PARTICIPANTS
Mark Brisley
Managing Director and Head of Dynamic Funds
Rose Devli
Portfolio Manager
PRESENTATION
Mark Brisley: You're tuning in to On the Money with Dynamic Funds, a podcast series that delivers access to some of the industry's most experienced active managers and thought leaders. We're sitting down to ask them the pertinent questions to find out their insights on the market environment and navigating the investment landscape.
You're listening to another edition of On the Money. I'm your host, Mark Brisley. It's easy to feel uneasy about bonds after a very tumultuous first half of 2022. The sharp rise in interest rates has been a massive drag on fixed income and with losses feeling even more acute when coupled with a stock market rout. The drivers of the challenges, however, facing the bond market are the usual suspects.
The surge in inflation and Central Bank actions to raise interest rates to curb that inflation have been seen before. While the factors underlying the bond market declines aren't unusual, the velocity and the extent of the losses and the accompanying jump in yields, that's what's unique to this post-pandemic economic recovery if we should even use that word.
Add in geopolitical instability, and it's not a surprise investors have more questions than answers, but are investors too pessimistic right now, and is the narrative changing? Are we at peak inflation? Are we starting to once again see the inverse correlation that has been absent in the face of both equity and bond prices declining amid rapid inflation? To unwrap all of these subjects and more today, my guest is Portfolio Manager, Rose Devli.
In a career that has spanned over the last 17 years, Rose has focused on a top-down, bottom-up approach to fixed income portfolio management with an emphasis on capital optimization and active risk management. Rose is also a guest lecturer at Queens University. Is featured regularly on business news networks including BNN and is a limited partner in the Women's Equity Lab, an empowering organization to encourage women to actively engage in early stage investing.
Rose, it's a pleasure to have you with us. I'm going to jump right into the first question, which is, let's start with talking about some of the issues facing investors as central banks are looking to combat inflation while trying to also keep us out of a recession.
Rose Devli: Yes, I would not like to be in Powell's shoes or any of the central bankers right now. I think what they did last year was a bit of a mistake. Now I understand heading out of a pandemic, but then getting faced with a mutation like Delta, they had to take a step back. Heading into the February or the March meeting last year, the market really thought that the Fed would be talking about tapering or raising rates in some degree, and then they really stepped that back and they said, out the door with the models and we're going to just look at the data.
They had the chance to increase rates last year and they, unfortunately, didn't. It fueled the fire. Then, obviously, stepping into 2022, a lot of the market just discounted a lot of the risk events that happened in the first quarter, such as the biggest one being the Russian War with Ukraine that really exaggerated things.
If you ask most bond managers what inflation in would be 2022, last year, I guarantee 99% of them wouldn't say 8% in the U.S. Unfortunately, that bond-stock correlation really breaks down when you have high inflation and stubborn inflation. The Fed walking into the 2022, everyone knew that they had to tighten financial conditions, but Russia really put a wrench into things, and they had to tighten quicker than they expected just because of all the supply chain issues and then all with the energy crisis with what's happening in Russia, Europe, and the rest of the world.
Right now heading into the second half of the year, inflation expectations should be heading down. That's why we've had this little bit of consolidation in yields for the past couple of weeks. It's definitely a question mark in a lot of portfolio managers' minds, why, where, or when, and what is the neutral rate out there, and when will the Feds stop?
It's a rock and hard place because the Fed and other central banks are going to be hiking into a slowing-down environment. The good thing that the Fed has on their side is the labour market. It is extremely tight, which is on their side. If they do hike aggressively and they talk about hiking above this neutral rate to calm inflation expectations because you really don't want.
What is worse than a recession? Entrenched inflation, in my opinion. Why is that? Well, in a recession, you have a probability of losing your job, but an entrenched inflation, everyone is experiencing 8%, 5%, perhaps another year of 3% to 4%. You're really heading into a 20% inflation environment within 3 year period, that is just a complete destruction of purchasing power, especially because a lot of the world isn't the top 1% and doesn't really have that savings rate that others do. Again, I wouldn't want to be the central banks right now, but that's the predicament that they're in.
Mark Brisley: Those numbers are staggering. We just haven't seen this before. When we think about the pressures now this is going to put on people trying to build portfolios, bonds have always been a ballast in an investor's portfolio, and you've described some things now that are making this more challenging. Is the situation we're in and particularly the beginning of how this year has started, does this change your view of bonds as a ballast as a bond manager?
Rose Devli: It's funny that you bring that up actually. In the midst of COVID when the Fed was buying primarily most of the bond market, volatility was extremely low and it was not looking great for active management to be 100% honest with you. We had a yield on the index of just above 1% at one point, it just really looked like the market was sluggish and there wasn't really opportunity to take alpha bets.
Now, as you could see the destruction in the bond market as well as other markets, that 1 to 1.5% has risen to almost 4% running yield on the index. You start to think to yourself this starts to make sense when you look at equities, when you look at the dividend rate, when you look at anticipated growth rate in the equity market.
Typically, when interest rates head to that 3 to 4% or a little bit higher than 4%, a lot of managers, risk parity managers or pension funds, they start de-risking because they think to themselves, "If I can get that 3 to 4% interest rate basically at a lot less risk-averse than buying the stock market, then, hey, that makes a lot of sense."
For a lot of pension funds, especially right now, their fund status ratio is exceptional levels, like over 100%, so that's why it's a no-brainer. You see a little bit of this and why the yield curve is flattening is because a lot of people are de-risking given that yield. Yes, there's been a lot of destruction, but with destruction comes value.
On top of that value comes a little bit of insurance protection too because if you have the market falling apart, then at least you have bonds really rallying in that environment. That correlation really comes back, especially on risk-off. At these kind of levels, I say that you have to start pairing in again.
Mark Brisley: What are some of the considerations an investor needs to be thinking about if they want to invest directly in a five-year GABY, for example?
Rose Devli: The alpha drivers or the drivers of performance in fixed income is always going to be the top three factors, and then everything else comes below that, but it's overall duration, yield curve positioning, and percentage of credit allocation to the portfolio. Your duration can be correct, let's say, but where you are on the yield curve really could help your performance or hinder your performance.
I think a lot of investors don't think about that. They say to themselves the yield on a two-year, let's say, treasury is a certain level so they buy that one security, or let's say the five year like you were saying, and then they think that they are protected, per se, and say, "You know what? I have an allocation of bonds because I bought this one bond. It's a government of Canada five-year."
The problem in that is that, yes, you have some duration risk which is great. You basically are subject to idiosyncratic risk. When you're talking about the Canadian government, there is no risk there, but let's say if you're talking about a credit bond, say a Rogers five-year, there is idiosyncratic risk, but if you're talking about just a five-year Canada bond, then you have yield curve risk.
What happens if the Bank of Canada sees that we had CPI this week that said it was just over 7%? That can be problematic when you talk about the yield curve because the front end of the yield curve, 0 to almost 5 year, really gets affected by central bank expectations. The back end of the yield curve, that 10 to 30-year part of the yield curve, really gets affected by inflation expectations as well as other risk-off sentiments.
If you have high inflation, and you expect the central bank to really be, as we call it, hawkish and raise interest rates more than the market expects, that five-year bond can actually underperform quite significantly a 10-year or a 30-year bond. You might say to yourself, "You know what? I have bond risk in the five-year part of the curve or four-year part of the curve," then all of a sudden that happens, and depending on how the yield curve moves, you can even be underperforming.
It's something to pay attention to and that's why you really have to think about the three factors that are driving your bond portfolio. I know a lot of investors that think that they're covered for bond risk just buying one bond on one particular part of the yield curve, but, unfortunately, you have to think about it on a portfolio basis, and that's why it's better to be in more of a portfolio than a one-bond structure.
Mark Brisley: I'm glad you bring that up because, obviously, you and I both work in an environment where we're dealing with managed portfolios. I've had a lot of conversations with both investors and advisors over the last few months where they've been saying they're probably opting for the individual bond position because they're saying, "I know what the bond is going to do and deliver. I don't necessarily know what the bond fund is going to do," but my question of you is, over the long term, a managed portfolio, an actively managed portfolio with an investment manager that has a track record in running these types of mandates is still a viable option, correct?
Rose Devli: Yes. An investment advisor or any kind of investor really has to think about why are you putting this bond in your portfolio? If it's just for that running yield, that yield maturity, which I would argue is a very small percentage of what you actually can get back from a diversified bond portfolio, then sure. Let's go back to the example on buying a short-end bond, let's say buying a four-year Rogers bond.
Well, that four-year bond doesn't necessarily have the duration of a 10 or 30-year bond. We discussed that a little bit and we discussed the yield curve. It also has a lot of idiosyncratic risk that Rogers, as well as other telcos are levering up their balance sheets, trying to buy growth out there. Obviously, we had a massive Rogers deal in the past few months. The credit quality could really depreciate.
The problem here with credit quality especially when you're buying a one bond, let's say this Rogers bond, you are buying an investment-grade bond, let's say a Triple-B bond like Rogers, but you have the probability, and some would argue, an increased probability of one day owning a high yield bond.
Now, why is that bad? Well, the spread difference when you're talking about credit quality in a corporate bond, the largest gap is from investment grade to high yield. When you're talking about the spectrum of credit risk, Triple-A, all the way to Triple-B, yes, you have increments for sure depending on market conditions, it can be as tight as 10 bps, it could be as wide as a hundred.
However, when you're getting to investment grade to high yield that spread, depending on market conditions, can really vary from a hundred basis points to-- I've seen it for a few hundred basis points. What does that mean? Well, that means that the bond price could drop potentially by dollar amounts. I think a lot of investors don't think about that. If you hold, you can argue back to me and say, well, I'm just going to hold the high yield bond until maturity, and at least I'll know I get my yield to maturity.
That's fair, but why are you holding bonds in the first place? For me, bonds increase, like we talked about portfolio insurance which is huge. Duration is a measure of the sensitivity of price of a bond to changes of interest rates. If you have-- Right now, I would argue we're in the ninth inning or almost at the end of an economic cycle, perhaps heading into a recession, at least probabilities are higher.
To me, the bond risk in the portfolio, especially at this part of the economic cycle really brings down your risk in the overall portfolio. That's why I would buy bonds right now, but if you're buying a Rogers bond, a four or five-year bond, you have to think about why I'm owning that risk and why I'm not owning the equity, I'm owning the debt and what are the risks associated with that? As long as the investor understands that, then I'm more comfortable with the overall answer to that. I think a lot of investors don't think about all the possibilities.
Mark Brisley: As a bond or fixed-income manager, I know how much you're focused on the macro environment. When we think about here in North America and specifically the focus today on Canada, when you look at the household balance sheet of Canadians right now compared to what we're hearing and seeing in the U.S., any specific concerns for you with respect to Canadian households, debt levels, the amount of wealth that's tied up, for example, in our homes, that have you thinking differently over the last year?
Rose Devli: Definitely. Everyone talks about how hawkish our central bank is, especially versus the Fed in the U.S. The problem here is that we don't have the diversification that the U.S. has. Yes, you can argue that the job market is extremely tight in Canada, just like the U.S. However, because of the lack of diversification, because of the increase of immigrants into Canada versus the U.S. in the last couple of years, I do think on a slowdown that we suffer more than the U.S. on the jobs fronts.
That's not even talking about the leverage that everyone has and unfortunately, we can't really get true numbers of leverage of the normal consumer just because there's different practices in Canada than there is in the U.S.
A lot of people, obviously, have taken out mortgages. However, they've also taken out home lines of credit too, especially in the last few years with COVID and with increased house prices, people didn't necessarily-- could afford to move because of associated costs, so what they did was take out these massive lines of credit and renovate their homes.
Unfortunately, there isn't really great data on that part of how levered we are too. Talking about what we have on outstanding mortgages and then adding in that home line of credit element as well as credit cards and other debt, I think that we actually are more levered than the markets could suggest, and these kinds of interest rates, especially the pace of interest rates and how high that they already have soared versus the beginning of the year, will be problematic.
The good thing about Canada, obviously, we have oil, we have wheat, a lot of the things that the world is looking for right now, but those types of commodities, being a commodity-linked country, when there is a slowdown, those things can really dive very hard as we've seen in other recessions. That gets things off the table. When I think about the Fed versus the Bank of Canada, I really do truly believe that the Fed has more power in the slowdown than we do.
Mark Brisley: It really does seem to. You've highlighted the fact you have to be ready for volatility in the short term, regardless, and that includes not just equities, which I think a lot of people think about, but it also includes fixed income and have to focus on maintaining an asset allocation that's suitable for their time horizon because, obviously, demographics life cycle play a role.
Any final thoughts as we're navigating this current situation for investors out there that are throwing their hands in the air, going, "Where to go, what to do, or what I should be thinking about?"
Rose Devli: Yes, sure. I think a diversified portfolio is definitely, especially at these types of economic conditions, the right way to go. Now, the percentage of bonds in that portfolio, I can be the first one to say, depends on your demographic, depends on your age, depends on how risky can you be at this point of your life cycle, let's say.
I personally believe that there should be a portion of bonds in your portfolio just because, A, we're talking about running yield of that 4% almost of the index starts to make sense when expectations on the equity market aren't as rosy as they were in the last couple years.
Even if earnings do keep up with what expectations are, that 5% to 10%, when you're in a period of tightening financial conditions globally, and this isn't just like a North America thing, this is Europe is tightening, the U.S., Canada, New Zealand, Australia. You have a global tightening. That really means that asset prices should be coming down and especially when we're talking about that, we're talking about risk-based assets.
When I think about that, I think about the added value to adding bonds. You get that running yield of that 3 to 4%, but then you get what we talked about before in terms of duration. If interest rates were to come down, the market is expecting interest rates-- When you look at the Ford curve and what Fed fund futures are looking at, it looks like the Fed will be lowering rates in that 2023 to 2024 period.
Well, if that's the case, then you really have that running yield of 3 to 4 % plus you have the added value of duration of your bonds. That can really add up like what happened in 2008 in the financial crisis. At the beginning of the financial crisis, the best trade to put on was going long 30-year U.S. treasuries. You made a killing on that because you had over 5% and it rallied all the way down to very lows, 1 to 2% numbers at the time.
You really have to put things in perspective and think about what kind of insurance that you want in the portfolio.
Mark Brisley: Maybe just a quick follow-up to that. For some of our listeners that follow portfolio management and think about their own portfolios, they'd be familiar with the term the 60/40 portfolio, weighting of equities to fixed income, and depending on your life cycle, that number may be reversed between the two. If you were to Google that right now, you would see a lot of headlines that say the 60/40 portfolio is dead. Is that too dramatic in your opinion?
Rose Devli: Personally, that 60/40 portfolio only holds when you have a period of a sluggish, I would say, inflation. Again, when you have periods of very high inflation, which we've experienced in the last one to two years with this pandemic that we've gone through. The U.S. itself printed 20% of GDP, so what were we expecting? Once inflation does come back down and that number you can debate about because you have different demographics. Still in North America, you have technology that's typically a deflator in the economy.
We have these long-term things that will put pressure on inflation. I'm not saying deflation, but it would probably bring inflation back to more reasonable levels like the Fed always talks about, that 2%. On the short term, you still have these pressures such as Russia. You had the China supply chain issues. You have ESG, which is a huge inflationary factor, which isn't going away anytime soon, and you have the changing labour market, which a lot of people are retiring and you don't necessarily have the type of people that want to work these types of jobs that we have out there available to them.
There's two types of differing factors right now that I would say, but on a long-term basis, especially in North America, I do personally believe that inflation will come back down to around that 2% average. If inflation comes back down to that 2% average or below, that 60/40 portfolio does hold because the correlation does hold.
Now, if you're wrong on inflation and you actually believe 5% to 8% a year, which every single Central Bank is not okay with, then yes, perhaps, maybe that portfolio does not work anymore. However, I'm in the camp of yes, we will get down inflation back down to that average. It might take a little bit longer than what we want, but sooner or later, we'll get there and that portfolio will come back. What's the biggest factor in that, is inflation.
Mark Brisley: These have been great insights. There's so much to unpack here and I appreciate your commentary here, in particular, most portfolios contain an element of fixed income, so it's equities get all the headlines, but this one is certainly, as we talked about it, being the ballast is not lacking for the importance of paying attention to it, so I appreciate this.
I wanted to shift the conversation just a little bit, Rose. An observation I can make having been in this industry for 30 years myself. You're a woman who's a portfolio manager, an investor. You don't have to look very far to determine that that's an underserved demographic in the investment world is female portfolio managers, but also as we start to think about just demographic shifts in the population and the realization when we think about investors themselves and the transfer of wealth that's going to occur over the next decades, where women are going to be in control of a lot of wealth in households around North America and the world.
First of all, maybe I'll start with what made you get into this gig, but I also wanted to touch a little bit on the importance for women looking at this as a career, but also women as investors?
Rose Devli: Terrific question. How did I get into this? I've always been fascinated with the markets, even in university. When I was in university and undergrad, at the time I wanted to be an academic because I was so involved. I was a teacher assistant, et cetera, to plenty of courses and research papers with professors. That was what I wanted to do and then one professor that I was working with, and the course was called Risk Management. He was a managing director at Scotia full-time and he was a part-time lecturer of that particular course. He said, "Why don't you come in for an interview?" I said, "I didn't really understand." He said, "For bonds." I took one course in bonds and I'm like, "Okay, I'll just go in. I have no idea what I'm getting myself into."
Life just took its toll from there. I got hired onto the trade floor. I remember the first day looking around and everyone was talking this different language that I didn't understand. The floor itself didn't really look very diversified. There was a lot of older men on the floor, and I thought to myself as I sat down, like, "What did I do?" [laughs] Since then, it's been a great ride. I can't complain, so I guess I got into the bond market, in particular, by fluke, but at the time, I didn't even realize how much of a multiple of other markets that it is and the derivatives involved in it, et cetera.
I'm very thankful that I was led into fixed income, it's given me such a lucrative career. I learn every day; the market is absolutely insane at times. Whatever you think you know, the market will teach you something else the next day.
Diversity is definitely a topic that has been, for the last 17 years of my career, been a hot topic. When I was in university, and even high school looking for those types of females, especially successful portfolio managers, wasn't necessarily a hard thing. There is a lot of them out there, they just don't get airtime. If you look for them, they're there. They're motivating, but they don't really scream in your face.
What do I think for the next generation, and what do I think about the biggest factors are is, if you're comfortable taking market risk, and you're really fascinated and want to be learning every day something new, this is the type of career for you. Don't be discouraged with a lack, still, of diversity out there. In that 17 years that I've been in the business, it's definitely getting better, but it's nowhere near where we should be.
There's a lot of things that are helping that like a lot of programs in university and even in high school women and capital markets, is definitely plowing the way as well as other programs there. Do I have hope? Yes. Definitely, getting out there talking to the different genders and different races is this something that we'll have to continue to do because the numbers are still not optimal, or at least what I'm seeing out there, Mark.
Mark Brisley: I want to also ask you, you're involved, as I mentioned in the opening, in the Women's Equity Lab, which is all about empowerment and encouraging women to engage in early-stage investing. A lot of financial institutions are now paying attention to the fact that women as investors is a market that they have, quite frankly, not done a great job in paying attention to, but are going to be dealing with it based on this transfer of wealth that I spoke to earlier. What advice would you also have just women not necessarily looking at this as a career, but women looking at investing with a more serious lens?
Rose Devli: That too is another great question. A lot of women are more risk-averse than the typical man, for sure. There's plenty of reasons behind that. When you talk about investing, I feel like the women, like you said, they have the capital behind them, they just are a little bit risk-averse. To get them more comfortable with investing, and that's why there's all these different types of programs and why I'm part of the Women's Equity Lab.
As long as they start or you give them a holding hand of, "It's just a little bit. Let's start here. Let's grow. Let's--" and reminding them that they don't have to be right 100% of the time, I think that is the biggest factor.
When I was starting out in the business, I went from sales to trading, and I was terrified to put on large trades. My manager at the time said, "You don't have to be right 100% of the time. Even an amazing trader is only right 60% of the time." I think education is number one. Once you educate a woman, it empowers them. They have the capital behind it, you have that trust with them, and you can move forward with them.
It just takes a little bit more hand-holding from what I've seen in the last 17 years, and especially my own experience. It took me a little bit, but once I heard that from my boss, I had that confidence, and then I moved forward with it. If we can communicate that to everyone, it gets them more comfortable.
Mark Brisley: Rose, you're about to embark on a pretty significant life change of your own as well. That's exciting for you, I'm sure, but also stepping away for a little bit from an act of career in Portfolio Management is something else that women have to deal with as well. How do you find managing the work-life balance and life stages that people go through that's been going for you and is there room to improve and evolve for organizations that have women working for them?
Rose Devli: I think at the beginning of my career, I didn't really know what work-life balance was. I was working 12 to 14 hours a day and then I was going to school. Then some of the days I was teaching at McMaster, trying to do my CFA. I would say my 20s was basically I don't remember very much of it. However, demographics as I-- at the time, I was at Scotia Capital and I remember every single intern that came through was different and changing the environment a little bit.
The whole trade floor, I felt like every year became more relaxed and more work-life balance focused. I think definitely the biggest leap was COVID, and showing management in the world that businesses can be as productive or even more productive with workers that are working from home, that are more satisfied, that can get a lot of the housework done, or raise children or whatever they have to do with also working at the same time.
I know personally for me, as soon as I wake up, I'll log in to work and it doesn't take me that time to commute in which is huge. When I'm locking down my day, take a little bit more time because I don't have to rush out and pick up kids or get to family things as quickly as I would need to if I was coming from the office.
I think this is really important. I think teams are extremely important as well. Going back to the office is definitely an important thing. You need to be collaborative with your team depending on what your role is, but at one-- especially in our industry, you do need to go in and have that face-to-face. It's a trust business and if you're not communicating with your team, then, even dealers, people on the street, you need to establish that type of trust.
Does that mean you have to be in the office five times a week? Definitely not. Something between that it's not going to be zero, it's not going to be five. Something in between makes some sense to me, but I think as employers trust their employees more and notice that they are more productive and happier at home and have that work-life balance, it's better for all, personally.
I think that's why a lot of people are hesitant to get back into the job market because they want to know that employers are sponsoring them and understand that element.
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Mark Brisley: Rose, this has been great. We've covered a lot of ground on two important subjects. One is managing the volatility and expectations in a difficult market environment, but also women in wealth management and women as investors is a subject that definitely deserves even more attention. I thank you for your insights on both of these subjects.
Rose Devli: Thanks very much, Mark. It's been a pleasure.
Mark Brisley: For all of our listeners, to learn more about what we discussed, I would invite you to join us on our webpage at dynamic.ca to our Volatility Resource Center, where you'll hear a lot of further insights that align with what Rose and I were discussing on today's podcast. I want to thank everyone for joining us and talk to you very soon.
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Mark Brisley: You've been listening to another edition of On the Money with Dynamic Funds. For more information on Dynamic and our complete fund lineup, contact your financial advisor or visit our website at dynamic.ca.
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