Market review
In the face of higher than expected consumer inflation, stresses in the commodity markets and another wave of global COVID-19 infections, Canadian bond markets were surprisingly resilient. The Canadian government bond yield curve moved higher and steeper, led by long bond yields moving 15 basis points higher. This contrasted with the mixed performance of the U.S. treasury curve, where shorter term yields rose while longer term yields fell in the third quarter. After a rise in unemployment earlier in the spring, the Canadian unemployment rate has fallen steadily since June. Headline inflation climbed from 0.7% year-over-year in December 2020 to 4.1% in August 2021. Bond investors have begun to question whether this rise will be temporary, as we continue to see demand increasing while supply bottlenecks remain both locally and globally. While the Bank of Canada continues to support the federal bond market, it has decreased its weekly bond purchases to $2 billion per week, with an eye toward further stimulus withdrawal as warranted by continued economic growth.
Canadian corporate credit spreads closed out the quarter at the tight end of their 2021 range. However, they could not break through February’s lows as equity markets sagged and implied equity volatility rose. Canadian credit spreads have been supported by the strong economy, improving fundamentals, and robust energy commodity prices. Corporate bond supply has been about 10% ahead of 2020 issuance levels and could be on pace to set a new annual issuance record, but the new issuance is well-balanced with demand as new deals continue to be well-subscribed. While we did see some longer corporate issuance this quarter, corporate new issuance in the 10-year and longer terms is still running below trend relative to recent years. Higher beta issues continue to outperform as the REIT sector continued its year-to-date credit dominance in the third quarter, followed closely by energy credits. The positive 2021 trend on corporate rating and credit outlook changes continued to favour improvements in the third quarter. Credit markets outside Asia have mostly ignored China’s Evergrande credit issue and its potential for contagion.
Provincial credit spreads widened earlier in the third quarter, but ended the quarter close to unchanged as fiscal fundamentals continued to show improvement in 2021. While it seems Ontario and Quebec are looking at the new issuance market daily, provincial supply so far this year has been below 2020 levels.
Portfolio review
The portfolio weighting in Federal bonds was reduced marginally in favour of corporates, including financials, utilities and energy. Financials added in the quarter include TD LRCN notes and BNP maple bonds. In the telecom sector the team rotated out of higher beta AT&T maple bonds in favour of BCE bonds. Although securitization has become a much smaller part of the Canadian corporate bond market, the fund’s overweight to securitization comes through its allocation to the SLC Management Short Term Private Fixed Income Plus Fund.
The yield on the portfolio and benchmark have moved higher during the quarter based on changes in interest rates, but the excess yield over the benchmark was unchanged versus the previous quarter. Duration remained slightly shorter than the benchmark, as inflation remains a concern. Credit quality continues to be in line with the benchmark.
The portfolio continues to favour the value found in the 20-year part of the yield curve relative to the more common 10-year and 30-year points of the curve. The Fund’s overweight to 20-year bonds increased again this quarter.
The credit quality of the overall portfolio was marginally lower compared to the previous quarter. The portfolio’s overweight in AAA-rated debt was reduced as the team sold federal bonds to increase corporate bond exposure
The Fund’s foreign weighting decreased from 20.9% at the end of the second quarter to 17.4%, as the team rotated out of U.S. dollar corporates and U.S. treasuries back into Canadian corporates and federals. Tighter U.S. credit spreads and a lower hedging benefit have combined to make U.S. debt less appealing. The portfolio hedges its U.S. dollar bonds using a cash flow swap to minimize the fund’s exposure to changes in U.S. currency and U.S. interest rates.
Portfolio positioning
The portfolio weighting in Federal bonds was reduced marginally in favour of corporates, including financials, utilities and energy. Financials added in the quarter include TD LRCN notes and BNP maple bonds. In the telecom sector the team rotated out of higher beta AT&T maple bonds in favour of BCE bonds. Although securitization has become a much smaller part of the Canadian corporate bond market, the fund’s overweight to securitization comes through its allocation to the SLC Management Short Term Private Fixed Income Plus Fund.
The yield on the portfolio and benchmark have moved higher during the quarter based on changes in interest rates, but the excess yield over the benchmark was unchanged versus the previous quarter. Duration remained slightly shorter than the benchmark, as inflation remains a concern. Credit quality continues to be in line with the benchmark.
The portfolio continues to favour the value found in the 20-year part of the yield curve relative to the more common 10-year and 30-year points of the curve. The Fund’s overweight to 20-year bonds increased again this quarter.
The credit quality of the overall portfolio was marginally lower compared to the previous quarter. The portfolio’s overweight in AAA-rated debt was reduced as the team sold federal bonds to increase corporate bond exposure
The Fund’s foreign weighting decreased from 20.9% at the end of the second quarter to 17.4%, as the team rotated out of U.S. dollar corporates and U.S. treasuries back into Canadian corporates and federals. Tighter U.S. credit spreads and a lower hedging benefit have combined to make U.S. debt less appealing. The portfolio hedges its U.S. dollar bonds using a cash flow swap to minimize the fund’s exposure to changes in U.S. currency and U.S. interest rates.
