Amid continued uncertainty, investors are branching out from the traditional Canadian bond market in search of yield and diversification.
Although two consecutive interest rate hikes by the Bank of Canada this year prompted a spike in yields for short-term bonds, Kathrin Forrest, portfolio manager at Sun Life Global Investments Canada Inc., said the move, which took the base rate to one per cent from 0.5 per cent over the course of three months, saw a more muted response when it came to those with longer durations.
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“Long yields are driven by inflation expectations, technology, demographics, overall demand for savings and investment in the economy,” she told attendees at Benefits Canada’s Defined Contribution Investment Forum earlier this month. “In a way, the bond market here is not painting as favourable a picture of the Canadian economy as the Bank of Canada is telling us on the short end.”
“It has been a really challenging time,” added Forrest’s colleague, Randall Malcolm, managing director of Canadian public fixed income at Sun Life Investment Management Inc.
He said the current environment has opened the minds of Canadian investors to newer possibilities in the bond market.
“Canada has gotten a lot more receptive to BBB funding over the years. As yields decline, we become more and more accepting of lower credit, in order to enhance our returns,” he said. But he warned: “That is a double-edged sword. There are opportunities within the BBB set, but there is also credit risk in there.”
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According to Malcolm, one of the big “untold stories” of the Canadian market this year is the dominance of provincial activity throughout maturity terms. At the long-term end of the spectrum, he said the provinces have always had a strong presence, accounting for more than half of the total index. But their weightings have also spiked in the short- and medium-term parts of the index in recent years. In all cases, Ontario and Quebec are the largest issuers.
“If it worries you that Canada might have two of the largest sub-sovereign borrowers in the world, it worries me a little bit, too,” said Malcolm. “We also have a heavy bias to financials and a heavy bias to banks in the index.”
He said those who want to diversify their portfolios have turned to Maple bonds, the name for Canadian dollar-denominated bonds issued by foreign companies such as Apple Inc. and McDonald’s, both of which made billion-dollar moves in the last year.
“We don’t really have a tech bond sector here and we really don’t have much of a food services sector, either . . . so Maples give you a great diversification opportunity within Canada,” said Malcolm.
“The Maple market has been on fire this year,” he added, noting that issuance has topped $13 billion in 2017.
Read more articles from the 2017 DC Investment Forum