Fixed-income investors should look abroad

Canadian investors are biased toward investing at home, especially in the fixed-income arena. But looking beyond our borders can help generate income, says Michael B. Reed, vice president and institutional portfolio manager for the Franklin Templeton Fixed Income Group.

Reed notes $130 billion of Canadians’ savings are concentrated in Canadian fixed-income assets, while Canadian bonds account for only 2% of the global market.

“If you’re just buying that core fixed-income asset class in Canada, you have a lot of interest rate and duration exposure.”

This doesn’t mean investors have to flock to equities. Instead, global fixed-income exposure can mean “decent levels of income, as long as you’re willing to step out a little further on the risk curve,” he says.

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Reed suggests looking to peripheral Asian and European countries because cores tend to export production to them.

Another component of his strategy is using floating-rate bank loans, which can protect against the “heavy exposure to interest-rate risk” many Canadian investors are currently facing.

“They give you the same sub-investment grade exposure as high yield, but they float to a prevailing market rate. As rates go up, the coupon payment you get on those bonds goes up over time. So in a rising-rate environment you have a degree of interest-rate protection built into those securities.”

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U.S. unemployment numbers

The labour market remains one of the key cogs in the American economy, which has historically been about 85% service-oriented, Reed notes.

“About two-thirds of economic growth in the United States comes from consumer spending, so any time we see job growth, it’s going to be healthy for overall economic growth.”

Good news, given that the American economy contracted in Q4 2012.

Reed suggests paying attention to the impact of job growth on inflation, and longer-term rates, which to a degree are a reflection of inflation expectations.

He cites Milton Friedman, who argued high unemployment will lead to low labour inflation because there’s a lot of quality labour available.

Low unemployment has the opposite effect.

“Unemployment in the United States is still relatively high on a historical basis, which is keeping labour inflation very low. If we were to see a very strong contraction in unemployment numbers, it would likely push labour and overall inflation up, and this would likely have a feed-though impact on rates,” Reed says.

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