Canadian bond investing is getting to be more international thanks to proposals in the 2007 federal budget. The provisions will open up what could be a vast market for bonds issued by entities domiciled outside Canada, but priced and sold in Canadian dollars. The Maples market, which had about $45 billion of these bonds at the end of February, is set to grow much larger.

Buried in Annex 5 of Finance Minister Jim Flaherty’s remarks is a proposal to expand the list of investments eligible for RRSPs and deferred profit-sharing plans to include “any debt obligation that has an investment-grade rating and that is part of a minimum $25-million issuance,” and any security listed on a designated stock exchange.

The significance of this bit of small print is potentially huge, because the $25-million floor will expand the market, which has customarily handled issues of $150 million and up. And as long as the issue trades on a major exchange, such as the Luxembourg exchange, where many euro issues are already listed, it will meet standards of eligibility for RRSPs and other registered plans. Previously, the issuers themselves had to trade on exchanges, which was a disqualification for government-owned issuers or private companies that do not have publicly listed shares. Now, as long as the issuer is a corporation that trades on a major exchange, or the bond itself is traded on an exchange and meets both the investment-grade and the $25-million tests, it will qualify for RRSPs, RESPs and DPSPs.

Maples, which have tended to be superior credits issued by sovereigns with taxing power and by large financial institutions that often have government backing, have added a wide range of AAA and AA bonds with attractive yield spreads to the market.

One example is a $2.5-billion deal offered by Morgan Stanley Principal Investments in mid-February with an A+ rating by Standard & Poor’s Corp. to pay 58 basis points over a comparable Canada bond of the same term for a tranche due in 2012 and 95 bps over the comparable Canada for the tranche due in 2017.

Maples arrived in the nick of time. There was an insufficient supply of long bonds for the needs of pension funds and life insurers, according to Tom Czitron, managing director and head of income and structured products at Sceptre Investment Counsel Ltd. in Toronto. Moves by the federal and provincial governments to pay off debt cut the issuance of long-term debt. Corporations, awash in cash, had net bond issuance in 2006 of $7.7 billion compared with $18.3 billion in 2005. Then the 2005 federal budget eliminated the Foreign Property Rule, which had limited foreign assets to 30% of each registered plan’s holdings. That move whetted the market’s appetite for foreign bonds. Maples began to flow in earnest with sales of $10 billion in 2005. Another $23 billion was sold in 2006, says Bank of Nova Scotia corporate bond analyst Robert Follis. In the first two months of 2007, $11.3 billion of Maples were issued, according to Daniel Child, managing director of credit trading at Scotiabank in Toronto.

Maples have added superior credits to the market. According to Robert Palombi, director of fixed income research at Standard & Poor’s in Toronto, as of late 2006, 40% of Maples were AAA credits, 25% were AA and 35% were A. Triple-A corporate credits were almost non-existent until Maples came along.

Maples are being marketed to fixed-income managers, says Steve Locke, senior portfolio manager for fixed income at Howson Tattersall Investment Counsel Ltd. in Toronto. “We found them reasonably attractive for yield relative to Canadian domestic corporates for equivalent risk,” he says.

It has always been possible to add foreign credits up to applicable limits or mandates. But those foreign bonds, usually issued in foreign currencies, added forex risk.

“They are ways to get global exposure with no currency risk,” Palombi says. “That makes them appealing to risk-averse bond buyers and conservative investors with a home-country bias.”

The spreads on Maples are no gifts to buyers, says Michael McHugh, portfolio manager for fixed income at Dynamic Funds Management Ltd. in Toronto. “We have bought one issue for the advantages of diversification in specific sectors such as financial services. There are more European and U.S. companies than are available in Canada.”

@page_break@But there are problems of liquidity and volatility, McHugh says. “There are fewer dealers making markets in Maples. Major dealers such as RBC Capital Markets, Merrill Lynch and HSBC have made markets, while others have added liquidity,” he says. He adds that the Maples market is smaller than the total bond market. There are only about 90 names in the market so far and most issues are $200 million-$300 million — small by institutional standards, he says.

There are also problems of valuation and of getting to know the issues of foreign bonds. If a problem develops in an issuer’s home market, it could be a few days before Canadian managers react. By then, the news would be priced into the bond,” he says.

For now, the Maples market appears to cleave between pension funds and lifecos that do not need liquidity, and mutual funds that may have to meet cash calls. “Past issues got orphaned and were left to mature without secondary-market support,” says Randy LeClair, senior vice president and portfolio manager at AIC Investment Services Inc. in Burlington, Ont.

That is changing because the March 19 budget expands the definition of qualified investments to include investment-grade bonds regardless of the style of issuance. Now these investment-grade Maples meet the qualifications for RRSPs, RESPs and DPSPs, says John Carswell, president of Canso Investment Counsel Ltd. in Richmond Hill, Ont.

“The Maples market will grow to allow an RRSP investor to buy them directly, although he would have the same problem of wide spreads that confront any bond buyer,” Carswell says. “Why would an investor with an RRSP or a DPSP not want to buy a major German lender such as KfW with its government guarantee and a 40-bp yield boost over a Government of Canada bond? Maples will trade on the same terms as domestic bonds, but will offer higher credit ratings, along with higher yields and substantial diversification opportunities. Financial advisors will be able to use Maples to replace federal and provincial issues. After all, the credits will be just as good and the yield will be higher.” IE