Don’t bet against bonds

In early 2013, investors weren’t abandoning bonds.

Despite Great Rotation rumours, many were simply selling money market investments and using the proceeds to move into equities, says Patrick O’Toole, vice president of Global Fixed Income at CIBC Asset Management. He is co-manager of Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.

However, he found more people were dropping bond funds in the second half of the year.

Read: Help clients boost bond portfolios

The trigger for that shift, says O’Toole, was the U.S. Federal Reserve’s tapering talk: after former chairman Ben Bernanke announced there’d be a pullback on QE at the end of 2013, “people were nervous about interest rates moving higher [and] bond market really overreacted.”

But there wasn’t a clean break, adds O’Toole. Rather than reject bonds en masse, many investors moved into balanced funds that offered exposure to both equities and fixed income. So on a net basis, “money [is] still flowing into bonds.”

Read: Ignore Great Rotation hype

Further, the demand for bonds will remain solid, says O’Toole. Not only have equity markets been volatile over the last 10 or 15 years, but also many of your clients are aging. They’ll “want cash flow [and they’ll] continue to look towards bonds and the fixed-income market for their investment needs.”

Read: Rotation into fixed income coming

Market predictions

Interest rates have risen since last year, so many investors think that trend will continue, says O’Toole. Yet, the market’s adjusted and he doesn’t expect yields to inch much higher throughout the year.

The Federal Reserve has mentioned an interest rate hike may occur as early as mid-2015, he adds, but advisors should consider that many of the Fed’s economic predictions haven’t materialized over the past four or five years.

Read: Lots of promise in high-yield bonds

So far, U.S. economic growth “has been disappointing,” finds O’Toole. “If [the Fed’s] going to be hiking rates in 2015, everything has to” line up perfectly.

The bottom line, he predicts, is interest rates could be on hold longer than people think. “The Federal Reserve, the Bank of Canada, and other central banks [will] wants to maintain stimulative [monetary] policies and keep rates low [since] economies are looking sluggish.”

For those in bonds, this means short-term rates won’t be moving up and, thus, long-term yields won’t rise much.

Read: Handling bonds in a low-rate environment

On the institutional side, O’Toole finds many major pension funds are actually moving away from stocks and towards bonds. That’s largely because stock-heavy funds were hit hard during the 2008 recession.

Pensions “became massively underfunded” during that period, he adds, “and now that they’re getting closer to [becoming] more fully funded, they seem to be look[ing] to match off their liabilities…by reducing stocks and increasing bonds.”

For more on bonds, read:

Prepare bond investors for year ahead

Can you crack corporate bonds?

Is a shift from bonds to equities coming?

Can you beat rising interest rates?

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