A progressive approach to fixed income

Fixed-income securities often make investors skittish. But veteran fixed-income portfolio manager Christine Horoyski has a strategy to ride a predicted interest rate rise.

An active manager presiding over a bond portfolio, she uses short-duration notes and keeps constant vigilance. “Don’t be afraid to go back into the bond market. There’s a reasonable valuation building now,” she says.

Horoyski joined Aurion Capital in 2003 and is now senior vice-president and head of fixed income. With more than 20 years’ of portfolio management experience, she manages $2.3 billion, including pensions for Shell and the Electrical Safety Association, as well as other retirement accounts, foundations, endowments and wealthy clients.

Much of that money stays in Canada, she notes, as high-quality bond and corporate markets make it easy to invest at home.

“If we’re investing outside Canada, it really has to be a compelling opportunity,” she adds. Exceptional yields, maintaining diversification, or a view on the price of a particular bond may prompt her to send money abroad. Since 2008, she’s also managed the Dynamic Aurion Total Return Bond Class, which has an AUM of $199.7 million. Its compounded rate of return over the last three years is 4% (so $10,000 invested in January 2008 is worth about $11,074 now).

Horoyski manages retail and institutional money differently.

Institutional investors look for returns over an index, she says. Since they’re in for the long-term, they’re more willing to have duration exposure than her retail investors. The retail fund, meanwhile, is focused on absolute return. That allows her to make off-index investments and take more credit risks, so she looks to corporate or high-yield bonds.

What do you think is the future of bonds?

In an uncertain environment, you have to approach bonds as an active asset class. Bonds aren’t cash; nor are they buy-and-hold investments. The bond market actually trades with higher volume and larger ticket size than the equity markets. But most traders are institutional and pension clients.

It’s not a market that is broadly disseminated. You can’t really get a good quote on live prices. So bond managers make trades based on their interest rate views. In January 2014, the bond market had a very good month because interest rates fell by 40 basis points. Most managers would be trimming some of their bond exposure to lock in those gains and to raise some cash. I’ve been selling. I’ll shift my exposures down into the shorter end of the bond market, or into cash or floating-rate notes as I wait for better opportunities. Active bond managers take positions ahead of big economic data and rebalance after.

Will you keep trimming?

The macro event that’s driven the market has been quantitative easing. Once we saw the expectation for tapering, that told us the artificial lowering of bond yields was ending. So, we have to take steps early to preserve capital when interest rates rise. We’re reducing our exposure and focusing on when we expect policy to change.

Do you hold a fair amount of floating-rate bonds?

We do. Floating-rate notes are bond securities with a coupon that’s reset typically every three months based on the overnight rate. Because of that coupon reset, they have very little interest-rate sensitivity, or very little duration. We use them as a substitute for cash—it’s what we invest our cash proceeds in.

Dynamic Aurion Total Return Bond Class

• Corporate bonds (CDN) 48.6%
• Foreign bonds and debentures 21.8%
• Common stocks (U.S.) 9.9%
• Cash, short-term investments and other net assets 7.6%
• High-yield bonds (CDN) 5.7%
• Provincial government bonds 5.6%
• High-yield bonds (foreign) 0.8%

Source: Dynamic Aurion Funds, as of Feb. 28, 2014.

Corporations typically issue floating-rate notes. For investment-grade corporations, you get 1.25% to 1.4%. In the non-investment grade, these tend to be leveraged loans and they are, like other high-yield instruments, between 4% and 4.5%. But they come at the expense of having lower credit quality, so we do credit work, which is similar to what an equity manager would do.

How long do you hold securities?

Our pension clients tend to have a 20-year or 30-year liability, but our investment style is active. That doesn’t mean we change our portfolio every three months. Every couple of months we’re retesting our thesis. That’s part of the reason we have a fairly short time horizon. It’s also because the fixed-income market changes quickly. Our new-issue counter is much more active than the IPO market. We typically have one or two new-issue corporate deals a day.

We participated in an interesting offering recently—Banco Santander-Chile. It’s a three-year, 4.5% yield with an ‘A’-rated company. We maintain a fairly prudent allocation policy of 1% to 2%. Because this was a less-liquid position and it’s in a foreign market, we limited ourselves to 1%. Typically, domestic bank exposure averages 2% to 2.5%. We have, on average, a 60% corporate weight and we have between 50 and 60 individual issuers.

Do you focus on particular sectors?

We stick to high-quality names: the major banks and insurance companies, large pipelines, utilities and telcos, as well as major consumer staples like Loblaw. We wouldn’t overexpose our portfolio to one issuer, or any one sector.

Real estate has been issuing a lot of bonds lately. You can buy subordinated debentures from a REIT, or invest in a mortgage bond or a mortgage. Commercial mortgage-backed securities (CMBS) or asset-backed securities (ABS) were one of the catalysts for the crisis in 2008. The real estate backing those securities was the issue, so we ensure the quality of the mortgages and the real estate assets are solid. The structure in Canada for CMBS is different than it was in the U.S., and it gives us more protection as a bondholder.

During the crisis, we didn’t have any U.S. ABS or CMBS, so we didn’t have any defaults. It was a sell-off in corporate bonds, which we were underweight in, and a big rally in government bonds, and we were overweight government bonds. We had a very strong performance in ’08 because of the government exposure, and then in ’09-’10 because we added corporate bonds and they rallied. This demonstrates that you need to have the flexibility to change your allocation within a core fixed-income mandate. The return on our funds over the last five years is a reasonable 5% or 6%.

We also buy a first mortgage bond, which is a single property. Those tend to be marquee commercial buildings like the Bow Centre in Calgary or the Bank of Nova Scotia Tower in Toronto. There would have to be a problem with the tenant or the building before we’d have any issues. Because of the high quality, the yield is lower than a CMBS pool.

Infrastructure is another big piece of the bond market, be it provincial or private. For instance, the Greater Toronto Airports Authority issued bonds to help finance a terminal expansion at Pearson International a few years ago. We invested in that. It continues to pay an incremental yield of about 1.5% over government bonds. We have predictable cash flow: all the landing fees they’re paid from airlines, concession and parking revenues.

Do you hold emerging market bonds or municipal bonds?

The Cities of Toronto and Montreal are municipal issuers, but they’re infrequent. They have little liquidity, so we wouldn’t be able to change the characteristics of our portfolio as easily. So we buy provincial bonds instead.

As for emerging markets, Latin American countries are attractive. They’re either part of NAFTA or have free-trade agreements in place, so capital flows more easily than investing in South Africa or Turkey. The yield is similar to other emerging market countries, and the currency is easier to hedge. If it’s expensive to hedge more illiquid emerging-market currencies, you give up most or all of your yield advantage; Mexico’s peso is easy to hedge.

We also find countries like Australia and New Zealand have yields similar to some of the emerging market countries, with solid investment grade ratings, well-established and democratic processes, and open market capital flow.

Jessica Bruno is content editor of Advisor Group.