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High-yield rally just too risky for Canada’s biggest bond fund

The Royal Bank of Canada (RBC) logo is seen on Bay Street in Toronto on Jan. 22, 2015.


(Bloomberg) -- While the rest of the bond market continues to gorge on high yield credit, the head of Canada's biggest bond fund has had her fill.

Dagmara Fijalkowski, who runs $50-billion in investments as head of global fixed income and currencies at Royal Bank of Canada's RBC Global Asset Management, says the extra yield on offer simply isn't worth the risk. Allocation to high yield in the RBC Bond Fund, the country's largest bond mutual fund with about $18-billion in assets, has been reduced to about 3 per cent from 6 per cent a year ago, she said.

"The probability of especially risky credit outperforming government is not attractive," she said in an interview at the asset manager's office in Toronto. "I'd rather stick with my government bonds."

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Ms. Fijalkowski, 50, is pulling back on credit after a red-hot rally which has compressed yields against slumping government bonds. The Bloomberg Barclays Global High Yield Index returned 19 percent over the past year while a global Treasuries index has lost 1.2 per cent over the same period.

RBC's investing strategy -- which looks 18 to 24 months out -- allows Ms. Fijalkowski and her 24-person team in Toronto and London to look through short-term volatility for its 27 funds, she said. The RBC Bond Fund, of which Ms. Fijalkowski is the lead manager, has a one-year return of 2.9 per cent, in the 59th percentile, and a 3.7-per-cent three-year return, in the 85th percentile, according to data compiled by Bloomberg.

Uncertainty over U.S. President Donald Trump is creating a "murky" investing environment which the team has created multiple risk strategies to address, she said. Pro-growth Trump policies such as lower taxation, a roll back of regulation, and fiscal spending may result in higher interest rates. Protectionist policies may outweigh the positive and drive higher inflation but slower growth, she said.

Multiple Engines

It's like building "an airplane with multiple engines," she said. "At any given time, I will have some engines that are firing up, and the ones that are not working are not going to lose too much money."

The team is looking to buy baskets of emerging market currencies, including the Mexican Peso, with Canadian dollars, Ms. Fijalkowski said. She is also the lead manager for the RBC Emerging Markets Foreign Exchange Fund, a basket of 22 currencies, which has returned 4.3 per cent in the past year, according to Bloomberg data. They're also significantly overweight investment-grade debt and Canadian provincial bonds, she said. Provincial debt still looks relatively attractive and could still have more to go if the credit rally continues, she said.

Over the next six months, RBC sees the U.S. 10-year Treasury yield rising 30 to 40 basis points to around 2.75 per cent, with Canadian rates rising less so, she said. The 10-year Canada yield currently sits around 1.65 per cent. There will be a small narrowing of credit spreads but not a lot of benefit to holding U.S. dollars, unless it's a hedge against high yield risk, she said.

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Trade Overdone

"If there was one trade that everybody agreed on after the election it was that it's positive for the dollar," she said. "While that view is correct in the longer term, in the short term, positioning has become so excessive that it's very hard for the dollar to rally from here without clarification on the border adjustment tax."

Ms. Fijalkowski, who has worked with largely the same senior team members since 2001, is no stranger to developing strategies to manage through unusual times. It's a main reason why she was hired 20 years ago as RBC's first fixed-income analyst for asset management.

"At that time we were worried that interest rates couldn't go any lower," she said. "That was when 10-year Canada was at about 5 per cent or so."

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