Managing risk in a fixed-income environment

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As we head into 2022, investors are asking questions. Will central banks continue to shower the economy with liquidity as they maintain historically low interest rates? Are stock market gains disconnected from GDP sustainable? Is re-emerging inflation transitory or persistent?

In uncertain times such as these, investors may turn to portfolio diversification as a risk management strategy. Lysander Funds Limited, an experienced, Canadian, employee-owned investment fund manager, offers that diversification through funds invested in fixed income in the form of high-yield corporate bonds.

For every asset, you need to know three basic things, says Timothy Hicks, chief investment officer at Lysander Funds: expected returns, expected volatility of those returns and the correlation of those returns with other asset classes.

“Ideally, you would invest in assets with higher returns, lower volatility and low or negative correlation with other assets,” he says. “While bonds have some correlation to stocks — they both discount future cash flows — their great feature is they’re a lot less volatile. The more bonds you have, the less volatile your year-to-year portfolio will be, and if that’s important to you, holding some bonds makes sense.”

But asset allocation according to volatility is a matter of personal preference. Younger investors may accept greater volatility in search of returns, while older investors are more likely to want to preserve their capital and deploy it in search of more stable returns. And while bond investing may be seen as a de-risking strategy, laser focus on yield may ignore the potential for increased risk over a longer duration.

That’s why investor assets held in fixed-income and credit markets benefit considerably from active management, Hicks notes.

“If you believe that equity markets are doing a relatively good job of weighting the market values of companies — for example that an EV manufacturer is worth $1 trillion — then you can buy an index and enjoy the market returns,” he says. “But if you try to do the same with bond indices, issuers increase the weight of companies within the index as their debt issuance increases.”

Essentially, bond indices select bonds according to how indebted companies are, without addressing other important considerations. If an index is made up of extremely indebted companies issuing high yielding bonds, it means little if they go bankrupt.

Selecting the most appropriate fixed-income bonds is an art as well as a science, involving proprietary credit ratings and rigorous internal research capabilities to amass salient information about the companies issuing the debt. These include collateral on the debt, such as real estate and inventory, the historic performance of the company and where the bondholder stands on the food chain for compensation, in the case of default.

It’s not a passive pursuit, as the best bond opportunities can be found only by proactively applying that rigorous research and market knowledge. It involves following individual companies to assess financial results and cash positions. It may also involve scouring the market for bonds that are set to mature and then putting together a pre-emptive loan offer to pay off those bonds — before banks become involved and present their own offers to the bond market.

Even when a company faces well-publicized challenges, it may still provide an attractive bond opportunity, based on its track record for solving its problems over the long term and the confidence it inspires regarding its ability to repay.

The Lysander-Canso Funds reflect such investment philosophy, in a nutshell: bonds can demonstrate portfolio value if there is adequate compensation provided to balance risk — and active management remains the best way to manage risk in a fixed-income portfolio.

For more information on Lysander Funds, visit: https://www.lysanderfunds.com

The views and information expressed in this article are for informational purposes only. They are not intended as investment, financial, legal, accounting, tax or other advice and should not be relied upon in that regard. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.

®Lysander Funds is a registered trademark of Lysander Funds Limited.

This story was created by Content Works, Postmedia’s commercial content division, on behalf of Lysander Funds Limited.