Getting the most from a corporate bond portfolio
Plan Sponsor Exchange - 2020 Conference Coverage
BY Yaelle Gang | March 20, 2020
Canadian pension plans have increased their demand for long corporate bonds, but high demand and low yields combined with a relatively small marketplace in Canada can pose challenges for investors, said Randall Malcolm, senior managing director and portfolio manager of Canadian public fixed income at SLC Management.
“When we look at the supply side of things, the long end of the corporate market in Canada is about $150 billion,” he said during the Canadian Investment Review’s Plan Sponsor Exchange conference in February. “It’s relatively small relative to the demand you could see there.”
Another challenge is that the market isn’t diversified and is highly correlated. As well, there are challenges trading. “If you’re a long corporate bond holder, it takes a lot to shake the Canadians out of their bonds.”
The U.S. market, on the other hand, has more diversity, said Malcolm. For instance, the U.S. has a technology sector.
For most Canadian DB plans that do go outside of Canada, it’s important to hedge both currency risk and interest rate risk, he added.
For longer-term foreign currency denominated bonds, using currency forwards will only hedge the foreign currency, but won’t bring the bonds back to a Canadian yield curve exposure, he said. Instead, he suggested that investors use cross currency swaps to provide both a currency and a yield curve hedge.
In addition, for more actively traded foreign bond strategies, he noted a cross currency swap portfolio hedge can help minimize the transactions costs.
While more credits are available outside of Canada, there are risks that investors won’t have insights into those companies, Malcolm noted. “Having insights as to who’s really going to attain their goals and who’s going to [deleverage] their business is key.”
Malcolm also cautioned about taking a passive approach to foreign corporate credit and highlighted the opportunities in both the U.S. and Canada. For example, SLC Management takes advantage of its U.S. insights, and manages the Canadian and U.S. credits in one portfolio, which can come with efficiency benefits.
As an example he noted if Bell Media Inc. trades at a credit spread of 140 basis points in the U.S. and this swaps to a credit spread of about 200 basis points in Canadian currency, but it could be bought in Canada for 210 basis points, then it wouldn’t make sense to purchase that name in the U.S.
“There’s trades even with the swap that trade cheaper in Canada and there’s names that trade cheaper in the U.S.,” said Malcolm. “Really, what we’re doing is a function of relative credit spreads and the benefit of the swap. So combining those two — and to the extent these move in different directions — it creates opportunities for us that might not be there for an index fund.”