Managing Director explains how indexes and active strategies can be used to capitalize on new dynamics in fixed income
The fundamental changes we’ve seen in fixed income since 2022 are, in Rachel Siu’s view, the beginning of a new golden age for the asset class. The Managing Director and Head of Canada Fixed Income Strategy at BlackRock says that the regime shift in central bank policy since the end of the pandemic and the onset of higher resting inflation has resulted in an environment where fixed income assets actually pay meaningful income again. Despite this shift in utility for the asset class, Siu still sees trillions of dollars sitting in money market funds globally. She argues that a new approach to fixed income can help encourage that capital back into fixed income assets.
Siu explained that BlackRock’s approach can be seen as a pyramid, with the three core uses of fixed income serving as tiers to that pyramid. At the base is the use of fixed income as an equity diversifier, often through core bond holdings. The second tier is stability across different market environments. The top tier is income. She argues that in a moment when fixed income yields are higher, but fixed income volatility is elevated as well, a blending of index and active strategies can help advisors optimize each tier of that bond pyramid.
“The yield environment today actually does allow advisors that opportunity to build income in their portfolios without necessarily needing to extend overextend on risk. You know, we were in a period for many years where interest rates were very, very low, zero, even negative in certain regions. And you know, in this last cycle, we've actually seen that. Clients can build a portfolio yielding four, five, six percent without needing to go too far down the credit quality spectrum. Or take on a lot of duration risk,” Siu says. “There is a lot of divergence, a lot of dispersion for us, but this does spell opportunity as well… whether it's through an index implementation or for an active manager doing security selection or country selection to try to deliver excess return.”
In looking at how advisors can approach fixed income markets, Siu explains that BlackRock does not see competition between index and active strategies. Instead, they see roles for both approaches in a portfolio. Index-tracking strategies can serve as an efficient way to gain core exposure to a major index, such as the FTSE Canada Universe Bond Index. That single-ticket exposure to roughly 1,800 bonds offers a mix of sectors, of jurisdictions, and of credit ratings often with a very low management fee. She notes that Canadian advisors are often facing a struggle to scale their offerings and that index-tracking core bond ETFs can help them with that scale, offering a robust platform from which they can add more targeted alpha-driving strategies.
That push for alpha, Siu says, may come more from active funds. She notes that active fixed income ETFs can be especially helpful for investors seeking income. Given Canada’s relatively small position in the global fixed income universe she argues that active managers can use a far wider menu to find that income. BlackRock’s active strategies, she explains, are often income-maximizing through global bond sectors. Often these fund managers will seek asset classes that are less available in Canada, like credit markets outside Canada and the US, securitized products, and mortgages. These are often asset classes that come with some risk and volatility, so a nimble manager can help manage some of those risks and shift quickly to capture upside where it presents itself.
Those active strategies, notably, often have little to no overlap with a core Canadian index-tracking product. Siu believes that by minimizing overlap between index and alpha advisors can deliver a better balance of exposures to their clients.
While active continues to grow in its specificity and sophistication, Siu accepts that indexes have become more sophisticated as well, especially when it comes to duration targeting. She notes that many clients have told her firm that they want to be more precise about exactly where on the yield curve they’re allocating funds. Last year, BlackRock launched a product called XSMB which shortened the duration on Canadian bonds by excluding everything above a 10-year maturity date. Advisors can select from the index side of their fixed income allocation how much duration they want to hold.
Underpinning Siu’s belief in this new golden age is an acknowledgement that fixed income volatility is now higher than it was pre-COVID. She argues, though, that by rooting fixed income returns in income and combining traditional benchmarks with active strategies, advisors can open up these opportunities for their clients.
“For all the volatility that we saw last year bond ETFs actually had a record year in terms of inflows globally and in Canada. I think this really underscores the strong demand that we see from investors. To take advantage of this golden age of Fixed Income outlook right to capitalize and lock in these yield levels,” Siu says. “I think the message is. Focus on your investment objectives, whether it's capturing income or it's adding more core exposures for portfolio diversification. I think thinking about that will be a big focus for how we see investors utilize Fixed Income outlook in the new year and ahead.”
