Fixed Income Strategies

October 2025

 

In the third quarter, the U.S. Federal Reserve announced a quarter-point decrease in interest rates. Fed officials projected that labour market softness would outweigh inflation risk in a context where the American government has imposed tariffs on all its trading partners, raising costs for manufacturers and small businesses.

Spreads, or the difference between corporate credit and government bond interest rates, are historically low. Most investors expect a slowdown rather than an outright recession, which is why they have been investing in corporate credit.

High inflation, increased government spending and elevated debt levels in major developed economies have pushed yields on 30-year government bonds to multi-year highs. “Core” inflation, which excludes food and energy prices, remains high at just under 3%. Additionally, the threat to the independence of the U.S. Federal Reserve remains a risk.

Meanwhile, the Bank of Canada has lowered its overnight interest rate to 2.5%, marking the third quarter-point cut of 2025. Canada’s exports have fallen since the beginning of the year, when companies rushed to fill orders ahead of the tariffs. However, the government’s recent decision to remove most retaliatory tariffs on imported goods from the U.S. should ease upward pressure on prices.

Overall, the credit spread widening experienced in the first quarter of 2025, which was due to tariff uncertainty, has been reversed by a rally that continued throughout the second and third quarters. The strongest returns were seen in BBB-rated and below credit.

CORPORATE BOND STRATEGY

So far this year, the Pembroke corporate bond strategy has delivered solid absolute returns, outperforming its benchmark. During this time, the yield curve steepened as short-term government rates fell and long-term yields rose. As a result, the strategy’s short duration contributed to its performance relative to the benchmark.

Below-investment-grade, first-lien and unsecured bonds issued by Hertz were key contributors to relative performance, appreciating as sentiment improved. Limited Recourse Capital Notes (LRCNs) also added significant value due to spread tightening.

The strategy is conservatively positioned, with 61.6% invested in AAA/AA-rated securities (54.4% of which are government bonds or federally guaranteed National Housing Act Mortgage-Backed Securities [NHA MBS]). The duration ended the period at 4.2 years, meaningfully below the 5.6-year benchmark duration. The portfolio continues to hold select high-yield issues that are well structured and remain attractive from a risk-adjusted perspective. With ample liquidity, it is also well positioned to fund future credit opportunities.

Role in a Diversified Portfolio

This strategy offers targeted exposure to fixed-income securities across all credit ratings and geographies. The mandate is unconstrained when selecting these securities, aiming to capture above-average risk-adjusted returns. This strategy can be employed either to balance an equity portfolio or to generate income.

CANADIAN BOND STRATEGY

The Pembroke Canadian bond strategy has delivered strong absolute returns year to date, outperforming its benchmark.

The portfolio’s 2.2% holding in a BBB-rated limited recourse capital note (LRCN) issued by Great West Life Co. was a key contributor to performance due to spread tightening. Other contributors to performance included AA-rated Funding Agreement-Backed Notes (FABN), which were issued by New York Life and MetLife and experienced spread tightening.

The yield curve steepened during this period as short-term government rates declined and long-term yields increased. This caused the strategy’s relative overweight in long-term securities to negatively impact performance.

Duration ended the period at 6.8 years and remains generally neutral relative to the benchmark. Given that spreads are well within historical averages, the strategy is positioned conservatively, with an emphasis on high-quality, liquid instruments, including AAA-rated Government of Canada bonds and National Housing Act Mortgage-Backed Securities (NHA MBS). These can be used to fund future credit opportunities.

Role in a Diversified Portfolio

This strategy provides targeted exposure to investment-grade fixed income. The mandate is designed to select high-quality fixed-income securities with the aim of preserving capital. This strategy can be used either to balance an equity portfolio or to generate income.

 

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