Ditch Canadian, buy European bonds: strategist

Loss said to be unlikely due to currency hedge

The goal for fixed-income investors, according to the head of Allianz’s global highyield strategy, should always be to win by not losing.

In other words, said David Newman, who is also the head of Allianz Global Investors’ multi-asset strategy, investors should avoid chasing high yields and instead buy safe and solid low-risk bonds.

But though Canadian government bonds are low risk, he said investors should target international fixedincome markets, since Allianz estimates the Bank of Canada will continue to raise interest rates toward what it perceives to be the neutral nominal policy rate — somewhere between 2.5 per cent and 3.5 per cent.

The central bank has held rates steady at 1.75 per cent since October, but if and when rates rise, bond prices and returns will drop.

“We think that interest rates are going to go up a little bit, so if you just bought Canadian governments’ bonds, the price could go down so you won’t make the yield that you think you’re making,” Newman said.

Newman was in Toronto last Thursday to discuss his fixed-income strategy and the Evolve Active Global Fixed Income ETF, which Allianz subadvises, at a private luncheon with approximately 30 investors.

There, Newman warned against looking inward on the fixed-income market. Investors should look to international markets, he told the Financial Post on Monday, and take advantage of a strengthened loonie that will result from rising rates.

Instead of buying Canadian government bonds, Newman suggested investors buy bonds in Europe, emerging markets or even the United States — all three transactions are usually made using the U.S. dollar — and then hedge back into the Canadian currency.

Investors are unlikely to lose money on the bonds themselves and, as interest rates and the loonie strengthen in Canada, they’re apt to see increased returns on the currency hedge alone, he said.

Ten-year Canadian government bonds are currently yielding just 1.89 per cent.

Investors have already begun to ditch Canadian government bonds, according to a National Bank Financial report.

The Canadian bond market in December had what National Bank called the largest monthly sell-off in history, as investors dumped $12.9 billion in government and corporate bonds. The divestment in corporate bonds was attributed to retirement, while the government bond sell-off was “driven by secondary market sales.”

Meanwhile, the U.S. Federal Reserve recently signalled an end to rate hikes, and the European Central Bank is expected to keep rates at zero per cent until at least 2020, meaning yields should remain steady in the near future.

In emerging markets, Newman expects some sovereign bond yields will fall.

Although some emerging markets — Venezuela and China, in particular — have been plagued by negative headlines, investors should not stop looking for opportunities, he said, since not all emerging markets are treacherous.

“Venezuela is a lot more risky than Colombia or Chile in Latin America,” said Newman, adding that the same reasoning applies to Europe for investors concerned by Brexit.

There could also be opportunities in corporate bonds, where investors could get 1.5 percentage points more than Canadian government bonds.

“Domestic holiday businesses will do well because people won’t travel abroad because (it will be) more expensive to so,” Newman said. “Similarly, there are companies in the U.K. that get most of their revenue from outside the (pound) ... so when the (pound) depreciates, they do better.”

Newman wouldn’t speak about specific bonds but said investors may find a window into Allianz’s strategy through the Evolve Active Global Fixed Income ETF’S holdings.

U.S. Treasury notes carry the largest weight in the ETF at 6.5 per cent, part of the 48 per cent in U.s.-based holdings. The ETF also has exposure to several European markets — the Netherlands, Ireland, Britain, France and Italy — and an emerging market in Brazil.

Navigating these markets could leave investors at the mercy of some volatility, which is why Newman suggests avoiding indexing or investing in passive ETFS that might provide some unwanted exposure. “The message is about selection: actively selecting the right bits in a much broader universe rather than blindly buying all of them,” Newman said.