Fixed income strategy:
Aim to offer relatively compelling yields with high credit quality in a low interest-rate environment
We are positive on preferred securities1 for a number of reasons:
The first is interest rates, which are likely to be lower for longer. We believe it will be some time before the US Federal Reserve decides to raise rates for fear of derailing a recovery. Developed government bond yields have fallen further on government stimulus measures, creating tremendous demand for positive yielding securities which should also help to keep interest rates low.
Secondly, we expect the economic environment to continue improving, particularly with the rollout of several vaccines. With an improving environment, we believe there is potential for yields to fall even lower as spreads tighten.
Preferred spreads over 10-year US Treasury bond yields2
Thirdly, preferred issuers have a relatively high credit quality, with an average credit rating of BBB-1. This is classed as investment grade (IG) – indeed, most preferred issuers are investment-grade rated. In terms of corporate defaults, preferreds have experienced relatively fewer events compared to high-yield (HY) issuers3.
Averaged long-term default rates3
Over time, we believe that the market will recognise the value of these high-quality companies.
With most classed as investment grade, preferreds offer a yield to maturity of around 4.3%, compared to 0.7% for US Treasuries, and 2.0% for US investment-grade corporate bonds4.
The Federal Open Market Committee (FOMC)'s latest projections indicate policy rates will remain on hold through 20225. As the recovery could be bumpy, investors would not only look to higher yielding asset classes for income but also focus on higher asset quality.
Yield to maturity of fixed income4
In terms of asset allocation, we differ greatly from our peers6 and the preferred market, as we generally have a smaller allocation in financials and a higher exposure to utilities – a sector known for its defensive nature. Also, we currently have no contingent convertible bonds (CoCos) in the portfolio7.
Through our differentiated strategy, we aim to provide investors with a more defensive approach to the preferred securities market.
1. Bloomberg. As of 31 January 2021. Preferred markets are represented by the ICE BofAML US All Capital Securities Index (I0CS).
2. Bloomberg, as of 31 January 2021. Preferred markets are represented by the ICE BofAML US Capital Securities Index since ICE BofAML US All Capital Securities Index has shorter history starting from 2012.
3. As of 31 December 2020. Global high yield bonds and global investment grade bonds default rate are sourced from Moody's Investor Services. Preferred Securities default rate from 1990-2017 was calculated by Wells Fargo. Beginning in 2018 Manulife Investment Management used the BofAML US All Capital Securities Index to calculate the annual default since Wells Fargo stopped providing related information after 2017.
4. Bloomberg. As of 31 January 2021. Preferred markets are represented by the ICE BofAML US All Capital Securities Index (I0CS). US Treasuries are represented by ICE BofAML US Treasury & Agency Index (GOAO). US IG Corporate Bonds are represented by ICE BofAML US Corporate Index (COAO). US High Yield are represented by ICE BofAML US High Yield Index (HOAO). Yield to maturity is the rate of return anticipated on a bond if it is held until the maturity date. Calculation assumes that all coupons are reinvested at the same rate. The above yield to maturity do not represent the distribution yield of any funds and are not an accurate reflection of the actual return that an investor will receive in all cases. A positive distribution yield does not imply a positive return. Past performance is not indicative of future results.
5. FOMC, 10 June 2020.
6. Bloomberg and market information. As of 31 January 2021. Preferred markets are represented by the ICE BofAML US All Capital Securities Index (I0CS).
7. As of 31 January 2021. Remark: Contingent convertibles (CoCos) are debt instruments mainly issued by European banks. Coupon payments that can be omitted or cancelled at the issuer’s discretion. Part of, or the entire security converts to common equity if capital level of the bank issuer declines to levels below regulatory standards, or regulators deem a bank issuer at risk. Information about the asset allocation is historical and is not an indication of the future composition.