It’s been a tough year for fixed income investors, but there could be a silver lining, says David Stephenson, director, ETF strategy and development at CIBC Asset Management.
The Canadian bond market was down 15.1% year to date through Oct. 21, Stephenson said. The drop is three times more severe than the worst calendar-year return for Canadian bonds since 1980, at -4.3% in 1994.
“Many investors have never experienced these types of returns in their fixed income portfolios,” said Stephenson. And because bonds have not served as a ballast for declining equity markets, the pain is all the more pronounced.
However, despite market returns, fixed income ETFs have seen about $9 billion of inflows year to date, with approximately half of that into high-interest savings account ETFs.
Stephenson characterized this as a flight to safety, as the only areas within fixed income that have seen positive returns are high-interest savings accounts and money market ETFs, floating rate notes, and short-term TIPS.
With inflation in Canada at 40-year highs, the Bank of Canada has undergone a steep tightening cycle, raising rates from 0.25% to 3.75% since March with further increases priced in before year end. This has led to a large repricing in fixed income markets, Stephenson said, as bond yields are up significantly since the start of the year.
“In this environment, there has been a lot of repositioning within the short end of the curve,” he said.
Investors have incorporated inflation protection into their portfolios by way of floating rate notes, Stephenson said, because they are less sensitive to interest rate increases. Unconstrained fixed income is another possible strategy because of its flexible mandates and ability to capture opportunities as they arise across different sectors. And one-ticket fixed income portfolio solutions can also help investors navigate current markets, he said.
“The focus is on risk-adjusted returns and flexibility to take advantage of tactical opportunities as they arise,” he said.
However, although demand has been concentrated in cash and ultra-short duration ETFs, Stephenson said there is a silver lining for investors.
For many years, investors referred to TINA, or There Is No Alternative to equities given low yields. As a result, investors looking to achieve certain yield targets had to take on a fair amount of risk. But now, Stephenson said markets are seeing some of the highest yields in fixed income since before the Great Financial Crisis in 2008.
With investors being overweight cash, he said it has helped preserve capital for future buying opportunities and portfolio repositioning.
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