All Duration isn’t Created Equal:
An interview with global fixed income portfolio manager John Beck

Ahmed Farooq, CIMA®, CFP

Ahmed Farooq, CIMA®, CFP
Vice President - ETF Business Development at Franklin Templeton Canada

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It has been a challenging time for fixed income investors so far in 2021. During the first quarter, inflation expectations in the United States saw U.S Treasury yields increase by 81 basis points, spurring a huge sell-off in bond markets.

We are in the midst of a global pandemic, but the outcomes for different regions have diverged widely—contrast India today and the U.K. for example. The global economic recovery will remain uneven, so fiscal and monetary policies will be far from uniform across jurisdictions. Duration risk will vary as a result, which is a key consideration for the investment team of Franklin Global Aggregate Bond ETF.

Launched in May of 2018, this ETF incorporates top-down macro views and bottom-up analysis to find the best opportunities, as portfolio manger for the strategy, John Beck, explained when we met this week to discuss the current investment climate.

Ahmed: After an extreme sell-off in fixed income markets in the first quarter of 2021, do you expect further inflationary pressure throughout the rest of 2021?
John: I think reopening economies will increase inflation pressure, but one of the key aspects is really how central banks respond to that. The lessons that central banks have learned through lots of previous crises is that they are going to be very tolerant.

Ahmed: How has the Franklin Global Aggregate Bond ETF team responded to the recent turbulence in fixed income markets?
John: The advantage of a global fixed income strategy is that it allows you the opportunity to diversify into markets where you think the opportunities will be greater, which I think we captured very successfully in 2020. In a more difficult environment in 2021, we have tilted the portfolio into areas where we think interest rate changes are less likely. Therefore, the simple mathematical link between rising yields and pressure on prices is going to be reduced.

Ahmed: Where do you see those opportunities at the moment?
John: Fixed income had a more difficult start to 2021 than we anticipated. Our focus this year has been to shift some of our interest rate exposure, taking out our exposure to the 10–30-year part of the yield curve, which we think will be more affected by interest rate adjustments. In other words, taking a slightly more defensive strategy.

Ahmed: When you say defensive, how is duration risk dictating how you rebalance the fund? 
John: We are being more defensive in markets where we think the economy is closest to being able to restart. At the height of the pandemic, there was a desire for safety, and that traditionally means the areas of U.S. Treasuries, German government bonds, U.K. Gilts and Japanese government bonds. We are materially underweight in our interest rate risk in all four areas. While our duration overall in the U.S. is similar to that of the benchmark (Bloomberg Barclays Global Aggregate (100% Hedged into CAD) Index), the composition is radically different—our duration contribution comes from corporates (Investment Grade and High Yield), which are much less sensitive to increases in the risk-free rate in Treasuries and carry a higher running yield. We also have some Sovereign Emerging Market exposure where there is little, none, or occasionally even inverse correlations to moves in U.S. Treasury yields.

Ahmed: The U.K. has had a pretty successful vaccine rollout, while the EU has lagged somewhat in comparison. How has that affected your strategy?
John: In the U.K., where the pubs and cafes are opening in mid-May, we have exposure only in the shortest maturities in 2024 and are at no risk from any threat of the yield curve steepening if the Bank of England ignores inflation risks. Our interest rate risk in the U.K. is half a year shorter than the benchmark. In Europe, our exposure had been longer as growth was weaker and the commitment of the ECB to keep interest rates unchanged was the strongest. We concluded that while the economic case for higher yields might have less justification, from a pricing perspective, we believe that the spread compression in Spain and Italy—where our exposure had been longest—has now run its course. So not only are we underweight the risk-free core markets in Germany and France, but we have significantly reduced our interest rate sensitivity in Italy and Spain, having locked in the gains achieved in 2020. Our longest dated bonds in Europe are pretty much confined to 10 years (maximum) and below.

Ahmed: And how about here in Canada?
John: We couldn’t really be much shorter in our Canadian bond exposure—we hold one bond maturity for June 2022. Overall, we hold about 10% of the portfolio in cash, and of course cash has zero duration. Bottom line, we’re defensive, and if rates do spike on an inflation scare, it gives us scope to react, much in the same way as we did in March of last year during the significant dislocation.

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What Are the Risks?

Commissions, management fees and expenses may all be associated with investments in ETFs. Investors should carefully consider an ETF’s investment objectives and strategies, risks, fees and expenses before investing. The prospectus and ETF facts contain this and other information. Please read the prospectus and ETF facts carefully before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses and other factors. The indicated rates of return are the historical annual compounded total returns including changes in share or unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. ETFs are not guaranteed, their values change frequently and past performance may not be repeated.

Ahmed Farooq’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.