What’s the next big trend in fixed income (FI) investing? “The big issue for bonds right now,” says Dave Makarchuk, a partner with Mercer who leads the investment consulting business for Western Canada, “is that many plan sponsors believe rates will rise soon, so they’re tending to put off investing more in longer-duration bonds. However, there are some new products that let managers take a lot more discretion on duration.”
Called tactical or absolute return bond funds, these funds tactically adjust their duration as interest rates rise and fall. “These funds provide an opportunity to make money when rates rise,” adds Makarchuk. “They allow investors to capitalize on a rising interest rate environment.” Although there aren’t many options in Canada yet, he believes these products will interest plan sponsors that feel that significant value can be added by making the right interest rate call (e.g., shortening durations when interest rates are expected to rise).
Denis Senécal, head of FI and cash with State Street Global Advisors, notes two other recent FI trends that he believes will grow over the next few years. “In the Canadian market, investors are starting to look at structured public-private deals that are part of the index now. It’s a small part of the index right now, but we’ll see more. People are very interested in these investments. Another trend is the Tier 1 capital being issued by banks—the contingent convertible notes or CoCos—based on Basel III [a framework of banking standards to improve regulation, supervision and risk management in that sector]. A few pension plans have been interested, and we’re finding ourselves explaining that these aren’t provincial bonds, and we’re explaining the risks.”
Marlene Puffer, managing editor, global FI strategy, with BCA Research, says plan sponsors should also invest the time and effort to understand FI derivatives. “[Derivatives] can be a good strategy if all of the risks are recognized and well managed, but there are pitfalls if you don’t do your homework. As a pension committee, you need to ask all the right questions.”
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