Manulife Yield Opportunities Fund: Commentary
January 15, 2021
Not all Bonds are Created Equal
Two weeks into 2021 the dominant narrative in financial markets remains interest rates. A steeper yield curve, higher inflation and musings of tapering have been headwinds for fixed income as an asset class. While the merits of this reflation trade can be debated, given prevailing market sentiment it will serve investors well to remember that not all bonds are created equal. Specifically, High Yield bonds and Leveraged Loans have outperformed the FTSE Canada Universe Bond Index (FTSE Universe) by an average of 7.6% during the last 5 periods where 10-year US Treasury yields rose more than 70bps. Indeed, given its heavier allocation to High Yield and Leveraged Loans during these periods, Manulife’s Yield Opportunities Fund has outperformed the FTSE Universe by over 8%, on average. So, while rates may rise further, let’s not throw the baby out with the bathwater – because Manulife Yield Opportunities fund has a well-established track record of generating solid returns historically, while managing downside risk, even when rates are on the rise.
Manulife Yield Opportunities Fund – A great strategy for a rising rate environment*
- Why have rates risen?: US 10-year Treasury rates have risen 60bps from their August 2020 lows on a mosaic of factors including a pick up in leading economic indicators; vaccine approvals; the elimination of US election related uncertainties; the election of a fiscal-policy-friendly US government across both the executive and legislative branch; and ample bond supply.
- Where are rates going in Canada and the US?: At 1.1% and 0.86%, 10-year US Treasuries and Government of Canada bonds are up 60bps and 40bps, respectively, from their summer lows. In our base-case, we see US and Canada 10-year rates rising to 1.5% and 1.15% with downside of 1.75% and 1. 45%.* Notwithstanding our outlook, we would caution that all interest rate forecasts are subject to revision, particularly given current wildcards such as central bank intervention, continuing COVID-related headwinds and vaccine roll-out challenges.
- What have we done to position the Fund for a rising rate environment?:
- Reduced duration to roughly 3 years, compared to the FTSE Universe at 8.3-years
- Reduced Investment Grade and Government bonds to near historically low weights
- Increased Floating Rate Loan and Equity exposure
- Maintaining 48% allocation to High Yield, Leveraged Loans and Emerging Markets
- Increased our USD hedge ratio to 94%
- Increased Cash to roughly 9%
- We implemented similar changes to our Manulife Corporate Bond Fund as well
- How have we performed during previous rising-rate environments?:
- Since 2010 there has been 5 periods where rates have risen over 70bps. On average, the rising-rate cycle has lasted 10-months and the average increase in 10-year US Treasuries has been 106bps. As it stands, we are 5-months into the current rising-rate cycle with 10-year US Treasuries up over 60bps from their August lows – about halfway through the average cycle.
- In all 5 periods, Manulife Yield Opportunities Fund has generated positive returns. While the FTSE Universe Index has averaged a -1.3% return through these past cycles, Manulife Yield Opportunities Fund has averaged a 6.8% return, for an outperformance of over 800bps! – see charts below.
- With 75% of the fund currently invested in less rate-sensitive asset classes, we expect continued outperformance through the remainder of this rising-rate cycle.
* Source: Bloomberg
(Roshan Thiru, Head of Canadian Fixed Income Team)
*all data is as of market close, January 14th, 2020, unless noted otherwise