The Manager's Commentary - March 2011

Like a recent family experience of cooking Yorkshire pudding, the expected removal of monetary stimulus in developed countries coupled with emerging economies, specifically China, keeping a lid on inflation will require a delicate balancing act. While the Yorkshire pudding turned out magnificently, we are concerned that the scale of central bank coordination required to keep the global economy running smoothly could be difficult to execute. To be clear, the risk to the global economy is that emerging economies end up raising interest rates aggressively at the same time the Fed starts to tighten monetary policy. This combination has the potential to disrupt the euphoric “risk on” trade that has existed for the past two years.

In the meantime, however, markets continue to fire on all cylinders. While the month of March was marked with volatility, the S&P 500 was flat on the year by March 16th but rallied during the final two weeks of the month to be flat for the month and up 5.4% year to date. While this volatility was obviously influenced by events in Japan, it did not slow down the new issue corporate bond machine.

In March alone the US high yield market issued over USD 37 billion, which is almost 40 percent larger than the total CDN dollar high yield market. The first quarter of 2011 was the largest ever for corporate bond issuance at USD 121 billion. And of course it would be amiss for us not to highlight the enormous and well deserved (sic) profits that the investment bankers have been earning in this new issue bonanza.

While we have not been participating in these new issues, the growing universe of issuers has us looking forward to future investment opportunities… when market volatility returns. One source of credit volatility that could negatively impact corporate bond spreads, assuming corporate bond issuance keeps rolling is the pickup in equity friendly transactions. The issuance of debt to pay a dividend and/or buy back public stock would be one such example.

These transactions can be carried out by investment grade companies, due to their low debt levels and loose bond covenants. While we wouldn’t be looking to these specific issuers for opportunities, this emerging trend could result in the spreads of investment grade corporate bonds to widen overall and may portend a pickup in LBO transactions.

Matthew Shandro
March 31, 2011