The investing shocker of 2014: Bonds

Ari Altstedter
Bloomberg News
Published Wednesday, Dec. 31 2014, 7:38 AM EST
Last updated Wednesday, Dec. 31 2014, 3:49 PM EST

Canadian bonds defied economists’ forecasts to deliver a rally this year that bested peers including the U.S., as faltering global growth and a series of international crises revived the refuge appeal of the country’s debt.

Canadian sovereign, provincial and corporate bonds returned 8.7 per cent, the most in three years, while U.S. debt rallied 6.1 per cent and global gains were 7.6 per cent, Bank of America Merrill Lynch index data show. A year earlier, economists predicted that yields on benchmark 10-year Canadian bonds would rise about half a percentage point as central banks sought to normalize interest rates. The yield is ending this year almost one percentage point lower at 1.80 per cent.

“Everybody thought the bond market was going to sell off in 2014,” Hosen Marjaee, who helps oversee $19-billion of fixed-income assets at Manulife Asset Management, said by phone from Toronto Tuesday. Instead, “there has been a flight to quality and risk reduction, so it’s been very, very rewarding for investors in the fixed-income and bond market.”

Even as a long-delayed pickup in U.S. growth finally began to take hold in the latter half of this year, the world’s other major economies, from Europe to Japan to China, began going in the opposite direction. That, along with conflicts flaring up from the Middle East to Eastern Europe, has kept investors’ demand high for the safest securities and boosted foreign purchases of Canadian bonds.

International Demand

“We’re considered to be a safe haven,” Marjaee said. “If you look at our government finances, they’re in a much better shape than the U.S., and the economy is kind of moving forward, puttering through.”

After years of record foreign inflows into Canadian bonds slowed last year, investment began picking up again in 2014. Foreigners have bought $39-billion of Canadian debt securities this year through October, up from $27-billion for all of 2013, according to Statistics Canada data.

The big winners have been provincial bonds, which have beaten out corporate and federal government debt this year with an 11-per-cent return, according to Bank of America Merrill Lynch data.

“Globally, rates remain low and investors continue to seek safe-haven quality credit spread such as provincials,” Yoshiaki Okabe, a fund manager at Barings Investment Services Ltd., who owns bonds of Alberta, British Columbia, Quebec and Ontario, said in an e-mail. “Investors treat provincials effectively as federal government debt.”

Provincial bonds are generally deemed safer than company debt but riskier than the federal government, and so offer extra yield.

Surprise Rally

Canadian speculative-grade debt was the biggest loser as projections that stronger growth would push up rates, and put a premium on the extra income high-yield bonds give when prices fall, were pushed out. Canadian junk bonds have seen returns shrink from 6.4 per cent at mid-year to 1.8 per cent.

“High-yield bonds are viewed as risky assets,” Andy Beer, an investment analyst with Investors Group, said by phone from Winnipeg Dec. 19. “It’s almost like the perfect storm has hit high-yield bonds.”

With U.S. growth booming and the Federal Reserve signalling this month it’s on track to raise interest rates next year – and the Bank of Canada optimistic some of that growth is spilling north – economists are predicting 2014’s surprise bond-market rally won’t be repeated. Canada’s 10-year bond yield will climb to 2.75 per cent by the end of next year, according to the most recent Bloomberg survey of forecasters conducted from Dec. 5 to Dec. 10.

“We had a surprisingly good year in the bond market,” Robert Gorman, chief portfolio strategist at TD Wealth, the asset-management arm of Toronto-Dominion Bank, said by phone yesterday. “I don’t think we’ll see that again.”

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