A bond portfolio for the late cycle

Bonds offer protection during volatile markets, and diversification within a bond portfolio can help protect against market shocks and selloffs—like what happened in Q4 2018, says Jean Gauthier, chief investment officer, global fixed income at CIBC Asset Management.

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Investors who had a core plus fixed income strategy, with 30% to 40% corporate bonds within their bond portfolio, saw corporate spreads widen by almost 60 basis points at the end of last year, he said. But the rest of the portfolio, made up of provincial and Canadian bonds, protects against the widening spread. A core plus portfolio probably returned roughly 1.25% during the volatile fourth quarter of 2018, Gauthier said in an April interview. “So a well-diversified bond portfolio is a big asset.”

Further, he said when corporate spreads rallied in the first quarter of this year, that same core plus portfolio outperformed, returning 4.4%.

“If you take only one single asset class, and you think that you should sell all your bonds because there’s going to be pressure on corporate spreads, I think it’s misleading,” he said.

Still, for investors who only have corporate bonds within their portfolios, he recommended short duration. “[It] will protect you if there starts to be weakening in the economy. The short bond curve will outperform the rest of the bond curve and rally.”

Yield curve inversion

Gauthier noted that we’re late in the economic cycle, when yield curve inversions aren’t uncommon. In the past, an inverted yield curve has signalled oncoming recessions but he doesn’t think that will happen this year.

“We still believe that recession is going to be something of [a] 2020 story,” he said. “All the yield curve is telling you right now is they expect central banks to ease enough to keep the cycle going. We went inverted for five or six days. Normally you need at least 15 to 20 days [of] being inverted to [know] if we’re really going to go into a recession.”

It’s difficult to time a recession based on an inverted curve anyway, he said, with studies showing it means a recession could come in four to 14 months.

And while it’s “tough to gauge” how long it will last, Gauthier doesn’t foresee a recession like in 2007 and 2008.

“[The] Federal Reserve, ECB, [and] Bank of Canada all came out with more dovish statements about the economy over the last six to eight weeks, which produced the inversion of the yield curve, and the market’s stabilized,” he said.

At this point in the cycle, he suggested that investors pare down on riskier assets and be overweight fixed income, especially short duration.

“Being diversified remains the name of the game for the time being,” he said.

This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.

Suzanne Yar Khan

Suzanne has worked with the Advisor.ca team since 2012. She was a staff editor until 2017 and has since worked as a freelance financial editor and reporter.