Fixed Income Strategies

Over the first three months of 2022, bond markets suffered their worst quarter in four decades, as yields logged their biggest gains. The Canadian FTSE Universe Bond Index fell 7% during the first quarter, and the FTSE Corporate Bond Index dropped 6.4%.

During this period, the U.S. Federal Reserve raised overnight rates for the first time since 2018. The Fed acknowledged stubbornly elevated inflation caused by high energy prices and demand-supply imbalances related to the pandemic. Furthermore, the invasion of Ukraine by Russia rattled already stretched supply chains and is expected to create additional upward pressure on inflation. Strong job gains and a declining unemployment rate also support the market’s bearish sentiment on yields.

In this context, Fed guidance indicates several additional interest rate hikes this year, continuing into next year. Additionally, a balance sheet reduction of holdings of Treasury securities, agency debt and agency mortgage-backed securities is expected to be formally announced at the Fed’s meeting in May.

As for the Bank of Canada, it raised the overnight rate to 0.5% during the last quarter. Economic growth is strong in Canada and household spending accelerated after the lifting of public health restrictions. Housing market activity remains elevated and is resulting in higher house prices. Poor harvests and higher transportation costs are adding to pervasive price pressures.

Bank of Canada guidance indicates further rate hikes to curb inflation. The Bank is considering when to begin its balance sheet reduction program.

Pembroke Corporate Bond Fund

The Corporate Bond Fund returned -2.56% in the quarter, outperforming the benchmark FTSE Canada All Corporate Bond Index by 3.89%, as yields rose sharply. The Fund’s shorter-than-benchmark duration and allocation to floating-rate securities helped offset some of the pervasive price declines caused by rising benchmark yields. Spread tightening on Occidental Petroleum and Continental Resources bonds also contributed to performance as oil prices continued to rise.

The Fund continues to maintain a duration meaningfully below that of the index to mitigate the negative impact of increasing interest rates. The Fund is positioned with a yield of 4.9%, duration of 2.5 years, and approximately 33% in floating rate notes. As elevated inflation persists and central banks play catch-up, yields are expected to continue to converge to inflation. The Fund will maintain its defensive positioning and increased weight in high-quality liquid bonds, whose liquidity can be used to take advantage of future opportunities.

Pembroke Canadian Bond Fund

The Canadian Bond Fund returned -5.54% in the quarter, outperforming the benchmark FTSE Canada Universe Bond Index by 1.43%, as spreads widened, and yields rose sharply. The Fund’s shorter-than-benchmark duration continues to be a positive contributor to performance along with its allocation to floating rate issues.

The Fund ended the quarter with a yield of 3.2% and a duration of 5.6 years, which compares with the benchmark yield of 3.0% and duration of 7.8 years. As elevated inflation persists and central banks play catch-up, yields are expected to continue to converge to inflation. The Fund will maintain its defensive positioning and increased weight in high-quality liquid bonds, whose liquidity can be used to take advantage of future opportunities.

Other Articles Of Interest