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High bank debt issuance: distortion in bond markets


Derek Brown of Beutel Goodman Investment Counsel says that high-yield debt and investment-grade fixed income are both good places to look for opportunities.

Investment-grade bond spreads in the Canadian market are all over the place, says Derek Brown, senior vice president and co-head of fixed income at Beutel Goodman Investment Counsel. This is because Canadian banks have been issuing debt at an unusually high rate.

He said that the Bank of Canada’s decision to raise interest rates and strong consumer spending have caused banks to issue a lot more debt this year—more than 1.5 times the normal amount by mid-summer.

High bank debt issuance:

“What that does is move the spreads around,” he said. “A-rated Canadian banks are now trading wider than almost all triple-B bonds on the market,”

This week, Brown said on the Soundbites podcast that he and his team have begun to “quite substantially” put more money into investment-grade bonds because of this.

He also thinks there are deals to be had in high-yield bonds, especially in what he calls the “crossover space” of rising stars among double-B bonds that are doing especially well in the current market.

He said that some companies in the consumer staples, telecommunications, and energy industries are about to be upgraded to investment grade. He used the airline industry as an example because it lost a lot of money during COVID.

“When you look at the securitized assets on their balance sheets and the rise in travel we’ve seen in the last six months, some of them are really set up well to move back to investment grade in the next 12 to 18 months.”

He said that things like this can cause credit spread compression, which can be good for an investor who knows what they’re doing.

He said, “So, in high yield, we’re looking for idiosyncratic [alpha] opportunities instead of beta exposure in general.”

Term loans, which are part of the high-yield sector, have recently been giving returns of 4% or 5% per year, while fixed income as a whole is down close to 10%.

“Term loans” are usually secured loans with an interest rate that can change. “When rates are going up, these instruments do very well,” he said.

The good news for investors in fixed

The good news for investors in fixed-income is that, after a rough start to the year, fixed-income investments are now starting to pay off.

“The yields on the [FTSE Canada Universe Bond] index have been in the 2% range for almost a decade now,” he said. “A few weeks ago, the index went back up to about 4%, which is closer to what we saw before the financial crisis. With yields going up, investors are getting paid for a lot of the long-term investments they have in their portfolios.

Brown said that investors may move toward safer fixed-income products if interest rates go up, but there are still great deals to be had.

“The Canadian banks look good. “Crossover high-yield credit is appealing to look at.” Term loans and notes with a variable interest rate also look good, “he said. “Fixed income has probably not looked this good since before the Great Recession.”

To find opportunities, you need to know that in the current high-rate environment, some parts of the fixed income pie are likely to do better than others.

Many investors think of fixed income as if it were one big thing. that everything is the same. We look at investing in fixed income as a matter of picking the right sectors. He said there are many different kinds of fixed income, and it’s important to use active management to pick and choose which ones you invest in.


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