Canadian corporate bonds losing their lustre
Investors keep eating up new Canadian corporate debt issues, but a dismal third quarter is creating some questions about whether the party is about to end.
Demand for Canadian corporate paper has remained strong the past few years as yield-starved investors migrated away from lower-yielding paper such as government bonds. Many high-profile new issues, such as BCE Inc. and Trans-Canada Corp., have even been oversubscribed.
The iShares Canadian Corporate Bond Index ETF, which holds issues from some of Canada’s largest companies such as Royal Bank of Canada, Telus Corp. and Hydro One Inc., has risen more than 33 per cent since 2011, not including yield payments.
But the third quarter was an awful one for Canadian corporate debt. Data from the Bank of America Merrill Lynch Global Corporate Index shows prices declined 1.1 per cent for the three months ending Sept. 30, making Canada one of the worst performers among developed markets.
The drop in prices (and rise in yields, as the two move opposite each other) created the biggest spike in borrowing costs for Canadian companies since 2012.
That doesn’t mean the corporate bond bull run is over. Heather McOuatt, a portfolio manager at Franklin Bissett Investment Management, said her firm is taking advantage of the widening spreads between corporate and government bonds in recent months to add to its position in the former.
“What we saw in Q3 was an extension of the energy selloff that started a year ago and is continuing to work its way through the system,” she said. “But I think what we’re seeing here is another opportunity for active managers to buy in and find some good value in the corporate credit space.”
There is concern, however, that more pain may be on the way in the fourth quarter, she notes.
One of the biggest catalysts for lower prices in Q3 was Standard & Poor’s downgrade of Enbridge Inc. to BBB+ from single-A, relegating it to the riskiest range of the investment-grade segment. Anything lower than BBB is considered a non-investment-grade or junk bond.
The downgrade naturally led many investors to ask who would be next as the market continues to reprice risk for the beatendown energy sector, though it isn’t the only one seeing higher risk premiums. For example, DBRS Ltd. downgraded Telus from A- to BBB+ earlier this year, after Telus said it would take on more debt to ramp up capital spending.
On Friday, the Bank of Canada highlighted the challenges Canadian businesses face in its annual business outlook survey. The bank said sentiment continues to remain “tepid” as the country adjusts to the crash in crude oil prices.
“The outlook remains weak for firms in the energy sector and supply chain, as well as those exposed to slowing household spending and diminished confidence in the affected regions,” the central bank said.