On the Money with Dynamic Funds

PARTICIPANTS

Derek Amery
Vice President & Senior Portfolio Manager

Domenic Bellissimo
Vice President & Portfolio Manager

Rose Devli
Portfolio Manager

Mark Brisley: You're listening to On the Money with Dynamic Funds, the podcast series that delivers access, insights, and perspective from some of the industry's most respected active managers and thought leaders.

Derek Amery: Welcome to the On the Money podcast. I'm your host, Derek Amery, Vice President and Senior Portfolio Manager and Co-Head of the Core Fixed Income Team here at Dynamic Funds. Joining me today are Dominic Bellissimo, Vice President and Portfolio Manager, and Portfolio Manager Rose Devli. In this episode, we will be discussing a few of the risks and the opportunities we're currently seeing in fixed income markets and how, as legitimately active portfolio managers, we can both mitigate those risks and take advantage of those opportunities. Obviously, these are challenging times for investors. The on-again, off-again start to a potentially significant tariff era has certainly injected considerable uncertainty into the growth, inflation and risk sentiment outlooks. When markets initially began to digest the impacts of broad-based tariffs, concerns were centered on the resulting inflationary pressures. More recently, however, downside concerns have centered on the headwinds to growth from tariffs and cuts to government spending. Overall, with the path of policy related to everything from trade, immigration, fiscal and monetary policy all in a state of flux, and that's not to mention geopolitical risks, it is certainly a difficult environment in which to manage money. That said, it is in environments such as these that active portfolio management can really show its worth and that the weaknesses in passive fixed income investing often come to light. If you've had the opportunity to listen to the episode of On the Money with Professor Martin Kramers, you will recall that the fixed income asset class has certain characteristics that make passive investing difficult. And so the asset class is particularly well suited for successful active management. In uncertain times, the ability to mitigate both risks and exploit opportunities is particularly valuable. So let's get into some of the risks and the opportunities we are currently seeing and how we're positioning portfolios as a result. So let me start with you, Dom. What are you seeing as the most pressing risk in credit markets and how are you and the team managing those risks?

Domenic Bellissimo: The most pressing would be the macro concerns, the uncertainty in the environment. So we're right now dealing with a lot of questions. We don't have too many answers at the moment. And what does that do potentially to people's comfort level? So whether it's the consumer and whether the consumer will continue to spend or will see a slowdown in consumer activity, whether corporate management teams feel comfortable in their capital expenditure plans or holding things off. And then if you put that all together, does that raise the risk of a slowdown or even a recession? So that's definitely top of mind. When you think about the knock-on effects of actual tariffs and if tariffs are in fact implemented for a prolonged period of time, what, if any, impact you might have to corporate income producing capabilities, profit margins, and even supply chains? Is there any disruption? And so from an operations standpoint, looking at corporate output and whether there's any material change. And I think that the last point that doesn't receive a lot of attention but is very important, yields right now are at elevated levels to where they've been since the global financial crisis. If we do go into, in fact, go into a slowdown, does the decline in yields make financial assets or bonds and corporate bonds less attractive? And if so, does that in any way impact the demand for corporate bonds?

Derek: What tools or strategies can you and the team employ to help mitigate or insulate portfolios to the list of risks that you just highlighted?

Domenic: The first is that we actually a lot of work was done heading into this period. So having a corporate book, an investment book, where we feel comfortable with each of the names. So we know that everything we hold is money good and it's part of our process to have a fundamentally driven approach so that even if we get into periods of volatility, we still feel comfortable holding the names and that the companies can weather any particular storm. The second thing that we can do and we are doing is actually using credit derivatives and hedges to protect against volatility in valuations. So if we like the existing book of business that we have in our holdings, but we want to protect against some potential negative headline risk or even some slowdown, actual slowdown in the economy, we can apply and have applied credit derivatives and hedges. So they do work out as a ballast and offset any negative moves in valuations.

Derek: And I assume as a tool, obviously those type of hedges add to the liquidity in the portfolio and are very efficient ways to add or subtract risk depending on your outlook?

Domenic: Absolutely. So they're very liquid, they're traded internationally and we use them in looking at a risk on a risk off approach. So they are very effective in being able to manage risk at a portfolio level and a very high level across all the mandates.

Derek: Same question to you, Rose, you know, what are you seeing as pressing risks in the rates market and what are you and the team looking to try to manage those risks?

Rose Devli: Everyone's talking about tariffs these days, but what we're really thinking about here in this group is, you know, the biggest risk being, you know, on the rate side, is this really the fall of U.S. exceptionalism? Given the last few weeks, we could see a new wave of spending by the most powerful economies of the world, ex-US. This could potentially lead to a ton of additional alteration risks to global bond markets, depending on how they actually want to fund this spending. We all remember a few weeks ago, there was this historical meeting by Trump. He had Zelensky in his Oval Office a few weeks ago. U.S. allies really realized that, you know, the U.S. no longer can be global policemen. The new administration has destroyed the following assumptions since basically World War II, where the U.S. agreed to provide military assistance, safe shipping lanes and security to all of its allies. In exchange for this, basically these global allies would agree to use the U.S. dollar as their main reserve currency and will reinvest any access trade balances back into U.S. assets, bonds, stocks, etc. Given this outlook, now we see defence budgets now have to explode. We've seen a ton of headlines out of Japan, Poland, Germany, France, as well as many others, Italy, throwing out numbers such as 200 billion, heck, even a trillion dollars. These types of policies, they have to be funded somehow. This repatriation is starting to weaken the U.S. dollar. And we think that there's plenty more to come. So basically the rest of the world can now fight back against the U.S. by not devaluating their currency, but selling U.S. assets.

Derek: You talked about the fact that, you know, we're likely to see a lot more fiscal spending outside of the U.S. and that has to be funded by, you know, an increased supply of bonds. You know, kind of what risks do you see from that increase in the supply of bonds that will be hitting the market?

Rose: We'll know more of the intricacies once, you know, people have voted elections. For example, what happened in Germany, they just voted. There could be some legalities behind it. You know, all the parties have to align. So there's a lot of headline risk there before we even know that it can go ahead. So for example, on one day, German bonds and 10-year area of the curve backed up 30 basis points. And that was actually after a backup of German rates into that election of a few basis points a day. So really, we'll get more information as it comes. But for now, we're being a little bit hesitant there.

Derek: The fall of U.S. exceptionalism has risks with respect to global fixed income markets. But, you know, what kind of opportunities is this environment presenting in the rates market in your opinion?

Rose: Outright duration, you know, you could talk about different countries, the U.S., for example, let's just talk about outright, you know, with their interest rates in the 10-year anywhere from 420 up to, you know, let's say 5%. That seems to be, you know, decent risk return there. Where we really see the opportunity, though, is the compression trade. So what does that mean? If U.S. exceptionalism is coming down, well, that means that their interest rates might compress to Germany, Canada, Poland, Italy, all these different economies now. So what we're doing in the portfolios, you know, depending on what index is holding, we have a large trade, for example, on U.S. Canada that spread throughout in the last few months, in the last quarter, just because of these tariff headlines. And now U.S. is trying to bully Canada and Canada is trying to bully the U.S.. So we saw spreads blow out from anywhere from 75 basis points, basically in Q4 of last year, all the way out to almost 160 basis points. So we've never seen these types of levels before versus the U.S.. We are historically highly correlated versus the U.S.. So we do think, you know, especially heading into a Canadian election, which we, you know, it doesn't matter what party it is, PC Liberals or NDP, all of them will be spending. So if they're going to be spending, that means that the BOC probably is close to being done now, especially after today's interest rate cut. So then now the next step is policy. And we could see a risk of the same thing that happened in Germany happening in Canada.

Derek: In short, you know, the fall of U.S. exceptionalism actually could be a good thing for the U.S. fixed income market and its relative valuations versus the rest of the globe. Maybe moving back to you, Dom, you know, what kind of opportunities are you seeing in credit markets that you and the team are trying to take advantage of?

Domenic: There's been a lot of volatility. And what we're finding is during periods of volatility, you know, credit spreads will move around and sometimes a little, sometimes a lot. When companies try to issue new bonds and they come to the market every day, and believe it or not, the market has stayed open throughout all this period of volatility. We've seen companies have to come to the market and on softer days, weaker days, they'll have to issue at a concession. So their credit spread would be wider than historically would have been the case if it was a very calm and relaxed market. Some of that is just a risk premium that investors are demanding to compensate for the uncertainty that they're seeing, you know, over this period. One thing we've been doing is to selectively add companies we feel are very strong, high-quality companies that are issuing new bonds at a discount, right? So at a discount to what would have been traded in the secondary market. So if you can do this selectively and thoughtfully, you can pick up that additional risk premium and that will go a long way over the long term to generating outsized returns.

Derek: In terms of your focus geographically, are you, are you focused solely on Canada at this point?

Domenic: No, it's actually, we have a North American mandate or North American approach. So we've built out a U.S. platform. It's been a lot of work, but we deal with all the major U.S., European, even Japanese shops and Canadian shops based out of the U.S. And so what we do is part of our value proposition across pretty much every mandate is to look for opportunities in both Canada and the U.S. And so when you have periods of dislocation or just volatility, one market might actually move more than the other. And so it's part of the value add that we find and where you can get opportunities and generate returns is by looking at the market that has moved the most and where the opportunities lie there. So whether it be new issue concessions, for example, or selling, selling the more expensive market to buy the cheaper. But this does take a lot of work. It's a day by day process, but we've been effective at it and it actually does increase the opportunity set over time.

Derek: Well, you know, I think it's clear that that fixed income investors are facing a number of both risks and opportunities. The Dynamic Core fixed income team offers a wide range of products and solutions that employ the strategies and the tools that Dom and Rose have highlighted that help to manage investors money in this difficult climate. So thank you again, Dom. Thank you again, Rose. Thanks everyone for for joining us. You've been listening to another edition of the On The Money podcast with Dynamic Funds. To learn more about Dynamic and our complete lineup of funds, please contact your financial advisor or visit our website at dynamic.ca.

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