Welcome to ETFs in Context. Markets are adjusting to the new regime of greater volatility and higher interest rates. While this has caused market challenge through 2023, it's also surged to create some opportunities in our view. We're seeing proof of this in global ETF flows. Flows into iShares fixed income ETFs are at record year to date highs. Through Q3, iShares alone has seen 82 billion of fixed income ETF flows globally. I'll speak with Nick Singh from the BlackRock Canada Capital Markets desk later to learn more about what we're seeing from an industry perspective. First up, I'm joined by Rachel Siu, head of Canadian fixed income strategy for BlackRock. And we're diving into the current rate environment and implications to portfolios. Hi, Rachel. How are you today?

Great, thanks for having me, Helen.

To start with the big picture, many central banks, Rachel, including the Bank of Canada and the Fed, have shifted to a more data dependent approach on interest rate policy decisions. We've seen elevated volatility as markets try to decipher economic data releases and the forward path of monetary policy. What is the outlook for interest rates for the remainder of the year and into next year in 2024?

Yeah, that's certainly a topic that's top of mind for many investors. It's certainly been a very, very volatile period for markets.

Certainly has.

Continued uncertainty. A lot of repricing or digesting of data to determine the future path of interest rates. More perspective in terms of the central banks. We do believe that policy rates are at or near terminal rates, but importantly, we do think that they need to stay higher for longer. Inflation pressures continue to remain persistently above what central banks, like the Bank of Canada and the Fed are targeting at two percent. The Bank of Canada's forecasts themselves indicate inflation is not going to get all the way back down to the target of two percent until 2025. Really, I think outlining their view that race need to stay restrictive for some time. And that is our base case as well. We do think that central banks will be hawkish and biased towards keeping rates higher for some period of time. And in fact, we don't think rate cuts will be on the table until at least the second half of 2024, driven by a weaker consumer slowing growth and, decelerating inflation dynamics. I think one more quick thing to note on the long end of the curve, given really the magnitude of moves that we've seen this year, the back end of the curve tends to be a little bit trickier. It's driven by different factors like growth, inflation, but also term premium dynamics. We think that term premium, which is the additional compensation that investors require for owning longer maturity bonds, can start moving higher due to more elevated and structural levels inflation, in the US, rising Treasury coupon supply, and also concerns over the fiscal outlook in the US as well.

You know, Rachel, it's difficult to know what to do as an investor right now. And when we think about this backdrop for higher rates for longer, what are the implications for fixed income investors?

Well, I think the interesting thing is that with yields now reaching levels we haven't seen in over 15 years.

That's amazing, actually.

We believe that the opportunities that a cross bond ETFs now is more compelling than ever. Investors are now able to achieve four to five percent yield, staying in high quality fixed income exposures. And against this macro backdrop of a gradually slowing but likely still positive economic growth environment, we do like short duration exposures and the belly of the yield curve to really lock in these higher yields that we're seeing today as we near the end of central bank hiking cycles. The higher yields we think at the belly of the curve can translate to higher carry and also as potential cushion to offset negative price returns. One example that we've been speaking about is XSB that iShares Core Canadian Short Term Bond Index ETF, which hold short term investment grade bonds maturity between one to five years. It's now yielding north of five percent with duration of two and a half years. You know, just a couple of years ago, investors had to go into US high yield or market debt for yield close to those levels.

Yeah, it actually has been amazing seeing where yields are. I'm old enough to know 1987 and some of what we're seeing in that playbook. Rachel, could you talk a little bit about the belly and when an investor thinks about what the belly of the curve is, could you just spend a few minutes describing what that is?

Yeah. We think about different parts of the curve as being driven by different factors. The very front end typically is driven by, for example, central bank policy decisions, the very front end typically is most correlated to that. But as you move further out into the maturities, call it kind of the five-seven year part of the curve, that can be an opportunity now we think, to lock in the yields that we're seeing. And in particular, if central banks do need to start cutting, call it in the next 12, 18 months, that's also an opportunity for investors to benefit from rate moves as well.

And when we think about RBC iShares line up, could you talk a little bit about how TMCBs would work in a portfolio in the context of the market we're seeing right now?

Yeah, This has been, I think, one of the key areas that we've seen investors utilize bond ETFs to start thinking about allocating more into that asset class. The Target Maturity Corporate Bond ETF, for example, very much feel an acts like an individual bond in that they mature in a specific year. We have target maturity corporate bond ETFs, a mature in 2025, 2026, and so on. So you get the familiarity of the bond ETF maturing on a specific date, just as you would an individual bond. But at the same time, you get the benefits of an ETF. You get the liquidity, you get the diversification of multiple bonds in one ticker as well as the low cost element that's compelling as well. I think investors are recognizing that and utilizing it as a way to step out of cash as a replacement for GICs, for example, and also to be much more custom in terms of where they want to take duration risk or build their own ladders.

When we think about the opportunity and the in global bonds today and we think about fixed income allocations, I know as a team we've been talking to clients about the bond pyramid. And I'm wondering if you can talk a little bit about how within the environment we're in right now, we should think about utilizing the concept of the bond pyramid.

Yeah, I think one of the big themes this year has been this step out of cash trade. We know that in 2022 a lot of investors move cash, moved into cash, I should say, and there's still a lot of cash on the sidelines. But increasingly, clients and investors are looking for ways to deploy that back into fixed income. Given this, you know, yield environment that we've been speaking about and increasing their overweight, their underweight, I should say, back into bonds from equities, from cash and alternatives. And I think the bond pyramid framework that we have at BlackRock, is very useful in thinking about how to implement that. Ultimately, we do think it's critical for investors to know the role of fixed income and determine what the optimal allocation is and determine what is the objective that you want bonds to play so you can determine whether or not it is delivering what you need and what you would expect. And the three key components in the bond pyramid that we think bonds deliver are number one income, delivering a steady level of income. Second, capital preservation. So, you know, similar experience, stable experience, I should say, throughout different market environments as well as equity diversification. The balance or protection, when you see risk off moves or equity market sell off. And we do think that it's important for investors to think about their allocations in fixed income, whether it's individual bonds, whether it's bond ETF, whether it's active mandates, and allocate accordingly to each of those objectives to determine it's delivering what you would need and adjust as while the bond pyramid, depending on your broader portfolio mix. And what I mean by that is if your overall portfolio is riskier, you have heavy allocations to stocks or alternatives, for example, you probably need more of your bond ETFs or more of your fixed income to deliver diversification benefits and offset the risks that you're taking elsewhere.

Yeah, and I think, you know, when we think about the bond pyramid and then we think about blending index and active, you've touched a little bit upon this already, but you know, each bucket of the bond pyramid potentially creates better outcomes at lower management fees depending on the exposure that you're looking for. Rachel, taking one step further, how are investors using fixed income ETFs? And as we think about RBC iShares, which fixed income ETF should they be considering?

Yeah, I think the interesting thing is when we have these conversations with investors on this bond pyramid framework and they look at their holdings, it's quite typical and interesting that through decades of low yields, many of their allocations tended to fit into that income objective. They were searching for yield, searching for income, and naturally became more overweight to that part of the bond pyramid. And accordingly, now that they're looking to reassess and adjust our allocations, they're looking to things like XFR, our floating rate ETF for capital preservation. XFR holds floating rate bonds with coupons that reset to prevailing interest rates, so the duration is close to zero. And it also allows investors to really take advantage or benefit from rising interest rates. And importantly, it fits into the capital preservation bucket because it's extremely high quality. Most of the bonds in XFR are issued by the government federal agencies and so overall credit quality is around double A. And so as a cash alternative, as a capital preservation tool, it is one that we see a lot of investors allocate to.

And actually higher than a GIC in certain cases.

And also gives you the benefit, of course, of liquidity and an optionality which I think is critical in a volatile environment like today. I think the other one for equity diversification has been XBB, which is, you know, one of our core tickers in terms of our universe bond ETF, of course the oldest Bond ETF as well, and it allows investors to get exposure to the broad Canadian fixed income market through one ticker, giving them duration of close to seven years and adding that balance or diversification against equity market selloffs, which we've seen play out in historical scenarios as well. And the way we've seen investors, I think, implement them alongside active managers or active portfolios is using ETFs as a core low-cost allocation and then building satellite positions around it with high conviction active mandates that have that track record of successfully delivering excess returns. Blending those two, as you said, Helen, that we do think has opportunity to really create more optimal outcomes at lower fees as well.

Well, Rachel, thank you as always. You always provide such interesting perspectives on opportunities in the current market. I think you've given us a lot to think about combining that blending of index and active as we look across, you know, getting cash off the sidelines as people think about their portfolios as we head in the last quarter of the year. Thank you very much.

Thank you, Helen.

I'm now joined by Nick Singh, head of capital markets at BlackRock, to learn more about the flows that we've been seeing from a fixed income perspective year to date. Hi, Nick. Great to see you.

Thanks, Helen. Happy to be on board.

Can we talk a little bit about some of the key industry trends we've been seeing in terms of fixed income ETF flows this year? Which sectors are seeing investor demand?

Investor flows have really found themselves in two buckets so far this year. You've had a steady bid in short duration, ultra defensive type products in the iShares suite. That means XFR, iShares Floating Rate Index ETF or CMR, iShares Premium Money Market ETF. On the RBC side, we have the Target Maturity bond funds, both the corporate and government bond flavors, as well as RCDB, RBC Canadian Discount Bond ETF. On the other side of things, we've seen recent additions to longer duration funds. Specifically, we've seen duration extension through the belly of the curve and further out using XBB, iShares Core Canadian Universe Bond Index and more recently XLB, iShares core Canadian long term bond index fund.

It has been such an interesting year when we think about the volatility generally that we've seen in the market. Does this story differ in Canada versus globally in terms of flows that we've seen in fixed income? And is there anything specific for our listeners today when we think about the Canadian market in isolation?

A few different differences in Canada versus the rest of the world. We're still seeing a highly inverted Canadian yield curve. The key investor has typically been more exposed to longer duration buckets. But we chalk that up to a little bit of the issuance that occurs sort of in that shorter duration field. The US, we found, have been a little more front footed in their allocation to duration extension sort of through the summer and into the fall. We find Canada is just sort of getting there right now.

Great chatting with you Nick, as always. It'll be interesting to see what the rest of the year brings because 2023 has certainly kept us on our toes. And for more information about RBC iShares, visit RBCiShares.com. Thank you so much.