Market Insights

As we head into 2024, we gathered some key themes and observations we believe will define the year ahead. Given the current economic outlook and valuation levels, we believe there is an opportunity for investors to de-risk portfolios by adding to active credit strategies. These strategies can act as an effective yet simple solution in a potentially choppy environment.

The final quarter of 2023 provided much-welcomed relief for fixed income investors, but there are a few things to look out for in 2024.

In this month’s newsletter, we take a step back and assess the market’s restored optimism that led to a sharp and broad-based rally in November. We discuss how the swift market moves could be an overshoot in sentiment and valuations, leading us to taper our positioning and proceed more cautiously. Nevertheless, we argue that there are still plenty of opportunities for active managers like ourselves to capitalize on the dispersion in credit valuations and dynamically allocate to what we view as the most promising risk-adjusted opportunities.

Although buying individual bonds may seem compelling in the current environment, understanding these under-the-surface risks is essential to choosing the right investment solution and ensuring investment portfolios can generate the best value, especially for long-term investors.

Despite disappointing recent performance for bonds, pension plans find themselves in an overfunded position for the first time in years. As many plan managers look to safeguard these gains through liability-driven investing, we believe fixed income - and active credit strategies in particular - can play a role in de-risking portfolios further.

In this new series, we summarize notes from the trading desk to provide a brief overview of the macroeconomic environment and examples of our positioning in our strategies. This past quarter, contradicting economic data sparked a tug-of-war between inflation and growth, and markets priced in the projected "higher-for-longer" environment as we navigate continued uncertainty.

The third quarter ushered in a broad-based selloff, as central bank projections of a higher-for-longer interest rate environment, fiscal deficit concerns, and unfavorable supply-demand dynamics reignited interest rate volatility. While this may make fixed income investors weary of what's to come, in a series of charts, we highlight why we believe high-quality credit is more attractive than it has been in a long time.

Central bank policies and their effect on economic activity and growth is continually creating dislocations in credit markets. Our research team highlights how we are opportunistically acquiring high-quality bonds in less understood areas of the financials sector and realizing profits through highly active tactical management.

In response to the unprecedented speed of rate hikes and tumbling bond valuations, many investors have turned to GICs for their attractive yields and capital preservation. However, with inflation moderating, we believe investors should consider looking beyond GICs and pivot back to bonds, particularly Active Credit, which can offer higher yields, capital preservation, and portfolio diversification.

Bond markets are extremely attractive from an all-in-yield perspective, and we genuinely believe the current opportunity set in fixed income provides investors with an excellent entry point. Nonetheless, the valuation dispersion across and within asset classes requires a tactical approach to identify and exploit the best risk-adjusted opportunities.

P&C firms face more complex investment decisions than most institutions due to regulatory capital guidelines, but now must re-evaluate their investment playbook in the context of today’s market volatility and weaker macroeconomic outlook. Based on the three P&C investment dimensions: return, risk, and capital charge, we believe P&C insurers can benefit from the relative opportunity in high-quality Active Credit, providing a better risk-reward profile.

In the 2023 Federal Budget released in late-March, a surprising tax measure was proposed, where Canadian insurers will be expected to pay the full tax rate for common and preferred share dividends, treating them as ordinary business income. We believe losing the tax advantage of these instruments gives insurance companies another good reason to rethink their preferred share allocations. We believe actively managed fixed income solutions can deliver better risk-adjusted returns for P&C firms, with a much lower capital requirement.

There is no denying that the income is back in fixed income. Investors may feel compelled to lock in attractive bond yields by overweighting portfolios to certain securities. However, we believe the still uncertain market backdrop calls for a more balanced approach when constructing a bond portfolio.

At RPIA, we believe risk management and hedging are critical elements of corporate credit investing. We seek to understand the varying risks in each underlying portfolio with precision, and then sell or hedge the specific sources of risk if our investors are not being adequately compensated for the cost of bearing them. In this paper, we review how we address explicit and unforeseen risks through our hedging program.

Financial instability and uncertainty from the bank liquidity crisis ignited further volatility in bond yields in the first quarter of the year. As we continue to monitor the far-reaching implications of recent events on growth and markets, we’ve recognized some opportunities amid the credit risk repricing.

The unprecedented volatility in bond markets over the past two years has resulted in many bonds trading at discounts to their par values. These bonds can offer a tax-efficient approach to generating returns for investors over the coming years. We explain this through a hypothetical scenario and by comparing the after-tax returns for discount bonds vs. GICs.

2023 has been a year marked by extremes. In early March, the market was fixated on the possibility of central banks having to increase the “terminal rate,” but the collapse of Silicon Valley Bank and the potential financial contagion risks that emerged from it, resulted in the quickest interest rate repricing in nearly 40 years. We discuss our views on the impact on the financials sector specifically and the market environment broadly.

As the year begins on a hopeful note, the shift away from artificially low interest rates and liquidity-flushed markets is making this a credit-pickers market once again. In this newsletter, we discuss how our game plan is evolving and the emphasize need to be flexible, selective, and targeted in this environment.

For years, businesses have been discussing the changes in consumer behaviour as younger generations become decision-makers; the same is true for wealth and investment management. We are in the midst of the largest wealth transfer in history – by 2030, American women will likely control $30 trillion of inherited financial assets from baby boomers. What does this mean for those helping families manage their wealth?

Following the softening in policy stance from the Bank of Canada, domestic bond yields have moved lower in recent weeks, and we see signs of potential stabilization at home. South of the border, the US market raised its overnight rate by 75pbs on November 2nd and has now priced in another 125bps of rate hikes by early 2023, increasing the expected terminal rate to over 5.25%. We believe interest rates are now sufficiently restrictive to slow the economy and the income opportunity is very compelling while providing significant safety for investors today.