Fixed Income Strategies

The past year was very difficult for bonds, as yields climbed. Central bankers were burned by bets that 2021’s inflation surge would prove transitory. Instead, price pressures were exacerbated by Russia’s invasion of Ukraine, which sent oil and gas prices soaring in the early part of the year. Furthermore, when energy prices moderated during the latter part of the year, inflation stayed stubbornly high.

In an attempt to bring inflation back down, the U.S. Federal Reserve executed its most aggressive interest rate increases since the 1980s. Tighter monetary policy led investors to flee the most popular bets across markets, from technology stocks to cryptocurrencies.

It takes time for the full effects of higher interest rates to filter through the economy, leaving investors wondering how the U.S. Federal Reserve’s sequence of rate increases will eventually affect the behaviour of businesses and consumers. The Fed Chairman has signalled that the fight against inflation is not done, and the unemployment rate has remained at a historically low level.

However, the markets are pricing in something entirely different. Bond traders are betting on the Fed pivoting from raising rates to cutting them later this year. Given the pace of monetary tightening, many economists suspect that a U.S. recession is imminent and will dent corporate earnings and erode the attractiveness of company bonds and shares.

With short-term bonds, money-market funds and other cash-like investments offering their highest yields in years, many investors are reluctant to bet on risky investments with uncertain payoffs.

The negative sentiment in the bond market had a chilling effect on companies and banks. Companies that hoped to go public have scrapped their plans in large numbers. Banks that typically cash in on fees for advising on deals and initial public offerings are slashing bonuses. Retirees have seen their savings shrink and are now flocking into the increased yields and relative safety of GICs.

Corporate Bond Fund

The Pembroke Corporate Bond Fund returned 1.12% in the last quarter of 2022, outperforming the benchmark by 12 basis points, due to spread tightening on high yield positions and a short portfolio duration, which contributed to relative performance as yields edged higher.

In 2022, the Fund returned -5.36%, representing outperformance of 4.51%. This result is attributable to a duration that was meaningfully short of the benchmark, while yields rose significantly over the period. Also contributing to outperformance was resiliency in air travel-related credits, such as Bombardier and American Airlines.

The Fund continues to maintain duration notably below the index, and a large liquidity position comprised of short-dated Canada bonds, which can be effectively sold to take advantage of future opportunities. Moving forward, the Fund is well positioned with a yield of 7.5%, duration of 2.3 years, and an allocation of 30% in floating rate notes (which benefit from increases in reference rates as central banks grapple with inflation).

Canadian Bond Fund

The Pembroke Canadian Bond Fund returned 0.24% in the fourth quarter of 2022, outperforming the benchmark by 13 basis points, as a relatively short duration partially offset the impact of a slight increase in underlying yields. Contributing to performance was an overweight in corporate bonds relative to the index, as spreads tightened and government bonds lagged during the period.

Over the past year, the Fund returned -9.41%, which is 2.28% ahead of the benchmark. This result is largely attributable to relatively short duration as yields rose significantly. The Fund enters 2023 with a yield of 4.6% and duration of 6.1 years, which compares favourably with the benchmark yield of 4.3% and duration of 7.3 years. The Fund will maintain its defensive positioning and increased weight in high-quality liquid bonds. These can be used to take advantage of future opportunities as yields and inflation converge.

 

 

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