Fund managers favour corporate bonds

Goldfried notes that the U. S. Federal Reserve Board has said it will maintain very low interest rates until at least the end of 2014.

Moreover, he adds, “Every central bank has revised their growth estimates downward. In Europe, they’ve had several quarters of negative growth and they’re talking about recession.” In addition, the “monumental amount” of global monetary stimulus has succeeded in only ballooning government balance sheets.

“We face many years of fiscal austerity and a long-term global deleveraging cycle that will have a material impact on future GDP growth,” Goldfried says. “We continue to see below-trend GDP growth and very little in the way of inflationary pressure. We’re at the beginning of a five- to 10-year deleveraging cycle, both at the government and consumer levels. Even though rates are very low, they can remain very low for a long period.”

Indeed, Goldfried notes, Bank of Canada governor Mark Carney has his hands tied, mindful of the global situation, even if Carney has hinted at the need for an interest rate hike to curtail a domestic real estate bubble. “Raising rates,” says Goldfried, “would choke off our export markets and prompt a huge flow of capital into Canada from the U. S.”

Strategically, Goldfried does not make duration bets and stays close to the benchmark DEX universe bond index’s duration of 6.8 years. In addition, he has long favoured the corporate sector, which comprises 70%-90% of the imaxx fund’s assets under management (AUM). Currently, there is about 74% of AUM in investment-grade corporate bonds, with the balance primarily in Government of Canada bonds.

“When we came into 2012, the market was a lot more bullish and valuations were much more compelling. We got out of the longer end of the range of our corporate bond exposure,” says Goldfried, who took profits in the spring. “And spreads are still rallying.”

Running a concentrated portfolio of about 25 investment-grade corporate bonds and 15 assetbacked securities, Goldfried likes names such as Rogers Communications Inc., which has a 2021-dated bond that is yielding 3.75%, and a 2039-dated bond yielding 5.25%.

Other favourites in c l u de prop er ty and casualty insurer Intact Financial Inc., which has a 2021-d ated bond yielding 3.4%, and a 2039-dated bond yielding 5%.

In contrast, 10year Canadas are yielding 1.7%, and 30-year Canadas are yielding 2.3%.

DAGMARA FIJALKOWSKI, senior vice president and head of global fixed-income with Toronto-based RBC Global Asset Management and lead manager of RBC Bond Fund, believes that the macroeconomic outlook remains opaque. “You can draw equal scenarios, she says, “with yields going lower and higher – and assign decent probability to them.”

But the likelihood of North America experiencing razor-thin interest rates such as those in Japan, where 10-year government bonds are yielding 0.8%, is not strong. Among the key demographic reasons, says Fijalkowski, is the fact that North America’s population is growing steadily while Japan’s is expected to decline by 35% over the next 40 years.

As well, the response of North America’s central banks’ to the financial crisis has been strong, with a more than threefold increase in the Fed’s balance sheet, compared with only a 15% increase by the Bank of Japan since the crisis in that country began in 1990. The result of the monetary policy support in the U. S. is reflected in the fact that the U. S. equities market has recovered 80% of its losses since 2007, whereas Japan’s Nikkei index is down by 77% since 1990.

“These comparisons are misguided,” says Fijalkowski, “because they look at the behaviour of bond yields, not [at] what’s driving them.”

In her view, yields have been driven lower by the so-called “risk-off” bet, with many institutional investors shifting into bonds, as well as massive buying by global managers of foreign reserves whose options for safety and liquidity are limited to only a handful of countries.

Fijalkowski, who works within a seven-person team, admits the RBC team has 11 possible scenarios for future bond yields, which are shaped by several key events. One scenario is a third round of quantitative easing by the Fed. “We have a lot of uncertainty as to what might happen, because you can be terribly wrong,” Fijalkowski says, noting that last year’s downgrade of U. S. treasuries had defied the pundits and actually led to bond yields falling, not rising.

“Making a drastic call on interest rates is not a contributor to performance,” says Fijalkowski, who is clearly reluctant to make a call on what investors can expect this year. “We don’t believe that forecasting is a meaningful way to make rational investment decisions. What we can do is evaluate the portfolio under different scenarios and try to decide on the portfolio composition that gives us the best risk/reward.”

Given a moderately defensive view, Fijalkowski says, the RBC fund’s duration is 6.5 years. She also is cautious on Canadas, as they account for only 4% of AUM, while 36% is in provincial bonds and 4% is in high-yield bonds. The lion’s share, 52%, is in corporate bonds, and the rest is in cash.

Running a fund with more than 500 holdings, Fijalkowski likes issuers such as Bank of Nova Scotia, which has a February 2017-dated bond yielding 2.37%; Bell Canada, which has a May 2021-dated bond yielding 3.5%; and Quebecor Media Inc., which has a high-yield bond maturing in 2012 currently yielding 6.2%.

CHRIS CASE, VICE PRESIDENT and director, active fixed-income, with Toronto-based TD Asset Management Inc. (TDAM) and lead manager of TD Canadian Core Plus Bond Fund, believes that the macroeconomic picture can be characterized as “low and slow”: “We have low returns, low interest rates and a slow economy. We see that in place for the medium term – three to five years.”

Case notes that this scenario is based on the high amounts of government and consumer debt in most developed countries. “It’s going to be a long period because quite a load of debt has to be deleveraged,” says Case, noting that Canada is in a better fiscal position than most of its G7 peers and that Canadian bonds may outperform on a relative basis.

But Case won’t speculate on whether North American interest rates may fall further. “If you make a bet on the next non-farm employment statistic, for instance, you are only increasing the volatility of the portfolio,” says Case, who shares portfoliomanagement duties with Robert Pemberton, TDAM’s managing director, and David McCulla, a TDAM vice president.

Still, Case acknowledges that the risk of so-called “normalization” of interest rates will continue over the medium term. “But at the same time,” he adds, “we’re maintaining a focus on the probability of extreme outcomes – both economic and geopolitical.”

Case, like his peers, is maintaining the TD fund’s duration slightly below the benchmark. His team also is emphasizing corporate bonds, with about 50% of the TD fund’s AUM in investment-grade bonds; 25% of the TD fund’s AUM is in high-yield bonds. There also is 12% in federal bonds, 11% in provincial bonds and 2% in cash.

“We are very optimistic on credit quality, asset quality and credit spreads,” says Case. “Corporate balance sheets in North America are very clean and have high levels of cash. The great thing about these bonds is that they offer incremental yield and protection against the absolute low level of government bond yields. We’re attractively compensated for maintaining an overweighting in corporate bonds.”

The TD fund has bonds from 48 investment-grade issuers, eight asset-backed issuers and four commercial mortgage-backed securities issuers. There also are high-yield bonds from 75 issuers.

Some of the investment-grade bonds include those from issuers such as Rogers Communications, which has a 2019-dated bond that yields 3.5%, or 180 basis points (bps) more than seven-year Canadas; and a Shaw Communications Inc. 2019-dated bond, which yields 4% – more than 230 bps over Canadas of equivalent time to maturity.

The 25% weighting in highyield bonds, says Case, “offers substantial incremental yield without having to move out the yield curve.” He adds that these bonds are generally yielding about 550 bps over comparable government bonds.

Pointing to issuers such as Ford Motor Co., Case says: “It’s done very well, and has seen its rating upgraded.“

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