank (ECB) and Bank of Japan (BoJ) to move into negative interest rate territory failed. Government bond yields rose significantly following this, with the market beginning to realise that ultra-low interest rates could not last for ever.
How did we react?
At Canada Life Investments, we recognised that fixed income investors would need protection from rising rates and future changes in monetary policy, in the form of short duration strategies. We have many years’ experience in this area within our balance sheet and life and pension funds, for example we currently manage approximately £12 billion in short duration bonds and liquidity assets. Therefore, in September 2016, the decision was made to launch an OEIC – the CF Canlife Short Duration Corporate Bond Fund. This would enable a wider audience to benefit from our shorter duration expertise, whilst also potentially delivering a greater risk/reward profile resulting from our long experience in the sterling credit market.
The environment since
Over the last 12 months, it has been somewhat of a slack tide, as government bond yields have both spiked and fallen sharply, reacting to central bank sentiment and geopolitical risks. However, global monetary easing has undoubtedly turned to global monetary tightening. Although we expect all central banks to tighten in a careful and gradual way, the tide has shifted. The US Federal Reserve (Fed) and the Bank of Canada (BoC) have already started raising rates and the market expects the Bank of England (BoE) to hike in November. In Europe, the talk has now shifted to a wind down of the ECB’s huge quantitative easing programme, which is currently purchasing €60 billion of corporate bonds per month.
CF Canlife Short Duration Corporate Bond Fund
Given the macroeconomic environment we have seen since the Fund’s launch, we have been confident that our conservative, low-risk style that concentrates on credits with strong fundamentals will be well-placed to outperform. This has been reflected in our performance profile, as the Fund has been able to outperform its benchmark and the wider IA Sterling Corporate Bond sector, with a less volatile performance profile.
Source: Morningstar Direct, one year figures to 30/09/17. Bid to bid, with net income re-invested for the C share class. The CF Canlife Short Duration Corporate Bond Fund was launched on 30/09/16.
Of course, in an environment where rates are falling, short duration products would inevitably lag the wider sector. However, given our current views on the macroeconomic outlook we believe the CF Canlife Short Duration Corporate Bond Fund is an attractive proposition over the coming years. We expect 10 year UK gilt yields to rise modestly by the end of 2018 for example.
Our investment process & philosophy
Our long-standing credit process is built around the principle of selecting solid companies whose business models are strong enough to weather a near term downturn. Although parts of the bond market are expensive, so are all assets, and we believe a diversified portfolio of corporate credit can continue to provide an attractive yield and total return profile. But where are we currently finding opportunities?
Our well-resourced and experienced in-house credit analysis team cover more than 400 issuers and adopt a bottom-up approach to stock selection, with wider macroeconomic trends taken into account when we construct the portfolio. Currently, we are overweight in insurance for example. It is a more specialist part of the market, with complicated financial reporting and is thus often avoided by many investors. However, we believe we have the expertise given the nature of our wider business and the strength of our Credit Analysis Team to invest in this sector.
During the financial crisis insurance sold off alongside the wider financials sector, without any change to its fundamentals. Everyone remembers the implosion of AIG, but its problems came from non-insurance activities. At Canada Life Investments, we assign an internal rating to each bond we invest in, although this cannot be higher than the highest external rating.
As a result, our credit research and selection process has favoured insurance as we believe, for example, we can invest in insurance bonds that are the same credit quality as bank bonds, but receive more in return. Furthermore, the modestly higher interest rate outlook that we forecast should be as supportive of insurance as it is of banks.
Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate.
The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com.
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