“What we’ve observed year to date is nothing short of historic in nature,” said Steve Guignard, senior director of client solutions at Sun Life Capital Management, referring to the poor performance of the FTSE Canada Universe Bond Index, which dipped 12 per cent in 2022.
“The market’s erratic and unpredictable behaviour is very similar to my golfing skills,” he said during a session at the Canadian Investment Review’s 2022 Investment Innovation Conference. “I want you to imagine that you’re playing a golf game, but you only have access to a driver. Adding alternative fixed income in your portfolio is like adding clubs to your golf set. It enables you to adapt your playing style to the situation that you’re facing.”
While Guignard said alternative fixed income is often ill-defined, he offered up his own definition. “For the benefit of this presentation, we are going to define it as everything fixed income outside of traditional investment grade and publicly traded Canadian corporate, federal and provincial bonds. As you can imagine, that leaves us with a big opportunity set.”
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He then pointed to private credit as one of the most popular and better known alternative fixed income asset class. As a result of regulatory changes in the aftermath of the Global Financial Crisis, banks have materially tightened their underwriting standards, he noted, leaving the door open for non-bank lenders. “Investors have stepped up and provided the capital.”
Another alternative asset class highlighted by Guignard was securitized assets like mortgage-backed securities, asset-backed securities and collateralized loan obligations. “They’ve had pretty bad press following the 2008–09 financial crisis but, since then, there’s been significant changes in both the regulation, as well as the underlying structure of the securities. At current valuations, they look quite attractive right now.”
For institutional investors in the search of yield and with a higher risk tolerance, he suggested considering high-yield bonds. “They’re just standard bonds, but issued by below investment grade companies.”
Another option he recommended for yield-seekers was bank loans. “They’re similar to high yield bonds, but with two major differences. The first one is that they’re secured on the capital structure — typically, assets are backing these loans. The second important difference is that the interest rate that is being paid on these loans is typically floating.”
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Throughout the first 10 months of 2022, the popularity of bank loans increased, said Guignard, noting that the aggressive rate hike cycles by central banks certainly helped. “As interest rates were rising, the interest paid to investors was also rising.”
Alternative fixed income is commonly regarded as a niche strategy, he said, which is one reason institutional investors may not be taking full advantage of these opportunities. “Some of the asset classes within this universe certainly are, but there are also others that are quite big, especially when you compare it to the traditional Canadian fixed income market.”
The U.S. bank loan and high yield bond markets are both valued at around C$2 trillion – significantly larger than the entire corporate Canadian fixed income market, he noted. “Alternative fixed income is really an opportunity that spans the risk and return spectrum. Each of these asset classes are quite interesting and not all are niche.”
Read more coverage of the 2022 Investment Innovation Conference.