Never Satisfied

We have the ability to seek out the best investment opportunities around the globe and the flexibility to invest in a variety of sectors, across credit qualities and up and down the capital structure — we like to say, ”the world is our oyster.” From a top-down perspective, we have developed a scorecard that measures 300 to 400 variables for each of the asset classes in our investment universe. Some of the variables include GDP, housing, employment, current accounts, and /or credibility of a central bank. We use this framework to help allocate assets, focusing on yield, quality, stability and total return in a relative context.

We divide the world into three buckets. The first is U.S. Treasuries, agencies and mortgages; the second is U.S. high-yield and investment-grade credit; the third is the foreign bucket, including developed and emerging markets, both governments and corporates, in hard and local currencies. We consider what each has to offer in relative terms over a three- to six-month timeframe, and make a judgment on where to allocate capital. We want to make sure that we maintain fixed-income volatility but seek the best risk reward opportunities throughout the globe, and deliver the best possible return for that level of risk. The volatility of the strategy has historically fallen between four and eight percent, which is more in line with high-quality fixed-income assets than high yield or emerging markets debt. It's taking a fundamental approach to seeking out relative value but using a risk-managed approach.

In managing a global fixed income strategy, there are four key risks that we must monitor: interest rate, credit, foreign exchange and liquidity risk. Today, these risks are heavily impacted by an uncertain global economic environment and a market focused on central bank policy. With regard to interest rate risk, we believe the U.S. will lead the charge in raising interest rates, so you have to be careful where you tread. Japan and Europe will probably be the last to raise interest rates. Looking at credit risk, you better understand what you own. You need to know the management teams, the company's financial statements and its ability to generate cash flow, the capital structure and covenants, and understand the industry and company growth trends. In managing foreign exchange risk, not all currencies move the same way. It is important to understand how they move against each other. Lastly, for liquidity, inventory at the banks has diminished significantly. We have to understand how we source bonds and at what price. Relationships here are key.

Our dynamic sector allocation approach is the primary driver of return and a key part of the strategy's investment process. Today, we find asset classes that benefit from a rising rate environment and a global recovery attractive. Those include high yield, emerging market government bonds and other emerging market credits. An example of a yield pick-up in an emerging market could be a government bond in a market with improving credit fundamentals. You can extend duration but have a potential credit upgrade, so it's really less duration sensitive while earning incremental yield. As global growth improves, the bonds can actually perform well even if rates go up.

Another example is bank loans. They are high in the capital structure, so you have less credit risk. Even though the credit may be below investment grade, you have a better claim on the assets, they pay an incremental yield that makes sense relative to Treasuries, and they have optionality on higher interest rates.

The strategy must maintain a minimum average rating of triple B minus or better, so the portfolio has to be investment grade. We can dip down into high yield and emerging markets, but there has to be a balance with other high quality securities. In addition, we implement the portfolio with physical bonds, which translates into a transparent approach so investors can really understand how we're positioned.

We consider ourselves risk managers first, bond managers second. Our strategy has delivered attractive returns and limited downside, but it's also not taking on a tremendous amount of volatility risk. We have historically been successful in reducing volatility by having guidelines that seek adequate diversification at the portfolio level as well as the individual security level. Two examples of how we mitigate volatility and liquidity risk are position sizes and sell discipline. First, we are careful about the size of our credit positions, and we limit ourselves to holding 1.5% or less in a given issuer. That way, we can get some yield, but do not take on too much risk because the size of our position is manageable. Second, we are quick sellers. In high yield, for example, there are asymmetrical risks, and when there is bad news, a bond can fall very quickly. If our analysts are uncomfortable with a situation because the original investment premise has changed in a negative way, we will sell the bond first and ask questions later.

Our portfolio is of a size that allows us to be nimble and maneuver effectively, and our smaller position sizes help us with liquidity. We also diversify, because correlations in each of our asset classes are not necessarily one to one. By making certain asset allocation changes that capture major market trends of each one over time, we can mitigate some volatility.

There are direct and indirect ways to manage interest rate risk. Direct ways include lowering the overall duration of the portfolio or buying floating-rate securities and inflation-linked instruments. Indirect ways include securities that have less correlation to rising interest rates. For example, if rates are going up because the world economy is getting better, then you can allocate into securities that benefit from improving credit but that are less sensitive to rates. Emerging markets and high yield are two examples. On the currency side, there might be one country raising rates faster than another, so you can buy that country's local currency bonds and get a strengthening currency to mitigate some of that duration risk.

Our immediate team has six investment professionals. We have three portfolio managers for the global multi-sector fixed-income strategy whose strengths complement each other through their experience in global bonds, asset allocation, currencies and interest rates. Two of us were traders at one time, with a more market-intensive background. Another member has an extensive credit background, which helps with position size, understanding covenants, liquidity, and tactical strategies. The other three team members assist with sovereign debt, asset allocation, cash management, foreign exchange hedging and trading. At the firm level, the team is also supported by over 50 Manulife Asset Management analysts in North America and Asia, spread across 13 regional markets, specializing in a sector or asset category, and handle the intensive credit work and modeling.

We tap into that wealth of knowledge globally, so we have a good, well rounded view of what's going on in the world. It's a dynamic process in which we challenge ourselves to make continual improvements. Our motto is never be satisfied.

This material is solely for informational purposes and shall not constitute a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. The opinions expressed herein represent the current, good faith views of the author at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The information herein has been developed internally and/or obtained from sources believed to be reliable; however, neither Manulife Asset Management nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. The information herein may contain projections or other forward looking statements regarding future events, targets, forecasts or expectations, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this material, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Neither Manulife Asset Management nor the author assumes any duty to, nor undertakes to update forward looking statements. No representation or warranty, express or implied, is made or given by or on behalf of Manulife Asset Management, the author or any other person as to the accuracy and completeness or fairness of the information contained in this presentation and no responsibility or liability is accepted for any such information.

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