A playbook for bond investors

For bond investors considering how to position their portfolios, the path of monetary policy is top of mind right now.

“I’m still in the rate cut camp for this year, especially for Canada,” said Adam Ditkofsky, vice-president and portfolio manager, core and core plus, with CIBC Asset Management, in an interview in early May.

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Ditkofsky noted that, relative to Canada, U.S. economic growth has been stronger, and inflation higher, given greater consumer spending south of the border.

“We’re seeing a large divergence between both countries that does continue to warrant rate cuts faster in Canada than the U.S.,” he said. 

While the bond market should react favourably to interest rate cuts, “modest” cuts are already priced in, he noted.

He suggested that bond investors take advantage of current yields, especially in shorter-dated maturities, given the inverted yield curve. Ditkofsky also recommended target maturity bond funds as an opportunity.

“If you hold bonds to maturity … you aren’t exposed to the mark-to-market or sensitivity to day-to-day changes in interest rates,” he said, adding that some shorter-dated high-quality corporate bonds have yields between 5% and 6%.

Further, “these funds can even generate returns better than GICs, as many bonds today trade at a discount,” he said.

Looking ahead over the next 12 months, Ditkofsky said he expects rates to move modestly lower, particularly at the short end of the yield curve. “This should enable investors to generate returns in line with where yields are today,” he said.

Should inflation reaccelerate and lead to higher rates, he suggested investors could reduce market volatility risk by focusing on shorter-dated bonds, discount bond funds, and target maturity funds.

And a scenario in which interest rates remain higher for longer would negatively affect risk assets, including investment-grade corporate bonds, high-yield bonds and equities, he noted.

On the positive side, corporate earnings are supportive for credit markets.

“We’re seeing companies maintain conservative balance sheets, so credit can continue to perform,” he said.

In addition to solid credit fundamentals, he said he focuses on geographic diversification. And within sectors, he likes the banking and real estate sectors, “but bottom-up analysis is key,” he said. With banks, for example, that means assessing lending practices and margins, loan provisions and capital levels.

Also, “banks should continue to see improved performance should we see further normalizing of the yield curve,” Ditkofsky said.

In real estate, he focuses on subsectors like senior living, industrial space and data centres.

“Essentially, we like companies [that] can continue to generate solid free cash flow, and can continue to increase their rental rates, and maintain strong credit metrics,” he said. 

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