ARTICLES MARCH 2021
How “creative destruction at light speed” impacts bonds
There’s a silver lining to the government-imposed government shutdowns: “Creative Destruction at light speed.” In 2020, a typical multi-year creative destruction cycle was condensed into less than one year. This may trigger a major increase in productivity growth over the next few years.
Understanding creative destruction
In 2020, I dusted off my old economics textbook and reread the section on creative destruction. The term was coined by Austrian economist Joseph Schumpeter back in the 1950s. According to Dr. Schumpeter, the “gale of creative destruction” describes the constant cycle of innovation that replaces obsolete companies, products and services with new ones. The profit motive for entrepreneurs is what drives this process. This big-picture, fundamental economic concept will have a major impact on investments for the next several years. Of course, there will be harmful fallout from this process that society will wrestle with. I don’t want to minimize that. But over the long term, creative destruction is positive for investors.
An accelerant to the future
Our entire fixed income investment team gets together two or three times a year to discuss macro issues and their potential impacts on bond markets in a forum we call our Portfolio Strategy Group. At last year’s virtual forums, I talked about “creative destruction at lightspeed”: how the COVID-19 shutdowns — which have extracted a distressing human toll — accelerated into a period of less than one year a cycle that could have taken years or decades.
Short- and long-term impacts to bonds
This development could be negative for bonds in the early stages, as expanding demand runs into supply disruptions (even unproductive companies and industries produce some goods and services required by productive businesses). That could lead to a period, maybe a short period, with higher inflation that might be serious enough for central banks to re-think their commitment to zero interest rates. And that could have an impact on bond markets. But beyond that period, the major improvement in productivity should support non-inflationary growth – that’s a major positive over the long term for capital markets, including the bond market.
Positioning Canadian Core Plus Fixed Income
Capital Group Canadian Core Plus Fixed Income FundTM (Canada) reflects a lot of these ideas. The mandate is diversified and flexible, and we can allocate to non-Canadian developed market bonds, emerging market debt, high yield debt and more.
Right now, the portfolio has a slightly defensive interest rate posture, but not extremely so. It has a lighter allocation to provincial bonds and Canada housing bonds, as their valuations are stretched. On the other hand, as of the end of February, the mandate had a larger allocation to credit than the FTSE Canada Universe Bond Index, as our credit analysts have faith that they have potential through the whole cycle. And, its holdings outside of Canada are at a low level compared to past years. The portfolio’s foreign-domiciled holdings are generally hedged into the Canadian dollar. If we do get a period of inflation that impacts monetary policy, we're prepared to become more defensive in our interest rate and yield curve positioning. It’s something that we're going to be watching over the next three to six months.
James R. Mulally is a fixed income portfolio manager at Capital Group. He has 45 years of investment experience and has been with Capital Group for 41 years. Earlier in his career, as a fixed income investment analyst at Capital, he covered non-U.S. sovereign fixed income markets. Prior to joining Capital, Jim was a research associate at the Federal Reserve Bank of Minneapolis. He holds an MBA from Columbia University Graduate School of Business and a bachelor’s degree in economics from Dartmouth College. Jim is based in Los Angeles.