Manulife's award-winning bond managers play defence

Janis says the team constantly monitors market volatility, periods of illiquidity and pricing patterns. "The key thing is to have circles of influence -- or people that we respect and can give us insights that we might be missing," says Janis, a 31-year industry veteran who counts among his network of contacts senior money and currency managers at leading U.S. and Canadian banks.

So while the market may be behaving one way, Janis and his team will hear opposing views that lead them to adopt perspectives that diverge from the market. "It's worth paying attention to that information to see why they are looking at the same things but getting a different conclusion."

Manulife Strategic Income has always been a "go-anywhere" type of product which has invested in a wide spectrum of assets, ranging from U.S. Treasuries to emerging-market corporate debt. In 2013, after several strong years, the team decided it was prudent to go through a process of "de-risking" the portfolio by selling off the CCC-rated corporate bonds. They used the proceeds to buy leveraged bank loans, which worked well. The bank loans proved to be the best asset class during the so-called "taper tantrum" of 2013, when interest rates spiked after the U.S. Federal Reserve cut back on its quantitative-easing program.

The next year, the team became more conservative, when it exited some of the cyclical areas such as energy and chemicals. It moved into defensive sectors such as hospital chains and consumer goods. "That rotation dovetailed with our view on the commodity cycle and where we were with the Canadian dollar," says Janis.

Starting early this year, when high-yield bonds were riding high, the team took advantage of excellent liquidity and reduced the high-yield exposure from almost 40% of the portfolio to about 18%. Among areas that they went into were investment-grade corporate bonds with shorter maturities and asset-backed securities such as adjustable-rate mortgages. "There were a lot of changes, going from playing offence to defence," Janis says.

This positioning emerged from the team's five-step process that includes macroeconomic analysis, identifying attractive sectors, conducting relative-value analysis, managing the currency exposures and managing risks. "From the macro side, in late 2013, we read a lot of articles and the conclusion on the energy side was the U.S. would be the swing producer, the cheaters would cheat and the Saudis would not cut production," says Janis. "Back then, 18% of the U.S. high-yield market had dicey exposure to energy. It was prudent to stay away."

The same approach was applied to oil-producing countries and their currencies. This led to an underweighted exposure to Canada and aversion to countries such as Malaysia. "It went the whole gamut, from the credit side to the country and currency side. We wanted that theme throughout the portfolio. Sometimes, it's what you don't own that can help you."

Besides the 18% in high-yield bonds, Manulife Strategic Income holds about 30% in investment-grade corporate bonds, and 17% in sovereign bonds outside of North America. The latter are spread across the emerging markets (with small exposures in countries such as Mexico) and Australia and New Zealand. Janis considers foreign sovereign bonds to be attractive because they offer more favourable interest-rate environments than North America. There are also small positions in U.S. asset-backed securities and convertibles and Canadian government bonds. There are no U.S. treasuries.

The fund's conservatively positioned duration is 3.5 years, versus 6.5 years for the benchmark Barclays Capital Multiverse Total Return Index (C$). From a currency perspective, 95% of the fund is hedged back to the Canadian dollar, with marginal exposure to currencies such as the Mexican peso.

"If you asked me two years ago, it would have been completely the opposite," says Janis. "We would have had almost no Canadian dollar exposure. It took that long for the dollar to weaken 33% to 34%. We thought we caught that move and it hit our target range. Going forward, we'll be tactical on a few currencies, such as the Australian dollar," says Janis, who acknowledges that currency played a significant part in the fund's 5.6% year-to-date gains. Looking ahead, the team is less bearish on Canada because the oil price appears to be at the low end of the range.

"After a 33% move (of the currency), you don't want to have a big short position on a country that has proximity to the U.S.," says Janis, adding that he is keeping an eye on the path for rising interest rates in the U.S. as well as signs that European economies are showing better numbers. "Over time, the Canadian economy will get a lift from the U.S. When the big dollar does well, so will the little dollar."