2022 has been a rather austere, if not hostile, year for fixed income investing. However, if it is true that a peak in interest rates seems to be looming over a not-so-distant horizon, a Bank of Canada key rate capped at 4 or 4.25%, followed by an outlook of downturn, would be likely to rekindle the appetite for marketable bonds. A quick look at some recitals.
First, the backdrop. They are always a little more numerous among the economists to foresee an imminent ceiling of the current bullish cycle of the interest rates. Possibly as early as December 7, after a meeting of the Bank of Canada’s monetary committee, which will have ordered a seventh rate increase since March, raising the target for the overnight rate likely to 4 %, possibly 4.25%.
In a recent analysis, National Bank economists point to extremely rapid real estate deflation. Thus, “in our view, it will not be necessary to maintain interest rates at such levels for long to calm inflation”. They even expect the Bank of Canada to lower them “substantially” in the second half of 2023, while the prevailing scenario instead places the reversal point somewhere towards the end of 2023. National economists n now expect growth of 0.7% next year, “with the consumer being hit simultaneously by a loss of purchasing power, a negative wealth effect and an interest payment shock”.
Daniel Ouellet, portfolio manager at Groupe Ouellet Bolduc, at Desjardins Wealth Management, also believes that “we are heading towards a plateau in the key rate, at 4-4.25%”. “The economy is holding up right now, but the lag effect [de la politique monétaire restrictive] will be felt. The trend for core inflation remains downward,” he said in an interview with To have to.
The specialist is working on an unconventional recessionary scenario, with inflation remaining above target for much of 2023 and a moderate key rate cut to follow. In doing so, he expects a rather negative yield curve.
In short, the table is set for a rehabilitation of marketable bonds in portfolios after a rather disastrous year 2022. The 10-year Government of Canada bond rate hit 3.6%, with the bond market posting a decline of 15%. By far one of the worst years for the bond market, he said. According to Desjardins Group forecasts, the FTSE Canada Universe Bond Index should post a contraction of 12.7% in 2022, to post a target growth of 5.6% next year.
In an interview with the specialist magazine Advise, the manager recalls that the role of the bond is to cushion the risks and the shock of a recession, and to reduce portfolio volatility. “There has been a transfer of risk from bonds to equities as a result of low interest rates. The balance should be restored with a bond component becoming attractive again and set to play its role in the next recession. He also sees what he calls a “tax opportunity,” with bonds currently trading at a deep discount. The fall in the price of bonds issued and the rise in the yield offered as a result of the rise in interest rates make it possible to combine higher yield and capital gain at maturity. “We thus make yield and taxation, with a less taxed capital gain”, he summarizes.
Shorter duration
Should we be long in duration? “I keep a little embarrassment. I would be cautious on the long end of the yield curve. In maturities of two to five years, you can go for good bonds issued by governments and “investment grade” companies (investment-grade), and a return of 5-6% with no duration risk. He adds: “A duration shorter than that of the reference index (which oscillates around 7.4 years) offers you 4 to 6% without taking any risk. »
Daniel Ouellet also invites us to pay attention to the “high yield” segment (high-yield), or non-investment grade bonds, or even so-called junk bonds. “Even though credit spreads have widened, there are going to be default situations. So it’s too early. »
Is direct ownership preferable to a portfolio approach, such as Exchange Traded Funds (ETFs)? “It’s a question of perception. We prefer direct ownership. You have a title, a capital repayment date. With an ETF, we talk about rolling over the bonds in the portfolio; you don’t see the due dates. »
And Daniel Ouellet likes to insert resettable preferred shares every five years. “It’s 10% of our bond portfolio. These securities are more sensitive to credit spreads. We then combine a distribution rate of 4 to 5% with a tax factor, the dividend being less taxable than the interest income”, we read in the magazine Advise. He adds that we are coming to reset dates. “We are currently at 5% [de rendement en dividende]. With interest rates reduced to around 3%, we can expect a return of 7-7.5%. In this case, he will opt for a direct holding-ETF combination, the latter providing liquidity.
Popularity of GICs
In the process, a text from The Canadian Press pointed out this week that financial planners are increasingly seeing members of Generations Z and Y adding guaranteed investment certificates (GICs) to their portfolios to regain a sense of security and — perhaps -be even more important — because the guaranteed returns have reached around 5%. “Higher GIC interest rates appealed to some younger investors who had never experienced a market downturn before,” said Graham Priest, investment advisor at BlueShore Financial.
“Indeed, it’s been a long time since we’ve seen this. But the rate is fixed and the capital is frozen until maturity. The marketable bond offers as much yield, but its advantage is liquidity. It also allows a mixture of taxation in a context of lower interest rates, comments Daniel Ouellet. But I’m not against the GIC if the investor wants certainty. »