TDAM Talks Podcast: Finding Fixed Income in Today's Markets

ANNOUNCER: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.

INGRID MACINTOSH: Hello and welcome to this edition of TDAM Talks. I'm your host, Ingrid Macintosh and this week we are talking all things fixed income. Today, we have the pleasure of welcoming our new head of fixed income here at TD Asset Management, Michael Augustine, as well as senior portfolio manager Elaine Lindhorst, welcome, Michael. Welcome, Elaine.

MICHAEL AUGUSTINE: Hi, Ingrid

INGRID MACINTOSH: So, Michael, I want to focus today on the fixed income team, how you structure and really, you know, people think this is a bit of the boring asset class, but I really want to dig into all the tools and levers that we have in terms of managing fixed income, but also talk more broadly about the state of the bond market and fixed income investing in 2023 before we start.

You've recently become head of fixed income here at TD Asset Management. Could you tell us a little bit about yourself, your background, and your time with TDM and really your sort of mindset around a team- based approach?

MICHAEL AUGUSTINE: Yeah, for sure. So maybe by way of background, I've been in the business for over 30 years. During that time, I think I've seen the business from many different perspectives. Funny enough, academically, I was trained as an actuary, so I'm fully qualified. At the same time, I'm also a CFA charter holder. I've spent most of my career as a portfolio manager and have spent time on the academic side.

I lectured on mathematics of investment and credit at the University of Toronto. If I think about work experience, I started in the nineties as a derivatives trader. Things in the derivatives market were quite interesting then, but I really cut my teeth in institutional investing at a large Canadian insurance company. At that company I was responsible for all aspects of fixed income, active management, and multi-asset portfolio construction.

If I think about my TDAM story that began almost 11 years ago when I joined the firm as an active fixed income portfolio manager, I really had two mandates. The first one was - be an active fixed income portfolio manager before institutional mandates. And two was grow the firm's ALM capabilities. So over that time these responsibilities grew.

I know about seven or eight years ago we thought about extrapolating or moving into private credit markets. So, I worked to help set up the private debt portfolio management team and later took responsibility for the passive fixed income team. In this new role, or maybe I'd refer to it more as an expanded role. What I'm really looking forward to is continuing to work with that same team, and this is the team that I've been working with for over a decade.

INGRID MACINTOSH: And you mentioned there Ireland management for our listeners, ALM is "Asset Liability Management" and that sort of institutional mindset of not necessarily being highest return seeking but trying to deliver on objectives. Could you just like give us a couple of seconds on that?

MICHAEL AUGUSTINE: Yeah, absolutely. It's all about objectives. I always say knowing our clients always comes first. Not every client's looking to solve for the same thing, but at the end of the day, they're trying to get an expected outcome. And I think that's applicable to all types of investors is really starting from what are we trying to solve for, and then gearing our strategies to.

INGRID MACINTOSH: That really if we're working with pension funds, were solving the retirement problems of many but those are different from our individual's needs. Want to pivot to late in the lane. Tell us a bit about yourself and your background here at TDM.

ELAINE LINDHORST: Ingrid, a reminder that my route here was a little different than Mike's. When you look back before to damn, I have a background in science, so I have an undergrad master's in Bio-chem. I worked in that industry for a little bit and then I came back to do a Masters in Business. And from there I interned in New York on Wall Street at one of the investment banks and returned there full time to their fixed income group.

So that was my entrance to fixed income. After a couple of years, I returned to Toronto and eventually landed at TD Asset Management. That was 2006. Ingrid, that's 17 years ago. And when you think of my role here at TDAM always been part of the active fixed income team. I started here, I had a focus on the short mandates, assured the money market funds, the liquidity and I've retained that focus throughout the time here.

When you think back to 2006, 2007, that's the last time we had interest rates where they are now. So four and a half percent overnight rate. We haven't seen that since the beginning of my time here. So really focused on these funds, managed them through the financial crisis, through COVID and everything in between. It's been a very exciting period of time here at TD.

INGRID MACINTOSH: It's incredible. I've been in the industry 35 years, and I started out as a fixed income geek as well. We certainly have seen so much change over time. I think. I think when people think about asset classes, fixed income tends to be fairly simple and straightforward. You buy bonds and they mature.

But can we talk a little bit about what innovation looks like in fixed income investing and how we do things here at TD Asset Management that might be unique when compared to other asset managers?

MICHAEL AUGUSTINE: So maybe the first thing I'd say and maybe some of your listeners would want to hear is that while I'm new to this role, our fixed income investment process remains exactly the same. As you know, we've been managing active fixed income at TD Asset Management, utilizing the same three guiding principles since 1994. You know, we do our own extensive credit research, confidently express this in portfolios, deconstruct the term structure of fixed income markets, and then perform strategic portfolio construction.

You know, the macro analysis informs our bond outlook, and it ends up informing our strategic themes. So again, no change there. And when I think about innovation, you know, I think about, you know, the phrase necessity is the mother of innovation. And late last year, we saw necessity come up when the Bank of Canada announced that it would be no longer issuing inflation protection bonds called real return bonds.

We were forced to innovate. There are a number of folks within the firm working together right now to look at alternatives. And these are different ways of providing our clients inflation protection, maybe synthetically, maybe utilizing a more global toolkit, recognizing the correlations between different asset classes. So, you know, in some respects what we're doing is we're innovating because the market's changed.

The other thing I'm thinking about a little bit more these days are the way we work, right? So, if we think about innovating the way we work, so one of the things that we want to do is amplifier credit research process. We have a talented team of individuals that know their individual credits really well. One of the things that we're looking to do is expand that knowledge base, have them provide more information on sectoral analysis, have them interact with the portfolio managers and recognize value add.

I think one of the other ways we're innovating, I would say, is the way we were utilizing our proprietary tools and getting the most out of the talent that we have.

INGRID MACINTOSH: And I think that focus on credit that you call out has been a hallmark of what we've done. You know, when you buy credit versus government debt, you get a higher rate of return for that. But it comes with the discipline. As you add that risk for return to our clients, I want to talk a little bit about the landscape that we've been witnessing in the land.

You touched on this. You know, we've really been in this lower for longer environment for the last 12 years, since the financial crisis, where we've had to innovate in different ways of garnering yield. And really for a long time, savers have been punished. The "low risk" has been punished. We've now had a quick pivot by the Central Bank, and it's hurt a little bit in 2022.

So maybe first, I'd love to explore, you know, sort of what you think about that landscape and the environment going forward for investors. And then also maybe we'll come back a little bit and talk about some of the other innovations we've had at TDAM in terms of seeking more yield through, you know, going down the credit structure into private markets, etc.

INGRID MACINTOSH: So maybe first let's talk about that interest rate environment.

ELAINE LINDHORST: Yeah. Ingrid So for 30 years we had low and stable inflation and when we think back to last year, last year was challenging. It's a challenging year for investors. We started last year, and inflation was elevated. We come through COVID. We had those COVID disrupted supply chains where we were at near full employment, and then the conflict between Russia and Ukraine really escalated. And that, of course, led to a spike in commodity prices in addition to the food and wage pressure we were already seeing. As we're all aware here, the central banks reacted by increasing interest rates aggressively. We saw the Bank of Canada move up to four and a half percent from near zero levels. The Federal Reserve did the same and for the risk-off assets, this was challenging.

We know that higher interest rates mean lower value for fixed income securities. But as we saw, these central banks really engage in their aggressive interest rate hiking cycle, we saw that risk off assets also decreased in value. So very challenging for investors, particularly so because the market response was up and down. We saw inflation peak then in the summer and we ended the year with optimism.

That was the market we really saw last year. And where we are now is that we have seen these interest rates take effect. Really the softer parts of the economy now are those that are interest rate sensitive. The question is, of course, where do we go from now? And the tone of last year, we have saw inflation peak, but we're not back at Target.

So that's really where we are right now.

INGRID MACINTOSH: And I think as investors, particularly if they had a fixed income allocation, they were getting outsized returns as rates were going down and then they were being punished with a scarcity of yield or return. And now we've had this price shock, but it's actually a good news story going forward for fixed income because we have more normalized yield levels.

So that's a great outcome. Michael, can you talk a little bit as well about some of the other levers we have at TD Asset Management to enhance yield in portfolios?

MICHAEL AUGUSTINE: Yeah, absolutely. I think I think you touched on one with private debt, and I think that's an exciting one. When I think about the fact that you can get safety, yield enhancement and diversification in an asset class that's complimentary to a public sleeve of credit, that's exciting. So, when you think about private markets, they're secured. You know, there's an asset behind the securities.

Unlike public markets, which are often unsecured yield enhancement, if you can pick up an extra hundred basis points for the same security just because it's uniquely structured or there might be a little less liquidity around it, that's a great trade off. And diversification. A lot of the deals that we're doing in the in the private space, you know, a bridge is not correlated to a telco, so you're getting inherent diversification.

So, a great lever to add value to portfolios. And you can see that in our core plus strategies, right? So, so if we think about providing the portfolio manager the broadest opportunity set when they can go into private markets, whether it's private debt, commercial mortgages, high yield and being a little bit more tactical, looking a little bit more global, these are all the levers that allows the portfolio manager to add value.

I think that's really important.

INGRID MACINTOSH: And I think that's a defining characteristic of TDAM's management as well in that some of those asset classes historically have only been available to large institutional investors. But through our product structuring, we able to bring those elements to every investor. I'm doing talk. Can we talk a little bit about investing for retirement or how our fixed income fits within our asset allocation accounts?

MICHAEL AUGUSTINE: Yeah, I mean, I could start, as Elaine mentioned, you know, rates repriced last year. You know, bonds are looking quite different than they have for some time. So, I think in some ways it's sort of back to the future. Fixed income can once again resume its role of adding incremental income and providing capital preservation within a multi-asset class portfolio.

You know, if we look at our last asset allocation piece, we are maximum overweight fixed income. So we definitely see a key role within asset allocation accounts for those with a retirement focus. Core fixed income strategies are now yielding roughly 5%. I know when I left my Bloomberg today, rates were up a little bit more. So it's really flirting with that level.

INGRID MACINTOSH: Should rates rise further?

MICHAEL AUGUSTINE: Right. There could be some capital losses, but these are much better offset by that 5% higher income offered by fixed income right now. I mean, tremendous asset for those with a retirement focus. I talked about core plus strategies. So again, I think right now there's many different fits for fixed income and a lot of interesting opportunities along the curve.

INGRID MACINTOSH: We said in our asset allocation strategies were max overweight and fixed income recognizing the risk reward tradeoff and within our fixed income strategies. Can you talk a little bit about where we are with respect to our view on credit?

MICHAEL AUGUSTINE: Yeah, so, so credit's interesting. We're late cycle, right? What we would be doing would be increasing the quality of credit that would set us up to take advantage should there be more recessionary conditions later in the year to redeploy into securities where we're better compensated for risk? It is interesting, we're eight weeks into the year it started off gangbusters, you know, risk on we saw a credit spread compression you know as active managers, though, we will look at that and sort of say, are we still getting paid for it?

And recently in WACC or our asset allocation piece, you'll notice that one minor modification that we made at the last meeting was to bring down the credit allocation from modest, overweight to neutral. So that really expresses where we think we are right now.

INGRID MACINTOSH: And everybody wants a crystal ball when it comes to central bankers. Are they done? Are they not? You know, following the last Bank Canada quarter point move, everyone said, okay, we're good. And now the Fed made their last move and we thought we were good, but not so sure what's from where you're sitting today. What's your gut say on the central banks and where we're going from here?

ELAINE LINDHORST: Everybody wants to know what's coming next when you think in the it's actually a little different for Canada versus the US when we think of Canada. Our central bank was very clear that they're now on pause. That doesn't mean that inflation has been one, the war, inflation's been one. We're not back at Target, but it really means that we have to wait and see the effects of the interest rates.

We have to see them work through the economy. And we know that takes time. That could take up to two years. So, for the Bank of Canada, yes. On hold right now, a pause. Inflation has not been declared low and stable, and that's still to come. So, at that point, what we see in the markets is the markets are also reconciling with this view.

So earlier this year, there was cuts priced in, but now in Canada, the market view is reconciled with what the central bank is telling us, that it's stable, it's higher rates for now. When we look at the Fed, as you mentioned, yes, they're indicating that they probably still have a couple more quarter point interest rate hikes before they're done.

And then I would expect that they also take a pause, and they wait to evaluate because these interest rate increases don't immediately work through to the market.

ELAINE LINDHORST: To be a lagged effect.

INGRID MACINTOSH: Having said that, central banks become very good at signaling intent. So even if the Fed were to go again, the market is likely to recognize that already and it's fully priced in or relatively priced in?

ELAINE LINDHORST: Absolutely. So, the market is very smart, and they have anticipated those hikes. Probably three more at this point.

INGRID MACINTOSH: We're not anticipating surprises at this point.

ELAINE LINDHORST: No guarantees. And that you're asking for that crystal ball, right?

INGRID MACINTOSH: I know you're a fixed income investor. You don't make bets.

ELAINE LINDHORST: You take calculated exposure. Got it. Probabilities.

INGRID MACINTOSH: Probabilities all it's all in the math. That's great conversation. Michael, we'd love to have you back more and more members of your team so we can keep exploring the different elements. One of the things we'd love to do on the podcast is wrap up with a bit of a lightning round and I'm going to throw some things at each of you and let's see where we land.

So lightning round. Michael: Credit spreads.

MICHAEL AUGUSTINE: Wider - so to probably those that we're just talking about. Again, late cycle, if I had to say where's the next 20 basis points move wider as opposed to tighter.

INGRID MACINTOSH: It's so adorable that we believe 20 basis points matters when equities go down 2% per day.

Elaine, are you aligned?

ELAINE LINDHORST: So, I would have said, "interesting," and then my focus would be really on the short end. There 1–3-year corporate credits are interesting at this point. When you think of, you know, how attractive the all-in yield is for very high-quality issuers. But I would caveat it is the short end too. To Mike's point, there is a bias to wider.

INGRID MACINTOSH: Big driver of what we've seen over the last year has been the global landscape. So, my next lightning round for you is: geopolitics.

MICHAEL AUGUSTINE: In the last Bank of Canada monetary policy Report, there were 11 references to Russia. Its attack on Ukraine continues to disrupt commodity prices and the economic outlook for European countries. It's really driving inflationary pressures in Europe and the impacts are going to weigh on growth. The other geopolitical term I'm hearing more and more is "friend-shoring."

This idea that you're going to bring back manufacturing either domestically or you're going to move it to countries that you're more aligned with philosophically. And either way, the cost of labor should rise, and this should generally be more inflationary. So, when I think about geopolitical, I think about that playing into this broader theme that we're trying to analyze right now, which is inflation.

INGRID MACINTOSH: And the trend is still some pressure on the inflation side.

ELAINE LINDHORST: I'm so glad Mike gets these questions first. I will say for geopolitics, I would probably say "changing." And I would focus in what Mike highlighted there. So there's security concerns, geopolitical rivalry, and that's causing globalization to reverse. And as Mike said, really, that could have significant economic considerations, this reshoring near- shoring, "friend-shoring". So something to focus and keep an eye on.

INGRID MACINTOSH: Which all plays back to the asset allocations view that all things being equal the risk reward favors fixed income currently versus the asset classes that are more vulnerable. Final one and you have to go first this time.

MICHAEL AUGUSTINE: You know that's what I was going to say…

INGRID MACINTOSH: So global debt levels, where are we?

ELAINE LINDHORST: Okay, global debt. Well, they still remain elevated. You can look at many aspects of global debt, but globally, public, private, they've remained high at year end. They've remained above the levels that they surged to during the pandemic. And one area of focus that we look at is the household debt. So, bringing that back home to Canada, household debt - Canadians remain very indebted.

ELAINE LINDHORST: Our debt to disposable income is one of the highest. So global debt levels on all fronts elevated but you know concern from that and when we look at the household in a higher interest rate economy, this will affect finances.

INGRID MACINTOSH: I'm not going to ask you the R-word, Mike, on the on global debt levels, maybe I will throw the resumption probability question at you as well.

MICHAEL AUGUSTINE: Yeah. I mean, I would echo what Elaine said. I'd say last year there were steep declines in global debt levels, but again, still high relative to pre-COVID. I think the other thing that's important is the change in debt levels are not equal across all the economy. So, you've really seen advanced economies have a greater amount of reduction in debt levels.

So, you know, I think like everything COVID, it wasn't homogenous and how it impacted different groups managing debt levels going forward is going to be a challenge. You know, central banks are doing it at a much higher rate level. So, I think fiscal policies will definitely have a role to play as well. So definitely one of these watch this space.

And if we're thinking about recession risks, I think we are in the camp that we will see a recession, but we don't see a deep recession.

INGRID MACINTOSH: So, nothing that's going to cause the central banks necessarily to quickly pivot back as they might have had to historically. So more of a soft landing into recession. That's fair. I think by the time we broadcast this again, let's get a little bit more human here. Let's get out of the bond land this week coming out around Oscars' week.

INGRID MACINTOSH: What are you watching these days like?

MICHAEL AUGUSTINE: So, if I think about what I'm looking forward to watching, you know, I grew up in the seventies, Star Wars generation, so the New Mandalorian on Netflix is what I'd like to watch. However, I have three kids under eight, so what I'll probably be watching is.

INGRID MACINTOSH: Something Disney.

MICHAEL AUGUSTINE: Shrek, follow up movie "Puss in Boots."

INGRID MACINTOSH: The new one that is not kid friendly and your kids are a bit older. What do you watch?

ELAINE LINDHORST: Well, so my kids are old enough that they can watch things on their own. So, I do have discretion what I can choose. And I'm going to have to throw "Ted Lasso" up there for anybody that is a TED Lasso fan.

INGRID MACINTOSH: I love Ted Lasso. And if you haven't watched "Shrinking" yet.

ELAINE LINDHORST: Oh, actually I'm in the middle of that.

INGRID MACINTOSH: Yes, yes, yes. Amazing. Thank you both for joining me today. I know that fixed income is you know, everyone thinks it's not as complex as equities. It absolutely is. And it really does hold the mantle of helping protect our clients' assets in the long run. And serve the needs that they have. I look forward to bringing you back, have more conversations on fixed income because fixed income time has come back.

Michael and Elaine, thank you for joining me.

ELAINE LINDHORST: Thanks.

MICHAEL AUGUSTINE: Ingrid - thanks.

ELAINE LINDHORST: Ingrid that was great.

INGRID MACINTOSH: And for our listeners, you can find a recently published asset allocation perspectives on the TDAMs asset management side, along with more of our latest thought leadership and also to receive the latest expertise and updates from TD Asset Management. You can follow us on Twitter at @TDAM_Canada and on LinkedIn at TD Asset Management. Thanks everybody. Have a great week and stay safe.