Rising yields shift focus to mid-duration bonds

Inflation fears due to the Middle East conflict and higher energy prices have pushed yields up, making mid-term bonds more attractive, says Pablo Martinez, portfolio manager, CIBC Global Asset Management.

“The five-year bond rate, for example, has moved up by about 70 basis points,” he said in a May 20 interview. “We believe that part of the yield curve is one of the most appealing as a resolution to the conflict, even a partial resolution would see this part of the yield curve rally strongly.”

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Mid-term bonds would also provide more upside if rates decline compared to short-term bonds in the one- to two-year range, Martinez said.

“Even though the market is expecting central banks in Canada and the U.S. to maybe hike rates between now and the end of the year, we believe those expectations are overdone.”

Right now, corporate bonds in the three- to seven-year range provide opportunities due to their higher yields and better downside protection, he said. Mid-term corporate bonds are also likely to outperform long-term bonds if spreads widen. Further, 20- to 30-year corporates offer poorer value due to limited supply and strong demand, making them expensive.

Investment-grade bond funds are one entry point into the corporate bond universe, Martinez said. These funds provide higher income and better value at current elevated yields compared to GICs, which offer limited yield due to low and stable policy rates in Canada.

Martinez favours corporate bonds with a one- to five-year ladder. He’s allocated equally across maturities, which he said enhances diversification and increases overall exposure.

“We’re not really concerned with spread widening for the investment-grade bond fund because we do hold the bonds to maturity,” he said. “But we do want to make sure that all our holdings are in line with our risk tolerance.”

While Martinez is overweight in mid-duration bonds, he’s still being cautious. If tensions in the Middle East escalate and energy prices rise significantly, he said yields could move higher, creating an opportunity to extend duration.

Another risk to watch is a non-renewal of the Canada-U.S. trade agreement, he said, which could weigh on Canadian growth.

“While we do not believe that it would be material for the names that we do hold, it would mean that some of the holdings might have to be tweaked to reflect the heightened risk,” Martinez said. “Our base case scenario remains that there will be a deal that will be struck with the U.S., and that would unleash capital spending in Canada, and there will be a significant increase in growth when that happens.”

This article is part of the Advisor To Go program, sponsored by CIBC Global Asset Management. The article was written without input from the sponsor.