Aubrey Basdeo: Bank Breakages, Inflation & Fixed Income Strategy

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[00:00:00] Pierre Daillie: Welcome back. I’m Pierre Daillie, Managing Editor at Joining me today, is Aubrey Basdeo, Head of Canadian Fixed Income, at Guardian Capital LP.

Aubrey, welcome to the show, and thank you so much for joining me today. It’s been such a dramatic period. I’m very excited about our conversation today, because in light of all that’s happening. And, of course, getting your take on all that’s happening in the economy, rates, the bond market, and your fixed income strategy.

[00:00:28] Aubrey Basdeo: It’s a pleasure to be here, and I look forward to our discussion.

[00:00:31] Pierre Daillie: Yeah I just over the course of the weekend, in preparation for our conversation today, I was I was taken aback by all that was happening, and I thought, “Huh, this couldn’t be the most perfect time to have this conversation with Aubrey. He’s gonna know, he’s gonna have a real take on it from the bond market perspective.” And so Silicon Valley Bank. [laughs]

[00:01:00] Aubrey Basdeo: [laughs]

[00:01:01] Pierre Daillie: It’s not just-

[00:01:02] Aubrey Basdeo: Yeah.

[00:01:02] Pierre Daillie: …. Silicon, so it’s not just Silicon Valley Bank, it’s Signature Bank, it’s-

[00:01:05] Aubrey Basdeo: Correct.

[00:01:06] Pierre Daillie: … Silvergate. Three, three, three breakages, in the context of the Fed breaking things, with its rate hikes this past year. What do you make of that?

[00:01:18] Aubrey Basdeo: I think there, there are a few commonalities here, across these three. They, the one thing that really sticks out is the deposit base was very concentrated for all three of these institutions. And a- and it was also ve- not just concentrated but, the customers there had very large significant deposits to a large extent.

So when you’re faced with one of those customers moving their deposits or cashing it out, and doing whatever they will do with it, then you have to raise, you have to sell assets in order to provide the cash. And that seemed to be the problem there. And in Silicon Valley Bank the customer base is largely VC’s. But the other part of this, for the other two banks, were that they were ca- they were bankers for the crypto folks-

[00:02:25] Pierre Daillie: Yeah.

[00:02:26] Aubrey Basdeo: … and, who can be very flighty. And that seems to be one common feature here with all of these, and really the risk once this started to play out, the risk is that it could end up being some, it’s the systemic risk across the system. So you have to have act pretty quickly here.

[00:02:50] Pierre Daillie: Yeah, I’m, I I’m curious to find out we’re gonna talk about it, I th- I think we’re gonna, we’re gonna get to it, and but it’s obviously gonna change the outcome of the Fed meetings and policy. It’s going to tilt things in the opposite direction, I’m guessing. And I’m gonna let you talk about that when we get to it. But so quite a weekend [laughs] lots to talk about. Before we get started, Aubrey, I’d like to introduce you, even though I suspect most advisors know who you are. But for those of you who don’t know Aubrey, Aubrey is an absolute veteran.

He’s one of the pioneers of modern fixed income management, having had long and fruitful tenures. Most recently 14 years at BlackRock, which is today, the world’s largest asset manager, as Managing Director of Fixed Income Strategy, which includes also his time as principal portfolio manager at BGI, Barclay’s iShares, which was subsequently acquired by BlackRock. And prior to that, Aubrey was portfolio manager, and head of the macro rates relative value fixed income group, at Ontario Teachers’ Pension Plan.

What you may not know, is that the groundbreaking work that Aubrey and his team did at BGI, at iShares, eventually became part of the bedrock, of what BlackRock does today in fixed income. Aubrey is known for being a trailblazer, in the very complex world of modern fixed income management, and how appropriated it is that he joined Guardian Capital LP, considering Guardian’s own trailblazing across the Canadian and global financial landscape.

[00:04:35] Audio: This is the Insight is Capital podcast.

The views and opinions expressed in this podcast, are those of the individual guests and do not necessarily reflect the official policy or position of, or of our guests. This broadcast is meant to be for informational purposes only. Nothing discussed in this broadcast is intended to be considered as advice.

[00:04:54] Pierre Daillie: Did I miss anything, Aubrey?

[00:04:56] Aubrey Basdeo: No, I think tha- that’s a pretty good, [laughs] summary of it. Yeah.

[00:05:00] Pierre Daillie: Good. Good. So Aubrey before we get to our your take, before we get to your take on fixed income and bond markets, tell us about your time at OTPP, and subsequently, your time at BGI pre and post the BlackRock acquisition, what was that like?

[00:05:21] Aubrey Basdeo: A lot of learning. When I joined Ontario Teachers I was coming from the sell side of the business, to the buy side of the business. So a different mentality where, you know, on the sell side of the business it’s minute by minute reaction to when you get to play on Ontario Teachers, who are very much focused on thinking longer term how you’re managing the assets relative to the objective of providing meeting the obligations of of the plan or its stakeholders.

And that, involves thinking more broadly about risks how you manage those risks, et cetera. So foundationally from BGI, and sorry, from Ontario Teachers it was broadening out my experience across global markets, from when I was on the sell side, very much focused on local, the local [inaudible 00:06:26] market.

So enrich myself by experience in, build up my toolkit, so to speak when looking at global markets, which was the big focus for me, at at Teachers. Excuse me. And then when I moved on to BGI although my role there was to, head of the Canadian portion of BGI’s business globally it, the plan was to deliver a global perspective to Canadian investors, so bringing global solutions or global returns back to Canada. Because, Canada is a very small portion of the total fixed income, the global fixed income markets.

And the bulk of the opportunity set really, resides outside of Canada, given, 97% of the markets are away from us. So again, that was a- additional access to other markets, understanding how other markets work, relative to Canada being able to apply a new set of tools given that BGI was global in its footprint, and starting to do really innovative stuff in order to, in part barring from what it’s already doing in the equity side, and trying to look at fixed income markets in the same way.

[00:08:02] Pierre Daillie: What was the I mean there was some cultural differences between BGI and BlackRock. So when BlackRock acquired BGI, what, what, how would you define those differences?

[00:08:14] Aubrey Basdeo: Yeah. Yeah we thought of it. So at BGI our philosophy was looking at markets using what we call a scientific approach, to analyze markets, meaning that we try to be very systematic in our approach in identifying opportunities. And one of the things that we felt very strongly about was any individual that was looking at markets, would be swamped by the amount of data that they would need to look at first, because, it’s, for you to do a really good job, you need to assemble a lot of data, and be able to make sense of that data.

The best thing to do then, is to look at it from the perspective of, if you can build models around being able to analyze this data in a systematic manner you could source yourself an advantage in doing so. The other point by then, that we felt also very strongly about was, any individual looking at information, would be looking at it, and have some inherent cognitive biases, so it’s always difficult to remove those biases, given, we’re, we’re human beings, we’re built a certain way, that’s what’s going to happen.

And there’s, not to sound to say there is something wrong with that, but more, more often than not these cognitive biases, because, they’re subconscious, you don’t know that you’re applying them, that it sometimes will lead to the wrong conclusion. We felt that let the models be able to sift the data out produce an outcome, and then the portfolio manager can look at that outcome and try and make sense of it, “Does this make sense?” Is at the end of the day what we’re trying to say-

… ourselves. And then we would say, “Okay, yes.” A- and recognizing as well that, when you build models, sometimes there are going to be certain exogenous things that it doesn’t understand, such as, a bank run, for example. So you have to look at the output, and, “Okay, now I need to incorporate this, because the model can’t quite understand what that means,” right? So that’s the approach we take.

Now, BlackRock was more of a fundamental, they took a more fundamental approach to how they make decisions about the investments. So we had on the one hand, a scientific approach, and then we had this fundamental approach. And one [inaudible 00:10:58] was we could learn from each other, so we didn’t wanna say to one another, “Okay, you gotta use my way of doing it and we will abandon what you have been doing,” right? So-


[00:11:09] Aubrey Basdeo: … Larry Fink to his credit, said, “Look there’s a value proposition on both of those, and to the extent that we can somehow marry those two things, and take th- the best of both worlds than the firm would be better for it.” And so we’re allowed to coexist and exchange information with each other, a- and in the end that proved to be the right decision.

[00:11:33] Pierre Daillie: Very interesting. And, a- I know a- there’s a question I wanted to ask you about technology, but I’m guessing that has a lot to do with what you’re doing at Guardian Capital now, and that’s bringing the technol- the technological edge to the, your systematic investing strategy with you, from the-

[00:11:56] Aubrey Basdeo: Yeah.

[00:11:57] Pierre Daillie: … like from your experience at BlackRock.

[00:12:00] Aubrey Basdeo: Yeah, absolutely. I think one of the, one of the changes we noted, or the evolution in k- in the marketplace, is that we’re moving from, one I mentioned, there was a vacuum of data, to now, the market’s recognizing, or investors recognize they, they really need data to make decisions about where they choose to invest. Now in the U.S. and pa- in Europe as well, there’s an abundance of information, and that information is available through to participants. You can use that information, there’s a lot of it. And you can use that information, as I said, to make help, help make you’re decisions.

Canada is gradually moving to increase transparency, because it serves investors best that way, but it also helps to lower transaction costs, the more transparency you have, the more information you’ll have at your disposal, and you’ll, you’re just going to be better off as a result. And we’ve been pushing towards having more transparency, so moving to an electronic trading and which information is going to be readily available gives us the same set of tools that we’ve applied in non, non-domestic markets, and so I think we’re just gonna be better off as a result of that.

[00:13:27] Pierre Daillie: Yeah, I’m curious, because you mentioned it just a moment ago, which was that, when something like a dislocation happens, this weekend’s collapse of Silicon Valley bank and it’s the ramifications of that, like how it trickles through the market, in terms of sentiment. We saw, like for example today big swings in the tenure, in the two-year. And given that the Fed reacts to the two-year, tends to focus on the two-year treasuries. H- how do if you’re using, if you’re using a systematic model, how do you take these events, how do you incorporate that into your strategy, when it happens? Because it-


[00:14:10] Pierre Daillie: … It’s ad hoc, right? It’s not-

[00:14:12] Aubrey Basdeo: Yeah. Yeah.

[00:14:12] Pierre Daillie: … it’s not part of the regular flow of data, or regular flow of markets, it’s a disruption.

[00:14:16] Aubrey Basdeo: Exactly. Yeah.

And, s- so you have a jump to you have a, like an event risk, and market’s kinda reprised in, in a jump function way. And so what you’re looking for are now, all right, historically, when I’ve seen something like this, is there a pattern that I can discern, and you’re trying to marry that up to what today. So for example, 2008 might come to mind, in terms of bank failures, what the markets did, what was the reaction function from the Fed, how do I interpret that, right?

You’re quickly… And this is, the ability of having technology in play, you’re quickly trying to, or you should be able to quickly assess that information. In some context, that will, not necessarily give you the answer, but help you be able to decipher, “Okay, what are the probability outcomes here,” right? I can assign various probabilities-

… to, “Okay, the Fed next week, may pause, or the Fed may go by 25, or the Fed may go by 50.” So you’ve got a range of outcomes, or you’re gonna have to assign a set of probabilities. The market is now suggesting that the Fed is likely on hold there, I think there’s even on s- at this point, in terms of whether they’ll go or not.

And, we still have data this week, CPI, PPI, retail sales that could we’ll also add more volatility to those probability outcomes as well. But the key point here is that, if you’ve got data, you can ma- you can try and make sense of it, and assign, and then make an informed decision, in other words, here, as opposed to trying to reflect back in your mind what’s been happening, how do I, your own experience, and try to decipher what that is. We’d prefer, as I said, to be able to use as a- as many tools as we can, in order to make a better informed decision and the edge is you suggested is, having technology assist us with coming up with a better decision.

[00:16:36] Pierre Daillie: Y- you, you would, you’re, you would be using the systematic approach that you’ve built, in order to neutralize any bias, so that-

… so that they’re not, there isn’t any you’re not have a disproportionate reaction in any direction, and just taking the information as it comes and then acting on it, but not in an emotional way not, right?

[00:17:07] Aubrey Basdeo: I think that, that’s a really good way of s- of, you wanna remove the emotions of out, … the decision making process, and just be informed by what the data is telling you. You’re looking at the change and the shape of the yield curve how does this relate to, either historical precedence to that, might look at, that you might look to as an example of a similar event, the kinds of risks that you could be exposed to, by making one decision or another, et cetera.

And I think that’s, for us is very important for us to be able to assess, the range of outcomes, and how do we assign probabilities to those and that’s much better done by using technology to, to derive those outcomes. You also have, you have your side, like Canada’s, there’s no run of the bank here but we’re obviously being side-swiped by global events, … Canadian financial institutions are being assessed in a similar way, that ta- a regulr- a regul- aa more, harsher, regulatory regime might ensue from here, what does that mean for banks’ earnings. Risk premia associated with bank debt, et cetera. So you can, y- you can see how you need to borrow information from other markets, in order to be able to, assess how things might unfold here in a domestic, in domestic markets.

[00:18:45] Pierre Daillie: Yeah I think this event this weekend, certainly makes a lot of room for some fear that it’s making it’s, has th- the risk of making even more room for moral hazard. Because if everybody thinks that the central bank is going to step in and, make everybody whole or at least the depositors, then that leaves the bank, or banks themselves, to be able to take even more risk down the road. Maybe not right now, but d- [laughs] down the road, it has not co- all these things have these knock-on-

… effects.

[00:19:26] Aubrey Basdeo: So you, just I think, yeah. So there, there are a number of things here that services immediately, one is, because of the implied Fed put, it looks like it’s back in-

… Given their assurances to depositors. And, in addition to the other step that they’ve taken, about providing liquidity to institutions who find themselves in need of being able to use an emergency facility, in order to meet deposit demands. So-

[00:19:58] Pierre Daillie: ‘Cause now everyone’s, everyone’s sitting there, wondering, like how much sham- how much losses are you hiding in your balance sheet?



[00:20:06] Aubrey Basdeo: … the mar- the market though, has a good way of sifting that out, Pierre, because I think-


[00:20:10] Aubrey Basdeo: … We’ve all seen what has happened to regional banks, right? They’re getting th- their stocks are getting drilled.

[00:20:16] Pierre Daillie: Yeah, th-

And there’s clearly-

[00:20:19] Pierre Daillie: They’re getting their assets handed to them. [laughs]

[00:20:23] Aubrey Basdeo: Yeah.

[00:20:24] Pierre Daillie: You can bring that up, but you can’t really.

[00:20:26] Aubrey Basdeo: Exactly.

[00:20:27] Pierre Daillie: [laughing]

[00:20:28] Aubrey Basdeo: So it sh- it would, while n- I think it would be a naïve statement to say that you could go back to, “Oh, yeah, this is back to where we were, maybe a decade ago that, the Fed’s gonna present to us, we can go out and do things.” a- I would say it, it would be very difficult for them, because I think y- you would have to assume that the regulators would now look to reinforce put stop gaps in place, in other words, to ensure that the issues that surfaced here more recently are going to be avoided, or they’ll be able to avoid those going forward. Now, your plug in one hole, is there another hole that might-


… Pop up. And-


[00:21:18] Aubrey Basdeo: … that’s to me…

[00:21:20] Pierre Daillie: Sorry, go ahead.

[00:21:21] Aubrey Basdeo: Go ahead.

[00:21:21] Pierre Daillie: No, you go ahead.

[00:21:22] Aubrey Basdeo: That to me is a, one of the considerations, ’cause, we are finding this issue about, as I highlighted earlier, the commonality around these three institutions is a concentrated deposit base. The other is, would be a very major issue was risk management of practices at these three institutions. It doesn’t seem to have been something that’s very rigorous given, this mismatch in their funding.

So they had very short deposits to a very short lending loan, and that gap seem to be very wide. And, they would argue maybe they were caught off-side by how aggressive the Fed was in raising interest rates and didn’t give them enough time to react. But the Fed was so transparent in what it was doing I came can’t buy that either. So I think risk management-


[00:22:22] Aubrey Basdeo: … is something-

[00:22:22] Pierre Daillie: … y- you’ve got on one hand, you’ve got the Fed being blamed, because at the end of ’20, at the end of ’21, they were saying they, they didn’t foresee at the end of, at the end of ’21, they didn’t foresee raising rates for quite some time, they were still in that transitory model. And-

… a- and then, so some folks were saying then, these treasurers didn’t, they took it at face value and went ahead with their plans to invest in, in, longer duration.”


[00:22:55] Pierre Daillie: And then, but the counter argument to that is, when you saw that rates were rising throughout the year, and that inflation wasn’t slowing down, and neither was the Fed, or neither was central banks anywhere where this is happening, including Canada, y- you saw the rate hikes coming, y- you saw the, the duration part of your, the longer duration part of your portfolio being impacted, why was nothing done, even at that time, or six months ago? Or May, or, th- the summer? So that’s where, there’s a suggestion of moral hazard taking place y- which could easily be relabeled as malfeasance, right? That, that, ne- or negligence, right-


[00:23:41] Aubrey Basdeo: … and what was, wh- I think critically, what was the incentive system or the executives that were running these institutions to not do the right thing, right? Yeah that all remains to be seen and by the sounds of it there’s gonna be some pretty lengthy investigation into all of this, yeah, and one of the horrible ironies by this is that Barney Frank was one of the board members for Signature Bank, and obviously he’s one of the architects of Dodd-Frank post the GFC. So that highlights for me something that gets to the other point that I wanna make about the, what are the commonalities there is that, where was the regulator in all of this? Like, where was the San Francisco Fed, overseeing SVB? Why were they not looking at this funding mismatch, knowing that the Fed, one part of the organization was raising interest rates, and the regulating side need to have been completely aware that, okay, here is th- the potential risk in the system, that they need to be very vigilant in monitoring-


[00:25:03] Pierre Daillie: … wh-

… even the auditors missed it. KPMG gave SVB a clean bill of health, I think like a co-

[00:25:13] Aubrey Basdeo: Okay.

[00:25:13] Pierre Daillie: … a few weeks ago?

[00:25:14] Aubrey Basdeo: Yeah.

[00:25:15] Pierre Daillie: When you have the auditors signing off on it, and the regulator doesn’t see it and, what it takes for, it takes, rumors, and depositors deciding to yank their funds out very quickly, $42 billion an th- on Friday, or Thursday or Friday.

[00:25:36] Aubrey Basdeo: Yeah.

[00:25:36] Pierre Daillie: $42 billion at once is unheard of. And, w- the reserve ratios at the banks just can’t support that kind of withdrawal either, right? When you don’t have any contingencies in place for that kind of, anyway w- we’re not here to get into the weeds about SVB, but what we are, what I do wanna get into with you is, now what are the repercussions we talked, there’s a probability now, that the Fed Bank of Canada already paused last week?

That was a very, that was a big deal. Some I think it was a Schwab commentary, called a trailb- was that a trailblazing move, right? And should the Feb be paying attention to that too? I- if, Tiff Macklem decides it’s time to pause, we don’t wanna break our economy by just continuing down this road blindly, until something does break. And th- and then i- it’s uncanny, because the break re- you know, the breakage that, that the Bank of Canada was afraid of, it’s happened, right?

[00:26:47] Aubrey Basdeo: N- no, exactly, yeah. So now, what are the chances, like you did mention the chances of a pause, but if there’s more breakage to come or more cracks are revealed in the, y- in the armor w- what does that mean for, I mean it’s not good, none of it’s good, I’m not, y- there’s certainly no, I mean-

[00:27:11] Pierre Daillie: … I don’t think there’s no joy in talking about it, it’s just fascinating that it’s happening.

[00:27:16] Aubrey Basdeo: It’s a cost benefit of analysis that, that I think have, has to try and figure out here. So there, there are two very distinct things here, that could argue, and still, so on next Wednesday, they could hi- by the 25 basis points, let’s say at a minimum that they had been articulating that, they still need to get to a higher terminal rate than the market was anticipating. And in order to fulfill their mandate of, inflation too, and full employment. So they’re very focused on the inflation side of the equation.

So they could go ahead, very clear what they’re doing on that side of it. And at the same time, be very clear about, how they’re handling this potential issue of, trying to mitigate bank runs on regional institutions. Now, in theory, that could work. In practice, trying to convince, investors or the populous at large, that you’ve got this under control, and all of this, if I can isolate these two things independently and I can act, because I’ve got tools on one side, and tools on the other side, the appropriate tools to handle each one of those objectives, then I’m good to go, right? So you can do that.

A- I, I don’t believe that’s how markets will work, a- and so that’s why they have to think very carefully about the cost and benefit of doing what they’re try, what they are trying to achieve, which up until now was, getting inflation under control. Could you argue then, what is going to happen here likely will be a natural tightening of standards or financial-

[00:29:10] Pierre Daillie: Yeah.

[00:29:10] Aubrey Basdeo: … conditions, and yes, economy. In fact, you’ve now seen that, will play out, and you can achieve, you’ll achieve your objective without having to do anything more.

[00:29:20] Pierre Daillie: Yeah, it certainly looks that way. [laughs] I, if you just look into the tech people talking today, like it’s gonna become even harder for, you venture capitalists and tech companies to raise money.

[00:29:33] Aubrey Basdeo: Absolutely. I think

[00:29:34] Pierre Daillie: Sorry.

[00:29:34] Aubrey Basdeo: … I think definitely, I would expect that at least for the next six months to a year-

[00:29:40] Pierre Daillie: Yeah.

[00:29:41] Aubrey Basdeo: … that there’s be a lot more caution about, allocating capital to be seized a- at this point, because, you’d wanna see how the dust settles, at least before you, you make any a- additional, And now if the regional banks like, in, in the w- the wider scope of this situation are also facing similar dilemmas with their, their reserves available for sale, healthy maturity reserves if they’re facing scrutiny, and they’re facing regulation, that too will force them to increase their deposit rates and, and-


[00:30:21] Pierre Daillie: … tighten their lending conditions as well, right?

[00:30:24] Aubrey Basdeo: Exactly. Y- I think that, that’s, that at least should be a cr- given a high probability outcome here. Just a natural typing would w- we should expect. Because, look, as an investor managing portfolios for clients, I have to sit here and ask myself, “Okay, what’s the assessment I think about risk premia, if I’m going to go and add risk to the portfolio. And I certainly wouldn’t be thinking, this is the end of it, it’s a bargain basement, I know I should run out there and buy stuff. I think I’m gonna wait to see how things manifest itself, and then try and decide when is the appropriate time.

But there’s just gonna be a lot of volatility in the near term. Best to stay on the sidelines, and at least pay attention to the risks that I have in the portfolio, and monitor those carefully to see if there are any unintended risk that I have that I need to neutralize, and the risk that I wanna take advantage of whether they’re appropriately priced or not and take the appropriate actions in order to mitigate those. The thing about, getting back to the tightening of lending standards the one, so we have a potential run of the bank, the Fed has said, “Okay, here, I’m acting decisively,” so Janet [inaudible 00:31:52] has come out and said basically, “Not on my watch, nothing’s gonna break here-

[00:31:55] Pierre Daillie: [laughs]

[00:31:55] Aubrey Basdeo: … so here’s what I’m going to do.” And again, which we’ve said, couldn’t give a false impression about, “Oh, the Fed is there to bail you out any time something bad happens.” so this issue of moral hazard comes into play. But I think what may happen, th- they have to consider, and this is what they’re trying to get in front of I think is, to the extent that folks are worried about their deposits a- at a financial institution. Because, JP Morgan is not in every single district throughout the U.S.

You keep your money under the mattress. If that is what’s likely to happen to some extent, and they have to be worried about an acceleration towards a very sharp slowdown in the opting here or somewhere, in, by the end of this year. And so that’s the, that’s a big risk at the moment, that they have to keep assessing. So it can, because I ask the question, do I pause? Do I go by 25 basis-

… points, that, that delicate balance now is in play. And just more volatility because of the potential outcomes, is what we’re gonna be faced with.

[00:33:06] Pierre Daillie: As head of Canadian fixed income at Guardian Capital, how are you approaching this? I’m, I, is it safe to say it’s too soon, or do you have a set of, y- are you looking at the situation and have you made decisions already, or trying to make decisions about how to go forward, given the new ’cause it’s not a, it is not a binary situation, and-

[00:33:33] Aubrey Basdeo: Yeah.

[00:33:33] Pierre Daillie: … and as you said, it’s going to be volatile, because those can, there’s gonna be the ongoing flow of data with this boulder of, SVB in the regional banks, in the middle of the river, and everything flowing around it, right? You’re gonna have this, like, how do you navigate from here? What’s the, like what kind of what kind of strategy are you considering right now given the, these variables?

[00:34:04] Aubrey Basdeo: Okay, so let me take a step back here and give you a sense of how we’re looking this. When you’re investing in the fixed income markets, you have to have a good sense of the macro backdrop. And when I say good sense, everybody has their own interpretation of how things are likely to unfold. We meet twice regularly, twice a week the team does, and where we’re updating ourselves on what are the factors we’re paying attention to, and what’s the probabilistic outcome, from a macro perspective that we see. So broadly speaking, we’re already s- we’re already thinking that there’s a slowdown e- unfolding. When we look at leading indicators in Canada and the U.S., that’s what is in front of us.

The coincident on lagging indicators, such as employment a- and some of the soft data sentiment and things like that, are suggesting, particularly employment, or suggesting the economy is still healthy. Employment is a lagging indicator, CPI is a lagging indicator. And so while we acknowledge that there’s still some economic momentum, long and variable lags to monitory policy suggest to us, and as evidence was, we’re looking at some of the leading indicators are saying that things are slowing down.

Credit card balances are building up, et cetera. So all of this points to us that there was gonna be a slowdown. Absent this event risks that we saw-

… This past weekend. Add that to what we’re already sensing or seeing suggest to us that it’s going to be more pronounced. How much more pronounced, is what we’re gonna have to monitor going forward. When we see that, you’re beginning to think about your portfolio construction, about the opportunities set in front of you, what’s the bank had or likely to do what’s a Fed likely to do, because, obviously we’re gonna be, we’re somewhat tied to very, we’re very tied to their economy.

This was suggested to us that, if we were thinking about short duration exposure, we would be thinking about lengthening our duration somewhat at this point. If we were thinking that curve flatterers were still the way to be for now, we would be thinking about curve steepening, as the way to go from now.

Now, clearly, the market went very steepener-ish today and let the dust settle there. We are in position for a steepening bias anyway, because of, as I said, we’re anticipating this s- slowdown in term at monetary policy, et cetera, is just accelerated that now, to some extent. In terms of risk premia itself if we wanna own provincial bonds or corporate bonds I think it now becomes right, or looking at individual corporations, and being able to suss out, where the dispersion is, … what’s value, what’s not value, et cetera. We quite like what’s in front of us, because we thrive in that environment, where there’s more dispersion. Because, we feel we have the tools to be able to identify the opportunities that are in front of us. So there are we’re likely to be quite active, a- ahead of us now, and even more so than we were anticipating, because the environment is changed I would say radically might be a strong word at this point-

[00:38:05] Pierre Daillie: [laughs]

[00:38:05] Aubrey Basdeo: … because we just don’t know how much is yet, but we certainly think, we’re leaning definitely more towards that.

[00:38:12] Pierre Daillie: I- I think, at the very, very superficially this event confirms y- you know, it confirms what many folks, what many investors, many people in the market were thinking all, for quite some time, since, you start to see data rolling over that there was, at the very minimum, things were gonna be disinflationary but now, you’re now, I think what you’re saying is that it’s deciding, is it gonna be disinflationary, mildly disinflationary or deeply-

[00:38:50] Aubrey Basdeo: Yeah.

[00:38:51] Pierre Daillie: … disinflationary? Or is it going to be even possibly deflationary?

[00:38:56] Aubrey Basdeo: Or you can argue that if anything, because of the loosening of financial conditions, vis-a-vis these emergency programs that they’ve enacted, that it could spur activity, because now you’ve given everybody a free-reign to go out and do stuff, right? But as I said, I don’t think that’s the likely outcome. I think what we’ll ne- what we’ll see is that, once we got past this week’s CPI in the U.S., that we will resume a more accelerated trajectory into the client CPI going forward-

… into year-end. Now I don’t know where the landing zone, where the destination is in ter- or rather I should say, we know what the destination is the Fed wants, the Bank of Canada wants to present. But for this year, I don’t know where that, where we land, my guess is somewhere between three and four percent. But I could ma- certainly make the case that we could get 2% now, given, how much things might potentially contract from here. With that’s the trajectory in which we see, at least for the remainder of this year, in terms of inflation headed.

I do wanna made this point though, that our belief is that we are entering a new regime going forward, that we’re exiting zero interest rates, easy mo- easy easy policy, or easy financial conditions. And we’re likely to see higher inflation going forward, higher volatility going forward, and a higher terminal rate going forward. But it’s not gonna be immediate, I know, like the next 10 or 20 years wer-

[00:40:55] Pierre Daillie: Yeah.

[00:40:55] Aubrey Basdeo: … we’re certainly going to be looking at a very different dynamic, relative to where we were in the past 20 or 30 years. And as I’ve said, I’ve indicated to some of those characteristic features that we’re looking at. The bigger macro backdrop is towards this new regime, that is where we’re gonna be lo- paying attention to. But the here and now, the immediate future in the next quarter or two, is gonna look a little similar to what we had coming out just pr- pre COVID or going into COVID. And I, the Fed has clearly indicated, their willingness to do certain things that, quite frankly we’d anticipated they wouldn’t embrace as readily as they did today, or over the weekend. Yeah.

[00:41:42] Pierre Daillie: So would you call that inflation volatility, where inflation, like we’ve got, we’ve had this inflation spike now, the one that’s come and gone, and or looks that way. But then with the inflation volatility, comes the need to also constantly manage or trying and manage the yield curve is-

Absolutely, yeah.


[00:42:11] Aubrey Basdeo: So the driver for inflation, we think is going to be, we’ve gone from a period or a regime of a- abundance of-

[00:42:20] Pierre Daillie: The terminal rate won’t be five, five and a half or 6%, right? It’ll be a lower terminal rate, over a period of time.

[00:42:29] Aubrey Basdeo: A lower terminal rate of time, Yeah.

… if you think of, le- the rule of thumb would be that, if you think inflation is gonna be somewhere between two and three for the long run, as opposed to so let’s take the number two and a half. So what should a real Bank of Canada rate be, or a real Fed funds rate, and so should that be an additional spread of 100 base points? Historically, that’s the number has been. So you’re looking at three and a, three to three and a half, that’s the-

… terminal rate. Now again, that is anchored around, inflation being around that zone, and we have to believe that central banks’ credibility is at stake here, so they need to get that down. But working against that objective, because remember, the U.S. has to do a mandate of stable prices and full employment. In this case, if you’re gonna have s- somewhat higher inflation, that you’re trying to suppress, you’re gonna have to give something up on the other side, which is going to be lower growth, meaning that potentially the labor market may no- you may not achieve the second part of your mandate, or it’ll be more difficult to do that.

What potentially could keep inflation higher than they’re anticipated? We’re looking at, as I said, this new regime, one characteristic feature of which is becoming evident is just fracturing of our global economy. So we went from globalization as being the dominant feature, which led to an abundance of supply, both in terms of labor and material, to one where the fracture is now challenging that abundance of supply. So we’ve some evidence of near shoring, re shoring, or off shoring-

… to more hospitable countries. That’ll take some time to really evolve. But that’s in play. And with that effect, cost of producing something is just gonna be higher. And it’ll be flow-through ba- back to us.


[00:44:55] Pierre Daillie: Back to the consumers, yeah.

[00:44:56] Aubrey Basdeo: And because here in the end, we’ll come to its employer and say, “Look I can’t live on these kinds of wages,” so something has to give here, right? So this is not gonna resolve itself in the next couple of years, I think it’s gonna, it’s gonna be quite a while before we, we come to that happy state. And again, we don’t know, that happy state means inflation is at three or two and a half, or whatever that number is.

[00:45:22] Pierre Daillie: In the meantime it’s inflation volatility, it’s, it’s-

[00:45:25] Aubrey Basdeo: Correct. Yes.

[00:45:26] Pierre Daillie: And what a- what, Aubrey, what do you think are the odds that the Fed, overshoots, I mean I think they’ve gone down dramatically, but just with this week’s activ- this week’s events. But what a- what are the odds that the Fed overshoots the, the 2% target, and, wr- we’re by overshooting, obviously we’re back to where we were the last decade.

[00:45:55] Aubrey Basdeo: Decade, yeah.



Gi- given the deglobalization, right?


[00:46:05] Pierre Daillie: So it’s strictly a probability question, what do you think-

[00:46:10] Aubrey Basdeo: … are the chances that happens?

So I think, I would give that a small probability that they could reverse the forces back to the levels that we saw during pre COVID. And when I say small probability, I don’t mean it’s insignificant, I just meant that I just don’t see given the other factors that-

[00:46:35] Pierre Daillie: Yeah.

[00:46:35] Aubrey Basdeo: … we’ve just described, in terms of the fracturing of global economies. Competition now, China, between China, Russia, and the western economies, that to me suggests that, it’s just going to be very difficult. There’s going to be more friction and movement of goods and commerce. For them to get, they can certainly get overshoot inflation on the downside, but that would mean you’re going into, at least from my perspective, a deeper session.

And that means that the other part of your mandate of full employment, you’re sacrificing that in order to get there. Politically, as you’re going into an election here, I find that the Fed might, not that they will play around with their credibility, but will tread very carefully in terms of looking like they’re sinking one administration, to the benefit of the other. It, politics does come into play, we have to acknowledge that when, for the Fed.

[00:47:41] Pierre Daillie: For sure.

[00:47:41] Aubrey Basdeo: And-

[00:47:42] Pierre Daillie: For sure.

[00:47:42] Aubrey Basdeo: … they can, th- they wanna stay above that foray.

[00:47:46] Pierre Daillie: So in a way, i- in a way this week’s events might serve that.

[00:47:51] Aubrey Basdeo: That, exactly. Yeah.

[00:47:52] Pierre Daillie: Yeah. Yeah.

[00:47:53] Aubrey Basdeo: It buys them some time. E- but I, so their only currency is credibility, and if they screw that up they’re gonna lose in a big way, that the market’s just not gonna believe what they say they’ll do, they’ll end up doing. That just adds more volatility to markets overall. A- and again, it gets back to my poin that, be prepared for more dispersion data exposure is not the thing to have going forward. It was the thing to have when the Fed saying, “I got your back, don’t worry-

[00:48:33] Pierre Daillie: Yeah.

[00:48:34] Aubrey Basdeo: … you can go ahead and buy risk assets and if things look like they’re gonna soften up, I’ll be there to assist you.” and that work beautifully, but going forward from here, I think active management is going to be critical to be able to, meet your objectives, but manage portfolios in a way that, can mitigate some of these things like you have had over the weekend.

[00:49:02] Pierre Daillie: So Aubrey, what’s the way forward here for fixed income, for Canadian fixed income investors what is the what is the direction now? Given e- everything that’s changed ballpark, not, [laughs] if you’re going after, you don’t have to give away any trade secrets but, you need to pay attention now, more so than you did in the past, because a bunch of there’s a good… There are pluses and negatives here. The largest, the pig and python, when I think about demographics is the baby boomers, that’s the bulge of, the pig moving through the python, in terms of-


[00:49:47] Aubrey Basdeo: … demographic profile. The youngest one of the baby boomers are now in retirement age. So their focus is on income, and-


[00:49:57] Aubrey Basdeo: … Today, if you can get a risk-free investment of 5%, and, you should be quite happy about that. Absolutely, yeah that was the big dilemma, for the longest time-


[00:50:14] Pierre Daillie: … You couldn’t get your four, you couldn’t get your 4% out of, but now we’ve got, anyway, yeah, sorry go ahead.

[00:50:19] Aubrey Basdeo: Yeah, you’ve got 5%, and you’re thinking, this is great. But the other side of the equation is, you’ve got risk assets that you own overnight, are money market stuff. It’s not gonna provide that balance to the portfolio that you need.

So y- you have to now be very selective and b- so some of your assets definitely, in terms of how you think about a portfolio construction going forward having that cash equivalent, earning at 5%, but you need to think about the rest of the portfolio, that fixed income, how does that provide diversification to the overall portfolio construction that you have. And having that exposure is gonna be critical to dampen the overall volatility. We’re beginning to see, so over the past 30 years th- there was a very strong, positive correlation between, a- across assets. So a fixed in equities move more or less in tandem, with minor interruptions.

That’s not how, it’s supposed work, we’re supposed to use fixed income as a way to diversity our exposure in the portfolio. And we’re beginning, I think we’re just beginning to see that negative correlation start to play out now, an- and that’s how I think we’ll see. So again, I think getting back to your point about what’s, the opportunities that, it’s really thinking about, how do I use fixed income in order to help mitigate the risk in the portfolio. A lot of the same time will generate an adequate return going forward.

I think you’ll do fine, you need to pay attention to the duration of the p- the risk that you’re raking from a fixed income perspective and to some extent the market is helping you sort that out, because its rates have risen, duration has gone from about eight and a half to seven and change. And so to extend that, we continue to see modest increases in interest rates, it’ll recalibrate that. But you’ve got choices between short duration the mid-part of the curve of the universe is a way to think about getting that balance in your portfolio appropriate.

[00:52:44] Pierre Daillie: I think you covered you, I think you’ve covered what really the big challenges are, which is that, if you for the last while anyways, investors, advisors have been hugging the shorter end of the curve because it just, it made sense on so many fronts given the last year’s volatility and d- draw down in the markets. But now of course, we see this opportunity set unfolding. And what do you think is a appropriate, if you’ve, I don’t think anybody’s out there with 100&, of their fixed income sleeve, sitting in short-term instruments. But in case they are, [laughs] well just in case they are, because of the duration risk that was there-

… before, before this quarter, what, like what would be, wou- would you say, would you suggest, like that, that, waiting into duration is the way to go, or?

[00:53:58] Aubrey Basdeo: Yeah, that, that would the right phrasing. And I think, start to think about adding some of the duration risk to the portfolio. The combination of capital gains and income that can be, looks to be a high probability outcome going forward and I really wanna emphasize the dampening of volatility that, that solution would provide to your overall portfolio. It is something that is the added benefit that you will get. So waiting, I think is the right approach. A day like today might make waiting seems you know-

[00:54:47] Pierre Daillie: Yeah, an impossible choice.

[00:54:49] Aubrey Basdeo: Yeah, y- exactly, you need to be there immediately, right?

[00:54:53] Pierre Daillie: Yeah.

[00:54:53] Aubrey Basdeo: But I think it’ll take some time for this to settle itself out, we’ve got all these meetings in the near term, in March and May and June, in the U.S. and in Canada. And today’s reaction was quite visceral, it’s not necessarily that it’s going to stick, that the tenure is gonna stay at three and a half it’s, there’s probably a good there’s probably as much likelihood that it will drift back up.


[00:55:24] Pierre Daillie: Yeah.

[00:55:25] Aubrey Basdeo: And, yeah, equilibrium is, we were trying to sort that out now, and it’s going to be, the market I think it will be very active to, we, it’ll be an asymmetric bias in the short-term. Week data will see a much bigger reaction, than strong data. So even if the CPI’s strong, in a relative sense to expectations i- it’ll get a muted, more muted reaction than if it, over a week or, it’ll certainly see a bigger reaction, because it’ll assume, the market will assume the Fed is now done, and, they’re sailing ahead in terms of, what the next turn in monetary policy is likely to be.

And not until we get past all of this kind of short-term duration or volatility, maybe start getting a better sense of the landscape looks like. And, but as I said, I, from my perspective, I think this event risk here, has just added, has done some of the heavy lifting, will do some of the heavy lifting for the Fed, and global central banks in general, and meeting demand, and getting, trying to get that better balance between supply and demand going forward. Notwithstanding that, I still have to emphasize, the external risks that we face, i.e, Russia and Ukraine, who knows-

[00:56:41] Pierre Daillie: Yeah.

[00:56:42] Aubrey Basdeo: … that’s something that we have to keep monitoring. China aligning itself with Russia how does that play out, vis-a-vis Taiwan, et cetera, so either of these events show political risk of, I think. Difficult to hedge, put it that way, because you never know when, what’s, what the outcome is going to be. But the, sort of the undertow to the economy are simply going to be that, tightening of lending standards, tightening of financials, vis-a-vis, something like what has happened, in addition to what the Fe- and central bank has been doing, is simply going to continue to reinforce the stronger undertow the suppressing growth.

[00:57:34] Pierre Daillie: Start waiting into longer duration, fixed income again.

[00:57:40] Aubrey Basdeo: I think, yeah, that makes sense.

[00:57:42] Pierre Daillie: Yeah. And how does that happen, how is that happening within your mandates? Within your portfolios that you manage?

[00:57:51] Aubrey Basdeo: We are managing for very specific benchmarks, so short duration would be, one to five-year exposure of the universe. And we keep our duration targets in plus or minus half a year. So we’re not taking very large duration bets per se. What we’re trying to do is, build a portfolio that we think will outperform, by making sector selection, security selection, and positioning along the curve as where we-

… spend all that risk budget. Similarly, for the universe it’s, we’re not making big duration bets on it, we think we can outperform by doing similar things, as I explained on the short duration profile. For an investor looking at, if mostly in cash like instruments, and terming out in duration, my tolerance for short duration or universe, or the mid-part of the curve is what I need to think about. So an advisor needs to contemplate, where do they think they can best land, in order to, again, as I said, think about the empeling and the volatility and the portfolio, and earn a reasonable or a respectable income out of that.

[00:59:06] Pierre Daillie: Excellent. A- I, I ask you, because I don’t think, I don’t think advisors or investors actually want to do a lot of fixed income management, because of the complexity. And then of course, trading individual bonds. But there’s obviously a, a multitude of solutions in the marketplace but I think it helps to know how you’re doing it your thought process around, around how to, h- how to structure a portfolio along the yield curve. And, making sure advisors understand that, that managed active solutions is available to them i- is above all the most important thing for them to know.

[00:59:55] Aubrey Basdeo: Absolutely. And I think just reemphasizing the point about regime change, passive serve you well over the past 30 years, but environment of higher vol, as we expect more dispersion active management is the right approach going forward from here.

[01:00:17] Pierre Daillie: I spent 15 years as a retail advisor, but it was only after I left retail, and I feel like a- I don’t know that’s true for all advisors, I don’t wanna, I’m not painting the industry with that brush. But I feel like I always had only a limited amount of time as an advisor to learn, the true complexity and power of the bond market. Not only as a diversifier in portfolios but obviously as the ruling in markets.

It’s been great talking to you, Aubrey I, I was really, I was looking forward to this conversation for all that, that it’s been. I think you’ve pretty much answered, the key questions. But I wanted to ask you in parting, what are some of your most memorable experiences or lessons learned from your career?

[01:01:16] Aubrey Basdeo: There are three that I’m gonna highlight, and it always reverberates in me when something like this happens what happened on the weekend. And in tho- in not in sort of importance. But number one would, ne- never underestimate how quickly liquidity can dry up. And you may, prior to Thursday, let’s say, you might have though markets, “Oh, I can do anything I want.” And then, two days later, and in our morning call today if it’s highlighted that th- the market, you can show a bid, but you could not find an offer or vice versa.

So it’s almost like in a, you can snap a finger, and liquidity can go away. You always have to, constructing your portfolio think of it, what’s the liquidity environment in terms of the assets that you put in the portfolio how could they survive if your call for liquidity. So in case, this extends, naturally to the way these banks were being managed, because the liquidity profile wasn’t stress tested enough in my mind, to ensure that they could, handle-


… any kinda dramatic drawdown in their deposits. So that’s number two is always pay attention to value, right? Don’t deviate from that discipline, as Warren Buffet will say, you’re always looking to buy something, 50 cents on the dollar, don’t overpay, just be patient, right? So just-

… keep assessing what the appropriate value of something is, and stick to that. And the third is always be patient, you’re investing for the long-terms and you’re going to be, so if you don’t go and get the price that you’re looking for, it’ll come back to you at some point. You just need to be very patient. I think if you stick to those three, or at least for me, I’ve stuck to those three, overarching principles, d- remember liquidity is a driver and you can’t underestimate how quickly that can disappear. Always, know it, what value, what you’re paying for value, and be patient. That I think will serve you well.

[01:03:55] Pierre Daillie: Thank you, Aubrey. That’s wonderful, that’s a… [laughs] I was, as you were saying there, I was thinking, I wonder, given last week’s very passionate Fed meeting where they reiterated, y- r- reiterated their drive with, to co- continue raising rates.

Rates, a day later the situation happens, right? But and then given days like today where you could easily see where y- some investors might have, that FOMO appetite back, or react enough in a way about, fear of missing out you’re absolutely right, being patient is is definitely a worthwhile endeavor. Thank you so much, that’s I’ve our conversation definitely exceeded my expectations. I I wanna thank you so much for you incredibly valuable time.

[01:05:00] Aubrey Basdeo: My pleasure, Pierre, and happy to be a part of this.

Recorded March 13, 2023

Listen on The Move

In this episode of Insight is Capital™, we explore the current state of the market and its reaction to both weak and strong data.

Aubrey Basdeo, Head of Canadian Fixed Income at Guardian Capital LP, shares insights on external risks and how they affect the economy. We also discuss the importance of diversification through fixed income and the correlation of equities and fixed income. Basdeo, a pioneer of modern, active, systematic fixed income management, from his beginnings at Ontario Teachers' Pension Plan, and 14 years at BGI/Blackrock iShares, emphasizes his and his team's use of technology to make informed decisions. He also discusses the portfolio management process, including the use of systematic models and the coexistence of scientific and fundamental approaches to manage fixed income. We then delve into the delicate balance of the current economic climate and potential risks, such as the recent effects of runs on the banking system (i.e. SVB, First Republic, CS). Finally, Basdeo advises patience and caution when investing for the long term and offers tips for constructing a portfolio for the regime change ahead, where it's critical to consider liquidity and value.


[00:05:23] Gaining global experience and applying new tools in global markets.

[00:08:16] Analyzing markets systematically with models to reduce cognitive bias and take the best of both fundamental and scientific approaches.

[00:14:18] Analyze data to make informed decisions.

[00:30:23] Potential risk of sharp slowdown, Fed acting decisively to prevent it, need to assess risks and act accordingly.

[00:34:06] Investment in fixed income must account for macroeconomic changes and expected monetary policy. Shorten duration and curve-steepening are likely needed. Opportunities lie in observing individual companies.

[00:38:56] Looser financial conditions may spur activity, but likely CPI decline until year-end; entering new regime of higher inflation, volatility, and terminal rate.

[00:42:29] Terminal rate of 3-3.5%, lower to maintain inflation and employment goals, fracturing of global economy leading to higher production costs.

[00:50:19] Need to diversify portfolio with fixed income to reduce risk and volatility, use cash equivalents to earn 5% return.

[00:55:23] Market reacts more to weak data than strong data; Fed and other central banks trying to balance supply and demand; external political risks difficult to hedge.

[01:01:18] Liquidity, value, patience.

Key Takeaways:

1/ The market is reactive to weak data more than strong data, and external risks of recent regional U.S. bank instability, Russia, Ukraine and China are difficult to hedge.

2/ Aligning with long-term asset management, the Guardian Capital Fixed Income team analyzes markets systematically through building models & interpreting their output to identify opportunities.

3/ Aubrey Basdeo advises caution and monitoring portfolios for potential risks, but doesn't believe it's time to make big investments.

4/ The delicate balance in the current economic climate means more volatility to come, particularly because of long and variable lags to monetary policy.

5/ To construct a balanced portfolio, always pay attention to value and don't deviate from your discipline. Invest for the long term, and don't rush to buy or sell.

6/ Lastly, don't forget about the importance of liquidity stress testing - liquidity can disappear quickly in unexpected times.


Guardian Capital LP manages its own group of Mutual Funds, as well as sub-advising numerous ETFs and Mutual Funds on behalf of BMO Global Asset Management, BMO ETFs, and Horizons Exchange Traded Funds.

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