Diversify fixed income to reduce risk

Investors should approach corporate bonds simply as lower-beta versions of stocks, says Jeff Waldman, first vice president of global fixed income at CIBC Asset Management.

Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management, adds these securities are riskier than government bonds, since companies are subject to economic forces.

“If any one of those companies has trouble, [clients] could lose a lot of principal,” says O’Toole. “You need to be in a well-diversified portfolio of corporate bonds and generally you get that through a mutual fund.”

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The grade of a bond is determined by “the cyclicality of the industry that the corporation may be in or the amount of debt that the company has on its balance sheet,” says Waldman. “That affects its ability to pay interest on the debt and repay its loans in the future.”

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If investors are looking for alternatives to government bonds, or investments that will earn higher returns than GICs, he suggests “corporate bonds would be the choice in the current market. They perform more like the stock market than government bonds, and that’s especially true for high-yield bonds.”

O’Toole adds, “When you’re lending money to companies—and that’s what you’re doing when you buy corporate bonds—you have to really understand those companies and make sure you’re comfortable with those issuers.”

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Otherwise, he says the investor can get stuck with unfavourable covenants and indentures, which are “little clauses which allow companies to do things that maybe you don’t like as a bondholder, and which might give the company more flexibility to issue more debt.”

Further, O’Toole says, “You might have somebody who becomes more senior to the bonds you hold.”

Waldman says to help clients look at “where [they] are in the credit quality spectrum. If [they’re] in securities that typically carry a below-investment-grade rating, [they’re] going to be exposed to companies that may have some strong cyclicality or correlation with the economy.

“[What’s more], some corporations may have balance sheets that carry excess debt relative to their overall growth and income profile.”

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