Effective portfolio positioning is proactive, done ahead of anticipated developments. Without anticipation, the opportunity for investment returns may have already sailed. This idea was the foundation of my March 12, 2024, Market Insight, “Fixed Income: Get on the Ship Before it Sets Sail.” The key message was clear: Canada’s economy was decelerating faster than many others globally, signaling an imminent global rate cutting cycle. The Bank of Canada was expected to be among the first to lower interest rates, leading the fleet.
Naturally, such shifts always invite healthy debates:
- When will rate cuts begin?
- How fast will they happen?
- By how much, 0.25% or 0.50%?
Rather than getting caught up in these questions, we focused on ensuring our portfolio was positioned to capitalize as events unfolded. Here’s how our strategy was articulated:
- Term/Duration: We adopted an overweight position to capture capital appreciation as rates declined.
- Credit/Corporate Bonds: We were underweight in this area. The yield premium in corporate bonds wasn’t sufficient to compensate for the economic uncertainty on the horizon.
- Curve Exposure: A barbell strategy was employed, balancing short and medium-term bonds which offered attractive yields, complimented with long bond exposure that stands to appreciate most when rates drop.
My intent in writing that piece was to address the opportunity cost faced by those invested in high-interest savings accounts and GICs. While rates on these instruments seemed appealing, the tail winds favoring a fixed income portfolio were stronger. With a healthy current yield of 4.0% and potential capital appreciation as rates fell, bonds, especially longer duration ones, were poised to outperform. If the term duration is unfamiliar, it simply refers to bonds that stand to gain the most as rates fall. This combination of yield and capital appreciation illustrated why a fixed income portfolio was a better long-term investment position than GICs or savings accounts. Ultimately, those who chose GICs may be left on shore, watching the ship sail away.
Fast forward to today and the story is playing out as expected. Matco’s Diversified Income Fund has delivered a 9.9% over the past twelve months. But how much of this journey is complete? The Bank of Canada has indeed cut rates twice, signalling that the ship has lifted its anchor and set out for the waters, but it’s still not far from the port. Looking ahead to the end of 2025, we anticipate another five rate cuts, bringing the overnight rate down from its current 4.50% to 3.25% Admittedly, this is an estimate-no one can predict the exact magnitude or pace of rate changes. The most important takeaway is that rates are likely to continue moving lower, and bonds will continue to benefit if properly positioned.
So, has our portfolio changed since Q1 when I wrote the previous insight? For the most part, we’ve stayed the course and are riding the same current. However, with the U.S. Federal Reserve trailing the Bank of Canada in cutting rates, their ship is yet to leave the port. We view U.S. Treasuries (the American counterpart to Government of Canada Bonds) as currently more attractive. Since the first quarter, we have added a long U.S. Treasury exposure to the portfolio to benefit from both the Bank of Canada’s and the U.S.’s rate cutting cycles.
As we look ahead to Federal Reserve Chair Jay Powell’s speech at the Jackson Hole Economic Symposium this Friday, the market anticipates hints of the Fed’s first rate cut on September 18. Powell typically keeps his cards close to his chest, often referencing their “data dependency approach” to avoid signaling policy moves too early. However, recent soft employment data in the U.S. may prompt more balanced remarks, leaving the door open for September’s rate cut.
If you’re still holding GICs or high-interest savings accounts, it’s true—you may have left some returns on the table. While no investment is without risk, the Diversified Income Fund continues to offer a 4.0% yield with potential for further capital appreciation if rates continue to decline, as we expect they will.
