February 04, 2021
An interview with Marc Goldfried, Chief Investment Officer and Head of Fixed Income at Canoe Financial
Colin Andrews and Greg Kraminsky of The CM Group connect with Marc to discuss, what the fixed income market is and, how does it trade? What are the pitfalls of excessive risk in fixed income holdings, and what should you do about it?
For the full interview please listen to the most recent CM Group- Free Lunch Podcast, Episode 37 “Fixed Income Facts with Marc Goldfried”.
Colin and Greg: Can you tell us just a little bit about the size of the bond markets globally? A lot of people, I think, don’t really understand how big the bond market really is. So maybe you could just put some perspective around that to get started.
Marc: So the bond market, just as a being, as an entity is huge, probably nine or ten times the size of the market capitalization. I'm going to be giving you guys weird, crazy numbers. But when we even talk about negative sovereign negative government yielding debt at number 17, 18 trillion dollars, and if you think about the bond market, is the public market for all borrowings that happen at either the corporate, the government, municipal, provincial level all around the world. So it's multi, multi, multi trillions of dollars with massive amounts of liquidity in certain parts of the market, less liquidity in other parts of the market. And it's varied.
There's all types of risk. Buying a government bond generally means you're guaranteed to get paid at the end. Buying a corporate bond, you get paid more to be in a corporate bond because it has more risk. It's a promise to pay. And that's where portfolios are constructed and defined. It's a large, large market.
Colin and Greg: Well, that's interesting, because when you turn on the news at the end of the day, what do they show in the news? They show where the Dow Jones is, where the TSX is. They talk about I don't know where the Canadian dollar is, the price of oil, maybe they might mention gas, but nobody ever references the bond market in the news. So in your seat, that must seem strange?
Marc: First off, let's all agree the bond world is a lot less sexy than the equity world. Let's also agree there's a truckload of actual math behind how yields are calculated, how prices are calculated, how prices move, and the inverse relation to their yields, i.e., when yields go down, prices go up and the opposite, when yields go up, prices go down. I think it's just it's a difficult structure for people to get their head around. The other thing is a stock market is what we call an actual market. It's a tech market. So every time stock trades, it's volumes are reported. We know where it finishes at the end of the day at 4:00. Very easy to get your head around that.
Colin and Greg: In March of this last year, there were investors who said, well, look, the stock market was down thirty five percent in 14 days or whatever it was, and the bond market went down as well. So, see, like I wasn't safe. Why didn't it protect me? Can you comment on that?
Marc: Yeah, absolutely can. So let me just back up a step. And what I'm going to say is something similar to what I said before. The bond market is not commodities. Not every bond is exactly the same. And we have government bonds. And just real briefly, government or federal government of the United States, the power of taxation and have a central bank that can print money that has confidence from the rest of the world. So when the United States Treasury issues a bond or the government of Canada issues a federal bond, you can pretty much say that your principal is good and your interest is good. So there's no doubt you're going to get your money back. And the interest rate that is paid on that at the government level is really for market participants like myself that decide based on the future economic fundamentals of the country and how much inflation, how much yield do we need. So a government bond is what we call risk free bond. OK, so that's a triple-A rated bond. Then you got a provincial government, for example. I don't think anybody on this phone call is going to come to the conclusion that we expect a provincial to default. But we have to remember that although a provincial government can tax or state government in the United States and taxes don't employ a central bank and they don't have frontier currency reserves, so there's an element of credit risk and there is a chance for me lend money to a province or a state of California, whatever, that you could lose money. It's very, very unlikely. Now, let's move to the next set. Investment grade corporations, big banks, big pipeline companies, big utilities, they also borrow. Now, when they borrow, they provide us what's called a prospectus. And there's a bunch of what we call covenants, which are protections of the bondholder. But in essence, when I lend money to a corporation or province, they are providing me a promise to pay. So I'm going to require premium over what I would get out of the similar maturity. So if I'm buying a 10 year government bond, I'm getting one percent. I'm buying a 10 year bank bond, I'm getting one and a half percent. It's probably different numbers, but I'm just trying to throw it out there just to make the difference. And that extra 50 basis points I'm getting is compensating for the credit risk that I'm taking. So now you're talking double A and single bonds and you get a triple B for Husky Energy or Suncor. Now their business is to produce gigantic amounts of cash flow but are tied to a singular commodity and they can have real changes in their business fundamentals. So I'm going to get an extra 100 basis points for Suncor. Now I'm investing a two percent as opposed to one percent, but I'm taking credit risk.
So I think what happened in March is that a lot of clients bond portfolios, although hitting all the necessary notes on a compliance basis, i.e. they own fixed income and it is the downside protection had a lot of exposure to be rated credit, a lot of exposure to high yield, a lot of exposure, floating rate loans. And you think about like they were absolutely paid to do that. They needed to lean into more amounts of risk because of the structure that has been in place for the last 10 years. As monetary policy authorities have continued to ease and ease their policy in an effort to keep the economy at least producing two, two and a half percent growth and keeping deflationary pressure from entering the mindset of market participants. If you lose your inflation expectations, i.e., if inflation goes away completely, you'd become Japan. That's not a bad place to live. They produce lots of growth, I should say. They grow every year. They produce lots of economic output every year, but there's no inflation there and there's no capital investment and there's lots of trouble that happens with that. So really, to back up quickly and get back to the original question was and I just went on a stairway to Heaven.
For more questions and answers with Marc Goldfried please refer to our Podcast.
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-The CM Group