Extraordinarily low interest rates are one of the legacies of the recent financial crisis.
As of July 2012, the BoC fixed the overnight rate at 1%, and 30-year bond yield stands at around 2.6%. Such low rates have particular implications for those seeking returns in the fixed-income asset class.
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With some Canadian government bonds currently yielding less than inflation, investors are facing negative real returns. Combined with the possibility that inflation could further increase—or that policy rates could increase as the economy improves—it’s hard to make a case for plain vanilla Canadian government bonds.
But, there are some areas of fixed income worth exploring:
Foreign opportunities: The Canadian bond market is heavily weighted toward federal and provincial government bonds, and these types of issues tend to have lower yields. In Canada, corporate bonds are skewed toward the financial sector, but the market comprises just 3% of the global bond market.
This presents potential opportunities for clients that have traditionally focused on domestic bonds. The much larger U.S. bond market, for instance, has proportionally more non-financial corporate bonds. This allows for improved security selection opportunities and diversification.
Also, remind your clients that due to Canada’s relatively strong economy, the BoC may act more aggressively in raising rates than other jurisdictions. While this would have negative implications for investors currently overweight in Canadian bonds, it raises a strong argument for pursuing more global diversification options.
Non-traditional fixed income: Because of the higher rates on offer, high-yield bonds and emerging market debt are two types of bonds that may outperform Canadian bonds on a long-term basis.
High-yield bonds have an attractive risk/reward profile, and may offer equity-like returns in favourable market environments. Emerging market bonds benefit from favourable long-term dynamics and economic growth.
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A crucial tip: Rigorous credit research provided by corporate and sovereign analysis resources is key for controlling the risks in high-yield bonds and emerging market debt.
Your clients need to be willing to move away from a purely domestic focus and enhance their fixed-income yield to enter these markets, so let them know they shouldn’t ignore other global opportunities within the fixed-income asset class.
Alexander Schwiersch is a portfolio manager with Aberdeen Asset Management Inc. firstname.lastname@example.org
This article was originally published on benefitscanada.com.