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Bond market review – March 2013

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The hunt for yield will remain the consistent theme for 2013. In this 30 year low interest rate environment as governments across the globe are looking to reflate the economy.

At TriDelta Investment Counsel, we are constantly seeking opportunities to enhance portfolio yield and returns by actively managing the portfolio and applying tactical shifts along the yield curve and with credit quality.

Persistently low inflation readings will keep central banks at bay suggesting that we are sometime away from rising interest rates. Although ironically, the Bank of Canada may actually be forced to consider a cut to its overnight lending rates because of recent sluggish growth and anemic inflation readings.

Political and economic turmoil persist in Europe, although economic growth in the US is tilted higher. The Federal Open Market Committee (FOMC) will likely stay the course with Quantitative Easing (QE), as benefits outweigh the costs. However, tapered QE purchases in the months to come will be mitigated by smaller deficits and a projected decline of $260 billion in bond issuance in the US. Growth, inflation, and job targets, none of which are binding constraints for the US Federal Reserve, will not force the Fed off its agenda to maintain low interest rates for awhile.

We believe interest rates will stay low for a prolonged and indefinite period.  The bond market is far from being complacent given the disaster experienced during the financial crisis of 2006 to 2008.  Fixed income investors are still seeking yield; however, less from duration and more from credit.  At TriDelta we continue to monitor and favour:

  • Gradually, and if appropriate, increasing our bond portfolio’s overall term to maturity (duration) to take advantage of higher interest rates on longer term bonds.
  • Take advantage of the premium interest rates paid on corporate bonds versus the low rates on government bonds.

At TriDelta we have structured our portfolios to provide ‘risk adjusted returns’ by ongoing monitoring of market internals and seizing what we see as opportunities to outperform. We have opted to:

  • Remain a little shorter on term to maturity than the overall DEX Universe Bond Index for most clients.
  • We have over weighted the belly of the yield curve (and underweighted the wings) by not taking a significant duration risk.

bonds‘Yield curve’, ‘sector’ and ‘duration’ allocation is important in bond portfolios; as such, we take these into consideration as we design and manage our portfolios.

We believe that investors are fearful of higher overnight lending rates, but central banks have little control over the rest of the yield curve (aside from central bank operations; such as, quantitative easing) and as such have made portfolio tactical shifts to put the odds in our favour.

Lastly, higher quality non-government bonds (known as investment grade bonds) continue to remain cheap, whereas slightly lower quality (known as high yield bonds) are particularly cheap when compared to US equivalents.  We believe that there is a good likelihood that these Canadian bonds outperform their US counterparts.  In a worst case scenario, we believe corporate bonds will perform better than government bonds.  Our portfolios are overweight in corporate bonds for this reason.

The yield-to-maturity for the Core and Pension Models is at 4.64% and 3.59% which will help cushion any decline, or add to the capital gains.

At TriDelta we feverishly monitor trends and look to capitalize on the tactical opportunities available to boost bond portfolio yield and returns without sacrificing our capital preservation and seeking a consistent stream of income mandate.

Article written by Edward Jong, VP Fixed Income at TriDelta Financial

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