Time to be picky about corporate bonds

Corporate bonds performed well after the short-lived bear market early last year, but credit spreads and an uncertain economy make the environment more challenging now, says CIBC’s Patrick O’Toole.

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“We have to be pickier,” said O’Toole, vice-president of global fixed income at CIBC Asset Management, in an interview earlier this month.

“That’s not just being selective of which companies that you buy and the corporate bonds that they issue, but also which bonds [from] the companies we like.”

O’Toole said he expects pent-up savings and consumer demand to drive economic growth higher than consensus expectations, benefiting corporate bond issuers that can refinance and collect the maturity.

“We see a strong economy and somewhat higher inflation as the seeds for moderately higher government bond yields and continued demand for the higher yields available on corporate bonds — meaning, the corporate sector will win versus government bonds again in 2021,” he said.

But the spreads on corporate bonds are leading to caution, with more volatility expected.

“After all, we have these lockdowns to start 2021,” O’Toole said. “They’re spreading, and investors may expect that will eventually lead to earnings downgrades, or there could be concerns that we could see spreads increase as that risk-off mindset takes hold.”

O’Toole, who manages the CIBC Canadian Bond Fund and the Renaissance Corporate Bond Fund, said his team doesn’t see much value in government bonds or short-term corporates this year. Corporate bonds in the seven- to 20-year range should “post pretty decent returns comparatively,” he said.

Within that corporate category, his team likes banks, telecoms, renewables, infrastructure bonds, some auto and retail firms, and industrial REITs. They’re less interested in other REITs and high-quality utilities, he said, and they’re being “pretty selective” on oil and gas companies.

With high-yield spreads about 370 basis points over Treasurys to start the year, they’re also cautious on that category.

“We think the high-yield sector could see some turbulence if lockdowns lead to that risk-off mentality,” he said. “But, if we see those spreads move back to the 500-basis point area, we’d be more apt to spend some of our firepower.”

Within high-yield, he said his team still likes technology and health care, as well as some higher-quality energy companies.

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