The run-up in bond prices has led many to question whether bonds are in bubble territory. But every piece of bad macro-economic news seems to send investors back to the bond market, driving yields ever lower.
Yields may be at record lows, but bonds still serve as a valuable counterbalance to “bad events” that can occur in a portfolio, says John Braive, vice-chairman, CIBC Asset Management and manager of the $1.8 billion CIBC Canadian Bond Fund.
“I don’t see any near-term change coming in terms of the big headwinds that we see for the economy,” “In the short-term, anything could happen. In the last three months we’ve had quite a bullish bond market as rates have come down.
The Federal Reserve is going to keep its rates down until 2014, so that provides a further anchor to interest rates for the next year or so, he says.
“You have to look at it from a total returns perspective; the total return on a bond is not just its coupon payment, but its change in price. We could have a year like last year where we have an improvement in the price of securities, which would give you a decent return in the bond market.”
He says corporate bonds are more exciting right now than government issues, as companies have massive cash balances on their balance sheets, reducing the risk of default.
“They’ve been through a near-death experience in 2008 on the credit markets, and they prefer to maintain these higher cash balances,” he asys. “They’ve also reduced the amount of debt they have outstanding. If you look at debt to equity ratio for Canada, it’s exceptionally low, at about 0.4%, which means there’s less debt than equity on corporate balance sheets.”
That’s a 30 year record low, he says.
Looking at the balance sheet and interest coverage ratio together, he says the spread on corporate bonds is well substantially higher than it was in the past, and that investors are, in fact, being paid to hold corporate securities.
“The offset of course, is that you could have an event that freezes up the credit market, like we had in 2008, but we think that the banks are in much better shape than they were in 2008,” he says. “They’re coming back into the commercial loan market and that is supportive of corporate bonds too.”
He’s been finding value in high-yield bonds, taking his funds’ exposures up to about 11%—their limit is 15%.
“This area of the market has been doing very well. It suffered a bit last year; during the first Greek crisis in the summer the spreads on the ML high yield index versus Treasuries got close to 900 basis points. Today that spread has come down to 650 basis points, so we think that’s very attractive.”