The prototypical bond client wants yield and security, which is precisely what investment-grade corporate bonds provide. And the task of the advisor is to blend expectation of return with risk tolerance. But with the yield curve currently very flat, it takes a special sense of the bond market to find issues that provide better safety than income trusts and that generate significantly better returns than plain-vanilla government bonds.

Bond raters and professional bond traders tend to see risk and return in close detail. They worry about vulnerability to the business cycle — especially to downturns, when credit is tight and coverage of interest due on a bond may be problematic.

Let’s start at the top with a benchmark return for a 10-year bank bond, such as one from the Bank of Montreal, which has a rate of 4.87%, is due April 22, 2015 and is rated AA-minus. The bond has recently been priced to yield 56 basis points over a Government of Canada 10-year bond that has recently traded to yield 4.2% to maturity. This bank bond is a good risk, has good yield and is probably a good deal, says Randy LeClair, vice president and global bond manager at AIC Ltd. in Burlington, Ont.

Consumer-product company bonds are almost as stable as those of banks. Cola drinkers could one day defect to Pepsi en masse, but for now, Coke seems to have a solid future. The Coca-Cola Enterprises Bottling Finance Canada senior unsecured 5.85% bond, due March 17, 2009, has been recently priced at $105.10 to yield 4.42% and offers a 43-bps boost over the Canada 5.5% bond due June 2009 priced at $104.64 to yield 3.99%. The Coca-Cola issue is rated single-A by Standard & Poor’s Corp. , and Coca-Cola is familiar to the market.

In the lower investment-grade levels of the market — below the AAs that give almost “gold standard” protection from default and the BBs that are OK but not quite bulletproof — there is a good deal of potential return.

A Shoppers Drug Mart 4.97% bond due Oct. 24, 2008, was recently priced at $101.60 to yield 4.30% to maturity. Compared with a Canada 4.25% due Sept. 1, 2008, priced at $101.70 with a yield to maturity of 3.96%, the Shoppers Drug Mart bond, with a triple-B rating by S&P, offers a 34-bps boost in return — a nice jump for very little risk.

But finding corporate bonds that offer good yields and acceptable credit ratings is tough, says Rob Palombi, director of fixed-income research for S&P in Canada: “Credit quality seems to be stabilizing.”

And that shows in S&P’s tracking of upgrades and downgrades of Canadian-issued bonds. In 2005, there were 13 upgrades and 24 downgrades of corporate bonds, compared with nine upgrades and 22 downgrades a year earlier, he notes.

However, there are fresh fields of low-risk bonds with good yield boosts. The elimination of foreign-content restrictions on RRSPs has been an incentive for foreign issuers to bring issues to Canada priced in Canadian dollars. Called “Maple bonds” — and mostly rated triple-A and double-A by S&P — they include issues from major U.S. investment banks such as Bear Stearns & Co. Inc. and U.S. student loan financier SLM Corp. (Sallie Mae), as well as major U.S.-based institutions such as Bank of America Corp., J.P. Morgan Chase & Co. and European institutions such as Royal Bank of Scotland PLC.

But Canadian bond buyers are unfamiliar with these products and are not stepping up to the plate to purchase them as readily as they do domestic issuers. Therefore, there are yield bonuses to be had. For example, The Bank of America 4.36% bond due Sept. 21, 2015, and rated AA-low yields 63 bps over a Canada 4.50% bond due June 1, 2015, that yields 4.17% to maturity, notes LeClair.

Bank of America is a great name in the U.S., slightly unfamiliar in Canada, but, most of all, the liquidity of the issue in the secondary market is not certain, he says.

To find the biggest yield boosts, one has to shop the really afflicted sectors — companies such as automaker GM Corp. and forest products firm Tembec Inc. Both companies’ bonds are deep in junk territory, with Tembec at CCC-minus. The Tembec bonds due in 2009 have recently traded at 47¢ on the dollar and now yield 37%, whereas a year ago they were trading on a dollar-for-dollar basis. If Tembec can come up with the cash to pay its coupons, the bonds will be a hugely profitable trade. But the market is clearly saying that it doubts the company can find the scratch for its interest payments. In the CCC group, there is a 69% chance of default within 10 years, Palombi says.

@page_break@GM’s bond ratings and yields vary widely from one issue to the next, notes Chris Kresic, vice president and portfolio manager for Mackenzie Financial Corp. in Toronto. In trading at the end of January, GM’s 8.375% bond due in July, 2033, rated single-B by S&P, fell to 72¢ on the dollar, providing a running yield of 11.6%. That’s a fairyland return, according to the bond market — and chasing it is likely to be hazardous.

The better deals are in the auto financing arms of Ford Motor Co. and GM, Kresic notes.

In a market of frothy stocks and improving corporate balance sheets, risk aversion has declined. Investors who want to take some risks have to be sure they are paid for it. And advisors who put clients into anything below a “sure thing,” AAA government bond should be sure the clients know the risks they are taking. IE