If your clients hold bonds, monitor interest rate predictions and duration benchmarks.
That way, you can more accurately predict returns and prepare people for price fluctuations, says John Braive, vice chairman of global fixed income at CIBC Asset Management. He manages the Renaissance Canadian Bond Fund.
The current duration for his fund is set at 6.75 years—duration refers to the number of years it will likely take for bonds to be repaid by their internal cash flows. In contrast, the current industry benchmark is set at 6.95 years.
“This means [that] is if interest rates were to move by 1% in either direction, the overall price of our fund would move by 6.75%,” says Braive.
“If rates were to fall by 1% across the full yield curve, for example, the price of the fund would go up by 6.75%,” he adds. “If rates were to rise by 1% instead, the price of the fund would fall” by the same ratio and that would negatively affect performance.
This past June, markets were depressed due to a steep sell-off in the U.S. Treasury market, says Braive. He finds bond funds generally had negative returns last year.
What’s on the horizon?
Despite a slow 2013, the bond market started to improve at the end of last year, says Braive. At that time, “bonds were [sitting] at cheap levels…They [also] started this year at levels that [were] pretty reasonable” and will continue to produce solid yields.
As well, he expects the Bank of Canada won’t hike short-term interest rates any time soon. Some predict the central bank may “decrease rates if the economy continues to sputter,” but Braive says rates will stay on hold, which means bonds may generate low, positive growth over the next twelve months.
If short-term rates remain stable, he adds, “that bodes well for the overall…market [since] they anchor other [key] interest rates.”
Further, Braive isn’t currently concerned about about long-term returns since inflation has been below the BoC’s 1% to 3% target for quite some time. Inflation was most recently measured at 1.5%.
Throughout 2014, he expects some short-term upward pressure on inflation due to factors such as “weather, natural gas pricing, increasing transportation costs and [rising] food prices,” but says the BoC won’t alter its monetary policy.
The driving force behind current trends is the weak Canadian dollar, he adds.