NCM Insights - Owen Morgan - NCM Fixed Income

January 21, 2020

1) Can we expect any shifts between leveraged loans and high yield bonds within your fixed income mandates
Given our interest rate outlook (see below), we like our current mix (CDN High Yield 22%, U.S. High Yield 19% and Loans 33%; Investment Grade Bonds 11% and the remainder in cash). Loans are coming back into favour as interest rate expectations seem to have reset following the Federal Reserve rate-cutting pause. They provide a nice yield (5%+), sit at the top of the capital stack in a company’s capital structure, and many have protections/covenants that protect investors, so we continue to like them. High Yield Bonds continue to grind tighter and enjoy better liquidity. We like the diversification these fixed income sectors provide as well.

However, we have migrated to higher-quality names as a general trend over the past three quarters and as the investment cycle grows longer in the tooth, we anticipate that will continue.

The final point is that the Fund’s duration must remain under three years and leveraged loans will remain a feature of the Fund, given they are floating rate securities (i.e. low duration). 

2) Where do you see interest rates going in 2020? 
We currently anticipate no change to interest rates in either Canada or the U.S. in 2020. However, rate hikes or cuts are not out of the question.

3) What are your favorite sectors in High Yield in 2020 and why?
I discussed this with Bill Holy who manages NCM Short Term Income Fund with me, and we both felt that it was more a case of which sectors is our least favourite. Our least favourite sectors are the Energy and the U.S. Telecom sectors – both of them are historically the most volatile, owing to the fluctuations in energy prices, high leverage, and rapid change in conditions (either economic or competitive positions). We consistently underweight those two segments and will likely continue to do so. 

Other than that we have a nice diversification in the Fund across sectors and within sectors as well (e.g. in our heaviest weight, consumer discretionary, this encompasses a home builder, a furniture manufacturer, a diet plan, casinos, and a landscaping goods distributor).

4) In 2019 (particularly in the summer), we saw a good amount of fluctuation in the U.S. 10 year.  What did you do within the portfolio to help avoid the volatility?
The fluctuation in the 10-year spread didn’t impact NCM Short Term Income Fund to a significant degree, given its short duration mandate, fluctuations in corporate spreads have a greater impact. For other NCM fixed income mandates, again, corporate spreads are the bigger driver, but we weren’t afraid of taking on more duration (e.g. invested in some 2027 bonds in NCM Global Income Growth Class, and shortest bond in NCM Income Growth Class is maturing in 2023).

5) Does a downgrade in credit rating change your outlook on a bond? In addition, if the credit rating goes from CCC to CC, for example, what would it mean to the portfolio?
Yes, absolutely – credit ratings are an important piece of the research mosaic, and so if a rating agency downgrades one of our names, we take notice, revisit the credit and our outlook, and determine whether action needs to take place and whether our initial investment thesis has changed. 

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