Public bond markets in the third quarter continued to look toward fiscal policy and central bank support to carry on the buoyancy that began in the second quarter.
The economy has also started to bounce back, although gross domestic product (GDP) has started to slow from prior readings and retail sales have continued to underperform. Canadians continue to be financially defensive given the unknowns they are facing. While central bank support of credit markets in North America was more in word than deed, the markets heeded the underlying sentiment that they would be supported, if needed. As a result, Canadian credit spreads tightened by 22 basis points, according to the Bloomberg Canadian Aggregate Corporate index. Front end corporate spreads significantly outperformed, while long corporate spreads were only slightly tighter on the quarter, causing the credit curve to steepen.
Canadian corporates outperformed both provincial and federal bonds in the third quarter across the short-, mid- and long-term. Outperformance was led by the securitization and real estate sectors, which were some of the more adversely effected sectors during the pandemic. The Telco and energy sectors lagged. Strong demand for corporate credit has kept new issuance volumes relatively strong versus 2019 new issuance. However, by September, corporate issuance in Canada had become more tempered, failing to keep pace with the record September issuance of 2019. New issue concessions in the primary market continued their decline after peaking in March. By September, most concessions had evaporated completely and even turned negative, but new issuance continued to be favoured over adding new corporate bonds through secondary trading.
The portfolio's excess returns in the third quarter were primarily driven by credit positioning. The Fund’s overweight position in corporate bonds was a positive contributor to returns as corporate spreads outperformed Canada bonds and provincial spreads.
While overall U.S. dollar corporate spreads tightening underperformed the corporate bond spreads tightening in Canada, long U.S. corporate spreads outperformed long corporate spreads in Canada. This long part of the curve is where the Fund has most of its active U.S. dollar corporate positions. In addition to the U.S. long corporate outperforming, the cross-currency swaps used to hedge the Fund’s U.S. dollar bonds also contributed to its outperformance.
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 largest corporate sector overweight was to industrial, where the portfolio manager is using the U.S. dollar corporate market to access high-quality issuers like Microsoft and Apple. The portfolio was overweight inflation-linked bonds by approximately 7% relative to its benchmark.
The portfolio is overweight the 10 and 30-year term of the yield curve relative to its benchmark.
The portfolio’s overall credit quality was in line with that of its benchmark. The overweight in “A” credit is driven primarily by an overweight to corporate bonds, such as utilities.
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