AIMCo's Sandra Lau on Delivering Fixed Income Alpha
It isn’t an easy time to be a fixed income investor.
After a volatile year that included a severe liquidity squeeze in the spring of 2020, Sandra Lau, executive vice-president of fixed income at the Alberta Investment Management Corp., says many different measures now suggest the bull market for fixed income is officially over and her team is bracing for low or negative returns, with interest rates likely to rise in the coming years.
Lau and her team delivered benchmark-beating fixed income returns in both 2019 and 2020, an achievement she attributes to a two-pronged investment philosophy she brought to the AIMCo more than two decades ago: stay ahead of the curve and be nimble and flexible.
“Staying ahead of the curve means constant innovation [because] the constant search for new and best ideas is a never-ending process. Personally, I strongly believe the best investment premiums come from first mover advantages or being early, so that’s really critical.”
Nimble flexibility comes into play because “some of the best investments may not fit neatly into a predefined category,” she adds. “As such, creative financial ideas and even flexible product structure can give us superior risk-adjusted returns.”
The AIMCo, whose $118.6 billion in assets under management make it one of Canada’s largest institutional investment managers, was an early Canadian adopter of credit derivatives, as well as in-house private credit and loans.For Lau, more asset classes mean more options in the toolbox to manage through different market cycles and even crises like the coronavirus pandemic. “We truly believe that diversification — being careful in our portfolio construction — is the key to success and to managing and mitigating risk.”
For Lau, more asset classes mean more options in the toolbox to manage through different market cycles and even crises like the coronavirus pandemic. “We truly believe that diversification — being careful in our portfolio construction — is the key to success and to managing and mitigating risk.”
She positioned the AIMCo’s fixed income portfolio defensively for the late-cycle market starting in 2018. However, she and her team were quick to recognize the opportunity offered by the sell-off in the first and second quarters of 2020 and rapidly shifted gears from defence to deployment.
“There were simply a lot of good quality assets trading at extremely less than their intrinsic value. That created a very wonderful risk-adjusted return.”
Lau also believes good environmental, social and governance practices offer solid potential to improve performance. She sits on the AIMCo’s responsible investment committee and her team integrates ESG factors into the due diligence processes for both public and private credit. Just as importantly, she says, the team participates in advocacy and influence.
“Through our responsible investment team, we’ve been constantly and proactively reaching out to a lot of issuers in my fixed income portfolio and engaging with them on ESG topics such as climate strategy and disclosure, diversity and inclusion and even cybersecurity risk. We are a believer of voice over exit. We prefer to work with the issuer [to] help the company improve. . . . Divesting doesn’t involve a company and doesn’t solve the problem. You have to work alongside a company and make sure they move along this ESG journey.”
In 2020, the AIMCo was one of the founding signatories of the Canadian Investor Statement on Diversity and Inclusion and, since 2010, has been a signatory of the United Nations’ principles for responsible investment, a voluntary set of investment principles that offer a menu of possible actions for incorporating ESG issues into investment practice. Last year, Lau’s team earned PRI survey scores of A+ in three out of four fixed income categories, with an A in the fourth.
“Building a strong, sustainable investment company is a triangle,” she says. “It’s the AIMCo structural benefit that we have, the culture and philosophy of staying ahead of the curve and a team of great talent.”
I recently discussed how AIMCo gained 2.5% in 2020, going over their annual report, and specifically noted that while there were troubles in Public Markets and some Private Markets, Fixed Income delivered solid gains last year, adding 50 basis points relative to benchmark (7.8% vs 7.3%).
Sandra Lau and her team are doing a great job and she has a stellar reputation both within AIMCo and outside the organization:
Quite an impressive lady and adding 50 basis points over a fixed income benchmark is no easy feat.
Sandra Lau leads a team of investment professionals responsible for managing fixed income, private placement, private mortgages and private debt and loan assets on behalf of AIMCo clients.
Since joining AIMCo in 1999, she has held progressively more senior positions leading to her current role.
She is currently a member of the Bank of Canada Canadian Fixed Income Forum and the Bank of Canada Canadian Alternative Reference Rate Working Group. Sandra also serves on the Alberta Cancer Foundation’s Board of Trustees and is the co-founder of Edmonton Women in Finance, a non-profit organization with objective to connect, coach and advocate for women in the finance industry in Edmonton.
Sandra holds a BCom and an MA in Economics and Finance from the University of Alberta and is a CFA charterholder.
Looking at the details in AIMCo's 2020 Annual Report, I note the following:
While 2020 was an extraordinary year due to the pandemic, it also resulted in unprecedented reactions in the fixed income markets. With both the economy and financial markets in a precarious position when the full scale of the pandemic became apparent, governments and central banks quickly brought out existing support measures but then did much more. In Canada’s case, that resulted in the Bank of Canada’s inaugural use of massive quantitative easing for monetary stimulus plus purchases of assorted sectors of the bond market to support market functioning, in addition to cutting overnight rates to near zero. With such policy support, the bond market registered very strong returns for the year.
The Core Fixed Income portfolios produced strong absolute and relative returns for 2020. The Universe Bond portfolio returned 9.9%, outperforming its benchmark by 1.2%, while the Long Bond portfolio returned 13.0%, outperforming its benchmark by 0.9%.
Conservative portfolio construction, strong discipline of portfolio diversification, and focus on short maturity high quality credit allowed us to weather market disruption well in 2020 and contributed to the strong performance. Our interest rate call of neutral to slight long in duration with steepening bias, and exposures to diversified non-directional interest rates strategies has also contributed positively. With our defensive and well-disciplined portfolio positioning, opportunistic investment in corporate bonds and private placements were also made as credit spreads widened to attractive levels during 2020.
While generating strong absolute and relative returns, our bond portfolios also provided strong liquidity support to broader client portfolios and to other asset classes for investment deployment during 2020.
It's also worth noting that Private Mortgages and Private Debt & Loan also fall into Fixed Income portfolio and they both added value over their respective benchmarks:
AIMCo’s Private Commercial Mortgage portfolio provides a steady cash flow and premium return over government bonds, aligned with the long-term objectives of our clients. The mortgage portfolio returned 9.4% during 2020, outperforming its benchmark by 0.7%.
The strong absolute return of the portfolio was driven by falling government bond yields. The real estate sector has been impacted in a significant way by the COVID-19 pandemic, especially the hospitality and retail asset classes. The mortgage group proactively worked with affected borrowers to understand impacts to their property level cash flow and address issues on a case-by-case basis, as appropriate.
Given our well-diversified mortgage portfolio and solid underlying loans supported by strong underwriting discipline, there was minimal impact from deferred mortgages or returns due to COVID-19.
Private Debt & Loan
The Private Debt & Loan portfolio proved to be resilient and well positioned despite the pandemic backdrop in 2020. The portfolio returned 5.9% during 2020, outperforming its benchmark by 0.6%.
Since 2016, the team became increasingly cautious about the market late cycle, and proactively constructed a defensive portfolio. Our portfolio had minimum direct exposure to COVID-impacted sectors such as airlines, airports, hotels, entertainment and brick and mortar retail. The team had also avoided leveraged lending in commodity sectors, in general, and was highly selective in cyclical and energy sectors.
In line with the overall credit market, the portfolio had increased loss reserves for certain loans. However, the overall impact on performance was small, with no realized loan losses in 2020.
The flexibility and capability to invest across the capital structure, in both primary and secondary markets globally is our competitive advantage in pursuing relative value to deliver consistent performance over the cycle. Given our defensive investments and well-diversified portfolio construction prior to 2020, the team was able to outperform and capitalize on opportunities from the market dislocations since the first quarter of 2020, while prudently growing the portfolio.
Now you understand why AIMCo's Fixed Income team delivered solid gains in 2020.
Last week, I discussed how Canada's large pensions are squeezing blood from fixed income stones, adding significantly to private debt to deal with record low rates.
Now more than ever, private debt is playing a critical role in fixed income portfolios, there's simply no choice:
This is what happens when central banks squash the risk of corporate defaults by suppressing borrowing costs: the difference between junk and high-quality credit rates shrinks dramatically. The yield gap between the two is now near the smallest on record. pic.twitter.com/XQlEolMd4C— Lisa Abramowicz (@lisaabramowicz1) July 12, 2021
Alright, let me wrap it up there and congratulate Sandra Lau and her team for getting the recognition they deserve.
Below, Howard Marks, co-founder and co-chairman at Oaktree Capital, says investors should "look at things that are downtrodden,” including emerging markets, China and other foreign markets. He speaks on "Bloomberg The Open."