Why you should choose corporate bonds

In today’s low-interest-rate environment, investors are unhappy with government bonds.

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The bonds continue to offer security. But they’re expensive in Canada, as well as in the U.S. and in Europe, says Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management. He co-manages the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.

So, until rates rise, investors should stick with short-term government bonds, he adds. “If you’re worried about volatility with rates rising, you’ll want to park some money into shorter-term bonds and wait for higher yields.”

Read:

• Short-term bonds are overvalued
• How negative rates affect economies

In comparison, corporate bonds are more attractive even though they’re riskier. To start, says O’Toole, the investment-grade market includes banks, and high-quality household names such as Loblaws, Enbridge and Canada’s major telecom companies.

And, while investment-grade companies are sensitive to increases in interest rates, “the extra compensation we’re getting seems attractive in this environment, particularly when we look at the safety of balance sheets, and at the expanding economy, which is good for corporate Canada.”

Read: Winners in the corporate bond space

In some cases, the yields of investment-grade corporate bonds are double that of Canadian government bonds, says O’Toole. “Overall, the investment-grade sector is adding an extra 1.25% in yield.”

For its part, the high-yield sector consists of riskier companies that have more debt. But, O’Toole explains, “the companies are less sensitive to [interest] rates rising, and more sensitive to economic growth. [So] as the economy continues to expand, that’s even better for a high-yield company than it is for an investment grade company.”

Read: The case for global bonds in a low-yield world

He adds, “The extra yield you’re getting on a high-yield bond is more in the order of 4.5%.”

Overall, O’Toole predicts there will be a moderate rise in bond yields over the next few quarters. “We expect the high-yield sector will have the best returns over the next 12 months, [while] government of Canada bonds will lag the performance of both investment-grade and high-yield bonds.”

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