Update on Sun Life Financial bond funds (sub-advised by Beutel Goodman)

March 2, 2015

Plan sponsors may wish to consider whether this investment news has any implications for the investment options available within their plans. Sun Life Assurance Company of Canada purchases units of the fund listed below, which is established as a segregated fund in accordance with the Insurance Companies Act (Canada).

Summary

  • After a recent review of Beutel Goodman (BG), Sun Life Global Investments Canada (SLGI), re-affirms confidence in BG as sub-advisor of the Sun Life Financial Universe Bond Fund and will continue to monitor developments going forward.  
  • GRS’ Investment Solutions team continues to monitor the  fund, but also re-affirms its confidence in BG. GRS Investment Solutions has a long-established relationship with BG as Sun Life Financial's Core investment platform offered BG’s universe bond fund prior to its sub-advisory relationship with SLGI. SLGI’s review also extends to the two other fixed income mandates sub-advised by BG available on our Core investment platform: the Sun Life Financial Short Term Bond Fund and the Sun Life Financial Long Term Bond Fund.
  • Bruce Corneil’s retirement at the end of Q1 2015 has long been planned and his successor, David Gregoris, Vice President, Fixed Income BG, has worked on the Fund’s strategy for over 20 years.
  • BG has positioned their bond portfolio to defend against an eventual rise in interest rates and the portfolio holds conservative corporate bonds; this has led to underperformance over the most recent market cycle. While the timing of a reversal in the path of interest rates cannot be predicted, we understand BG’s rationale at this stage of the cycle.
  • While we have confidence in this fund, our Core investment platform provides choice in the fixed income category. This includes Core Plus, global bonds, passively-managed offerings, as well as other active bond funds. To the extent that a less conservative bond fund makes sense from a diversification perspective, plan sponsors are encouraged to consider other options to offer their members additional diversity as necessary.  

Performance and Portfolio Positioning
Bond Fund managers use a variety of strategies, but there are two key areas of decision making that will typically explain the majority of performance relative to benchmarks or peers:

i) choosing to own higher or lower quality corporate bonds, and

ii) anticipating changes in interest rates

Corporate bonds have credit ratings that indicate the financial health of the issuing company.  Just like banks charge higher interest rates on loans to consumers with weak credit scores, the bond market will demand higher yields from companies with low credit ratings and lower yields from stronger ratings. This trade-off requires bond managers to make a decision on behalf of investors – hold the best quality credits to preserve capital, or lower credit ratings to earn higher yields, but also take on greater risk. The difference in yields (credit spreads) is always changing based on bond investors’ changing appetite for risk. Bond managers conduct their own research on these companies in an attempt to determine which corporations are worth the added risk.

In the current environment, it has been BG’s view that the risk in these lower quality bonds does not justify the reward. This has led their portfolio to be concentrated in high quality bonds of pipelines, utilities, and infrastructure. These bond issuers tend to have long-term contracted cash flows with predictable liabilities. Because of these long-term commitments, BG can buy the debt of these issuers with comfort. To illustrate, over the last five-year period, the “BBB”-rated bonds within the FTSE TMX Canada Universe Bond Index returned 7.20%, outperforming the index overall (return: 5.45%) by 1.75%, per annum. BG had little to no exposure in this lower quality segment of the market, which represents about 9% of the index.

BG also believes the lack of investment dealers in Canada (there are six) is a material constraint on liquidity and that actively trading corporate bonds can lead to a large risk. They cite the recent credit crisis, when dealers refused to make a market in many credits (including some investment grade). BG places a premium on quality and liquidity so that even in challenging markets they can sell positions without negatively impacting the remaining unit-holders.

Changes in interest rates will have a significant effect on most bond values. When rates go up, bond values decline and when rates go down, bond values increase. Bond managers can adjust their portfolio to benefit from their view that rates will rise or fall. Interest rates have fallen to historically low levels in recent years and BG believes that they will eventually rise. BG has maintained a short duration, overweight to cash and the short end of the yield curve. This positioning reduces risk from an eventual rise in interest rates but as rates have declined, the fund has underperformed its benchmark as rates have fallen.    

In summary, BG’s highly rated corporate bonds have underperformed riskier bonds and the short duration position has underperformed while interest rates have declined.   However, market conditions can change.  No one can predict when interest rates will rise, but given how far they have fallen, it is only logical to conclude they will rise at some point and BG would rather protect investors when that happens.  Rates are repressed to levels below what BG believe are sustainable in the long-term. This cycle has proven to have been materially longer than others, which has been difficult to predict.  Market participants have been calling for an increase in interest rates for quite some time, but the economy has been slow to respond.  

We believe it makes sense for investors to take a holistic view of their portfolio. Bonds are primarily used to mitigate risk and are typically used in conjunction with equities; BG’s Balanced Fund (also available on our platform) has been a consistently strong performer as a result of strong performance from the firm’s equity portfolios.  

BG has a long track record as one of the more accomplished fixed income managers in Canada. It wasn’t too long ago that we looked at BG’s stand-alone bond fund’s performance well ahead of benchmark and peers.   Despite the headwind of declining interest rates and four years of below benchmark results, the strategy’s 10-year annualized return is still essentially even with its benchmark.  
 

Retirement of Bruce Corneil  
After more than 40 years in the investment industry, Bruce Corneil will retire in the first quarter of 2015. Mr. Corneil’s retirement has long been planned for and is not a surprise to Sun Life. David Gregoris has managed the Fixed Income Team along with Mr. Corneil for more than 20 years and has long been viewed as the successor. After the departure of Mr. Corneil, the team will be comprised of six dedicated fixed income professionals. Sue McNamara, who has worked with Mr. Corneil and Mr. Gregoris for many years, will continue leading the firm’s credit research efforts.

GRS has a long-established relationship with BG; the Core Investment Platform offered BG’s bond fund prior to its sub-advisory relationship with SLGI.  While Mr. Corneil’s departure is a significant loss of experience, we believe internal succession managed through a team oriented approach is the best way to ensure the continuity of investment process and philosophy.   

All of the key tenets of BG’s fixed income team’s strategy and philosophy remain sound. The fund has always been focused on remaining true to the Universe mandate, adding conservative, high-quality corporate exposure at the longer end of the curve. Remaining focused on Universe attributes is important and in SLGI’s view, is a key factor in the fund providing diversification from equities in a portfolio context, particularly during a crisis.
 

Fixed Income choices on our Core investment platform
While we reiterate our confidence in BG, we understand plan sponsors are placed in a difficult position when it comes to the optics of underperformance. Some plan sponsors have considered adding a second choice in fixed income so that they don’t risk changing members’ exposures to rising interest rates at a potential turning point in the market; moving away from BG’s defensive, short duration position could be a painful choice to explain once interest rates do rise.    

A second choice in fixed income will provide members with the ability to diversify within the category in various ways, including but not limited to:

  • Adding a fund that is not solely dedicated to the traditional Canadian bond market provides the potential for diversification by investment region. Our Core investment platform offers funds focused on global bonds, as well as, “Canada Plus” bond funds where the manager has discretion to allocate part of the portfolio outside of Canada. Investing outside of Canada broadens the opportunity set. At times, this can lead to stronger performance and at other times foreign exposure could be a detractor. Diversification geographically is a good idea over longer time periods.
  • Adding another actively managed Canadian Universe bond fund would diversify holdings by investment manager – we currently have two other actively-managed funds similar to BG, namely MFS and PH&N.
  • Adding a Canadian Index bond fund, which has historically been well justified based on fee differentials vs. active funds. However, it is important to remember that index funds will maintain the same exposure to interest rates as the broader market, regardless of the potential direction of interest rate movements.
  • Offering broader focused mandates like Target Date Funds or absolute return oriented strategies. This places less of an emphasis on “build your own” menu funds – and the burden on plan members to monitor and select them.    

Our platform choices have evolved in recent years as the GRS Investment Solutions team has continued to bring more choice to plan sponsors and their members.  

As part of Sun Life Financial’s commitment to ongoing due diligence, we will continue to closely monitor the fixed income funds managed by BG to ensure that the positioning makes sense given market conditions. SLGI believes that BG is positioned well for the future and is confident that over the entire business cycle, their performance will be consistent with their stated style.

Questions?
Please contact your Sun Life Group Retirement Services representative.