E15: For Your Ears Only... Bonds with Richard Usher-Jones

This podcast is brought to you by Gensler Wealth. The information discussed today is meant to be general in nature and not tailored to your specific investing circumstances. This means that you should talk to your regular Gensler wealth advisor or your own advisor before acting on any information we discussed today. Nothing in this podcast is intended to be a solicitation, and past performance does not guarantee future returns. Today we are discussing bonds. As hard as I tried, I never got a good James Bond reference in here. But I'll keep trying and never say never again. Today on the Gensor Wealth Unlimited podcast, we have Richard Usher Jones, portfolio manager from Canso Investment Council, a $35 billion fixed income specialist manager. We do two things. First of all, we go back to basics and we talk about bonds 101. And secondly, we hear Richard how Canso manages fixed income and bonds in this environment. Let's go.

Foreign.

Welcome everyone, to the Gensler Wealth Unlimited podcast. Really excited to have Richard Usher Jones from Canso Investment Council as our guest. Today we are going to talk about a very important topic that while if you read the press and watch tv, it would seem that everyone's familiar with this, and that topic is bonds, fixed income and bonds. What I'd like to do with Richard is initially pull us back to the basics. And for those who may not be super proficient in what bonds are and how they work and everything you're hearing and reading in the news and interest rates and government raising things, et cetera, we're going to try to break it down to fundamentals for you. And then we're going to hear a little bit more from Richard about how can. So about he and how Canso manages fixed income in general and in this environment. So, Richard, thank you so much for being here. Really appreciate it.

Ryan, thanks very much. Really appreciate the invite.

Yeah, for sure. So let me, let me give a quick intro to you, and then you'll probably do a better job than me. But first of all, Richard and Canso. So Canso, it's an investment management firm focused on fixed income, or also called bond or credit investing, and it manages in excess of $35 billion in this space. So very, very focused expertise in this core area. Richard's a portfolio manager at Canso. He's been in the industry since 1991. He's a chartered investment manager and also a fellow of the Canadian Securities Institute. And he's been focused on corporate bond analysis since joining Canso in 2009. We'll put Richard's full bio in the podcast notes, but maybe Richard give us a little bit of an overview of yourself, Canso, et cetera. Just to paint the picture of, of you and the firm. And before we dive into your expertise on explaining this, this world to us.

Sure. And, you know, a bit, bit more background on myself. I joined Canso in 2009, as you mentioned. I'm a member of the investment team. We're 27 people on the investment team and Canso I think total is, I think 57 employees. So I say that because while the investment team is crucial in delivering the investment results, what's also very important is all the other staff members and our team members that work with us, allowing us to focus on the work of doing credit research and portfolio management. So it's really, you know, the whole team that's crucial in that. So you mentioned I joined Canso in 2009. But it's interesting. I feel like I've. Well, I have been associated with Canso have far longer than that. I worked for a company called Russell Investments, which functions as a manager of managers. And they were actually Canso's first institutional client. And just over 25 years ago, as a colleague of mine, Tim Hicks, who I work with now at Canso, actually hired Canso to be a sub advisor on one of the funds at Russell. So I was lucky enough to be a client of theirs for about 12 years before I actually joined Canso.

Nice. Amazing. There's something interesting about the Canso name. There's some aviation tie in or something along those lines. Where'd that name come from? And just for fun, give us. I always love to understand where company names originate.

Sure. So John Carswell, who's our, our founder, CIO and president today and still, you know, very actively involved in the business, he left. Well, he was a Calvist early on in his investment career as a, as a portfolio manager, then went to Foiston Gordon Payne for a number of years. And when he left Hoyston, his dream was to start an investment shop and a portfolio management firm specifically focused on corporate bonds and credit. And as John thought, rather than naming the firm after himself, he went back into his own personal history. And John was an Air Force navigator, a graduate of Royal Military College, and his father was also a pilot in the Air Force, flew the Lancaster bomber in the Second World War. But after service he flew the cancel airplane. And I encourage you, if you haven't seen what a cancel airplane looks like, Teresa, a number of the images on our website or you can just Google it, but if you take a look at it, it's an amphibious plane that could land on water and also on land. And if you look at it closely, it was not maybe the sexiest or fastest plane, but it had a reputation of being incredibly dependable and getting the job done. And John's view was if he could build an investment firm in the same image as the airplane, dependability, adaptability, you know, the, the view was that we would have some satisfied investors. And, you know, I, I'd say he's been very successful in, in doing just that.

Amazing. Great. Yeah. Full disclosure, Ginsler wealth works with Canso and allocates client assets to Canso. And Canso was nice enough to send us a little model of that plane. And I have it so sitting on my, on my desk over here. So it's very cool. Very cool. Okay, so step one of today's podcast, or part one, I guess I call Bonds 101. I love James Bond. I'm still trying to figure out how I can get like, a James Bond sort of theme going here, but, you know, I can't steal their music. And I'm not cool enough to say, you know, bond, James Bond, as you can see. But anyways, we're going to go back to basics on bonds because as I say, I think, you know, for, I think for some people, it should be a nice, a nice way to understand this, this asset class. And actually, speaking of this asset class, Richard, give us a sense. Even before I ask you any questions about what a bond is. Everyone talks about the equity markets. The papers are equity markets. The news is equity markets. What's the size of the bond market relative to the size of equity markets? Just to give listeners some context, give.

Or take, you know, I'd say the actively traded bond market, those that are liquid and actively traded, it's about twice the size of the equity market. But I'd say it's actually also much bigger than that because there's a whole other category of debt that wouldn't be included in that, and that's leverage loans, bank loans, private debt. So, you know, safe to say, while the, the bond market, a lot of people, it doesn't get the attention and sort of the fanfare that the equity market does, but it absolutely dwarfs the size of the stock market.

Right. And that's my understanding as well. And so I think, just to give listeners context, this is a, a major, major piece of the capital markets and much, much bigger than equities would be. Although equities tend to get all, all the glory. I guess. So. Okay, so let's go back to all the way back to basics. In the podcast there will be, you know, timestamps for all the different things we're covering here. So bond basics is too basic for you as the listener. Just fast forward a bit, but let, you know, let's, let's go back to basics. So first of all, what is a bond and just in general, how does a bond work? These are really basic, I know, but you know, you're going to be the expert to explain this to us better than better than I can, I guess.

Well, it sounds like a basic question, but you kind of don't know what level they answer it at. And I think when I think of a bond, it's really a contract between two parties, let's say yourself and myself. Right. If I have excess cash and you're in need of cash. Well, basically we create a contract where I can lend you that money for a period of time and I'll probably put some caveats and some protections on that. And in our world you call those covenants. But also we're going to agree for the length of time that you're going to borrow that money from me and also how much you're going to pay me for the use of that money for that period of time. And typical bond, say it's a 10 year contract that you and I have. I'm going to lend you say $10,000 for a period of 10 years and we'd agree on a rate of interest. And let's say that rate of interest is 5%. That means you're going to pay me 5% each year for the right to use that capital of $10,000. And you typically get, you get paid that rate of interest twice a year. So it's a semi annual rate of interest or what gets called a coupon payment.

Okay. And, and so is this where you hear this term clipping coupons? What does that mean?

It's funny, you know that that term coupon is one that I've, I've got a son, I have two sons that are doing BCom degrees and I, I've tried to explain to them what a bond is and how a bond works. And one of the terms we use.

You were practicing before the podcast. It sounds like this is perfect while practicing.

But I hope my two sons don't hear this. I don't think I've been successful in trying to explain to them how it works. But if you, I, I had to imagine in learning this years ago of what a bond is. A bond was A piece of paper that was a contract and attached to that main principle, the, the bond, were a whole bunch of different coupons. And if it was a 10 year bond, there were 20 coupons.

Every coupon you're talking literally physically attached to a piece of paper that you would take off.

Literally.

Yeah, yeah.

Well, actually you wouldn't rip it because these were pretty valuable. So you take a really sharp pair of scissors and you know, you call it clipping the coupons. You would cut that coupon off.

Yeah.

And you could go into a bank or a participating institution and they would pay you, pay you the value of that coupon and they take that coupon and submit that back to the, back to the issuer. And so when you, when you hear that term of you buy your bond and you just sit back and you clip the coupons, that's exactly what they were talking about years ago. You actually had bonds with the principal value and coupons were attached to it. And that's where that term came from.

Amazing. The old school, the old school approach. And the terms continue. So you were talking about you and I entering a contract. But you know, assuming we're not doing that, I'm not good credit. You don't, you don't want to borrow from me, that's for sure. Who, who issues bonds generally?

I borrow from you, I just might not lend you money.

Exactly. You know, exactly. So who, who are the issuers of bonds that you would mostly and, and investors would mostly be interacting with the issuer being the, the lender on the other side.

So I'd say some of the biggest issuers on the planet are countries like the government of Canada, US Government issuing US Treasuries, and all of the provinces issue debt as well. And you know, these are federal and provincial issuers. But then one thing that we specialize in, can specialize in at Canso is in evaluating bonds that are issued by different businesses and corporations. So when you're, when you're buying a government of Canada bond, you're basically, you know, you're, it's the ability of the federal government to tax us as, as citizens. Right. And the taxes that we pay and, and that's actually what services the interest payments on those bonds. And some are on the provincial side.

And that's why people say government bonds are pretty close to risk free because they can always just tax, tax, tax if they get into trouble and, and pay off bonds.

Pretty much. I, I kind of, I, I, I, I don't outright answer saying, yeah, for sure. That's guaranteed because as you know, nothing in life is guaranteed. But also.

Yeah, I'm talking, I'm, I'm thinking sort of Canadian government bonds or U.S. bonds, not necessarily other countries that, you know, may have some troubles.

Yeah, I'd say, I mean, if there's a default in the government, a North American government bond, we've got some pretty concerning issues.

We're in a bunker somewhere if that's. Yeah, good. And, and of course, corporations would also be doing this because they, they can issue equity potentially if they're public or otherwise, but bonds would be another way to finance their business or their growth, I guess.

Yeah, no, that's, that's the difference. When you're, when you're evaluating a corporate bond, you're really spending a lot of time understanding that, that business, that underlying business and how it operates, how it generates cash flow, because it's that cash flow in the business that's going to be there to, to service the debt and to pay you your interest and allow that business to refinance when it matures.

Right. Okay. So using, just following on the, you know, the governments are issuing bonds and corporations are issuing bonds. As you said right at the beginning, obviously a key component of, of a bond is the interest rate or the coupon payment, which actually may be different things, if I'm not mistaken. You can, you can explain why do we see certain, why are, why is there different interest rates or coupons for, for different issuers? Governments, corporates, federal government versus provincial government versus BCE or Rogers or Air Canada? What determines the interest rate?

Um, yes, I'd say there's a couple different ways to look at it. You know, first off, the environment. Whereas, you know, if you look at today, interest rates are, are measurably higher than they were a year ago. Right. So you're issuing within that particular interest rate environment. Right. And then the different rates of interest on different bonds are really an indication of, of the health of that business or of, you know, you can look at it on the negative side. What are the chances that they may not be able to pay you and the more risk that exists in the ability for those interest payments to be made, typically the higher the rate of interest you need to get paid. So a more fragile business would typically have a higher coupon payment or be paying you a higher rate of interest and essentially paying you for the risk that they may not be able to continue to pay you.

Right. Okay. And so, and so I, I mentioned a moment ago that actually, let me, let me ask a skill testing Question first, not to you, but to the listeners. And then bring that back to this coupon and interest rate. So skill testing question for listeners. What happens to bond? And of course I'm not actually going to be able to hear if anyone answers, but you know, just for fun, what happens to bond prices if interest rates rise? So right now the government is raising rates at a pretty rapid clip. What happens to existing bond prices if interest rates rise? Very, very important concept that essentially every investor who's investing in bonds and frankly every investor, period should understand. And, and if you don't, then you should definitely call us against their wealth, by the way. But what happens to bond prices if interest rates rise? Bond prices go down and vi. And vice versa. And maybe Richard can explain why that is and also therefore explain because I think I made a comment before, you know, coupon rates and sort of the interest rate I guess are not necessarily the same. Maybe I'm not using the right language, but because bond prices change. So can you explain, Richard, why do bond prices fall if interest rates rise and vice versa? And then how, how does the coupon and whatever make up for that change?

Yeah, So I guess the way I think about it, I've got to think about actual examples and we've seen some significant moves in interest rates in the last year, as I mentioned. So let's take a simple example and say two years ago you could have bought a Government of Canada bond and would have been priced at say $100. The par value and interest rates were very low.

And par value means. Sorry, what? The face value of the bond.

Correct, face value. And most bonds are issued at face value of $1,000. Right. And you talk about them in increments of $100. So you go, yeah, face value, par value $100.

And that's what you lend and that's what you have to get back whenever it matures.

Correct.

Okay.

And then you're paid those coupon payments or those interest payments twice a year. Right. For the use of that money when you lend it. So let's say, and, and you know, I probably should have looked to see exactly where rates were. But as an. I know there are a number of government of Canada bonds in circulation that only pay a rate of interest of 0.25%. Call it 25 basis points. Right. So say you had a, a year ago you bought a two year bond that was paying a rate of interest of 0.25%. So that's 1/4 of 1%. Interest rates were very low a year ago. Well, you roll forward to today, that was a two year bond when you bought it a year ago. Yeah. It's got one year left of maturity.

Yeah.

A one year government of Canada bond today is yielding about 4.3%. So no one's going to pay you a hundred dollars. That bond that's only paying 0.25.

Right.

So basically, but you know that that bond matures at a hundred dollars in a year.

Yeah.

So you basically discount that bond and the cash flows on it, that you've got two cash flows remaining or actually three cash flows. You've got two interest payments of 12 and a half cents and then you've got that principal return of $100. So you know, sort of simplifying this, someone would pay you basically, you know, discounting that bond. Probably $96 for that bond. And why do I say $96? Because you're going to get the two interest payments, 12 and a half cents plus that $4 discount is that rate of interest you're not going to make if you bought a Government of Canada bond today.

Right.

And you know, whenever I think when we're evaluating a bond and say a corporate bond, all we're really doing is applying discount cash flow models saying what are the cash flows we're going to get paid and we're going to attach a single price to that today. And when you talk about whether a particular company or bond is more risky, essentially what you're doing is you're evaluating the likelihood you're going to get paid and the less likely, the more you better get paid.

Right. And that's why, I guess, I mean, maybe during, I don't want to jump ahead of ourselves here, but maybe during COVID that those first month or so when the world looked very scary, I guess I'm assuming bond prices for corporates or others would be coming down to reflect some increased risk. Is that what, what you saw then?

Well, at the beginning of COVID it was a significant shock to the market. And the shock with every, every business operator was looking around saying, how is this going to impact my business? And for some businesses it was incredibly detrimental. Like the leisure of travel business that all travel basically stopped and ended then. And you know, the question was, how long is this going to last and how much cash do we have in order to keep the business alive and surviving? So, so the, you know, I have to say the shock that we saw and the interruption, the business interruption for so many different industries was so significant.

That.

Caused everyone to take a real step back and and try and figure out what all these new investments were worth.

Right. So we've talked a little bit about interest rates and risk of different countries and companies, et cetera. You know, you hear the terms, you know, AAA rated or, or bonds or junk bonds, which doesn't sound so good, but maybe, maybe they are. Fine. Can you just explain sort of how somebody, and maybe you can explain also who is evaluating these sort of bonds and assigning ratings and what does that mean for interest, for coupon rates or interest rates? Sure.

So there are a number of different credit rating agencies and some people might be familiar with the name of Standard and poor's or DVRs, which stands for Dominion Bond Rating Services or Fitch Rating Services. And essentially when a company or an entity issues a bond, oftentimes they will pay a rating agency to rate their debt. And the higher the rated the debt, the lower the probability of default or the higher the probability of the chances you're going to get all your money back and there's no risk to it. So essentially every entity that's issuing debt wants to have the highest rating possible because that, that permits them to finance with the lowest rates of interest possible.

Right.

And the way the ratings will work is the highest rating is triple A plus or AAA high, flat to AAA minus to double A plus to double A flat to double A low and then single A. And then the notch down from single A is triple B and there's triple B high and triple B flat and triple B low. So there's lots of notches on the way down and it goes all the way down to single B. And then after single B is getting a D on your, your, your high school assignment. D is default. That means that the issuer has defaulted, they're no longer paying their interest, and it means that you're likely not getting the full value back of what you lent that entity in that business. And just going to quickly go back to that triple B and triple B low rating. Because when you go from triple B low could double be high. That, that's a significant differentiator because anything rated triple B and above is considered to be investment grade good. Everything rated double B high and below that is considered to be. Actually there's three terms they're used. Junk bonds, high yield or below investment grade and anything double B or below is, is rated junk high yield or below investment grade. And you know, what are those? Why do they have different names? I don't know. Actually, I think if you don't like lower rated debt, you call it Junk. If you like it, you call it high yield. And if you're kind of ambivalent, ambivalent, you call it below investment grade.

And so is there a problem investing though in junk bonds or high yield bonds? Because it seems like something lots of folks are doing. I know Canso invests in, in this space as well. So maybe just describe how you, or how bond investors could get comfortable with bonds that some might call junk bonds.

Sure. So we, we do, we have the ability to invest in high yield or junk bonds. Um, and you know, the important thing there should really need to make sure you're doing your work because you're really evaluating that business and the company, their ability to service that debt. The other thing which I alluded to in the beginning is let's say go back to an example where I'm lending you $10,000 if I'm concerned that you may not be able to pay me back if you're a lower rated credit. Sorry, Brian.

Yeah, I'm junk. I'm a junk.

Yeah, I'm making up maybe going to put some caveats or some covenants in there and I'm going to say, well, your car is probably worth 10 or $12,000. So I'm going to secure that loan of $10,000 against the value of your car. And by the way, you're not allowed to sell your car to anybody else in the period that this loan is outstanding. So if, if you cannot continue to pay the loan, well, I can take possession of your car, I can sell it, I can recover that money and that $10,000. And if I get more than 10,000, you would get the extra money back.

Right.

So it's, it's really evaluating not just the business or the entity's ability to pay their interest and to refinance it, but also what protections that you need to have in order to get comfortable in lending that money.

And I assume as the ratings go lower and lower, which I guess is into that junk bond or worse territory, the interest rate would, would commensurately be going up and up and up. So if I'm, if I, if, if Brian Gensler's a junk bond, I'm paying you a way, I imagine a way higher interest rate than, you know, Justin Trudeau is paying you for a Government of Canada bonds with no comment on Justin Trudeau, just.

No, then that, that's exactly it. You know, the higher the perceived risk of the money that you're, you know, or the entity you're lending to, you should be, you should be Paid more for that risk.

Right.

So more in terms of that rate of interest.

So, you know, sometimes when the market gets a little challenging or otherwise, you know, I've seen some investors get really excited. Oh, this is amazing. Someone's issuing a bond that's paying 14%. Like, this is awesome. Let, let's, you know, I, I think the key is they gotta understand that there's a reason you're able to get 14% on a particular bond. And that reason must mean in almost all cases that there's something much more risky about it than, you know, say, other bonds that are paying far less interest.

Correct, Correct.

Okay, so I, I still want to talk about bonds. Sorry.

You know, to give you an example, I always, I'm kind of, I have to think about examples. In our portfolios, we've owned bonds that have been issued by Apple. Right, Right. So Apple, I've got. Well, you're on my Apple iPhone right beside my Apple iPad. They're. They're a company that is very highly rated, rated double A, very low probability of default, tons of cash on their balance sheet, and frankly, we would say very little risk in being a lender to Apple. So because of that, you're not actually paying that much rate of interest.

Right.

Whereas in the portfolio in the last couple of years, we've lent to a number of airlines. And while air travel's returning and Air Canada is doing quite well financially, there was a period in time where the business was under a lot of pressure. And we were comfortable at the time lending to some of the airlines, American Airlines, Air Canada, and more recently Latam, which is an airline based in Latin America. But because of that, we had to get proper protections with security, meaning recourse with assets behind that debt instrument. And also a much more attractive rate of interest than say you would get from an Apple because you think, I mean, maybe those are drastic extremes, but pretty good illustrating example.

Yeah, I actually want to come back to some of those airline bonds that you bought when we get into post the bonds 101 section. But let me just repeat what you said and maybe ask a question. So Apple, which is the largest company in, you know, if not the largest, both of the largest company in the world, is described as you did tons of cash earnings, billions and billions and billions of. Of net income each quarter. And you said their bonds would be rated double A, and double A is not the highest rating bond. AAA would be. Is there any company whose bonds would be rated higher than Apple then? Or like, what's Apple missing that its Bonds couldn't be rated aaa, or is that just reserved for really stable governments?

Pretty much just governments. I'm thinking of instances we've bought some bonds issued by Canadian banks where unsecured debt of the Canadian banks can be rated triple B. But there are some categories of debt rated aa. But also they've issued covered bonds that are rated aaa. And a covered bond is not only backed by the promise of the bank to pay, but also if it's covered, there's an additional pool of assets that are also backing that investment. So there can be some, some covered bonds that have significant coverage in backing that can be issued by corporations that are rated triple A, but it is quite rare.

Okay, so I have a few more questions about bonds in a second, but just switching back to everyone's favorite, which are equities. I say that jokingly, but, you know, maybe a very simple and everyone knows the answer to this question, but as you think about stocks and bonds, which one is safer if, you know, all else being equal and why?

Well, you know, I definitely have to say bonds are certainly the safer asset because if you look at the, the capital structure of, of say, a business, right, if that business were to, to go into bankruptcy, the bond holders need to get paid back before any money gets paid to the equity holders.

Right?

But what you forego with that is, you know, you've got unlimited upside when you're buying the stock or the equity of a business that, assuming it does very well and continues to grow, you participate in that. Whereas if you buy a bond or you own a bond from a company that's paying you 5%, you're not going to do better than that. 5%, right?

Yeah, it's exactly. It's a risk reward trade off. You're getting no more than what the bond is contractually obligated to pay. But you're also first in line if something goes wrong. I think, I think that's really the core of what I was trying to get at for people to understand. Bonds get, you know, again, very simplistically, bonds get paid first and then, and once and only once all the bondholders are paid back, then the company could start paying some of the equity holders. Okay, so I think, I think that's a Pretty good bonds 101. Only one question I'm going to ask that may be getting into the Bonds 201 question, but we're starting to hear this term. Well, sorry, the term's been around for forever, but starting to hear more. The yield curve. There's something Called the yield curve. Can you just, and this is important for interest rates, both, you know, current rates, future rates, etc. But can you explain to listeners what's the yield curve and what does it look like?

Sure. I mean, that's a bit of a loaded question because the look of it can change.

Well, exactly what's it typically look like? Let's say typically as a start.

So if you were to build a yield curve, you typically do it with, with say Government of Canada bonds, if you're investing in Canada and you would take the yield or the rate of interest that is available and being paid on bonds of 1 year, 2 year, 5 year, 10 year, 20 year and 30 year, and you would plot those, and you would plot, you know, across time being on the, on the lower axis and you would plot those rates of interest. Right. And what a normal yield curve looks like is the longer term that you're lending money, the higher the rate of interest. Right. So in a normal environment, if you're making 3% in a one year bond, the 30 year bond might be 5% and it's a gentle upward sloping curve. And that's where you get the term yield curve. And so that's how you plot the yield curve.

And the concept being why we're just for listeners, why would the interest rate traditionally or typically be higher on a 30 year bond than a 2 year bond? Like why, why, why is the curve sloping upward? You know what I mean?

Yeah, I mean that's, that's debatable if it's the same credit risk like the Government of Canada, but you're locking your money up for longer, so you should be paid more. And there's a lot more uncertainty in that period between now and 30 years that you're subject to. And so you're, you're paid more for that.

Yeah, those assumed risks, it's, it's I guess the concept of time value of money along with uncertainty, et cetera. So generally it, the longer you give someone your money to hold on to, the more they have to compensate you for it. Relative to, if you're just lending someone money for a year, you're gonna, you know, there's much more knowns in the next 12 months than there are in the next 10 years, give or take. Okay, so if that's what a typical yield curve looks like, what does the yield curve look like today? And today being middle of December, government has increased both in Canada and the U.S. and elsewhere in the world, increased interest rates dramatically over the past 10 months or less. Frankly, what does the yield curve look like today?

The yield curve does not look like the normal yield curve I described. It's, it's quite inverted. And so if you were to actually plot those. My. No, I would, plotting that I would start with say a three month treasury bill which is yielding about 4.2%, and then a one year, which is about, almost 4.4%. But then if you stretch all the way out to a 30 year government of Canada bond, it's yielding about 2.8.

So it's almost like it's upside down.

Correct. There's a distinct inversion to it where basically the highest point is one year and it just gradually declines from there out to 30 years. What does that mean?

Why is that?

You know, if I, if, if I knew that definitively, I'd be. Yeah, so, so one of the arguments is that an inverted yield curve is a potential sign that we have a recession around the corner.

Right.

And you know, I think the concern is we've seen a significant lift in interest rates, the overnight rate by the bank of Canada and by the Fed, and that's all to address higher inflation and hopefully bring that inflation in check and really to get in front of demand and growth in the economy. And you know, there is, there's a number of investors, maybe the yield curve is telling us that there could be a potential recession around the corner. And, and I'm being kind of cautious in my choice of words because frankly, nobody knows definitively.

Right. I, I had a good friend of mine and famous economist David Rosenberg on as a guest of this podcast a good number of months ago, spoke with him recently, saw some of his presentations recently. And to your point, Richard, at least from Rosenberg's perspective, based on the stats and the charts that he's produced generally, every time, generally. And this is not a promise or a forecast by Gensler wealth or Richard or otherwise, but generally when the yield curve inverts, there is a recession that follows for a period of time after. And I guess the yield curve's inverted because I, folks expect that the rates, that will be the longer term rate, eventually rates are going to get lowered again to counteract the recession potentially, and maybe the yield curve returns to normal, but again, we'll see what happens in the world, but definitely want to be cautious now.

Okay.

And then just before we dive a little bit deeper into how Canso invests and thinks about corporate bonds or bonds in general, we always hear this term, you know, the 6040 portfolio. Like our role at Gensler wealth is to construct portfolios for clients. We definitely don't just do a 60, 40 portfolio, which we'll explain in a second. But you always Hear, you know, 60, 40, what's your portfolio? It's a 60, 40, a 70, 30, an 80, 20. You know, generally bonds are that latter piece, you know, 60% equities, 40% bonds. But why, why do many portfolios include bonds? You know, and how do you think about that when you're building portfolios?

Yeah, you know, I think my strong feeling is every portfolio should have a combination of bonds and stocks. And the question is, which I think is, is where your expertise comes in is making sure you get the right fit for that client of what the balance of them are. And you know, as we mentioned, bonds have, have a lower but more predictable return with more stability than stocks. So you want to, I always think you need to have some complement of bonds in the portfolio to limit the overall ups and downs in the pattern of performance. And also, you know, I think most importantly, if you go into a difficult period that impacts the stock market equity significantly, you should be, that's when you don't want to be redeeming and spending caps with, by selling down your equities. You want to have the stability of bonds in there. So it's, it's really the balance of those two.

Okay, got it. Yeah. When I say against the wealth, we're not, quote, unquote, just doing the 60 40s, because we tend to invest in a whole variety of other asset classes that, that also complement the equities and the bonds. Okay, so look, that was, I think, a wonderful bonds 101 maybe slash 201 overview for folks. So thank you so much for that. Now let's take it to the next step, which is Canso and what you guys do and how you invest. Can you just give us a little bit of an overview of your approach to investing in the space and, you know, what do you do day to day as you're, as you're trying to generate the best returns you can for your clients.

Yeah, you know, I'd say when I, when I talked about the job of, say, a rating agency. Well, at Canso, we don't rely on the rating agencies to evaluate the risks of the underlying investments. We do all of our own credit work and our own research. And first of all, it's really important to understand when you're, when you're evaluating a corporate bond, there's a business behind it. And so part of the job as a credit analyst is understanding that business thoroughly. And Then understanding what could potentially go wrong that could interrupt that business's ability to service their debt and to pay you for, you know, your rate of interest and for lending them the money. That's a significant out of the research. The other element is understanding all those, all those protections, those contractual protections, if any, that may be there. Is the bond secured? If it's secured, what is it secured on? What other covenants and protections do you have as a bondholder that you could act on if things went against you and if there was a potential default? So it's, and it's also understanding what our downside is and doing an estimate of that. And that's an input into how we size a particular position within the portfolio. So it's, it's, it's really spending the time to, to understand for ourselves at Canso internally all the opportunities and all of the risks associated with all the potential investments.

Great. So, you know, in the equity markets, again, I always defer back to that for sort of what folks are talking about that, you know, there's a big push around passive investing, Exchange traded funds, ETFs, as they call them. You can similarly invest in the bond market through ETFs. You are, obviously, you and Canso are active bond managers, just like there's active equity managers. What's the case and why should investors consider actively managed bond portfolios as opposed to just going to buy these ETFs for very low cost? Well, so, big question, big question. No pressure.

Yeah. But I gotta tell you, I feel really strongly about this because investing in a stock or equity etf, you're aligned with the business operators, right? The better a company does. Take Apple as an example, right? The better Apple does, the more its business grows, their sales grow, the more profitable it is, the more the stock of that company grows and the bigger component of the index it becomes. So if you're owning the index in an etf, the better Apple does, the more of that stock of Apple that you own. Right. I would say when you look at the same thing from the debt or the bond side, that approach makes no sense at all. Because essentially, look at it. The more debt that a company issues, the bigger a component of the index it becomes, the more indebted, potentially the higher Lieberstein is. And if you're buying the index, then the more exposure you have to the most indebted companies. You almost need to have an algorithm that actually reverses that.

Right.

So it really doesn't hold together and make a lot of sense when you're looking at investing in corporate debt. And our view at Canso is indexing corporate debt makes no sense at all. And the other thing I'd also say is the bond market's quite complex, and there's a lot of price movement, a lot of inefficiencies. And when I say inefficiencies, that's a really good thing because our shop at Canso is set up to take advantage of those inefficiencies to the benefit of our investors.

Right, Great. So speaking of the difference between active and passive, speaking about the intricacies of issuers and bonds, maybe talk about where you sit at the table and essentially create an opportunity to lend to a corporation. Obviously, if you're buying an ETF or if you're just buying a bond out in the market that's already out there, the pricing has been sort of fluctuating or adjusting to whatever's going on, and the buyer pays, you know, whatever that price might be. My understanding of you and Canso is you can actually go and create these new issues in some way. Can you maybe discuss that a little bit?

Sure. So, you know, part of the job of being accredited analyst at Canso is understanding what the, what the needs for cash is for all of the different issuers and businesses you cover. And as an analyst, if you can identify an issuer that has the need for some refinancing or some financing period, and if you think that that can be structured in a way that's mutually beneficial for a CAMPSO portfolio and our clients and also for that issuer, then, you know, we're encouraged to make an outbound call, and usually through an investment dealer to that business or that issuer, and to propose a potential debt issue to them. And, you know, one of the ones I can think about in the early stages of the pandemic, where Air Canada, as an example, was staring down a period of tremendous uncertainty, they didn't know how long the pandemic was going to last for when vaccines might become available. The other thing they knew is they needed a significant amount of cash in order to weather through that, that business interruption. And we actually approached Air Canada and said, well, if a bond is structured with good downside protections for us and a good rate of interest for our investors, then we'd be interested in being a lender to you. And, you know, I think the figure was about 840 million. We ended up blending them in a bond with a coupon of, I think it was eight and a quarter percent. And we also bought that at an additional discount, but bought the bonds at $98 rather than a hundred dollars and with good downside protections and security, so that we had recourse to some assets if there was a default. And it was, I would say that worked out for Air Canada. They had some additional cash and also worked out for us and our investors. And we thought we were properly protected and also compensated for the risks of lending Care Canada.

Right.

And we've had a number of examples like that over the years. And that's typically how you get some of the larger investments in weights within your portfolio by be proactive and working with an issuer. And oftentimes they will lend the money that we've asked for or, sorry, we'll be lending our money for the dollar amount. And that issuer may also increase the size of the debt standing bond deal because there are other investors like cancer that want to participate in that. And I should also mention these aren't deals that are private. These are, we can trade and buy and sell these bonds in, in the market. And we always want to make sure that we have liquidity within the portfolio. And that's liquidity is the ability to buy and sell these bonds.

Yeah, yeah. I mean, to me, that's an amazing case for even, I don't know if you even call it active management plus, you know, actively seeking out issuers and essentially negotiating a great bond issue. My personal view, our view at Gimsler wealth is we'd rather be in a fund where the managers negotiate the deals directly with the issuer, as opposed to being the group that's buying bonds after Canso selling them, which is sort of out on the open market. You know, that's, that's just our approach here. So last few questions, because we're, we're taking up a lot of your valuable time here. This might be the hardest one. So I don't know, you'll, you'll tell us, you know, you're living and breathing bonds and interest rates and the bond market all day, every day. What is Canso's outlook for interest rates and the bond market and what are you doing as a result in the portfolios?

I'd say first of all, we're going back into a period where if you amass some savings, you're actually getting paid on them again.

Right.

Which is a good thing with a, you know, a government of Canada bond, a one year bond yielding 4.3 or 4.4%, and a corporate bond yielding a margin above that. It's a good thing we're paid on a rate of interest. Again, you know, I think the other issue though is the enemy and that is inflation. Inflation deal with levels above that. But hopefully this measure of higher interest rates and of removing a lot of the stimulus that central bank put into the market is going to be addressing and reducing inflation. And you know, it's a, it's a difficult situation that central bankers are in because they know that increasing interest rates and removing a stimulus is going to have an impact on the market. But it takes quite a bit of time before that that impact is known. You know, a term we use at Canso is yields are converging to inflation. And a normal situation is where even in a risk free government of Canada bond you should be making more than inflation. And that's a more normal environment. And we'd like to think and hope it can so that we're, we're gradually getting back to that environment. But we've been in an incredibly low interest rate environment for, for really almost 13 years, ever since the credit crisis back in 2008. And hopefully we're going back to a more normalized environment where we're going to be making more than inflation. And good news though as savers, like savers are going to be paid on their savings again.

Right. And so what does that mean at a little bit more of a nitty gritty level within the portfolio in terms of the types of bonds you're buying? You know, duration isn't a word that we generally, that we explained in the early part of bonds 101. But you know, shorter duration, longer duration, you know, more corporate bonds rated higher or rated lower. Like what do you do in your portfolio today in a, in an environment like this?

It's a good question. And you know, the first I'd say you never want to be doing only one thing. You want to have a portfolio that's going to perform well in a, in a variety of different environments. So if you look at say our corporate value portfolio, it's yielding a little bit less than 7%. It's got a duration for those of you familiar with the concept of two and a half years. So it's still quite short in its duration. And we've got about a third of the portfolio in some high yield investments or below investment grade that are, are quite well structured. Some of the airlines I talked to you about, where they're secured, we've got significant downside protection. And I'd say another big component of the portfolio is in really high quality very liquid bonds like bonds issued by the government of Canada. And you probably wonder why Canso that sees ourselves as a corporate bond shop and a credit specialist investing in government of Canada. I'd say that's, that's a lot of our dry powder that we think as this higher level of interest rates has the impacts of slowing down the economy. It's likely going to result in a number of defaults and a number of businesses that aren't able to pay their debts because rates are higher when they go to refinance. And that's going to create some confusion out there. And we think we're going to be in a pretty good situation with really high quality investments where we're going to be able to reposition those in some pretty attractive opportunities as they unfold.

Okay, great. So back to the 6040 portfolio for one second. Last, last question. Formally on the bonds, you know, should, should investors generally, of course, everyone has a different scenario and, and particulars to each of their own investment circumstances. But should, in your view, should people be increasing allocations to bonds at this stage? Decreasing. What would you be advising clients at this point?

You know, I'd say it really depends on their own personal situation and their appetite for risk. I love bonds, right. Like, I do own stocks and bonds, but I've got a lot more of my own personal savings in bonds.

Right.

And it's a market that, you know, I, I think because I'm so close to it, I, you know, I, I understand it far better and I'm certainly very comfortable with that. And as I mentioned, with the inefficiency in the bond market, I think, you know, with the colleagues I work with at Canso, our ability to identify some of those inefficiencies to the benefit of, of our investors and ourselves. I mean, you know, we invest alongside all our external clients by investing in the exact same funds that they do.

Right. Okay, great. Amazing. So, last and final question that we ask all our guests. And I know you love bonds and you're fully immersed in the bond world, but, you know, our theme at Gensler wealth is, you know, our tagline is unlimited your wealth unlimited. Because we can look at any asset class, we can help families with anything that really touches their financial lives and sometimes a whole bunch of other stuff as well. So the question for all our guests is, if, you know, your world was unlimited, you could do anything, you know, maybe different than what you're doing now as a portfolio manager at Cancel the world's your oyster, what would you be doing?

Honestly, I really. Well, I love the bond market. So I would be doing this. I'd probably be doing a lot more skiing in my free time, though.

Right.

And, you know, and. And, yeah, enjoying a lot of the things that we haven't been able to do as much of in the last couple of years. But honestly, I really enjoy what I do. And I'd say the same to about all my colleagues at Canso, that we're all passionate about it and we've chosen this as. As a career, and we're all actually happy to be back at work, working together again. So it's like a. It's like a good reunion.

Amazing. Okay, good stuff, Richard. Well, look, thanks so much. You've enlightened us on bonds 101. You've explained how Canso approaches this. This very, very large market, and I just. Thank you so much for your time and look forward to chatting with you soon again, I hope.

Hey, thanks very much for the invite, Frank.

Okay, talk to you soon.

Take care of.

This has been Brian's conversation with Richard Usher Jones of Canso Investment Counseling. This podcast is not to be taken as investment advice and is not an endorsement of Canso Investment Counseling. This has been a Ginsler Wealth Audio production. The unlimited podcast is hosted and produced by Brian Ginsler. It is edited and mixed by myself, David McMillan. Don't forget to rate the podcast and follow us on social media at Gensler Wealth. Thanks for listening and see you next time.