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The yields for U.S. Treasuries continue to languish at low levels. That has some investors wondering if it’s still worth having government bonds in their portfolio. Kim Parlee speaks with Greg Kocik, Portfolio Manager, TD Asset Management, about different strategies to manage risk with your investments.
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[MUSIC PLAYING]
- With bond yields so low, the big question for a lot of people is just should bonds even be in your portfolio right now? But if you should be holding bonds, what type should you be looking at?
Greg Kocik is Portfolio Manager and Head of High Yield and Leveraged Finance Team at TD Asset Management. He joins me now. Greg, I want to start with some numbers that you are oh so familiar with. 0.1% and 0.7% are respectively the yields for 1-year and 10-year US Treasurys. With inflation at 1%, I think, with my math, that's a negative return. Do they even belong in a portfolio right now?
- Yeah, and to be honest, we've had this situation for a long time, maybe not that low. The gap between inflation and government bond yields wasn't that significant as it is now, but it's been a while.
So investors are obviously asking questions, and Europeans and Japanese have been asking questions for years now. It's kind of our turn now to figure it out.
I think that people are looking at alternatives. And when you're an equity investor, you could look for, let's say, real estate or commodities. But when you're buying a safe Treasury, safe government bond, it really is hard to figure out what could be an alternative for that kind of a safety because, after all, the bonds are there in a portfolio to stabilize your long-term risk-adjusted returns. How do you do it with something else?
I think there are ways to do it, but you have to be pretty careful how you construct those portfolios. And one of those would be corporate bonds, whether it's investment-grade bond or even high-yield bonds, as long as you're very careful how you put it all together.
- Well, then let's talk a bit about investment grade and high yield. How are they? How are they looking? What do the yields look like this year?
- Well, we started the year with fairly tight levels. And then obviously during the crisis, we've had the largest and the fastest sell-off since '09.
So after the recovery since then, which is, to large extent, due to the Federal Reserve and the fact that the economy is, in fact, bouncing. But the recovery has been different for investment-grade and for high-yield bonds. So we are looking at investment-grade bonds now delivering something like 8% total positive return year to date-- not since March-- but the year to date. So that's including that initial drop. And high yield is 0%, 0% return.
Now, high yield did recover from this huge drop of about 22%, 23% back in March. But year to date, the gap between those two asset classes is quite large. It's 8% or so.
- Some interesting numbers. And I know from when you and I have talked in the past, one thing you look to a lot is quality, and you talk about risk. But I'm sure-- have those definitions of those two terms evolved in the past few months as we go through this?
- That's right. And we start talking about government bonds, how difficult it is to replace a safety in this environment without actually giving up the yield or increasing the risk in the way that you don't want to do. But you can make a case for a quality portfolio if you truly understand what quality really means. You're looking at underlying quality of the asset, but you're also looking at a price you're paying for that asset.
So you could have the best asset in the world, but if you're really overpaying for it, that's not a quality investment, not at all. You could really underperform over a long period of time. So then let's say you look at higher-risk assets, such as commodities, equities, or, in my case, high-yield bonds. How do you make sure that the combination of OK quality-- because in high yield, you're not going to get a great quality of an underlying asset. It's going to be OK, but it's not AAA, AA security.
However, you're buying it at a price which is quite low, and therefore if you put together a portfolio of the right names, you can actually deliver a quality investment outcome over a period of time. But the underlying securities may not look like your safe government bonds, obviously. They will be high yields. They will be more volatile from month to month.
But my point here is really after this huge rally in government bonds or even in investment-grade bonds, the price you're paying for safety on the bond side is starting to question the overall merits of that investment.
- So if I understand you again, it's the architecture, if you will, of how you construct and put these things together to get the outcome you're going for. Obviously there's active management and then there's what we're doing right now in this environment, which I'm sure is a whole new level of active management. But tell me a bit about, if you could just in a minute, just what you're seeing in terms of opportunities from sectors. Just what's interesting right now?
- I think it's a great environment for active managers because we have quite a significant difference in performance of different sectors, different names. The gap between the best sectors and the worst sectors within high yield is something like 25%. And some of that is obvious-- airlines, energy, travel-related names. Most people don't want to touch it, and I think I actually don't want to touch a lot of these names myself except for maybe selected situations maybe in the energy or some suppliers to energy.
The whole travel industry, we don't know what's going to happen there. It could be the best buying opportunity of all time. But on the bond side, even in the high-yield-bond side, you have asymmetric risks if you buy the wrong securities. You could be facing some significant downside.
So we're staying away from companies that are directly impacted by the COVID situation, but we are finding opportunities in situations that may have suffered from association with COVID but really have reasonable long-term fundamentals. So great environment for active picking because you can find-- the universe of those interesting situations is quite large except that these are smaller names. They're not in your top 50 names within ETF, for example. So that, again, is a great opportunity for us to pick up some of those interesting situations.
KIM PARLEE: Greg, always a pleasure. Thanks so much for joining us.
- Great. Thank you.
[MUSIC PLAYING]
- With bond yields so low, the big question for a lot of people is just should bonds even be in your portfolio right now? But if you should be holding bonds, what type should you be looking at?
Greg Kocik is Portfolio Manager and Head of High Yield and Leveraged Finance Team at TD Asset Management. He joins me now. Greg, I want to start with some numbers that you are oh so familiar with. 0.1% and 0.7% are respectively the yields for 1-year and 10-year US Treasurys. With inflation at 1%, I think, with my math, that's a negative return. Do they even belong in a portfolio right now?
- Yeah, and to be honest, we've had this situation for a long time, maybe not that low. The gap between inflation and government bond yields wasn't that significant as it is now, but it's been a while.
So investors are obviously asking questions, and Europeans and Japanese have been asking questions for years now. It's kind of our turn now to figure it out.
I think that people are looking at alternatives. And when you're an equity investor, you could look for, let's say, real estate or commodities. But when you're buying a safe Treasury, safe government bond, it really is hard to figure out what could be an alternative for that kind of a safety because, after all, the bonds are there in a portfolio to stabilize your long-term risk-adjusted returns. How do you do it with something else?
I think there are ways to do it, but you have to be pretty careful how you construct those portfolios. And one of those would be corporate bonds, whether it's investment-grade bond or even high-yield bonds, as long as you're very careful how you put it all together.
- Well, then let's talk a bit about investment grade and high yield. How are they? How are they looking? What do the yields look like this year?
- Well, we started the year with fairly tight levels. And then obviously during the crisis, we've had the largest and the fastest sell-off since '09.
So after the recovery since then, which is, to large extent, due to the Federal Reserve and the fact that the economy is, in fact, bouncing. But the recovery has been different for investment-grade and for high-yield bonds. So we are looking at investment-grade bonds now delivering something like 8% total positive return year to date-- not since March-- but the year to date. So that's including that initial drop. And high yield is 0%, 0% return.
Now, high yield did recover from this huge drop of about 22%, 23% back in March. But year to date, the gap between those two asset classes is quite large. It's 8% or so.
- Some interesting numbers. And I know from when you and I have talked in the past, one thing you look to a lot is quality, and you talk about risk. But I'm sure-- have those definitions of those two terms evolved in the past few months as we go through this?
- That's right. And we start talking about government bonds, how difficult it is to replace a safety in this environment without actually giving up the yield or increasing the risk in the way that you don't want to do. But you can make a case for a quality portfolio if you truly understand what quality really means. You're looking at underlying quality of the asset, but you're also looking at a price you're paying for that asset.
So you could have the best asset in the world, but if you're really overpaying for it, that's not a quality investment, not at all. You could really underperform over a long period of time. So then let's say you look at higher-risk assets, such as commodities, equities, or, in my case, high-yield bonds. How do you make sure that the combination of OK quality-- because in high yield, you're not going to get a great quality of an underlying asset. It's going to be OK, but it's not AAA, AA security.
However, you're buying it at a price which is quite low, and therefore if you put together a portfolio of the right names, you can actually deliver a quality investment outcome over a period of time. But the underlying securities may not look like your safe government bonds, obviously. They will be high yields. They will be more volatile from month to month.
But my point here is really after this huge rally in government bonds or even in investment-grade bonds, the price you're paying for safety on the bond side is starting to question the overall merits of that investment.
- So if I understand you again, it's the architecture, if you will, of how you construct and put these things together to get the outcome you're going for. Obviously there's active management and then there's what we're doing right now in this environment, which I'm sure is a whole new level of active management. But tell me a bit about, if you could just in a minute, just what you're seeing in terms of opportunities from sectors. Just what's interesting right now?
- I think it's a great environment for active managers because we have quite a significant difference in performance of different sectors, different names. The gap between the best sectors and the worst sectors within high yield is something like 25%. And some of that is obvious-- airlines, energy, travel-related names. Most people don't want to touch it, and I think I actually don't want to touch a lot of these names myself except for maybe selected situations maybe in the energy or some suppliers to energy.
The whole travel industry, we don't know what's going to happen there. It could be the best buying opportunity of all time. But on the bond side, even in the high-yield-bond side, you have asymmetric risks if you buy the wrong securities. You could be facing some significant downside.
So we're staying away from companies that are directly impacted by the COVID situation, but we are finding opportunities in situations that may have suffered from association with COVID but really have reasonable long-term fundamentals. So great environment for active picking because you can find-- the universe of those interesting situations is quite large except that these are smaller names. They're not in your top 50 names within ETF, for example. So that, again, is a great opportunity for us to pick up some of those interesting situations.
KIM PARLEE: Greg, always a pleasure. Thanks so much for joining us.
- Great. Thank you.
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