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© Copyright 2000 Rogers Media. The following article first appeared in the February 2000 edition of
BENEFITS CANADA magazine.
Beating the bond market
Can the bond market be beaten? Sure it can. But a multi-style, multi-manager approach is
important.
By Barbara Clapham
Bond managers have had trouble beating the market lately, and those who have managed to outperform the
index have done so by a small margin. Over the five-year period ended December 1998, a first-quartile bond
manager beat the market benchmark by less than 40 basis points, compared to 150 points against the Toronto
Stock Exchange (TSE) 300 total return index for a first-quartile active equity manager.
Given how difficult is seems to be to add value in an efficient bond market, plan sponsors may wonder
whether they should simply index their fixed income assets.
Can the bond market be beaten?
Harry Marmer, director of investment funds, and Timothy Hicks, portfolio manager at Frank Russell Company
in Toronto, think it can. Although they acknowledge that it is no easy task, they believe managers should
not necessarily abandon ship and index their portfolios.
According to Marmer and Hicks, the case for active management rests on several points, including:
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One of the key premises in selecting a passive index strategy is that the underlying benchmark reflects
the opportunity set of the asset class. However, the Canadian fixed income market has started to
broaden out with the development of new sectors not included in the index. Non-C$ Canada, provincial
and corporate bonds are available.
Other choices not found in the index are corporate high-yield bonds in both Canadian and U.S. dollars, and
asset- and mortgage-backed fixed income securities. A passive investor will not obtain exposure to these
opportunities. Active management is the only way to capture the higher returns available with these types
of securities.
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The global fixed income arena provides a much broader array of choice than is found in Canada alone.
Opportunities for higher returns can be found beyond our borders in such areas as high-yield debt,
sovereign debt, mortgage- and asset-backed securities, corporates and emerging markets. New types of
fixed income securities are expected to enter the European market as Europe continues to integrate into
one economic union.
One way to take advantage of these opportunities would be to use as a benchmark a broad universe of
Canadian fixed income securities (such as DS BARRA or Scotia), then search the world for potential value
added.
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A strategy that overweights corporate bonds versus the benchmark should add value. Over the long term
investors in corporate and other below-AAA securities are well rewarded.
Since 1948, corporates have yielded, on average, 85 basis points more than similar duration Government of
Canada bonds. Of course, corporate bonds should be selected carefully to avoid a loss should the underlying
company go bankrupt. If a bankruptcy causes a loss, this is not a result of overweighting corporate bonds.
This is a result of bad corporate bond selection.
Marmer and Hicks also note how different investment styles work at different times, with no predictability.
One year a rate anticipation style may work the best, while the following year yield curve forecasting or
bond swapping may produce the best returns. Thus, to implement an active, fixed income approach, it is best
to use a multi-style, multi-manager fixed income structure.
Pension plan sponsors should ask their active managers how they plan to add value. Efficient as the bond
market may be, opportunities do exist. An innovative, proactive manager has the potential to beat the
market.
Barbara Clapham is contributing editor of BENEFITS CANADA.
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CONFERENCES
New Developments in Pension
Fund Governance
A Practical, Hands-On Approach
March 6 - 7, 2000
Toronto Board of Trade
Speakers at this conference, sponsored by the Institute for International Research, will provide feedback
from the joint ACPM, PIAC and OSFI governance task force, and discuss what that will mean for plan
sponsors. Call (416) 928-1078 or fax (416) 928-9613
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