Consider investing in fixed income securities

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Longer duration bonds — bonds with a longer maturity — whose prices are more sensitive to changes in market yields (market interest rates), have underperformed in the first four months of the year as investors recalibrated their expectations for central bank policy. Investors, myself included, were expecting a rate cut of more than 0.25 percent so far. But that underperformance began to reverse with U.S. yields falling amid improving inflation data, and Canadian yields falling relatively more sharply as the Bank of Canada (BoC) finally started to embark on its easing cycle.

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The total return of a 5-10 year Government of Canada (GC) bond index is now back in positive territory for the year, but still lags slightly behind the 1-10 year index. 5 years. RBC Capital Markets expects yields to continue to fall in the second half, as the Bank of Canada lowers its overnight rate to 4% by the end of the year. This should be an additional advantage for longer duration bonds in Canada. By 2025, further reductions in interest rates are expected at this point, which will drive the value of bonds even higher.

When investing in bonds, investors should consider not only the duration of their bond investment, but also the type of bond they are purchasing. Generally speaking, the decision involves considering investment grade debt versus non-investment grade debt. Despite a Canadian corporate bond market that still offers attractive yields, the additional yield compensation offered for default risk (or credit spread) is historically low.

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This compression of credit spreads has reduced the barrier preventing Government of Canada bonds from generating higher yields over time. When the reward for risk in terms of return is this low, it is essential to understand that bond markets are vulnerable to outlooks that are anything but perfect. In other words, if an economic downturn occurs, non-investment grade debt will suffer.

Given the risk of a future economic downturn, my preference has shifted away from fixed income categories such as higher yielding bonds issued by companies with weaker balance sheets and toward bonds issued by the Government of Canada or the United States Treasury.

Mike Candeloro, senior portfolio manager and wealth advisor at RBC Dominion Securities and head of the Mike Candeloro Wealth Management Group, provided this article. RBC Dominion Securities Inc. and Royal Bank of Canada are separate and affiliated legal entities. FCPE member. Mike can be contacted at[email protected]. You can also visit his website atmichaelcandeloro.comOr onLinkedIn. To read Mike’s archived articles, please visitMike Candeloro / Special to The Nugget | National Post.

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