Global Insight- Quality Check
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The document discusses the need for investors to assess the quality of their portfolios as monetary policy shifts away from stimulus. Major central banks are approaching a long transition period where government bond yields will gradually rise. Portfolios that took on more risk in the search for yield may need upgrades, as credit spreads tighten and corporate debt levels increase the risk of losses. Now is a good time to lock in gains from recent strength in credit markets and improve portfolio quality and liquidity.
![7 Global Insight Focus Article | June 2017
Required disclosures
Analyst Certification
All of the views expressed in this report accurately reflect the personal views
of the responsible analyst(s) about any and all of the subject securities or
issuers. No part of the compensation of the responsible analyst(s) named
herein is, or will be, directly or indirectly, related to the specific recommenda-
tions or views expressed by the responsible analyst(s) in this report.
Important Disclosures
In the U.S., RBC Wealth Management operates as a division of RBCCapital
Markets, LLC. In Canada, RBC Wealth Management includes, without limita-
tion, RBC Dominion Securities Inc., which is a foreign affiliate of RBCCapital
Markets, LLC. This report has been prepared by RBCCapital Markets, LLC
which is an indirect wholly-owned subsidiary of the Royal Bank of Canada
and, as such, is a related issuer of Royal Bank of Canada.
Non-U.S. Analyst Disclosure: Mark Allen, Jim Allworth, Mark Bayko,
Jean-François Dion, Christopher Girdler, Patrick McAllister, and Jay Roberts,
employees of RBC Wealth Management USA’s foreign affiliate RBC Dominion
Securities Inc.; and Frédérique Carrier, Hakan Enoksson, and Jack Lodge,
employees of RBC Wealth Management USA’s foreign affiliate Royal Bank
of Canada Investment Management (U.K.) Limited; contributed to the
preparation of this publication. These individuals are not registered with
or qualified as research analysts with the U.S. Financial Industry Regula-
tory Authority (“FINRA”) and, since they are not associated persons of RBC
Wealth Management, they may not be subject to FINRA Rule 2241 governing
communications with subject companies, the making of public appearances,
and the trading of securities in accounts held by research analysts.
In the event that this is a compendium report (covers six or more compa-
nies), RBC Wealth Management may choose to provide important disclosure
information by reference. To access current disclosures, clients should refer
to http://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.
aspx?EntityID=2 to view disclosures regarding RBC Wealth Management
and its affiliated firms. Such information is also available upon request to
RBC Wealth Management Publishing, 60 South Sixth St, Minneapolis, MN
55402.
References to a Recommended List in the recommendation history chart may
include one or more recommended lists or model portfolios maintained by
RBC Wealth Management or one of its affiliates. RBC Wealth Management
recommended lists include the Guided Portfolio: Prime Income (RL 6), the
Guided Portfolio: Dividend Growth (RL 8), and the Guided Portfolio: ADR
(RL 10), and former lists called the Guided Portfolio: Large Cap (RL 7), the
Guided Portfolio: Midcap 111 (RL 9), and the Guided Portfolio: Global
Equity (U.S.) (RL 11). RBCCapital Markets recommended lists include the
Strategy Focus List and the Fundamental Equity Weightings (FEW) portfolios.
The abbreviation ‘RL On’ means the date a security was placed on a
Recommended List. The abbreviation ‘RL Off’ means the date a security was
removed from a Recommended List.
and Underperform (U) most closely correspond to Buy, Hold/Neutral and
Sell, respectively, the meanings are not the same because our ratings are
determined on a relative basis (as described below).
Explanation of RBC Capital Markets, LLC Equity Rating System
An analyst’s “sector” is the universe of companies for which the analyst
provides research coverage. Accordingly, the rating assigned to a particular
stock represents solely the analyst’s view of how that stock will perform over
the next 12 months relative to the analyst’s sector average. Although RBC
Capital Markets, LLC ratings of Top Pick (TP)/Outperform (O), Sector Perform
(SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and
Sell, respectively, the meanings are not the same because our ratings are
determined on a relative basis (as described below).
Ratings: Top Pick (TP): Represents analyst’s best idea in the sector;
expected to provide significant absolute total return over 12 months with
a favorable risk-reward ratio. Outperform (O): Expected to materially
outperform sector average over 12 months. Sector Perform (SP): Returns
expected to be in line with sector average over 12 months. Underperform (U):
Returns expected to be materially below sector average over 12 months.
Risk Rating: As of March 31, 2013, RBCCapital Markets, LLC suspends its
Average and Above Average risk ratings. The Speculative risk rating reflects
a security’s lower level of financial or operating predictability, illiquid share
trading volumes, high balance sheet leverage, or limited operating history
that result in a higher expectation of financial and/or stock price volatility.
Valuation and Risks to Rating and Price Target
When RBC Wealth Management assigns a value to a company in a research
report, FINRA Rules and NYSE Rules (as incorporated into the FINRA Rulebook)
require that the basis for the valuation and the impediments to obtaining that
valuation be described. Where applicable, this information is included in the
text of our research in the sections entitled “Valuation” and “Risks to Rating and
Price Target”, respectively.
The analyst(s) responsible for preparing this research report received com-
pensation that is based upon various factors, including total revenues of RBC
Capital Markets, LLC, and its affiliates, a portion of which are or have been
generated by investment banking activities of the member companies of RBC
Capital Markets, LLC and its affiliates.
Other Disclosures
Prepared with the assistance of our national research sources. RBC Wealth
Management prepared this report and takes sole responsibility for its content
and distribution. The content may have been based, at least in part, on
material provided by our third-party correspondent research services. Our
third-party correspondent has given RBC Wealth Management general permis-
sion to use its research reports as source materials, but has not reviewed or
approved this report, nor has it been informed of its publication. Our third-
party correspondent may from time to time have long or short positions in,
effect transactions in, and make markets in securities referred to herein. Our
third-party correspondent may from time to time perform investment banking
or other services for, or solicit investment banking or other business from, any
company mentioned in this report.
RBC Wealth Management endeavors to make all reasonable efforts to provide
research simultaneously to all eligible clients, having regard to local time
zones in overseas jurisdictions. In certain investment advisory accounts,
RBC Wealth Management will act as overlay manager for our clients and will
initiate transactions in the securities referenced herein for those accounts
upon receipt of this report. These transactions may occur before or after your
receipt of this report and may have a short-term impact on the market price of
the securities in which transactions occur. RBC Wealth Management research
is posted to our proprietary Web sites to ensure eligible clients receive
coverage initiations and changes in rating, targets, and opinions in a timely
manner. Additional distribution may be done by sales personnel via e-mail,
As of March 31, 2017
Rating Count Percent Count Percent
Buy [Top Pick & Outperform] 843 51.94 285 33.81
Hold [Sector Perform] 679 41.84 149 21.94
Sell [Underperform] 101 6.22 8 7.92
Investment Banking Services
Provided During Past 12 Months
Distribution of Ratings - RBC Capital Markets, LLC Equity Research
Distribution of Ratings
For the purpose of ratings distributions, regulatory rules require member
firms to assign ratings to one of three rating categories - Buy, Hold/Neutral,
or Sell - regardless of a firm’s own rating categories. Although RBCCapital
Markets, LLC ratings of Top Pick (TP)/Outperform (O), Sector Perform (SP)](https://image.slidesharecdn.com/giqualitycheck-170607193511/85/Global-Insight-Quality-Check-7-320.jpg)
Global Insight- Quality Check
- 1. For important and required non-U.S. analyst disclosures, see page 7. All values in U.S. dollars and priced as of May 31, 2017, market close, unless otherwise noted. F o c u s A r t i c l e June 2017 R B C W E A L T H M A N A G E M E N T Global Insight Time for a quality check The multiyear quest for yield may have produced risk distortions in portfolios.Time to use strong markets to upgrade quality. Christopher Girdler
- 2. 2 Global Insight Focus Article | June 2017 Time for a quality check –– Gradual “sea change” approaching for global monetary policy and interest rates –– Time to assess risks taken on during the long search for yield Major central banks have been running intensely accommodative monetary policies since the financial crisis began. Excluding the Federal Reserve, for the most part they still are, but to us it appears the period of peak monetary policy stimulus could soon be behind us. We foresee a long unwinding process during which time government and corporate bond yields could gradually increase. In our opinion, it’s time for investors to do a quality check on their portfolios to make sure they haven’t inadvertently increased risk in search of higher yields. We believe corporate credit still offers selective yield opportunities, but with stretched valuations now is the time to upgrade portfolio quality. Focus article Christopher Girdler Toronto, Canada christopher.girdler@rbc.com Monetary stimulus is passing its peak Source - RBC Global Asset Management Opportunities as interest rates rise As central banks gradually move toward a more balanced policy stance, government bond yields are likely to rise at a similarly deliberate pace, reflecting improved growth prospects and receding risks of deflation. When bond yields go up, bond prices fall. Faced with this, conventional wisdom would say an investor should remain in cash and very short maturities, waiting until higher rates have arrived before re-investing. However, in this case that means accepting a very low coupon return perhaps for several years. For the buy- and-hold investor, in our view, this is a heavier cost than the current circumstances would justify.
- 3. 3 Global Insight Focus Article | June 2017 Time for a quality check Investors holding bonds to maturity will naturally see the path of returns altered by interest rate changes, but their overall return, set when they bought the bond (the yield to maturity) will remain in place. Over the life of the bond, assuming the issuer remains solvent, the investor will continue to receive regular interest payments as well as principal at maturity. Rising interest rates could actually improve the buy-and-hold investors’ realised returns thanks to the reinvestment of coupon and any principal repayments at progressively higher interest rates. Too much of a good thing? Massively accommodative monetary policy across most major developed economies since the financial crisis has pushed government bond yields down to exceptionally low levels. Investors looking to maintain the level of income in portfolios have increasingly chosen to assume additional risks in search of better yields. Typically that has pushed them towards corporate bonds where the risk of default is higher than for governments and liquidity much lower, especially during periods of market stress. Corporate credit has provided solid returns with limited volatility over the past three years Source - RBC Wealth Management, Bloomberg Corporate credit has recently demonstrated a superior risk-return profile compared to Government bonds. Annual equivalent return (%) Volatility of returns (%) US Treasury Total Return Index 2.38% 4.49% US Corporate Total Return Index 3.90% 5.40% US High Yield Total Return Index 4.57% 5.23% European Treasury Total Return Index 4.04% 4.76% European Corporate Total Return Index 3.43% 2.59% European High Yield Total Return Index 4.99% 4.54% Moody’s BBB Corporate Bond spread Source - RBC Wealth Management, Bloomberg; data through 5/19/17 Corporate credit spreads (BBB-rated) have narrowed to the tightest levels in a number of years. 100 200 300 400 500 600 700 Dec 2003 Dec 2006 Dec 2009 Dec 2012 Dec 2015 Spreadinbasispoints
- 4. 4 Global Insight Focus Article | June 2017 Time for a quality check As business conditions have improved over the past several years, this appetite for corporate credit has grown steadily. During last year’s episode of ultra-low, even negative, government bond yields, this preference for corporate credit became so pronounced that the differential (spread) between the yield on corporate bonds and government bonds narrowed to the tightest level in a number of years. But we now ask ourselves, was this spread compression justified? Credit fundamentals for both investment-grade and high-yield borrowers, as measured by financial leverage, have worsened at the same time as compensation for assuming credit risk has fallen. It’s true the current interest rate environment keeps borrowing costs for corporate issuers at an affordable level, but the large pile of debt that has made its way onto most balance sheets over the past several years—to fund expansion plans or large share buy-back programs—could prove a headwind to corporate bonds as interest rates rise. Correlation risk: Out of sight, out of mind The correlation of different financial assets is a topic usually discussed at portfolio construction but is often forgotten thereafter. In addition to providing reliable income, the fixed income component of a portfolio is supposed to act as a countervailing force when the equity component is under pressure. Government bonds and high-grade corporates usually do just that. When the economy heads into recession, earnings and share prices fall. Funds looking for a safe haven often flow into high-grade bonds pushing bond prices higher, taking some of the sting out of equity losses and giving the investor the financial and psychological staying power to hang in through the downturn. But the worse the credit characteristics of a particular bond or preferred, the less it acts like a high-grade bond during periods of economic duress and the more it behaves like a stock. As the multi-decade search for yield has pushed investors toward lower-quality credits, it has simultaneously exposed portfolios to more equity- like volatility than intended. So far there has been no discernable cost to investors: they have enjoyed higher incomes than government bonds would have provided, and spreads are pretty well as low as they have been in the past seven years. Counting on that continuing indefinitely seems to us to be an unreasonable assumption. In addition to providing reliable income, the fixed income component of a portfolio is supposed to act as a countervailing force when the equity component is under pressure. Corporate bonds, especially high-yield, display positive correlation to equity markets * For U.S. equities, we use the S&P 500 Index and for Europe we use the STOXX Europe 600 Index. ** Correlations are calculated using daily returns over three years. Source - RBC Wealth Management, Bloomberg Correlations** vs. Equities* U.S. Treasury market -0.37 U.S. corporate bonds -0.27 U.S. high-yield bonds 0.48 European Treasury market 0.01 European corporate bonds 0.08 European high-yield bonds 0.69 Corporate bonds, especially high-yield, display positive correlation to equity markets
- 5. 5 Global Insight Focus Article | June 2017 Time for a quality check ... the recent strength in credit markets provides an opportune time to lock in well- earned gains ... It would be prudent at this point, when yields and spreads are both so low, to assess portfolios to ensure investors are being fully compensated for taking the risks that are present as well as making sure fixed income holdings offer appropriate portfolio diversification. While we feel that select corporate bonds still offer worthwhile yield advantages and that spreads have the capacity to remain at current levels or tighten in some cases, the recent strength in credit markets provides an opportune time to lock in well-earned gains and reduce exposure to positions more susceptible to suffering in a bond market pullback. Reinvesting proceeds into higher-quality bonds would have the natural benefit of increasing credit quality of the total portfolio as well as improving its liquidity profile.
- 6. 6 Global Insight Focus Article | June 2017 Research resources This document is produced by the Global Portfolio Advisory Committee within RBC Wealth Management’s Portfolio Advisory Group. The RBC Wealth Management Portfolio Advisory Group provides support related to asset allocation and portfolio construction for the firm’s investment advisors / financial advisors who are engaged in assembling portfolios incorporating individual marketable securities. The Committee leverages the broad market outlook as developed by the RBC Investment Strategy Committee, providing additional tactical and thematic support utilizing research from the RBC Investment Strategy Committee, RBC Capital Markets, and third-party resources. Global Portfolio Advisory Committee members: Jim Allworth – Co-chair; Investment Strategist, RBC Dominion Securities Inc. Kelly Bogdanov – Co-chair; Portfolio Analyst, RBC Wealth Management Portfolio Advisory Group – Equities, RBC Capital Markets, LLC Frédérique Carrier – Co-chair; Managing Director, Head of Investment Strategies, Royal Bank of Canada Investment Management (U.K.) Limited Mark Allen, CFA – Portfolio Advisor, RBC Wealth Management Portfolio Advisory Group – Equities, RBC Dominion Securities Inc. Mark Bayko, CFA – Head, Multi-Asset Portfolios & Practice Management, RBC Dominion Securities Inc. Craig Bishop – Lead Strategist, U.S. Fixed Income Strategies Group, RBC Wealth Management Portfolio Advisory Group, RBC Capital Markets, LLC Jean-François Dion, CFA – Head, Equity Portfolio Management, RBC Dominion Securities Inc. Janet Engels – Head of U.S. Equities, RBC Wealth Management Portfolio Advisory Group, RBC Capital Markets, LLC Hakan Enoksson – Head of Fixed Income - British Isles, Royal Bank of Canada Investment Management (U.K.) Limited Tom Garretson, CFA – Fixed Income Portfolio Advisor, RBC Wealth Management Portfolio Advisory Group, RBC Capital Markets, LLC Christopher Girdler, CFA – Fixed Income Portfolio Advisor, RBC Wealth Management Portfolio Advisory Group, RBC Dominion Securities Inc. Jack Lodge – Associate, Structured Solutions team, Royal Bank of Canada Investment Management (U.K.) Limited Patrick McAllister, CFA – Canadian Equities Portfolio Advisor, RBC Wealth Management Portfolio Advisory Group – Equities, RBC Dominion Securities Inc. Jay Roberts – Head of Investment Solutions & Products, RBC Wealth Management Hong Kong, RBC Dominion Securities Inc. Alan Robinson – Portfolio Analyst, RBC Wealth Management Portfolio Advisory Group – Equities, RBC Capital Markets, LLC The RBC Investment Strategy Committee (RISC) consists of senior investment professionals drawn from individual, client- focused business units within RBC, including the Portfolio Advisory Group. The RISC builds a broad global investment outlook and develops specific guidelines that can be used to manage portfolios. The RISC is chaired by Daniel Chornous, CFA, Chief Investment Officer of RBC Global Asset Management Inc.
- 7. 7 Global Insight Focus Article | June 2017 Required disclosures Analyst Certification All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of the subject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommenda- tions or views expressed by the responsible analyst(s) in this report. Important Disclosures In the U.S., RBC Wealth Management operates as a division of RBCCapital Markets, LLC. In Canada, RBC Wealth Management includes, without limita- tion, RBC Dominion Securities Inc., which is a foreign affiliate of RBCCapital Markets, LLC. This report has been prepared by RBCCapital Markets, LLC which is an indirect wholly-owned subsidiary of the Royal Bank of Canada and, as such, is a related issuer of Royal Bank of Canada. Non-U.S. Analyst Disclosure: Mark Allen, Jim Allworth, Mark Bayko, Jean-François Dion, Christopher Girdler, Patrick McAllister, and Jay Roberts, employees of RBC Wealth Management USA’s foreign affiliate RBC Dominion Securities Inc.; and Frédérique Carrier, Hakan Enoksson, and Jack Lodge, employees of RBC Wealth Management USA’s foreign affiliate Royal Bank of Canada Investment Management (U.K.) Limited; contributed to the preparation of this publication. These individuals are not registered with or qualified as research analysts with the U.S. Financial Industry Regula- tory Authority (“FINRA”) and, since they are not associated persons of RBC Wealth Management, they may not be subject to FINRA Rule 2241 governing communications with subject companies, the making of public appearances, and the trading of securities in accounts held by research analysts. In the event that this is a compendium report (covers six or more compa- nies), RBC Wealth Management may choose to provide important disclosure information by reference. To access current disclosures, clients should refer to http://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup. aspx?EntityID=2 to view disclosures regarding RBC Wealth Management and its affiliated firms. Such information is also available upon request to RBC Wealth Management Publishing, 60 South Sixth St, Minneapolis, MN 55402. References to a Recommended List in the recommendation history chart may include one or more recommended lists or model portfolios maintained by RBC Wealth Management or one of its affiliates. RBC Wealth Management recommended lists include the Guided Portfolio: Prime Income (RL 6), the Guided Portfolio: Dividend Growth (RL 8), and the Guided Portfolio: ADR (RL 10), and former lists called the Guided Portfolio: Large Cap (RL 7), the Guided Portfolio: Midcap 111 (RL 9), and the Guided Portfolio: Global Equity (U.S.) (RL 11). RBCCapital Markets recommended lists include the Strategy Focus List and the Fundamental Equity Weightings (FEW) portfolios. The abbreviation ‘RL On’ means the date a security was placed on a Recommended List. The abbreviation ‘RL Off’ means the date a security was removed from a Recommended List. and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis (as described below). Explanation of RBC Capital Markets, LLC Equity Rating System An analyst’s “sector” is the universe of companies for which the analyst provides research coverage. Accordingly, the rating assigned to a particular stock represents solely the analyst’s view of how that stock will perform over the next 12 months relative to the analyst’s sector average. Although RBC Capital Markets, LLC ratings of Top Pick (TP)/Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis (as described below). Ratings: Top Pick (TP): Represents analyst’s best idea in the sector; expected to provide significant absolute total return over 12 months with a favorable risk-reward ratio. Outperform (O): Expected to materially outperform sector average over 12 months. Sector Perform (SP): Returns expected to be in line with sector average over 12 months. Underperform (U): Returns expected to be materially below sector average over 12 months. Risk Rating: As of March 31, 2013, RBCCapital Markets, LLC suspends its Average and Above Average risk ratings. The Speculative risk rating reflects a security’s lower level of financial or operating predictability, illiquid share trading volumes, high balance sheet leverage, or limited operating history that result in a higher expectation of financial and/or stock price volatility. Valuation and Risks to Rating and Price Target When RBC Wealth Management assigns a value to a company in a research report, FINRA Rules and NYSE Rules (as incorporated into the FINRA Rulebook) require that the basis for the valuation and the impediments to obtaining that valuation be described. Where applicable, this information is included in the text of our research in the sections entitled “Valuation” and “Risks to Rating and Price Target”, respectively. The analyst(s) responsible for preparing this research report received com- pensation that is based upon various factors, including total revenues of RBC Capital Markets, LLC, and its affiliates, a portion of which are or have been generated by investment banking activities of the member companies of RBC Capital Markets, LLC and its affiliates. Other Disclosures Prepared with the assistance of our national research sources. RBC Wealth Management prepared this report and takes sole responsibility for its content and distribution. The content may have been based, at least in part, on material provided by our third-party correspondent research services. Our third-party correspondent has given RBC Wealth Management general permis- sion to use its research reports as source materials, but has not reviewed or approved this report, nor has it been informed of its publication. Our third- party correspondent may from time to time have long or short positions in, effect transactions in, and make markets in securities referred to herein. Our third-party correspondent may from time to time perform investment banking or other services for, or solicit investment banking or other business from, any company mentioned in this report. RBC Wealth Management endeavors to make all reasonable efforts to provide research simultaneously to all eligible clients, having regard to local time zones in overseas jurisdictions. In certain investment advisory accounts, RBC Wealth Management will act as overlay manager for our clients and will initiate transactions in the securities referenced herein for those accounts upon receipt of this report. These transactions may occur before or after your receipt of this report and may have a short-term impact on the market price of the securities in which transactions occur. RBC Wealth Management research is posted to our proprietary Web sites to ensure eligible clients receive coverage initiations and changes in rating, targets, and opinions in a timely manner. Additional distribution may be done by sales personnel via e-mail, As of March 31, 2017 Rating Count Percent Count Percent Buy [Top Pick & Outperform] 843 51.94 285 33.81 Hold [Sector Perform] 679 41.84 149 21.94 Sell [Underperform] 101 6.22 8 7.92 Investment Banking Services Provided During Past 12 Months Distribution of Ratings - RBC Capital Markets, LLC Equity Research Distribution of Ratings For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - Buy, Hold/Neutral, or Sell - regardless of a firm’s own rating categories. Although RBCCapital Markets, LLC ratings of Top Pick (TP)/Outperform (O), Sector Perform (SP)
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