1. Beyond Vanilla Fixed Income “ From Boring Diversifier to Alpha Source” Jamie Colliver Fixed Income Seminar CAUBO June 2009
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3. Implications for Pension Plans Investment risk was measured as volatility of returns, or relative to benchmarks not relative to liabilities Asset mix typically 60% stocks 40% bonds Not enough alpha. Too much volatility. Interest rates fell almost continuously since the 1980’s which increased PV of liabilities Stock markets outperformed in the 1990’s then did not meet assumed rates of return when the bubble burst while PV of liabilities grew faster Bond portfolios were short term , usually measured against a Universe Bond Index, so as rates rose, value of bond portfolios did not rise as much as PV of liabilities grew
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6. What About Bonds? Universe courtesy of Mercer Investment Consulting. Calculations monthly in $CDN. Past performance is not indicative of future results.
7. What About Bonds? Greater opportunities globally Rates of Return(%) Expanded Global Opportunities Over 96% of Fixed Income Opportunities Range of 7.9% between top and bottom performers Global Fixed Income Universe courtesy of Evestment. Calculations quarterly in $US. Performance before fees for periods ended December 31, 2008
8. The DB Dilemma It’s real. It’s here! Time to “ de risk “? Fixed Income in Canada
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Notes de l'éditeur
The old days for bonds and why a pension plan would own them was “ pretty simple “ I have a 60/40 portfolio and that seems to be the right allocation so I will make bonds a core holding in the portfolio and my Board will be happy because Canada bonds are safe and they keep the overall portfolio less volatile. We can rest easy at night. I don’t really care so much about returns from my bonds because I know my 40 % equity allocation will always skate my total portfolio returns onside. Also, to make owning bonds even easier I will index the bonds because I can even make money lending the bonds as well. As for my liabilities, I don’t really worry about those because my plan is young and, oh yes, double digit equity returns will make my assets look good and who really needs to deal with the liability side of the equation. Oh yes, if I need long bonds there are Real Return bonds which have a long duration and, oh yes, they protect against inflation too. Finally, my liabilities are in Canada, therefore I am happy to own Canada $ bonds because we like them and it is a simple decision even though we really don’t truly understand our liabilities. And, if I decide to outside Canada with an allocation to Yankee bonds then they must be hedged in my portfolio because I don’t need any incremental returns jeopardized by currency so I will fully hedge this position. And by the way, did I tell you I only spend a few minutes a day on bonds?? I have heard some really smart plans out there are “ immunizing “ their portfolios which mean they don’t even have to deal with their bonds at all. Anyway, I just love the stock market because it returns well over 10 % most of the time.
Liability models are popping whether it be based on VAR or some other measure The notion of Canada representing only 3 % of the global economy it becomes a fiduciary responsibility to look outside Canada for incremental returns. Do Canadian bond managers have that expertise? Foreign fixed income managers become educators as plans look outside for investment opportunities and strategies.
Balance sheets used to be important, when plans were in surplus the CFOs wanted to make their bottom lines look better and they did with the help of their pension plans. Cash flow is everything now. Plans looking for regulatory relief from “ writing checks”. Companies must now build pension plans together with their corporate balance sheets. They must look to the future and better predict their liabilities and construct appropriate portfolios that serve to “ de-risk “ their pension plans. This will likely lead to greater allocations to longer duration fixed income as a first step. We have seen more use of derivatives over the last few years as synthetic beta allows plans to seek “ alpha “ now from overweighting certain fixed income sectors. Core plus mandates have replaced core holdings as managers go outside their benchmarks to add all important alpha. We saw this a few years ago as Canadian FI managers used HY or EM as the “ plus”. Now the opportunity set for alpha is much broader as more plans go global with their bonds.
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