Angie Cantillon: It's important to emphasise that we do not have a global homogeneous inflationary situation. It's different country by country. In the US, we have healthy growth coming in; we have low unemployment; and inflation is starting to dampen. However, when you look overseas, there is slower growth than in the US. So, this is not only an inflation story but a growth story. That's where the stagflation concerns come in.
While consumer spending has been strong globally thus far, especially in the US, we're now sitting at over a trillion dollars in consumer credit card debt. This is what keeps me up at night. With expectations that the US Federal Reserve (Fed) will lower rates sometime later in the year, which will benefit exposure to this floating rate credit card debt, there are concerns about the impact on consumer spending and debt loads going forward and the contagion exposure to lower spending and higher debt on US GDP.
"As a global investor, we have diversified across geographies,
but we are not making top-down views on countries."
In other countries, such as Canada, consumers’ floating rate debt exposure is not only through credit cards, but you also don’t have fifteen or thirty -year fixed rate mortgages, so Canadian consumers have exposure to rising mortgage expenses too.
As a global investor, we have diversified across geographies, but we are not making top-down views on countries. We hire external managers, give them wide boundaries of what geographies and sectors they can invest in, and make decisions on which securities to purchase taking into account both top-down views and bottom-up fundamentals of the companies. While there are concerns about the US stock market and P/E ratios in the headlines, we do see some overweighting to US companies relative to Europe and Asia due to growth prospects going forward.
Angie: You look at the Canadian housing market, especially in Toronto and Vancouver, prices have dramatically escalated over the last decade. Couple these high property values with floating rate mortgage exposure, and there is concern if the Bank of Canada does not take action on rates sooner rather than later.
Angie: Not necessarily curve balls, because it has been a slow moving-train with both of these factors, but now we are at a point of reckoning on global warming and consumer debt loads.
With global warming, it's going to make the topic front of mind for individuals now that we’ve exhausted the “slow and steady” move towards reducing greenhouse gas (GHG) emissions. It’s time to take care of this situation and make it front and centre.
For consumer debt loads, a slowdown in spending will need to occur, which will trickle through earnings and ultimately GDP.
Angie: In 2019-20, we added Collateralised Loan Obligations (CLO) to our portfolio partly for liability matching. It was also because of its short duration – a quarter of a year – and it helps us better position ourselves if rates go up, and those CLOs have performed amazingly well.
"The Fed’s new baseline rate is going to be very important to the markets
regarding where opportunity is set in liquid fixed income going forward."
When rates start to go down, we may rethink the allocation to floating rate debt in our portfolio. What I am interested in seeing, though, is where the new baseline Fed fund rate lands. This discussion of a baseline rate around 5-5.25% or 4.5%, and not going back to 2.25%, means that there will be some great opportunities in the fixed income market. We had no opportunity between 2009 and 2020 to make good money in liquid fixed income. There was so much money that went to private credit because that's where you can pick up yield.
The Fed’s new baseline rate is going to be very important to the markets regarding where opportunity is set in liquid fixed income going forward.
Angie: Over the last couple of years, we've been looking at privates, especially with the shift to IFRS 17, which was significant for us. With these changes, unrealised gains and losses are now above the line. Previously, it was all in comprehensive income, so market volatility of publicly traded securities had less of an impact on a company’s profitability.
In terms of private assets, We're exploring private equity more than we had previously. We were looking at real estate, but now it’s off the table because the commercial real estate market needs to figure itself out. We are also adding private infrastructure to our portfolio this year.
Angie: Yes – infrastructure. We recommended and had approved adding two infrastructure funds to our portfolio last week, and we're going to continue to build that out.
We are looking at private equity, but we're being more specific. We're looking at InsurTech venture capital. It's a dual objective of aligning with our strategic initiatives, as well as earning a private equity return.
Angie: We're doing infrastructure equity, not infrastructure debt. It has to do with the demand for capital in that space.
It also goes back to sustainability. We have a sustainable investment policy where we have two objectives: one is to lower GHG emissions in our publicly traded securities portfolios. The second is to allocate up to 10% in impact investing. We define impact investing as putting our capital to work to increase resiliency in light of climate change and the transition to a lower carbon environment.
"You need more resilient, hard assets when you have five standard
deviation events hitting them."
When we spoke to infrastructure managers, it wasn’t an altruistic case. It was an economic case. Capital is needed, because government capital is not going to fully fund this infrastructure transition – the electrification of grids and projects around resiliency. This is significant when you think about seaports, toll roads, and the wider infrastructure that we need to maintain our daily living in the event of climate change.
You need more resilient, hard assets when you have five standard deviation events hitting them. It's an interesting opportunity with a healthy return of, say, 8% to 12% (a good part of that is real cash yield), and it doesn't have the volatility of the publicly traded equity markets.
Angie: While concerned about the outcome of the US election in November, we're also concerned about the geopolitical situation with Russia and Ukraine. That is significant and can impact our NATO allies and the energy sector. The outcome of the election could potentially exacerbate the geopolitical risk landscape.
"We don't have any private credit right now, but it's something that we're keeping our eye on – particularly IG private credit as well as below investment grade."
In terms of other areas to watch for, there’s artificial intelligence (AI), which is flowing through the earnings at the moment. Certain companies have skyrocketed because of their use of AI, so that’s interesting to watch.
Then there’s private credit. We don't have any private credit right now, but it's something that we're keeping our eye on – particularly investment grade (IG) private credit as well as below investment grade.
