$6 trillion in bonds trading in negative yield

Currently, there are negative bond yields in many parts of the world.

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“In fact, about one third of European government bond yields are trading with a negative yield and, globally, about a quarter of government bond yields have a negative yield,” says Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management. He co-manages the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.

Overall, he adds, “That means more than $6 trillion worth of bonds are trading in negative yield.”

Some governments are keeping yields low to get banks to lend to consumers, says O’Toole. “By charging banks to hold government bonds, they’re hoping banks will sell those bonds and take the money, and lend that money out into the economy.” The theory is this should stimulate growth at a quicker pace.

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However, the result has been that government yields are dropping, which is widening the spread between corporate and government bonds, he adds.

This has also occurred in Canada, even though we have low but not negative yields, O’Toole explains. “If you look in the Canadian market, one of the safest bonds you can buy, other than a government of Canada or provincial bond, is a deposit note from Canada’s big banks. Whereas a five-year Government of Canada bond offers a yield of about 0.75%, a Canadian bank offers about 2% yield—that’s almost triple the yield.”

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Further, the domestic investment-grade corporate bond market is offering a credit spread of 1.7%. O’Toole notes, “Outside the credit crisis of 2008 and 2009, today’s spreads are [historically] high, meaning corporate bonds look cheap. They’ve only been this cheap about 5% of the time over the past 35 years.”

In this type of environment, O’Toole suggests investors analyze companies to ensure they’re able to “earn enough money to pay investors their coupons as well as pay bonds back at maturity.” Currently, he finds, “Corporate balance sheets have fairly low leverage, particularly in Canada and the U.S. And, for bond investors, the lower the better.”

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He adds that companies’ earnings are currently able to cover interest payments. So, since balance sheets are strong and corporate spreads are cheap, O’Toole finds it’s time to increase allocation to corporate bonds and reduce exposure to government bonds.

When it comes to individual sectors, he says energy and materials bonds are attractive but still risky. “Given what we’ve seen with oil and commodity prices over the last almost two years, those two sectors just got pummeled, particularly last year. There are some cheap bonds at companies that were penalized along with some of their weaker counterparts, but we’re not looking to overweight those sectors yet.”

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Instead, O’Toole favours bonds tied to telecom, transportation and infrastructure companies. “We’re looking at the telecoms—specifically, we like BCE. The REITs we like are Choice Properties, which are assets that are related to the Loblaw properties. And, in infrastructure, we like public private partnerships that have over been issued the past few years.”

O’Toole is also looking at the high-yield bond market because spreads there have hit their highest level in four years. “There, too, we like the telecom sector. T-Mobile [bonds] are yielding about 5.5%, while Sprint is yielding over 10%.” Both bonds are denominated in U.S. dollars.

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Overall, he concludes, “We expect investment-grade and high-yield bonds to outperform government bonds going forward.”

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