Discussing Corporate Credit: A Q&A with Portfolio Manager Adrienne Young

Ahmed Farooq interviews FLCI Portfolio Manager Adrienne Young.

    Ahmed Farooq, CFP,

    Ahmed Farooq, CFP,CIMA® Vice President - ETF Business Development

    As outlined in my previous blog, Canadian advisors who see risks on the horizon are increasingly looking for actively managed fixed income solutions. Our Franklin LibertyShares Investment Grade Corporate Credit ETF is a testament to the growth in this space as its one of our fastest growing actively managed ETFs. It recently surpassed its $100m AUM milestone.

    Since I have been on the road over the past couple of months visiting advisors with some of our portfolio managers, I thought it would be good to address some of the common questions I’ve received in a blog post. So, I sat down with Adrienne Young, Portfolio Manager (FLCI) to get insights straight from her and the Franklin Bissett Fixed Income team.

    Why is active management important in the fixed income space?

    2019 saw a pretty broad rally across many markets but looking to the year ahead I see a number of factors that present risks. First, credit spreads are historically tight across all credit ratings and virtually all industries. This combined with a Canadian economy that is projected to slow down means investors can’t expect a rising tide to continue to lift all boats. Investment managers who pick and choose based on good fundamental and technical research stand a better chance of outperforming.

    Liquidity is also a concern. Although the Canadian market has always been less liquid than the US market, both markets are currently less liquid than they were. In periods of market dislocation, it is especially important to be invested in assets that are chosen through thoughtful analysis. Otherwise, investors may find themselves owning bonds that cannot be sold easily and can consequently see outsized mark to market losses and wider bid/ask spreads.

    Why are advisors looking for exposure to Canadian Investment Grade Corporate Credit?

    We are in a prolonged cycle and equity returns could, at this point, become more volatile than bond returns. So, investors with lower risk tolerance probably want to reevaluate their equity and bond allocations. Within the bond market, they can be invested in government debt or corporate debt. For investors facing uncertainty around interest rates going forward, corporate credit spreads offer a useful cushion against the risk of rising rates. In fact, Canadian corporate bonds historically performed well relative to other fixed income sectors in rising and falling interest rate environments.

    Bonds in general and FLCI had great performance in the past year and some investors may fear they have missed the boat. Why should investors consider it now?

    Yes, FLCI was up 8.1% in 2019 – which is great1. It is probably optimistic, though, to expect investment grade bonds to generate similar numbers in 2020. This is where the value of active management comes into the picture. As we are in a remarkably long economic cycle in Canada, investors should look for a fund that has as many options as possible to help navigate what we see as an increasingly complex environment. FLCI can invest in a discriminating way across sectors, across issuer curves, within the index and in the maple bond market as well. You want a fund that can overweight management teams that are looking to upgrade credit quality, underweight teams that are less concerned with maintaining credit quality. Furthermore, Canadian bonds continue to experience strong demand from international investors, as they continue to generate higher and more stable yield than their counterparts in a number of other developed markets.

    Investors should also consider the benefits of a fund that can adjust duration in anticipation of macro conditions. A fund that can adjust by going overweight A or AA credits in anticipation of a weaker economy or BBBs in anticipation of a stronger economy. Or a fund that can shorten duration in anticipation of market weakness or lengthen in anticipation of strength. FLCI can do that. And if you want even more flexibility, FLCP and FLSD can also invest in non-Canadian markets, have an even wider variety of options: US IG, US high yield, US corporate loans. And we use currency hedges and credit hedges in those funds, as well, giving us the maximum number of options to improve risk-adjusted return.

    We are also seeing sell side analytical support shrinking pushing the buy-side shop to do more – so you need a firm who is equipped and experienced to do it. At Franklin Bissett we have always done our own analysis, whether that’s meeting with management teams, building our own ranking sheets and models, doing our own analysis of industry conditions, management teams, management strategies, ESG risk etc. around the world. You want a team that has experience doing this and continues to do it on a global scale to do it efficiently, allowing you to minimize the fees your clients pay.

    How accessible is corporate debt right now?

    New issues, both in Canada and in the US, are consistently oversubscribed. 3-4x oversubscribed is quite common, as we near the end of the year. As a result, allocations are often very poor. It is not unusual to ask for $20MM and get $5MM, for example. In this environment, you need to have good relationships with debt capital markets teams and with issuers. And you need a research/trading process that includes “reverse inquiry” – that is, asking banks and issuers ahead of time for the issues one wants in order to get a better order fill. This requires significant research time and significant time from trade desk staff as well, but it works. Because it works, at Franklin Bisset we make it standard practice.

    Given the risks in the market, how are you managing risk within FLCI?

    We rely on our fundamental research and selection process to identify likely trends and risks, and, with that work done, to identify corporate sectors and issuers and bonds we think will outperform. We try to limit our exposure to less liquid bonds. We also actively manage our duration and yield curve positioning. This means we regularly review and manage our exposure to corporate sectors, issuers, securities, adjusting positions as needed. Sometimes daily, if required although we try to minimize transaction costs, so will never trade just for the sake of trading. Where we see attractive opportunities, we also invest outside the Canadian index to diversify our portfolio, taking advantage of our global team and infrastructure.

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    ENDNOTES

    1. Annualized NAV Returns in 2019 as of Dec 31st 2019. Past performance does not guarantee future results.

    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.

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