What’s the buzz about corporate bonds?

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In the current economy, government bonds may not be as attractive as they used to be

Investing in a low yield environment is a challenge for many investors.  It is especially difficult on seniors, or those within the 5-10 year window to retirement whose portfolio needs have shifted to require more fixed income investments.

For years, with attractive guaranteed GIC rates and high bond yields, investing in traditional GIC’s, Canada Savings Bonds, and Government bond funds has been reliable conventional wisdom for the retired fixed income investor.

Then came increased government debt and a weak global economy creating a challenge for investors – low yields.  Along came an economy that would turn traditional conservative investing on its head.  Bond yields and GIC rates have declined to historic lows.

Settling into a high guaranteed rate of return in retirement is no longer easy to achieve in our current low yield environment.  Our boomers are being faced with fixed income investment challenges at one of the most critical times in their investment timeline.

With such low GIC rates available, GIC investors are turning to non guaranteed, low risk options.  Some of which include government bond funds (which purchase bonds from various government bodies i.e. Countries, Provinces, Municipalities etc.) and corporate bond funds (which purchase bonds from various businesses i.e. Apple, Enbridge, Amazon etc).  When considering government bonds another question of security arises.  With the general state of soverign debt, are government bonds still the safe haven they used to be?  There is good argument to suggest that corporate bonds may be a reasonable alternative or addition.  It seems corporate bonds may currently be a better investment on a risk reward basis than government bonds.  Why would this be?

Fundamentally, let’s look at how differently governments respond in times of crisis compared to corporations.  During an economic slowdown, a government implements a monetary policy to encourage economic recovery.  A government response to stimulate the economy is to increase spending in stimulus programs with the intention of avoiding or lessening the effects of recession.  The result is high government debt levels generated by money spent to stimulate the economy. 

A corporation on the other hand has no direct obligation to stimulate the economy, and during tough economic times a business’ first instinct is self preservation.   Normal behaviour for a corporation during times of crisis would be to reduce spending, tighten up inefficiencies, and fatten their balance sheet.  They weather the storm in survival mode.

Here we have two very different reactions to the global credit crisis of 2008.  On one hand we have corporations saving money to survive, and we have governments’ spending money to stimulate the economy.  The result is that the corporations who have survived the downturn are now stronger than before the crisis.  They have weathered the storm and have come out the other side with more solid balance sheets holding the highest cash levels in years.  According to Statistics Canada, corporate debt is at a record low.  

Governments are in a different position, and gross debt as a percent of GDP (Gross Domestic Product) has risen significantly.  For example, according to the IMF Fiscal Monitor, September 2011; in 2006 the US had gross debt of 60% of their GDP, and in 2011 it was up to 100% of GDP.   By comparison, in 2006 Canada had gross debt of 70% of GDP, and in 2011 it was up to 84% of GDP.  The governments are working to stimulate the economy but they come out of it worse for wear on the debt side.

Many retiring Canadians have slowly incorporated more non-guaranteed lower risk investments into their portfolios the last couple years.   Given the number of Canadians in, or heading into retirement who need a solid portion of their investment portfolio to be in fixed income products, many are still looking to find other alternatives to GIC’s.   For some investors, corporate bond funds, if suitable to the overall investor risk tolerance and investor needs may be worth considering as a part of their full portfolio plan.

 

Link to column as it appeared in Elgin This Month April 2012 edition (page 8)

 

Stephanie Farrow, B.A., CFP.,  Stephanie has over 20 years experience in the financial services industry, a diploma in Financial Planning from the Canadian Institute of Financial Planning, and Certified Financial Planner designation.  Stephanie has been writing a financial planning column for the local business magazine Elgin This Month since 2010 and hosts our Farrow Financial Blog and Twitter @farrowfinancial.  Stephanie and her husband Ken Farrow own Farrow Financial Services Inc., are busy raising three young children and actively involved in the community. Our Farrow Financial Services Team.