Interest Rates?

Concerned about higher interest rates affecting your portfolio? Are you thinking of increasing your weighting in equities coming out of the recession? Take a closer look at corporate bonds.

Interest Rates

With the recent market rally the question is when, not if, interest rates will rise and what impact this will have on corporate bonds. However, rising interest rates are not necessarily bad news for corporate bond investors. For a carefully managed bond portfolio, the potential for capital appreciation increases.

A strengthening economy means cash flows are improving and companies are better able to repay debt. Credit ratings are reclassified higher, increasing their value and demand, which sees interest rates on the bond drop. The overall effect is an increase in the potential for capital appreciation and tax efficient returns.

Take a look back in recent history to see how the interest rate cycle impacted high yield bonds.

By June 2003, the Federal Fund Reserve had reduced rates down to 1.00% where they remained for 12 months. Then, from June 2004, they raised them back up until in June 2006 interest rates were 5.25%. Looking at the data below for the same period, while investment grade and 10 year treasuries did not do well, high yield bonds had a compound annual return of around 9% - still very good. 

(Source: Merrill Lynch)

Historical Post-Recession Trends

History also shows that the annualised returns of high-yield bonds have outperformed the annualised returns of stocks coming out of the last three recessions.

While many are saying that corporate bonds have run their course, we believe that they continue to be a very appealing alternative to equities. They provide an attractive level of current income and, with spreads still hovering at about two times the long term average, there are many bonds that continue to trade at a discount, allowing potential for capital appreciation.

(Source: Bloomberg and Merrill Lynch)

Cautious Investing

Although there is increasing confidence in the rally, the impact of the recession is too fresh for many investors to be anything but cautious. Portfolios have recovered significantly, and those who are weighted to equities may be looking to re-allocate some of their recovery to re-balance their portfolios.

The Pender Corporate Bond Fund invests in fixed income securities of investment and non-investment grade North American corporations. It is conservatively managed by Matt Shandro whose primary objective is the preservation of capital. Mr. Shandro specializes in security selection and takes advantage of inefficiencies in the fixed income market where many investors place too much reliance on rating agencies. He is a former portfolio manager at CI Investments and Marret Asset Management and began his 15 year investment career as a high-yield analyst at Deans Knight Income Corp.

The Fund has several unique competitive advantages:

• Nimble size, able to access a wide range of bonds including smaller issues ($50-150M in size) unavailable to retail investors and unworkable for larger corporate bond funds.
• Avoids over-diversification, aiming to hold no more than 25 to 40 carefully selected positions with exposure to US$ being hedged.
• A fundamental, bottom-up, value approach and is focused on finding issuers with robust free cash flow and/or assets.
• Conservative and award-winning portfolio manager. During the period in which Mr. Shandro co-managed the CI Investments Signature High-Income Fund it achieved a 20.2% annualized return (net of fees) and in 2004 it was named “Canadian Income Trust Fund of the Year”.