Global fixed-income markets are throwing up challenges that require seasoned managers like Dan Janis III, who oversees the $8.1-billion Manulife Strategic Income, to be extra cautious.
"These are not traditional markets, due to two things. Number one, we have monetary policy that is not acting normally because it's been in a quantitative-easing phase over the last eight years," says Janis, senior managing director at Boston-based Manulife Asset Management (US) LLC. "Number two, we have not had a fiscal policy to coincide with the monetary policy, and as a result have not generated growth in line with a normal business cycle. We have two different things -- too much monetary policy and a lack of fiscal policy -- that sometimes confuse investors."
Janis argues there is considerable volatility around short-term events, such as pronouncements from the U.S. Federal Reserve. Then volatility subsides until the next event. "Their message is garbled and not consistent. When that happens, you create short-term volatility around their speeches," says Janis, a 32-year industry veteran who works alongside portfolio managers Thomas C. Goggins and Kisoo Park. The trio received the Morningstar Fixed Income Manager of the Year award at Morningstar Canada's 2015 awards.
"It's not a normal environment for a bond manager," says Janis. "The overriding factor is that you have to make sure you adhere to your risk-management process. You cannot deviate much because the market can lend itself to what you think is your comfort level. Then, suddenly, things can change dramatically."
Sticking to one's discipline may hurt in the short term, Janis admits. "You may not take as much risk as everybody else. But when there is a drawdown and liquidity dries up, your discipline will protect you. I think we've done that."
For the 12 months ended in September, the 5-star-rated Manulife Strategic Income has lagged the median return in the High Yield Fixed Income category, though it has outperformed over the three- and five-year periods. Janis notes that the fund is not a pure high-yield fund, since only about 21% of its assets are in the high-yield space. "We characterize the fund as a global multi-sector product, of which high yield is one piece."
At the start of the year, Janis cautioned investors that investment returns for 2016 may range around 2.5% to 5%, net of fees, with 3% being most likely. "There's no surprise element in that range. If we do better, great. But I want to stay conservative."
One of the worries that keeps Janis up at night is that central banks do not have an exit plan for their monetary-easing policies. "With this easy money, they have created a tailwind for professional and retail investors. The grab for yield was protected by central banks continuing to do QE (quantitative easing.) But when that starts to change, who is left holding the punch bowl? That is one of the biggest worries," says Janis, adding that central bankers must reduce the element of surprise to ensure markets are stable. "How will the banks communicate this to the market without having the worst implications of high volatility and illiquidity? Unless they communicate this properly, it could become a major headwind."
Janis is maintaining the defensive stance on interest rates that he and his team began in early 2015. The fund's duration is around 3.8 years, well below the 6.6 years for the benchmark Bloomberg Barclays Multiverse Index (C$). "We are taking duration risk in countries that have friendly environments, such as the Philippines, Indonesia, New Zealand and Australia, and to a lesser extent in Singapore," says Janis, adding that the fund's duration was mandated to stay within two and six years.
On the credit side, and given the managers' focus on lower volatility, the Manulife fund holds between 150 and 200 issuers. Individual issuer exposure is limited to 1.5% of the portfolio. Other large components in the fund include 30% investment-grade corporate bonds, 4% convertible bonds, 15% U.S. municipal and securitized debt, 20% investment-grade foreign developed markets, and 7% in a mix of non-investment-grade and investment-grade emerging markets.
In 2015, Janis and his team began switching into higher-quality bonds. They acquired a number of asset-backed securities (ABS) and commercial mortgage-backed securities (CMBS). "For instance, you could get an AAA-rated bond issued by University of North Carolina at Chapel Hill paying substantially higher yields than comparable federal government securities. Relative to Canadian assets, that's pretty attractive."
The team also bought asset-backed securities that are based on royalty payments and issued by firms such as Domino's Pizza and Dunkin' Donuts. "These issuers are more predictable." On the CMBS side, the fund owns bonds issued by single properties such as the Time Warner Building in New York. "They offer predictable cash flows and lower volatility."
From a currency standpoint, Janis believes that the Canadian dollar is in a range of 74 cents to 80 cents in U.S. dollars. Accordingly, the fund is 95% hedged back to the Canadian dollar.
Over a business cycle, about 50% of returns are generated through asset allocation, says Janis, plus 20% from security selection, 20% currency management and 5% to 15% from duration. "But in some years currency can be important if we have a big move in the Canadian dollar."
A defensive posture provided downside protection in 2015 but has worked against the fund in 2016, Janis admits. "There are times when we are a little bit offside. Being defensive has hurt us because we didn't have the risk-on positions," says Janis. "But you could give all that back if risk comes back in a hurry."
