Transcript
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MODERATOR 1: TD Asset Management welcomes you to this week's podcast. As a reminder, this podcast cannot be distributed without the prior written consent of TD Asset Management.
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TOM GRANT: Hello and welcome to TDAM Talks ETFs. My name is Tom Grant and I'm the ETF Capital Markets Specialist here at TD Asset Management. Today we're going to be discussing fixed income within the TD ETF suite. To help me do that, I have a very special guest. It's Benjamin Chim who's a Portfolio Manager on the Fixed Income Team at TD Asset. How are you doing today, Ben?
BENJAMIN CHIM: I'm great. Thanks, Tom. Thanks for having me on.
TOM GRANT: Well, we're really looking forward to this. This is the first time that we've discussed fixed income on the podcast. Can you give me a little bit of background just on yourself and how you became a PM at TDAM Fixed Income?
BENJAMIN CHIM: Sure, yeah. I'm happy you're finally get around to fixed income. It's a great asset class. And obviously, there's a lot going on in fixed income, so there's going to be a lot to talk about today. In terms of how I started off in the fixed income space. I began my career back in 2000, so about 22 years ago, as a credit analyst at a rating agency. So I covered companies of all different sorts of sectors, thinking about their credit risk and their credit quality, profile, and whatnot.
So over five years in, I moved over to the buy side or the investment side where I joined one of Canada's largest independent mutual fund managers on the high yield side, so I was a high yield credit analyst looking at high yield bonds and looking at high yield companies and investing in them for a number of years. I did that for a few years there at the independent and then moved over to TD Asset Management, this was around 2008, and worked in the high yield investment team here as well as high yield analyst as well as associate portfolio manager.
So I got to see a lot of different credit situations through what was probably the most challenging credit backdrop we've seen in a long time. But a little bit into my term, I realized I wanted to really manage my own portfolio and manage different strategies.
So I left TDAM around 2011 to join fixed income hedge fund where I was managing corporate bond portfolios, both investment grade and high yield, doing long only as well as long short and other different types of strategies managing credit. And obviously learned a lot through that process and I learned different ways to really invest and get value through corporate bonds and through yield products.
Moved over from that to an independent where I was managing-- the manager for both the high yield fund as well as the corporate bond funds there before coming back to TDAM in 2018. And on my return, I was mostly managing the Canadian-- as Lead Manager of the Canadian investment grade corporate funds, as well as the global investment grade corporate funds. And then since then, I've become the Lead Manager of the high yield corporate bond funds as well here at TD Asset management. So that's really my 22 year journey in fixed income and continued joy looking at corporates and investing in them.
TOM GRANT: Well, we're certainly happy you have all that experience. It sounds like you've learned a lot of things along the way. But I guess it seems we're having more and more conversations about fixed income stakes, why is that? What's going on in the space?
BENJAMIN CHIM: Yeah. I mean, it's been-- probably has been the most interesting fixed income market for a lot of people in terms of their careers this year. And really, the reason why is, of course, what central banks have been doing in terms of continuing to increase the policy rate to try to fight high levels of inflation to try to get that out of the system.
Policy rate is-- or the Fed funds rate in the US or the Bank of Canada rate here in Canada is what's considered the risk free rate for bond yields overall. So if that rate is rising, if bond yields are rising on a policy level, then yields for any kind of security that has more risk than the risk free rate also has to rise.
And so we've seen government bond yields rise, we've seen corporate bond yields rise, we've seen the need for preferred share yields to rise as well as dividend yields. And all of that has stemmed from the fact that the risk free rate is now higher. Yields have, of course, an inverse relationship with prices. So as the need for return rises, the yields rise, prices fall. And so we've seen an unprecedented amount of decline for the first half of this year in the bond market and prices continue to stay at these lower levels and continue to be quite volatile.
But what that's left us with is a bond market where the income is back in the word fixed income. We have yields now that are at levels we haven't seen in a long time. In investment grade, you've got yields about 5 and 1/2%, 6 and 1/2%. That's the highest we've seen really since the Great Financial Crisis. And high yield, they're 7 and 1/2% to 9 and 1/2%. And in both cases, of course, we now become very viable components of long term investment solutions and particularly on the retirement side.
TOM GRANT: And another thing that I think is kind of interesting is just the velocity with which that they've changed too. That also seems relatively unprecedented. When I hear about interest rate changes, we're not talking about 25 basis points anymore, we've seen some substantially higher hikes.
BENJAMIN CHIM: Yeah. I talked about how central banks have needed to fight these high levels of inflation. And if you back up a bit, how did we get these high levels of inflation? It really stems from the fact that we've had over a decade, really since the financial crisis, of interest rates at very low levels, in what's called accommodative levels. Levels that are lower than their target rate, and that creates a situation where money is very cheap, people can borrow cheap money, and invest in different areas of growth growing the companies, investing in assets, and whatnot.
And of course, the more people are borrowing, the more liquidity is in the system, the more people are bidding for these kind of assets. And so that's inflationary. And then, of course, we got to the point in 2020 where we had the COVID crisis. There, the world stopped completely and things got shut down. And more liquidity needed to be pumped into the system at that point to keep investors afloat, keep companies afloat, keep individuals afloat as the world had grinded to a halt.
And that injection of liquidity into the market on top of what we already had served to further increase some of those pricing inflationary pressures. And then of course, COVID itself, with those lockdowns and with the disruptions that we had on the business side, created supply chain bottlenecks, created shortages of goods and services, and other things that, of course, exacerbated the need for those goods and the prices levels of those goods further.
And so the central banks have looked at that and obviously been concerned about how quickly rates of goods are rising and how that's impacting financial stability for their currencies, but also for individuals as they try to make their interest payments and try to afford houses going forward and issues like that.
And then on top of all that, this year, of course, we had the Russia-Ukraine conflict. And that's an area of the world that is quite fertile and obviously an area of what that has a lot of resources. And so that created shortages of food, created shortages on energy that contributed further to what is now inflationary pressures that we haven't seen in decades. We had at the peak inflation here in North America was 8 and 1/2%, 9 and 1/2%.
So central banks have realized that they were behind the curve and started to hike rates aggressively to really try to get liquidity back out of the system. Try to create a situation where investors no longer were looking to invest in growth or at least the hurdle rate, to borrow money and to try to grow the economy was much higher than it had been in the past.
And so trying to get interest rates into a more restrictive territory was a challenging task because we had gone from a point where it will raise red zero. So we've seen it, like you said, unprecedented rate hikes. Sometimes 50 and most recently, we've seen 75 basis point hikes both in Canada and the US. And that has started to get inflation down to more normal levels, but you need to be in this backdrop where with inflation at 6% to 10%, we'll continue to see interest rate at fairly elevated levels.
TOM GRANT: So there's a lot of concepts that get thrown around whatever we have these discussions and we discussed inflation and discussed interest rates. But when I'm reading through different articles, another term that pops up is duration. And I hear this a lot when people are talking about bond portfolios. Can you explain what duration is to me in very simple terms?
BENJAMIN CHIM: Yeah, I'll do the best I can. I mean, duration is the-- in a very simplistic variance in definition is really the sensitivity of an asset or sensitivity of an investment security to changes in interest rates. So the longer the bond is and the more payments, the more sensitive it's going to be to any changes in the risk free rate and a shorter bond. And it works both ways. So longer bond prices will fall $10 if you have a 1% increase interest rates and they'll rise by $10 if you get a 1% decline in interest rates.
TOM GRANT: So just to clarify that on my side, if I'm thinking about duration, I'm thinking about the sensitivity of my coupon or interest payments relative to my bond holdings and any changes in interest rates, is that approximately correct?
BENJAMIN CHIM: Yeah, you think about the sensitivity to any changes in the overall interest rate backdrop. Because when prices are to market, a bond is worth what you can sell it to someone else for. So the marginal buyer of the bond that you might own in your portfolio now needs to yield attractive yield for the market to be something that someone else would buy. And so that yield will adjust to whatever the risk free rate is moving towards.
TOM GRANT: OK, I think that's a little bit clearer for me. I know [INAUDIBLE] said, it's one of these terms that occasionally causes me a little bit of confusion, but at least now I have some clarity in terms of the sensitivity, the interest rates, and their changes that have on my bond portfolio. Now, if I was an investor that was interested in putting some money to work in this space, what should I be thinking about or what should I consider?
BENJAMIN CHIM: Well, there's a number of things you should think about as you invest in the fixed income space. Of course, you want to think about your target return or what kind of yield you want to achieve. And you can think about that in two ways. You can earn higher yields through taking on interest rate risk, so going further out the yield curve, 10-year, 30-year bonds rather than one year bonds because you're taking on more volatility in interest rates, so you can typically earn higher yields from that.
Or you can earn yields from taking on more credit risk, which means more default risk is more risk of the credit spread premium on a bond or company-- corporate bond that a company is issuing moving higher and that could obviously negatively impact the value of the bond. So you're taking on more credit risk, and you can earn much more yield from doing that.
And then on top of all that, you want to think about the liquidity of the bond holding that you're putting on. So you can own a GIC, which I think today is roughly around 5%. And if you're lucky and going to walk in for longer, you have a 5 and 1/2% or even more than that. But you are locked in on the GIC and not able to cash out and use that cash for other purposes until your GIC matures or you take a big penalty for that.
If you own a bond fund or you own an individual bond or an ETF, you have instant liquidity for what you're owning. And you can still earn yields that are as high, if not higher, than GICs through owning a bond fund. The other thing, of course, in owning a bond fund or owning bonds versus a GIC is benefit from any upside from owning a GIC.
You're going to get whatever the yield is that's stated in your GIC and nothing more. But if bonds yield do start to fall, the duration benefit you get from owning bonds and owning a bond fund will result in returns that could potentially be higher than your yield if you own a bond fund.
TOM GRANT: So which solutions have you seen an increased usage of recent? Where have investors been directing their money within the bond market universe?
BENJAMIN CHIM: So for us, particularly on the ETF side, we've seen really good interest in our short term corporate bond ladders. We have both a Canadian and US dollar short term corporate bond ladder, which is a ladder that essentially has five different buckets or one-year bucket, two-year bucket, all the way to a five-year bucket.
And so about a fifth of the fund is in each of those different buckets. So it minimizes the amount of interest rate risk that we take through. The duration of the fund is around 2 and 1/2 years, so a very limited amount of interest rate risk. And we own corporates and short term corporates in that portfolio. With the yield curve inverted, you're getting really good yields to own five year and under investment grade corporate bonds.
I mentioned something about 5 and 1/2% to 6 and 1/2% yields to do that. The fund is about 87% investment grade, we have about 12% high yield in that fund as well. All of that being high quality high yield, so that will be corporates. And there, you're getting yields, of course, of 7%, 8% for the high yield bond.
And so we're getting a blended yield in that fund about 5.6%, 5.7% for the Canadian bond ladder and 5.3% for the US bond ladder. It's a very little limited amount of it. I guess I mentioned, interest rate risk and credit risk will be giving you some pretty good returns and being very liquid.
TOM GRANT: OK. The next question, I'm not going to hold you to this just in case things change. But where do you think we are in the interest rate hiking cycle?
BENJAMIN CHIM: It's a tough question, but I think with where we are right now in terms of policy rates and candidates, it's about 3 and 1/4%, in the US, it's 4%. We're now very firmly into what's called restrictive territory for policy rates. What that means is yields are at a level where they are discouraging growth and cutting off investments and creating pressure or creating tighter financial conditions. So things are starting to slow down as a result of that.
And since central banks have already gotten interest rates into that level, they can now be a lot more measured, a lot more data dependent as they think about rate hikes going forward. We're still at a very high level in terms of the inflation data, we're about 6%, 7% on a headline basis here in North America. So the central banks will likely continue to hike rates a little bit more as they try to see-- but they may pause shortly after that early into next year as they start to see what the lag effects are for those rate hikes in terms of how they're impacting the economy.
So we think in Canada, we could see rates get to, in terms of early next year and on the policy side, maybe 4%, 4 and 1/4%, maybe in 4 and 1/2. Data in terms of inflation continues to be quite high. And in the US, we think things will probably be a little bit higher as the economy's stronger. So something in the 4 and 1/2%, 5% level.
And once they hit that level, we do think the central banks will start to pause at that point and reassess how much influence and how that's happening on the economy and how quickly things are slowing down. We could see these elevated rate levels for quite some time in the future. The central banks are much more concerned about missing-- in terms of making sure that they hike enough to really snuff out inflation.
And then they are concerned about a recession and concerned about how deep the economic downturn is going to be. They do feel like they have the tools to deal with the latter and the tools to deal with the former are a little bit more challenging. And so we could see this elevated rate level for quite some time going forward. We think it could be 6 to 12 months before we start to see a little flex in some rate cuts.
TOM GRANT: So still a few more potential hikes on the way and really the question is just how long they're going to remain? Is there any topics that we didn't go over today that our listeners think they should learn a little bit more about or any closing comments you'd like to share with our audience?
BENJAMIN CHIM: I just want to say that in terms of how you think about investing in fixed income, we have a very broad suite here at TD solutions to really address whatever way you want to approach the fixed income market going forward in terms of yield, in terms of credit risk, in terms of duration.
I mentioned the short term corporate bond or bond out of ETFs. There's also our global income ETF as well as our high yield ETF, which gives you much more yield in talking about 6 and 1/2% yields for the global income ETF and 7 and 1/2% yield for the high yield ETF today. Of course you're taking on more credit risk, but you're still not taking on a lot of interest rate risk about five years of duration, 4 and 1/2 to 5 for those two funds.
And in a backdrop where credit quality is still quite strong and we think very healthy, you can earn some really good returns going forward being in those funds. And if you want to take more advantage of the upside of rates, I talked about duration and the effect that has on longer term bonds. And for the longest end of the curve, 30 year government bonds, they've been hit the hardest with this increase in policy rates and you're seeing long bonds down $20, $30 this year.
And owning the long bond portfolios, the long bond ETFs really gives you access to the upside should bonds start to rally because the economy maybe we can-- significantly, inflation gets down, move down materially, and interest rates start to get cut. We could really see some upside to those type of funds. So we have those options as well.
TOM GRANT: All right, Ben. Thank you so much for taking the time to dive into the fixed income discussion with us. For all you listening, we thank you for tuning in. And for more information on our ETFs, please visit us on the LinkedIn under TD Asset Management to stay up to date on all of our ETF related podcast, blogs, and so much more. Lastly, if you have any comments or suggestions on what you'd like to hear more of, please don't hesitate to email us at td.tmtalks@td.com. Thank you all very much for listening today, and have a great rest of your day.
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