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Announcer: Hosted by Dean Colling, senior Wealth Advisor and portfolio Manager at CIBC Private Wealth. Edited and produced by the Colling Group. And now on to the show.

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Dean Colling: Welcome to Wealthview. I'm your host, Dean Colling. On this edition of Wealthview, we're going to discuss interest rates and the end of one of the most aggressive tightening cycles in economic history. Joining me today is Geoff Castle. He's a portfolio manager at PenderFund Capital Management and the lead on their corporate bond fund. Geoff's been a professional investor for over two decades with a specific focus on credit analysis and business valuation. In his tenure as portfolio manager, he has received numerous industry awards for outstanding performance on a risk-adjusted basis. Geoff, welcome to Wealthview.

Geoff Castle: Hey, Dean, great to be here.

Dean Colling: Well, it's great to have you, and it is in particular, it's great because this is a unique day for us. Obviously, we're going to be talking about fixed income and credit markets today with you. And you know we've got a unique event today where this is a the changeover of what's been a very, very tight monetary policy regime around the world and particularly in the US. We had a big rate cut today in the US. That's going to be interesting. We're going to spend a lot of time on that. But before we do, why don't you give the audience a little bit of background on you and what brought you to this place today with Pender?

Geoff Castle: Thanks, Dean. So, you know, I've been an investment professional for over, I guess, 24 years now being in the business. And, you know, my background as an investor was I began as an equities investor with a company called AIC in 2000, which was at the time the largest privately held Canadian mutual fund manager.

Dean Colling: I remember those guys, yeah.

Geoff Castle: Yeah, and around about 2008, 2009, I became a credit guy, no longer an equity guy. And in 2015, I joined this little firm called PenderFund Capital Management in Vancouver as manager of the Pender Corporate Bond Fund, which at the time was a $100 million fund. And we were kind of facing some difficult markets back then. And as it turned out, those difficult markets had a lot of opportunity. We had some wonderful years of performance, and over the last ten years, we've grown that fund from about 100 million to 1.9 billion today. And, you know, our approach has generally been to find attractive yields relative to their risk of default of the issuer and find pockets of inefficiencies in the market, and credit markets being what they are that's been a really successful niche to be in. So you can get more than just the underlying yield that's available in the government bond market, but get some real interesting price discounts and some corporate bond structures. And that's helped us to deliver a really solid return for investors over the past ten years.

Dean Colling: Yeah. And many of our listeners, clients of ours, know that you and your fund represent a pretty sizeable position in our Colling Group Global Fixed Income strategy. The reasons we've brought you in and your team is, is for just what you said. This is sort of a real alpha, value added kind of credit analysis fund that, you know, you're seeking great value for companies that all of a sudden enjoy a better future, lower cost of capital and and a lift in bond prices. So it's been a real nice advantage to have in our overall strategy.

Dean Colling: Tell me how you approach the universe in, essentially in North America, in terms of sectors, and are you a sector agnostic, in terms of size, in terms of liquidity?

Geoff Castle: Yeah, so one of the things we look for in the bond market, look, there are thousands of issuers. I think there's something like 3000 issuers of bonds in US dollars or Canadian dollars, more than 100 million. So a big universe out there. So our approach to finding ideas is we look around sectors and indices for places and pockets in the market where you see things trading 2 or 3 standard deviations as widely kind of out of the normal level in terms of cheapness. And then when we get a market that we identify like that, you know, for instance, we might take a look at, you know, the oil and gas market, or it might be shipping or it might be recently kind of post-pandemic. There were a lot of kind of pharmaceutical and biotechnology companies which are, you know, really, really cheap from the point of view of the enterprise value relative to, let's say, the sales of the company or the price to book or some financial metric. And then that will give us an area to start digging in, and then we'll say, well, let's get down to the issuer level and we'll find a name.

Geoff Castle: Let me give you an example. So this last year, one of the the nice performers we had in the fund was a company called Esperion. And it makes a kind of a cholesterol lowering drug. So for people to remember Pfizer in the 90s and 2000, they had this drug called Lipitor, which was a blockbuster of all blockbusters. It went generic, and Esperion's drug represents sort of the next step forward. And this drug was launched during the pandemic, and not a lot of people were going to the doctor in the pandemic to have cholesterol checks.

Geoff Castle: And so the launch was a bit of a flop, but the drug works. And then in subsequent years, as you know, more patients were doing more kind of like overall medicals. And the company itself produced some data on the effectiveness of the drug. You saw, you know, prescription counts come up and, and sort of a kind of a strong, you know, company performance by the company. So we're bond investors. What we saw was a bond where we thought the company was worth the, you know, far more than the debt. And yet the bonds, you know, late in 2023 were trading around $0.40 on the dollar, right?

Geoff Castle: And we looked at this, this company and what we thought the value was. We saw where the credit was and it just didn't add up. And so we made it one of our larger positions. And then, you know, as the good results continue to come and the market began to pay attention, you know, the underlying equity related to Esperion did well. But also the bonds went from sort of $0.40 on the dollar to where they are in the mid 90s. And so from the point of view of 40 going to mid 90s, that's, you know, over 100% return and you put a kind of a one and a half or 2% position there and that can, you know, in the context of a bond fund add up. So that's the kind of idea which, you know, it's a bond idea, but it's not necessarily something where the prevailing interest rate moving around, you know, 25 basis points really influences that much. It's just an opportunity in the capital markets to take advantage of an inefficiently priced security.

Dean Colling: At the beginning of that analysis you sounded like an equity guy at first, right? And as I say, maybe you're your old equity side, sort of identifying the opportunity, and then going in and looking at the balance sheet, and cost of capital and pricing, and see where you can see that value.

Geoff Castle: Yeah. I mean, you're looking for an undervalued capital structure. The nice thing about credit is you're playing like the less risky part of that capital structure. I often, you know, if you are familiar to going to the horse races, it's kind of like we're betting on the favourite to show, you know, as opposed to betting on the long shot that you do sometimes in the equity markets. And that has been a way to over time, now, obviously, you know, we have a lot of just regular kind of bonds that we think, you know, they're yielding 6% and maybe they're of a risk where they ought to be yielding 5.5%. And so we, you know, buy a bond a bit cheap to what it should be, and that's obviously a big part of what we do. You know, it all adds up in terms of total return of the fund.

Dean Colling: And like, and obviously you're not looking at distressed securities per se. You're not going there in the sense that there's more of just undervalued, or will you dip into the distressed market every once in a while?

Geoff Castle: So we have, you know, sort of three buckets of, of, you know, kind of securities in the fund, sort of bucket one, which is the biggest bucket is things with very, very low levels of default risk and really kind of like either investment grade or if they're not investment grade, they're securities with a very, very low default risk that are kind of trading well and priced relatively tightly to the curve, we're looking for, you know, anomalies in there. We have kind of bucket two, which is sort of a mid-range kind of high yield. But there is a bucket three where we will look at a kind of distressed security, and in our fund we can even do things like walk a bond through bankruptcy. One of the secrets of the of the bond market that's not well known is that the highest returning segment of the bond market is actually in senior unsecured debt in the two years following it filing chapter 11. Now, by the way, Dean, you do not want to hold that bond in the two years prior to it filing chapter 11, because that's, you know, obviously a bond will go from 100 to a very low number, like $0.30 or $0.40 on the dollar.

Geoff Castle: But subsequent to a workout, what often happens is, you know, a bond like that going through bankruptcy, bought a low price, you'll get back maybe a piece of take back debt, you know, but you might also get some of your debt equitized. But the performance of the equity can actually do reasonably well if it's, you know, cheap and you can have a good total return from that. So I think the, you know, in the two years following a chapter 11, you know, studies show that there are, you know, as much as a 20% IRR on that debt in the first two years. So it's been, you know, a pocket where we don't do a ton of it, you know, we limit real distressed securities, never much more than 4%, or 5%, 6% of the fund. But it is an area where we've been able to generate some interesting returns.

Dean Colling: Yeah. That's interesting. And if we talk about the capital structure or various types of securities, I know you have done well with some convertibles this year. Do you get into the pref market at all? What other types of instruments do you bring into the portfolio?

Geoff Castle: Yeah, one of our the other sort of tools in our toolkit that other funds sometimes don't have is our ability to look at many different types of securities, often from the same issuer. So, you know, an issuer of bonds might also have a floating rate term loan, they might have preferred shares. You know, there would be you know, sometimes it would be a convertible bond in that structure. And so we think with the credit skill set, particularly if you're able also to kind of value an entity, then you can look at a variety of different types of securities. So yeah, we do get involved in convertible bonds. And sometimes, you know we typically will initiate those positions in the convertible bond in what we call a busted convert, which would mean that if it was issued, let's say the stock of the company that issued the convertible bond was trading at ten, they might issue a convertible bond with a strike price, or that it would convert into stock at, let's say, $12. Well, if the stock of that issuer falls to sort of $4 or $5, the bond might be still good from the point of view of credit. Like they can pay it off on maturity, but from the point of view of the option value of the convertibility, it would disappear.

Geoff Castle: And so it would be called what you call a busted convert. And it might trade at, let's say, $0.75 or $0.80 on the dollar to yield, let's say, 7% to its maturity date. But if you come upon an issuer like that, at which point when the related equity, like the whole company's value is undervalued, maybe it's gone through, its industry has gone through, a downturn or a cyclical dislocation or something of that nature. There's always the outside chance that you can have it stock go back up and the convertible bonds go back into the money. So you might have signed up thinking you'd get 7% just getting that thing paid out at 100 maturity, but you could get more than that. And one example recently for us in the corporate bond fund was we were invested in a company called Novavax. And Novavax, many listeners will remember that from the pandemic, it was one of the 4 or 5 companies that had a Covid-19 vaccine. And of course, as the pandemic ended, the prospects for Novavax and a bunch of other vaccine makers diminished significantly. And we looked at that, you know, Novavax late last year and saw a convertible bond, you know, priced in the 50s to yield over 20% to its 2027 maturity.

Geoff Castle: And, you know, had a lot more cash than debt, and there was a whole number of reasons why we thought it might pay out at par. A bunch of different things happen, I'm not going to go through the entire rigmarole as a story. But ultimately, what happened is that, you know, in about May of this year, a company called Sanofi came along and bid, you know, three times the market cap of Novavax at the time for its main product. They weren't even buying the company, they were just buying its main product, and that caused the stock of the company to move to such a point where the convertible bond we bought in the 50s actually went into the money, that you could have converted it and put it into stock, and made money at the level of the stock was trading. So we got out of that position around 109 cents on the dollar. So we made you know around about 100% on that position. And that's kind of one of the, you know, sort of hidden opportunities within a convertible bond. Sometimes the stock does its thing. And. You know, we were comfortable, again, we were taking the base level return, but if it happens that way we'll we won't turn away the extra money.

Dean Colling: Take me through the portfolio diversification, in terms of sectors and position sizing and things like that. And is there any sectors that you, as a rule, avoid or just some you know you prefer over others?

Geoff Castle: Yeah, we are like, from the point of view of sectors in the market, we are diversified across a number of different sectors and a few different geographies as well. I'll say our approach to it is not necessarily what a lot of people's approach to sectors diversification is. So, for instance, one of my first meetings in the investment business back when I was a wet behind the ears telecoms equity analyst at AIC, there was a guy from the Dresdner RCM Global Telecom Fund came into Burlington and he was going to have lunch with me. And so the night before, I studied up on his fund, and I noticed that his number one position in the fund was Nippon Telephone and Telegraph. So I sat down at lunch and I said, hey, I read about your fund and your number one position was NT&T, can you tell me all about it? And the guy looked at me straight in the eye and he goes, Geoff, I don't know a damn thing about NT&T, it's just the largest weight in my index, so I market weighted it. So, we don't do that, but suffice it to say, that is how some people diversify by sector. What we do is we hold a relatively small number of positions, 80% of the fund is in the top 60 issuers within the fund. And some of those issuers are things like McDonald's and Loblaw, which I don't toss and turn a lot at night, you know, worrying about their results. So we have about three dozen issuers of some significant size, we think we have value at risk, and those we do diversify by sector just because we like to take some different bets.

Geoff Castle: But we know the intimate details of each of those names, and we are in contact with management and we follow things along that develops in that company, so that when you see a press release coming to that company, hopefully you've understood what they were doing before, and it doesn't come as a surprise to you to say, oh, they were trying to sell that division and they were successful, that's interesting to see. So you have a level of understanding which you can't do over-diversified, but you're going to find sometimes some sectors have more opportunities than others. So you know, when the price of oil was negative, you remember that?

Dean Colling: Oh yeah.

Geoff Castle: -$38 a barrel? The day that the price of oil hit -$38 a barrel, we were buying the first lien secured term loan of Chesapeake, which is a Texas based oil producer, between $0.30 and $0.40 on the dollar. You know, that thing was worth over 100, you know, less than a year later. You know, sometimes a sector goes into one of those issues and you have to look at yourself and say, is the price of oil going to stay negative for a long time? Probably not. But people are scared and those are where you get opportunities. And the thing about, you know, difficult times in the market is that rolls around from sector to sector. So you get a chance to get in a bunch of different sectors.

Dean Colling: And that's why we like it too. I mean we, this is a very alpha seeking strategy, but really from our due diligence with your group, take risk management seriously, and you know and it's shown in over the last I forget how many years we've had you in the strategy. But really drawdowns have been very, very limited. Let's switch gears for a second and talk about Pender as a group, your team, a little bit of background on the other folks on the team, other guys doing credit analysis. We'll give some of them credit as well. I know you're the lead guy, but I'm sure you don't do it alone. Can you tell us a little bit about that?

Geoff Castle: Yeah, I don't do it all myself. And without a really solid team at Pender, it would be impossible to do what we do consistently for as long as we have. So there's five full time people dedicated to Pender Corporate Bond Fund. In addition to myself, Parul Garg, who's been with me on the mandate for the past nine years. You know, in terms of area of speciality, she really focuses in on some of these distressed and distressed names, some of which we've talked about here and a big part of the team. Another person very important on the team is Emily Wheeler. Emily joined us about five years ago. She also works on, you know, some of the funky credit names we have within the core bond fund. But she also focuses a bit on the investment grade. We haven't talked much about the investment grade side of things, but it's a very important part of our mandate, trying to get a return in some less risky things, but still trying to optimise return there. And she and I work together on a side project, the Pender Bond Universe Fund, which is more investment grade. There are a couple of other analysts on our team and also outside of our own specific team. There were a couple of other mandates within Pender, where one is the absolute return fund that's run by my colleague Justin Jacobson, who's a very experienced credit analyst.

Geoff Castle: He runs a kind of absolute return long short hedge fund. There's analysts that support him. And then outside of that, obviously we have an equity team, and equity team relationship with a bond team is kind of funny because we were also a more conservative, we're kind of like the downers of the party in terms of not worrying about things going to the moon, but only going to 100. We have a conversation and a dialogue about opportunities that they see and whether we think the bonds are attractive in the situation. Likewise, we might throw one across the fence at them and say, here's where the bond might not be as attractive, but this company is doing really well. You maybe should should look at that on the equity side and that, you know, we're not such a big company that the equity team is on the third floor of building B, and we're on the 19th floor of building A, and we all kind of sit together. And it's really a great kind of environment to be part of a sort of an alpha seeking boutique.

Dean Colling: Yeah. That's the vibe we got when we were doing our due diligence is that, you know, experienced enough group across absolute return, across credit, across equity. But idea sharing amongst all groups and that's that's pretty valuable to the end investor in your fund in particular. You know, at the beginning of our chat we talked a little bit about uh, today, obviously we had a 50 basis point rate cut by the US Federal Reserve, marking the end of a historical tightening cycle. Um, started back in 2022, and rates went up more than they ever had on an absolute basis, um, in terms of time and quantum. So, you know, this was fairly telegraphed, obviously most people felt there was either a quarter or a 50. Where were you guys? Were you in the quarter or the 50 camp or we don't care camp?

Geoff Castle: We weren't really orienting many investment decisions around whether it was a quarter or a 50. I would say that where we've been generally on on the fed was that we could see the slowdown developing the economy. I mean, you know, it's often said that, you know, monetary policy works with a lag. But I think that and maybe people hear that, but people forget it a lot. And so, you know, people are, I think, there's quite a lot of negativity around bonds last year when, you know, rates would be going up and up and up, and people were worried about inflation and bonds going up, bond yields going up further, therefore bond prices going down more. Um, at some point last year we realised, look this is going to have an impact. And actually if you take a look at, you know, one indicator the US composite leading indicator I think is it's declined. It's gone down for something like 23 months in a row. So we knew things were softening. And you can kind of see it now in unemployment and that kind of statistic as well. So we really were expecting the fed to come on on board with cuts for four or five, six months now. And we've seen some early indicators of that one thing.

Geoff Castle: If you watch the other central banks in the world, I mean, you see obviously the Bank of Canada got a head start on the fed, but so did you know 20 or 30 other major central banks, and you could kind of see the trend moving from all central banks in hiking mode, to most central banks in pause mode, to some of the of the early indicators of central banks kind of starting to cut. And now you're going to see, you know, kind of the herd of elephants all kind of moving together as they go into cutting mode. And, you know, we honestly, we didn't know how high things were going to go when they were hiking. And we don't really know how low things are going to go now that they've been cutting. Obviously here was a 50 basis point cut on one day. So it gets you off to a big start in the uh, in the US kind of yield curve. I mean, I think that we had looked at, if you look at what the market was saying, I mean, the market doesn't actually set the overnight rate. That's the Federal Reserve, but the market does set the rate all the way along the curve. So what you'd seen is, you know, you had yields in the kind of between 5 and 10 years as high as, you know, the high fours, low fives, uh, about a year ago that's already moved down to about three and a half, so you've already had quite a big move along the curve.

Geoff Castle: And I think this is what you're seeing, the market discounting future fed cuts and how low that goes. I'm not sure we're going back to, you know, 1% or 0.5% or something like that on the on the fed funds rate. I think that we might end up at a, let's say, a higher low versus where we were in 2020. And that might be honestly, the direction for the next 10 to 15 years that we kind of had, I think a blow off bottom in terms of yields back in 2020. And you remember we were talking about $17 trillion worth of bonds that were having negative yields, to me was the absolute blow off insanity low of the bond market rally that was 40 years long. And, you know, bond market moves in long cycles. You know, maybe we've got 15 or so years of a gradually rising, you know, yield curve with occasional counter-trend rallies, counter-trend declines like we're seeing in this year.

Dean Colling: Yeah, it was amazing back in those days where we would see brand new bond issuers buy, you know, governments or good solid, you know, investment grade corps with a coupon on their prospectus of zero, you know. And there was still a line up to buy them.

Geoff Castle: So we used to joke that, you know, you should get off a zero coupon perpetual.

Dean Colling: Yeah.

Geoff Castle: That's otherwise otherwise known as just taking their money.

Dean Colling: Yeah, exactly.

Dean Colling: It was just a weird situation. So, yeah, so here we are. And, you know, we've been saying that to clients and writing about it, we don't want a zero rate environment. There's, there's, we wrote a piece, uh, last year on the dangers of free money in a zero rate environment. We want something a little bit more normalised, but it's interesting to see maybe what your viewpoint on this is, is that because this is a monetary cycle that was born out of Covid, this was a very unique circumstance. I mean, this is not a normal economic cycle where things got overheated, and now we need to cut rates and or raise rates. Sorry. And then, you know, and growth slows as a result of that. This was just a absolutely new playbook that no central banker could really know what to do. And so, you know, we'll flood the system with money, and until you know, we're okay again, and then we'll pull it back out. Like how did you guys, can we, can we say this time it's different?

Geoff Castle: Well, you make a good point in that the things that drove inflation to their heights, I mean, central bankers were roasted for saying inflation was going to be transitory because, you know, the high inflation levels lasted, you know, more than three months. They lasted more like a year and a half. But in a way, they weren't totally wrong.

Dean Colling: I know.

Geoff Castle: Right. And so and there was the rare circumstances around shutting down the entire economy, the supply chain bottlenecks that kind of resulted, the unprecedented cash in the jeans kind of policy that most governments came out with, and then the kind of the, the bottleneck in terms of actually accessing product and so forth. I mean, that was a kind of unique circumstance. And if it was like super quick to kind of go up, it has also been kind of somewhat symmetrically quick to kind of fizzle out. That being said, I do think that this may have happened within the context of a longer term inflationary cycle, but the particular facts around this last year or two suggest that it may be a bit of a relatively short cycle, and maybe not as deep as people might have expected, given the inverted yield curve and, you know, a leading indicator that was declining. But, you know, maybe it is something that will prove to be a bit unusual from that point of view.

Dean Colling: Yeah. One of our viewpoints was as well, and you mentioned it earlier, about bond yields out on the curve at the sort of five and ten year rate. I mean, we always say and this is a credit to you, you bond guys, the bond guys are always the smart guys. They're really looking at it from a credit perspective. But had they had, you know, had the collective bond market felt that inflation was going to be a long term secular problem those yields wouldn't hung around there in the fours. They would have been far further up, nobody likes to get a negative real return on their on their bonds. And those rates would have gone higher if the bond market felt that inflation was going to be really, really sticky.

Geoff Castle: Well, the funny thing about the yield curve and again, you know, if you go back and think about what the yield curve looked like in the 70s and the 80s, one of the interesting thing is there just wasn't that much debt in the scheme of things, relative to the size of the economy, relative to the size of people's incomes back then. And as we went through, I kind of call this period the great barbecue, you know, sort of between the early 80s and the 2020s, early 2020s, where you take like the short term interest rates, go from 13% to 14%, basically to nothing all around the developed world. You did get, um, some strange phenomenons towards the end of that, and that was any hint of rising rates brought out central banks to basically print up a relatively unlimited amount of cash to buy down bonds at a certain yield. So we're not currently in North America in a yield curve control environment now, but we have been in the last the last decade. And if you take a look across the Pacific over to Japan, I mean, look at the reverberations around them, just backing off that stance to a degree for a long time. The most interesting thing about the Bank of Japan's, you know, the Bank of Japan would come out, they have the interest rate decisions, but they wouldn't just have interest rate decisions, was rather boring because it's zero again, but they'd also say how much money they were going to use to buy down the ten year JGB, down to a certain specific yield around like 0.1%.

Geoff Castle: And just backing off that stance to a degree has caused, you know, some some shaking around the market. So what I'm thinking is that as we go, you know, out of this kind of Covid driven cycle back to what I would call the regular cycle, we're still dealing with that huge, the huge levels of debt which exist both of the private and government levels in the West, and there still is a question of how that normalises and will that normalise without yield curve control. And I think if people believe that there would never be a yield curve control again, or the central banks would never buy their own bonds again, you might actually see a much higher long bond because, you know, people wouldn't think there's someone there to to back them up. But in a way, those tools which are kind of unpacked after the financial crisis, are still in the arsenal of central banks. And so I think that is keeping people from, you know, keeping the bond vigilantes, as they call them, away from too aggressively shorting bonds along the curve. But over time, I wouldn't be surprised if we see that the 40 year bull market kind of unwind a bit. And let's go back towards higher absolute rates over a kind of a 5 or 10 year horizon.

Dean Colling: Okay. Interesting. And so we're kind of talking a little bit of macro here, which I think if you ask any portfolio manager, they try to say that macro doesn't matter that much. But I want to know from you guys how much does the macro view have impact on your investment decisions or your strategic positioning in the portfolio?

Geoff Castle: Well, a lot of times it has no impact because we're looking, you know, very specifically like that case I talked about earlier with Esperion, which is more to do with what was happening with one drug company and selling their drug. Other times there are, you know, industries where the level of real interest rates, that is like the level of interest rate minus the level of inflation kind of comes to bear. So, for instance, if you take a look at the gold mining industry, you know, the price of gold tends to respond very well in periods when inflation is higher than the prevailing level of interest rates, or a situation you call negative real interest rates. And it tends to do poorly in situations where real interest rates are quite high. And so when you see, I think what we might see over the next couple of years is as rates come down, there has been a kind of underinvestment in certain commodity sectors, and some producer prices might go up and you might see a reignition of higher interest rates. And so it's interesting that, you know, the gold market is kind of sniffed that out a bit. And and, you know, we don't actually necessarily invest in the bullion, but you also see the gold miners where there are some very interesting securities, you can make a lot of money potentially. But we would look part of this thesis on those investments in, you know, let's say you take the Equinox gold convertible bonds.

Geoff Castle: Well, you know, if that strike price of the bond is like $6.50 or so and the stock goes to like $10, when obviously you're buying that otherwise is going to make you 4.5% coupon or so you might make, you know, 50% return or something like that. And so we pay attention to the macro as it relates to these particular sectors. I mean, another place we look at macro for would be something like the utility sector, where, you know, let me characterise that sector, the the profitability is more or less locked in. If you're running a regulated utility, as long as you invest your capital, the regulator allows you to earn a stated return on capital. It's not very exciting, from the point of view when large returns are available to corporates. But when the economy is in a bit of a profit slump, then utility type profits become relatively scarce and those securities can again do quite well. And again, there are convertible bonds in the utility area where you can actually again make more than just a coupon. And also just the yields on high quality credit, you know, might come down from six down to three or something like that. And so, so long as the profitability of the underlying issuer is not in question. And so, you know, utilities might be a really interesting sector to get involved in right now, if you believe the slowdown in the economy is going to continue.

Dean Colling: Does yield curve positioning and trying to sort of catch the tailwind of falling rates come into play? Or are you guys relatively, like how long have you been in terms of duration in the fund and where you positioned today?

Geoff Castle: Yeah, there's um, there's a measure in the market called the term premium, which is sort of a mathematically derived number, which essentially tells you whether you're getting paid a lot to extend duration or not. And in the absolute lows of the, you know, of yields in the summer of 2020, the phenomenon we saw is if you measure the term premium versus a ten year US Treasury, for example, you saw that the term premium was negative, right? So basically the market was basically paying extra for the added volatility that comes with ten years of duration. And you can kind of see how that turned out. If you bought a ten year US Treasury in August of 2020, yielding 0.5% over the next approximately two years, it declined in price, something like 22%. So imagine you took a client, you said you're going to make 0.5% a year in this investment I'm making for you. And the first two years you give them more than -40 years worth of returns. Now, look, if you if you held that that bond to its maturity in 2030, you would have over that time earned, I promise you, 0.5% US dollars per year.

Geoff Castle: But imagine taking that that 40 year drawdown first and having to explain that and people trying to understand who aren't necessarily in the bond market every day. So what we try to do with our fund is when the term premium is positive or higher, we try to take on a bit more duration. So what you've seen us do in the last couple of years is move our duration from around two to closer to four, kind of like 3.7, 3.8. And then when the term premium comes down, try to go back more towards the front end of the curve, where you're not relying so much on what happens with the overall term premium. Now, in corporate credit, you also have to overlay on top of what happens in the government curve, what the spread is. So we might actually, even if there wasn't much of a term premium in the government market, we might still, because of security, might be distressed, we might still buy a corporate bond. And that's only because, let's say $0.60 or $0.70 on the dollar, we think we might go to $0.80 or something like that.

Dean Colling: Yeah. And then that's that's kind of what we like about you guys as well is when we're building a strategy, a global fixed income strategy, you know, we look to your group to really not incorporate a lot of interest rate risk. This is more credit and relative credit value, and that's what you guys have been doing very, very well. Sticking with the macro theme, obviously we had an interesting day today as we just mentioned, and we've got something else coming up in a few weeks, six weeks or so. We've got a US election. How do you feel about that? And does that play into your view in terms of credit risk or just how the market will react in the next couple of months?

Geoff Castle: Yeah, it's obviously a big event that is probably on the minds of lots of investors. In a way it's kind of hard to, I mean, there obviously are some securities associated with each side of, of that election that are kind of aligned with the Democrats being ahead or the Republicans being ahead. I think as I look at that election, one thing that really sticks out to me in terms of what you hear the candidates saying is that on the on the Democrat side, you have essentially a lot of spending that is going to come along. So the expansion and maintenance of the welfare state, etc., which is quite popular, and you see kind of voters connecting with that on the Republican side, you don't see them walking away from spending, but you see a big commitment to cutting taxes. And they put both of those kind of propositions together, and one thing that seems to be a bipartisan policy seems to be basically expanding the budget deficit in the United States. You know, so that again, talking about why we think that, you know, yields in the bond market over the longer run may rise is because, you know, sooner or later, there are limitations to your ability to just borrow from the future in real terms. And it will, I think, you know, oblige future central banks and future US treasuries, and not just in the United States, but in democracies around the world of face similar issues, it will oblige them to do more of this unconventional monetary policy. And I think some of the winners there are basically scarce real assets which cannot be magicked into existence the way you can magic money into existence.

Dean Colling: If we think about the extension of that with deficits and spending and obviously money printing, what's your view on the US dollar and how do you incorporate any US dollar hedging or hedging within the portfolio?

Geoff Castle: Well, we in the corporate bond fund, we have some US dollar securities, we have some Canadian dollar securities. And what we do is we essentially sell forward a kind of a derivative basis of the US dollar to the CAD. And that essentially, if you own the Canadian dollar class, you more or less own like the local currency return, as opposed to seeing a big currency impact in in the fund and in the US dollar versions, we kind of do the inverse, we hedge out the Canadian dollar. You know, we don't take a view necessarily in the bond fund on currencies. But, you do watch the US dollar. So what has happened over the last few years is that as the United States has had a higher real interest rate that has propped up US dollar currency versus other currencies, and there's this thing called the dollar index, you know, ticker symbol DXY for those playing along at home. And you'll kind of see that has rallied versus other currencies quite significantly in the last 3 or 4 years. It looks like, if you take a look at some of the drivers of what was keeping the US dollar up there, outside of this relatively high interest rate, there weren't a lot of other drivers in that. The United States economy is running a huge trade deficit, they're running huge budget deficits, and there are other reasons why you might be a bit leery of the US dollar.

Geoff Castle: The last leg of that stool that was keeping it afloat was a relatively high interest rate curve. And now with the fed kind of in cutting mode, you know, we've kicked away that last leg of the stool. So what happens, you know, as a US dollar is potentially weaker going forward, is that you might see, you know, certain markets and segments, etc., kind of their backs against the wall, or returning, and making lower returns, suddenly turn around and do a bit better. And I think an analogous period to this time was back between 2002 and 2007, where a similar hiking cycle ended and you suddenly had a weaker dollar. And what you saw was a rally in like emerging markets, you saw a commodities rally, and you saw just a sector rotation away from, you know, large cap tech that had obviously ruled the roost in the early 2000s down to kind of meat and potato kind of value kind of companies and, and older economy. And, you know, the rest of the world's markets, which are full of kind of older economy companies kind of outperformed. And so there's places to look for credit opportunities along that line. And so with a decline in the US dollar leadership, that's the kind of idea that we're spending time kicking around as we think about how things might go going forward.

Dean Colling: So looking forward then with that in mind, and again, this is maybe not be a big part of the overall strategy, but do you believe in the soft landing narrative still, or do you think there's more risk to recession in the US in the coming quarters?

Geoff Castle: Um, yes, it's a good question. I mean, I think that because of the weirdness of this cycle, even though all the flags that tell you that we have a recession coming of some magnitude because of how long the yield curve is inverted, how high it is inverted, how long the leading indicator went down, there is a potential that it might be a bit more fleeting of a downturn than you have seen in some other cycles. And so, you know, the long, elusive soft landing may appear. That seems like a possibility. I mean, I think as someone who invests other people's money, you tend not to, you know, make your base case like the best possible outcome, right. You tend to say, you know, well, it's not cloudy right now, but I am going to Vancouver, so I should pack a raincoat, and I think this is the same kind of scenario. So we are being a little bit cautious. You know, we're holding a higher degree of investment grade in the fund that, you know, compared to what we would allocate under a sort of all systems go kind of economy. But we do recognise that, you know, a soft landing could be a thing. And, you know, that won't be bad for corporate credit mandate. But, you know, we're not necessarily just putting the pedal to the metal all the way because, you know, we have to have some humility against, you know, not knowing what might be coming down the pipe.

Dean Colling: My final question to you is, is the impact of credit spreads and where they sit today. I mean, when we're managing equity portfolios, we look at that as sort of canary in the coal mine, governments versus investment grade versus high yield, all relatively calm right now. They're benign. There's no, spreads are kind of a little tight actually. Um, you know, I don't know if you're seeing any value there or on the flip side, any risk because they are relatively normal or tight at this point.

Geoff Castle: Yeah. One of the interesting things about credit spreads that we see is that you're right. You have seen a market where the spread that is the extra yield that you get for holding a high yield bond compared to a government, a government bond of same tenure is, you know, between 3% and 3.5% has been for the better part of last year, which is historically, you know, on the lower end of things, not the record low, but on the lower end of things as they normally are. I think that this time around, there has been a bit of a change in the structure of, call it, the leveraged finance market. So the leveraged finance market, which is basically the high yield kind of market, is composed of three parts, one part is what you call high yield bonds, right, and we're obviously holding quite a few of those. Another part is syndicated term loans. So banks syndicate term loans, and you'll see these floating rate loans which you know we can also buy in the market and trade. And those two markets are each, if you add them all up about 1.5 trillion with a T. What has emerged over the past decade is a private credit market, which was, if you go back ten years ago, was around 100 billion, which is now also 1.5 trillion with a T, and a lot of the edgier borrowers and the deals that might push spreads in the high yield market, were those borrowers borrowing in that market higher have actually migrated over to that private credit market, where they actually are getting those higher yields in that private credit market. But because of the opacity of that market, you can't see what we think is actually going on very clearly.

Geoff Castle: But what we see is that is the kind of issuer which is being hit right now. And what is, you know, what are those loans are in the private credit market. A lot of them were made to leverage buyouts. You know, in the years 2020, 2021, 2022, when those leveraged buyouts were done, massive amounts of capital, but they were done at valuations that were extreme high, right? The highest EV to EBITDA multiples that we've seen in leveraged finance. And then they've done it, like, record terms of debt. So more debt to EBITDA turns than normally done, and we think that we are seeing a kind of spread blow-out happen. But you're not seeing it in the official kind of spreads which track the high yield bond market, because a lot of the issuers that are having problems are domiciled in this different market, where you have a bunch of private credit funds trying to paper things over and deal with these, uh, losses that are showing up in the system. So, yes, I think look, if you have a more serious recession, I think you're going to see spreads in the leverage loan market and the high yield bond market move higher, but maybe not as high as some of the blow-outs in the past, because just some of the more dangerous underwriting has been done in the thing that's grown the most quickly, which is often what happens in an underwriting cycle that goes bad. You don't want to be the person that gains the most share just at the end of the cycle, because that blows up real good.

Dean Colling: Well, interesting times to say the least, in particularly this year and the last three where we've seen tightening cycle now a cutting cycle. We've got an election coming up. We thank you again for your time today, Geoff. It's been a pleasure. And let's do it again sometime in the new year, and we'll do an update and see where we sit.

Geoff Castle: Dean, thank you very much. Thank you for your support of our project. And I really appreciate talking with you today.

Dean Colling: Great. We'll see you again soon. Thanks, Geoff.

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