A new script for the bond markets

 

An intriguing story from 2018 was how the bond market reflected investor sentiment shifts with yields and spreads not reacting in a typical way. In an unusual twist, government bonds ended up outperforming corporate bonds despite the fact that corporate bonds normally outperform in times of solid economic growth. When government bond yields rise, hurting all fixed income assets, corporate bond spreads typically compress; and this is all considering that in historical terms steadily rising yields normally reflect a healthy economy. But this was not the case in 2018 due to the extraordinary mix of geopolitical, macroeconomic and monetary policy changes that moved into the markets.

The graph below illustrates how this relationship changed using the 10-year US treasury yield and US investment grade corporate spreads as data points:

Source: Markit iBoxx & St Louis Fed, as 31/12/18.

Historically, we can see that higher yields typically equal tighter spreads; that is until the start of 2018 when the relationship broke down and the lines diverged. At Canada Life Investments, the LF Canlife Global Macro Bond Fund adopts a ‘triptych’ approach to generating returns focusing on interest rates, corporate spreads and foreign exchange movements. At the beginning of last year we were overweight in corporate credit based on strong fundamentals and a supportive economy. However, as you can see spreads widened (in the US and globally), which meant that the corporate element of our ‘triptych’ approach detracted from performance. Elsewhere, our interest rate exposure was broadly neutral in terms of return generation with global yields ending the year at a similar levels at which they started.

The idea behind our approach is that although it is unlikely all three drivers will positively contribute at the same time, you are still able to pull different levers in different market environments, generating returns and enhancing the defensiveness of the portfolio in trickier times. In 2018, it was our foreign exchange strategy that contributed most; we were overweight in bonds denominated in currencies such as the Japanese yen and US dollar, which strengthened against sterling.

And even though spread widening detracted from performance, from a forward looking perspective, this allowed us to buy high quality credits at more attractive levels particularly towards the end of the year. Despite political uncertainty continuing, the global economy is still growing and we believe this should continue to support the high quality, attractively valued global corporate credits that we remain invested in. Currently, the Fund retains 63% of its portfolio in this space with 33% in global sovereigns and 4% in cash.

Important Information

The value of investments may fall as well as rise and investors may not get back the amount invested. 

The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Investments. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeinvestments.com. Some Canada Life Investments funds may invest in property funds that may be illiquid and subject to wide price spreads, both of which can impact the value of the fund. The value of the property is based on the opinion of a valuer and is therefore subjective.

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CLI01353 Expiry 03/31/19

ADAM CREED

ADAM CREED

Sales Director, Discretionary & Group

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