The volatility that was seen towards the end of the first quarter in the bond markets seemed to completely dissipate in the second quarter, as a massive dose of fiscal and monetary policy seemed to quell the potential pain from the spread of COVID-19. In the bond market, the most compelling indicator of this massive shift in sentiment was the corporate bond market. While the market for new corporate bond issuance had ground to a halt in mid-March, it was enthusiastically revived in April and finished the second quarter with record new corporate issuance in both the U.S. and Canada. Credit spreads also retraced much of their first quarter widening.
In Canada, the Bank of Canada’s new programs for supporting provincial and corporate credit have had more impact on the market through their mere existence and their commitment to keep markets liquid and stable than through actual purchases so far this year. Contrary to this liquidity support in the corporate bond market, the Bank of Canada has been actively engaging in quantitative easing in the market for federal bonds and treasury bills. This activity has led yields on most terms of the Canadian federal bond market to close at new month end lows with 30-year bonds being the strongest performer.
Lower yields on cash and government bonds spurred investors to look to the corporate bond market for better returns and the Canadian corporate new issue market responded to the demand with record new supply. Even though Canadian year-to-date corporate new issuance roared almost 40% ahead of comparable 2019 levels , spreads continued to tighten with the Bloomberg Barclays credit spreads for all corporates moving 84 basis points tighter in the second quarter. The Bloomberg Barclays index for long corporates lagged the broader corporate index, tightening only 57 basis points in the second quarter, but outperformed provincials such as Ontario that were only 32 basis points tighter. While credit spreads for both indices are still wider than 2019 year-end levels, this was an impressive performance given that the pandemic continued its global spread at the same time.
Over this period, the strong positive returns were substantially driven by the portfolio's overweight position in corporate bonds and security selection within the Fund’s U.S. dollar corporate holdings reversing much of the negative impact of the previous quarter. Corporate credit spreads continued to rally over the quarter with U.S. corporate spreads compressing and outperforming Canadian corporates over the period after underperforming during the crisis in March. The portfolio's underweight in provincial bonds was a drag to performance. However, this was more than offset by the strong contribution from the overweight position in corporate credit with both Canadian and especially U.S. corporate bonds contributing significantly to the quarter's positive performance. Duration and curve added to this quarter's results as the curve flattened while a modest contribution from Real Return Bond's contributed to performance as inflation breakeven levels rose. Swap levels reversed over the quarter, marking our hedges wider, which offset some of the positive contribution from the U.S.
The duration and credit quality was kept relatively close to the benchmark.
The portfolio was relatively diversified across the Federal, Provincial, and Corporate sectors. The Fund’s federal and provincial bonds exposures were underweight relative to the benchmark, and corporate bonds were overweight. The corporate bond overweight was largest in the insurance sector with a bias toward higher-quality U.S. dollar issuers. The portfolio was overweight inflation-linked bonds by approximately 7%.
The portfolio is overweight the 10 and 20-year sector of the yield curve.
The portfolio's overall credit quality was in line with that of its benchmark. The overweight in "A" credit was driven primarily by an overweight to corporate bonds, such as utilities.
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