Investors should focus on fees right now

In an uncertain, late-stage economy that’s also seeing bond yields fall with interest rates, BMO thinks a fee-focused ETF approach to bonds is your best bet

Andrew Willis 25 July, 2019 | 1:14AM
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Andrew Willis: Market uncertainty is persisting internationally, all while we remain at the later stages of the economic cycle. That means investors might want to avoid speculative equity bets as they become riskier. However, at the same time, central banks are signaling lower interest rates and that's seeing bond yields decline. So, where are investors to go? Alfred Lee, Portfolio Manager at BMO ETFs, is here with us today to discuss his latest market observations, some potential strategies for investors to strike a balance amidst the uncertainty and why he feels a focus on fees may be the best way forward today.

Alfred, thank you for joining us.

Alfred Lee: My pleasure.

Willis: Let's start with the state of markets today. What are some of the latest observations you have on the investing environment out there?

Lee: Overall, I think the economy is still rather robust. If you look at economic data, especially coming out of the U.S., the U.S. looks really strong right now. Unemployment data is at 3.6%, the lowest it's been since the 1970s. I think there's a lot of factors outside of that, such as corporate earnings that look very healthy overall, which is why the S&P 500 recently rallied to record highs.

The bigger question is, how much upside is left. So, I think when you look at things like manufacturing data, durable goods orders, it is growing, but at a slower rate. I think even when you look at clues from the bond market, the yield curve, we see some inversion on the front end of the curve, both in the U.S. and Canada. So, that typically is a lead indicator suggesting that the equity markets will turn over within the next 12 to 16 months. So, I think, with the rally that we've seen in the equity markets over the first six months of the year, I think it's a good opportunity for investors to rotate out of more aggressive growth areas and into more defensive-oriented areas in the market.

Willis: What are some of the challenges you see ahead for equity investors or those that want to stay in equities, particularly those eyeing more speculative investments?

Lee: That's a good question. I think that with where the equity markets are at, what we've seen so far year-to-date in the last six months, whether you're looking at MSCI World or the S&P 500, all the indices have rallied in the neighborhoods of between 16% to 20% year-to-date and typically, when you look at equity markets, we assume a long-term annualized return of between 6% to 8% on an annual basis and already, we're close to 20% in the first 6.5 months. So, I would say, overall, equity markets have fared pretty well this year and central banks are looking at lower interest rates, and I think, that's going to be a positive for equities in general over the next several months. But I think what investors should be doing is looking at the overall longer-term trends.

So, one of the key longer-term trends is, obviously, aging demographics in the developed economies. So, as you have aging demographics, what typically happens is, investors typically de-risk their portfolios. So, I think some of the factors or some of the themes that are going to benefit over the long-term are things like low volatility strategies and also things like blue chip high-quality stocks. So, I think those are themes that are going to do well over the next decade or even two decades.

Willis: And how about bonds? Are they holding up and what are some of the trends that you're seeing with them?

Lee: With bonds, I think, given that central banks are trying to engineer a soft landing right now, they are lowering interest rates. So, I think that's going to tempt a lot of investors into rotating into higher-yielding areas. So, non-investment-grade areas, things like high-yield, things like emerging market bonds. But I think one thing that investors have to keep in mind is that in the stage of the business cycle that we're in, and typically during the later stages, where we see defaults tend to happen first is, in things like high-yield. So, investors need to be a little bit cautious right now. And even though we have low interest rates, I think switching to investment-grade or focusing on high-quality bonds is one of the key areas that investors should be focusing on right now. So, we do like high-yield and emerging market bonds as long-term strategic asset allocation positions. But I think as a tactical play, I think investment-grade corporate bonds and also government bonds is the better place to be given we could get equity market sell-offs, there's a better hedge to the portfolio right now.

Willis: Lastly, you believe that a bond-based focus on fees might be the way to go for investors looking for balance today. Could you tell us a little bit more about this strategy?

Lee: Yeah, absolutely. I think as central banks look to lower interest rates, yields are going to remain low for the time being. So, I think one way for investor to keep more is obviously to focus on lower fees. ETFs are a good way to manage the fees in their portfolios. So, for example, we have a suite of ETFs that focus on lower fees. You could get exposure to the broad-based fixed income market through our BMO Aggregate Bond Index ETF, [ZAG], at only 8 basis points. Or if you want to focus on corporate bonds, you could get [ZCB], which is only 15 basis points in government bonds, [ZGB] which is also 15 basis points as well. So, it's a good way to focus on specific parts of the fixed income market and also dial back your risk and also manage your fees in this environment.

Willis: Alfred, thank you again for coming on today.

Lee: Thank you.

Willis: For Morningstar, I'm Andrew Willis.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
BMO Corporate Bond ETF46.54 CAD0.39Rating
BMO Government Bond ETF45.65 CAD0.51Rating
BMO Short-Term Bond ETF47.86 CAD0.04Rating

About Author

Andrew Willis

Andrew Willis  is Senior Editor at Morningstar Canada. He previously produced content for Fidelity Investments and finance industry events for Euromoney Institutional Investor and has written in the past for Thomson Reuters and CNN. Follow him on Twitter @Andrew_M_Willis.

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