Bond Market Observations - March 22, 2018 Presented by Kevin De Sousa, Vice President & Portfolio Manager
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Bond Market Observations
March 22, 2018
Presented by
Kevin De Sousa, Vice President & Portfolio ManagerGreek Debt Safer Than US Treasuries?
16
14
Greece 2 Year Bond Yield
12
10
Yield (%)
8
6 ???
4
U.S. 2 Year Bond Yield
2
0
Dec-15
Dec-16
Dec-17
Mar-16
Jun-16
Sep-16
Mar-17
Jun-17
Sep-17
MFA Financial Forum – March 22, 2018 2Bond Market Observations
PH&N Fixed Income Investment Philosophy
Multiple Sources of Risk/Opportunity
Multiple Aim to provide consistent
Strategies value-added
Breadth of strategies is key
Interest
Liquidity Credit
Rate
Focus on return/risk
relationship
Predictability of expected value-added
Most Least
Goal is to build a diversified portfolio with attractive relative returns
MFA Financial Forum – March 22, 2018 4Bond Market Review
Short Term Bonds Fared Worse than Long Term Bonds on Year
FTSE TMX Canada Short Term Overall Bond Index Yields
2.1%
2.0
Total Returns 1 Yr 4 Yrs
As of December 31, 2017 % %
Short Term Overall Bond Index* 0.1 1.7
1.5 Universe Bond Index* 2.5 4.1
Long Term Overall Bond Index* 7.0 7.5
Yield %
Sector (Short Term Overall Bond Index)
1.0
Canada -0.6 1.1
Provincial 0.2 1.8
Corporate 1.0 2.4
Source: yc..\sc index NEW… 12/31/17
0.5
* Representative components of the FTSE TMX Canada bond indices
Dec-17
Dec-13
Dec-14
Dec-15
Dec-16
Source: FTSE TMX Global Debt Capital Markets Inc.
MFA Financial Forum – March 22, 2018 5Higher Interest Rates on the Horizon?
Fed Hiking Doesn’t Necessarily Mean Higher Rates Across Curve
6.0
5.0
4.0
Yield (%)
3.0 10 Yr US Treasury
Federal Funds Rate
2.0
1.0 Last time the Fed began a
hiking cycle was 12 years
0.0
ago
Nov-04
Jul-03
Jul-04
Jul-05
Jul-06
Nov-03
Nov-05
Nov-06
Mar-04
Mar-05
Mar-06
Source: Bloomberg, as of June 30, 2017
MFA Financial Forum – March 22, 2018 6Yield Curve Flattened Over the Year
Short Term Rates Significantly Higher
Government of Canada Yield Curve
2.5
MFA Funds
Opportunity Set
2.0
1.5
Yield (%)
1.0
0.5 December 31, 2017
December 31, 2016
0.0
2 Years
3 Years
5 Years
7 Years
10 Years
20 Years
30 Years
3 Mths
1 Year
Source: FTSE TMX Global Debt Capital Markets Inc.
MFA Financial Forum – March 22, 2018 7Yields are Low….
…..But Can Remain Low For Extended Periods
10 Year US Treasury Yields
18.0
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.4%
2.0
0.0
1792
1807
1822
1837
1852
1867
1882
1897
1912
1927
1942
1957
1972
1987
2002
2017
Source: Global Financial Data, FTSE TMX Global Debt Capital Markets
MFA Financial Forum – March 22, 2018 8Provincial Bond Market
Strong Performance Influenced by Less Domestic Supply
Borrowing Completed (% of Target)
Funding Schedule Fiscal Year 2017/2018
150%
Valuations at post-crisis lows, resulting from:
125%
• Focus on issuance outside of Canada
• Investor demand for high quality yield
100%
75%
Strong international demand allows provinces to:
• Issue in large amounts, at attractive yields
50%
• Diversify source of funding
25% Issuance well ahead of target
• Only 75% through fiscal year
0% • Less supply for domestic investors
P.E.I.
BC
Sask
Total
Alberta
Ontario
Quebec
New Brunswick
Nova Scotia
Manitoba
Newfoundland
Source: BMO
MFA Financial Forum – March 22, 2018 9Provincial Bond Market
Strong Demand Have Left Valuations at Low End of Range
5 Year Spreads (5-Year Range)
1.0
0.9
0.8
Demand from international investors was a
0.7 key theme in 2017
• $25B of international issuance, (2nd highest
0.6
Spread (%)
on record), $10B more than 2016
0.5
• $52B of domestic issuance, lowest since
2010
0.4
0.3
0.2
0.1
0.0
Ontario Quebec BC Alberta MFA of
BC
Current (Feb 28, 2018)
Source: FTSE TMX Global Debt Capital Markets Inc.
MFA Financial Forum – March 22, 2018 10Compensation for Credit Risk at Low Levels
Provincial and Agency Bonds Relatively More Attractive
Spread Over Similar Term Canadas
3.50
3.25 Short-Term Corporates
3.00 Ontario 5 Year
2.75 Canada Housing Trust 5 Year
2.50
2.25
2.00 Defensively biased in corporate bonds
Yield Spread (%)
1.75
1.50
Preference for Federal Agency and Provincial
1.25 bonds over Government of Canada bonds
1.00
0.75
0.7%
0.50
0.4%
0.25 0.3%
0.00
Dec-16
Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-17
Source: FTSE TMX Global Debt Capital Markets Inc., BondLab
MFA Financial Forum – March 22, 2018 11Corporate Bond Market Outlook – Current View
Increasingly Cautious
1. Valuations: Negative Valuations
• Spreads near post crisis lows
Negative Neutral Positive
2. Fundamentals: Negative
• Elevated event risk Fundamentals
• Stretched corporate balance sheets
• Concerns: consumer leverage; housing markets;
US protectionism Negative Neutral Positive
3. Technicals: Neutral
Technicals
• Strong new issue demand
• Tightening of Canadian spreads likely to result in
more domestic issuance
Negative Neutral Positive
• Headwinds: liquidity, investor credit positioning,
rising rates
As of December 31, 2017
MFA Financial Forum – March 22, 2018 12Corporate Bond Valuations Expensive
Reward-for-Risk Not Attractive
Short-Term Corporate Bond Spreads
4.5
4.0
Returns
1 year 5 years
3.5
BBB 1.8% 3.0%
Spreads near post crisis lows across
3.0 A 0.9% 2.3%
all rating buckets
AAA/AA 0.6% 2.1%
2.5
Yield Spread (%)
Lower quality has outperformed
higher quality
2.0
1.5 Took profits and upgrading credit
quality of your portfolio
1.0
0.5
0.0
Dec-14
Dec-07
Dec-08
Dec-09
Dec-10
Dec-11
Dec-12
Dec-13
Dec-15
Dec-16
Dec-17
Source: FTSE TMX Global Debt Capital Markets Inc., BondLab
MFA Financial Forum – March 22, 2018 13Corporate Bond Issuance Reached Record Levels
Selective in Participation
Annual Corporate Bond Issuance
Record breaking corporate bond issuance in
2017 (20% higher than 2016)
Maple bond issuance contributed $15B ($6B
in 2016) – highest since financial crisis
Spreads tighten despite record new supply:
strong demand for yield
Selective in our participation – 2017 we
participated in 15% of new issues vs 40% in
past 3 calendar years
Source: BMO Capital Markets
MFA Financial Forum – March 22, 2018 14Corporate Bond Fundamentals
Security Selection – Passed on McDonald’s Maple Bond
$180 3.0x
McDonald's Stock Price (LHS)
$160 Leverage Ratio (RHS)
2.5x
Fundamental credit risk concern – bond
Net Debt / EBITDA
$140
issuance used to buy-back stock and increase
Stock Price ($)
dividends
$120 2.0x
Shareholder-friendly actions negative for
bondholders
$100
1.5x Passed on new issue as it did not offer adequate
reward for concerns about fundamental risks
$80
$60 1.0x
Dec-10
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Source: Bloomberg
MFA Financial Forum – March 22, 2018 15Corporate Bond Fundamentals
Cheap Funding = Lots of M&A Activity
Total Annual Global M&A Volumes
6,000
5,000
4,000
USD Deal Volume (Billions)
3,000
2,000
1,000
0
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: Bloomberg
MFA Financial Forum – March 22, 2018 16Corporate Bond Fundamentals
“Quintessentially Canadian” M&A Portfolio Implications
Tim Hortons Common Stock Price Tim Hortons 4.2% 2017 Corporate Bond
100
110
109
90
108
80 107
Bond Price ($)
Stock Price ($)
106
70 105
104
60
103
102
50
101
40 100
Mar-14
Mar-13
Jun-13
Jun-14
Dec-12
Sep-13
Dec-13
Sep-14
Dec-14
Sep-13
Sep-14
Mar-13
Mar-14
Jun-13
Jun-14
Dec-12
Dec-13
Dec-14
Source: FTSE TMX Global Debt Capital Markets
MFA Financial Forum – March 22, 2018 17MFA Pooled Investment Funds
MFA Pooled Fund Choices
Money Market Intermediate Bond
Fund Fund Fund
Interest Rate Risk & Returns Increase
Benchmark 30-Day T-Bills 1-Year T-Bills FTC Short Term Bond Index
Key Focus on high quality Focus on high quality Focus on high quality
Guidelines Max. 366 day maturity Max. 2 year maturity Max. 7.25 years maturity
Investment
0-9 months 9-24 months 24 months - 5 years
Time Horizon
MFA Financial Forum – March 22, 2018 19MFA Funds Under Management
As at December 31, 2017
$ Millions %
Dec 31, 2017 Dec 31, 2017
Money Market 1,200 52%
Intermediate 341 15%
Bond 775 33%
Total $2,316 100%
MFA Financial Forum – March 22, 2018 20MFA Funds Performance Review
As of December 31, 2017
One Three Five Since
Year Years Years Inception2
Annualized Performance1 % % % %
MFA Money Market Fund 1.12 1.02 1.11 4.10
Benchmark3 0.63 0.56 0.70 3.84
Value-Added +0.49 +0.46 +0.41 +0.26
MFA Intermediate Fund 0.99 1.32 1.42 3.77
Benchmark4 0.26 0.57 0.79 3.38
Value-Added +0.73 +0.75 +0.63 +0.39
MFA Bond Fund 0.45 1.58 2.00 6.21
Benchmark5 0.08 1.23 1.70 5.93
Value-Added +0.37 +0.35 +0.30 +0.28
1. Information shown is gross of fee. Investment management fees are approximately 4bps annually. Other fees and expenses are approximately
11bps (Money Market) to 16bps (Intermediate and Bond Funds)
2. May 1989 for Money Market & Bond Fund; March 1994 for Intermediate Fund
3. FTSE TMX 91-Day T-Bill Index from May 1, 1989 to March 31, 1994; FTSE TMX 30-Day T-Bill Index from March 31, 1994 to July 31, 2001; FTSE
TMX 91-Day T-Bill Index from July 31, 2001 to December 31, 2012; FTSE TMX 30-Day T-Bill Index thereafter
4.FTSE TMX Canada 365 day T-Bill Index
5.FTSE TMX Canada Short Term Bond Index
MFA Financial Forum – March 22, 2018 21Higher Short-Term Interest Rates Expected
Beneficial for Savers
2.5
U.S. Federal Reserve
2.0 Bank of Canada
Central Bank Rate (%)
1.5
1.0
0.5
0.0
Dec-10
Dec-18
Dec-08
Dec-09
Dec-11
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Source: FTSE Global Debt Capital Markets, Bloomberg, CME Group
MFA Financial Forum – March 22, 2018 22Canadian Money Market Portfolio
Focus on Yield Enhancing Strategies
Canadian Money Market Yields
1.75
Focus on yield enhancing
1.50 strategies
1.25
• bias to high-quality
corporates and commercial
1.00
paper
• longer than neutral maturity
Yield (%)
0.75 as longer-term securities
maintain attractive yield
0.50 advantage
0.25
30 Day Bankers Acceptance
30 Day Canada T-Bills
0.00
Dec-14
Dec-12
Dec-13
Dec-15
Dec-16
Dec-17
Jun-13
Jun-14
Jun-15
Jun-16
Jun-17
Source: Bloomberg, FTSE TMX Global Debt Capital Markets Inc. credit\corp paper … 90days (yld chart BA & 3M) 3/31/16
MFA Financial Forum – March 22, 2018 23MFA Money Market Fund
Portfolio Structure as at December 31, 2017
Sector Distribution Corporate yields remain attractive relative to
government securities
Fully invested in high quality Corporate
securities
High Quality Portfolio
R1High 62.0%
R1Mid 13.2%
R1Low 24.8%
Average Term to Maturity: 63 Days
Market Value: $1.2 billion
Portfolio Yield2: 1.45%
Benchmark3 Yield2: 0.99%
Incremental +0.46%
1 Bank-Sponsored Asset Backed Commercial Paper
2 Gross of fees
3 Benchmark is FTSE TMX Canada 30-Day T-Bill Index
MFA Financial Forum – March 22, 2018 24MFA Intermediate Fund
Portfolio Structure as at December 31, 2017
Sector Distribution
Government allocation low in favor of yield
enhancing credit strategies
• Maximum allocation to corporate bonds
• Government allocation made up of
Provincial securities
High Quality Portfolio
AAA/R1H 7.7%
AA/R1M 76.7%
A/R1L 15.6%
BBB 0.0%
Average Term to Maturity: 0.83 Years
Market Value: $341 million
Portfolio Yield1: 1.72%
Benchmark2 Yield1: 1.53%
Incremental +0.19%
1 Gross of fees
2 Benchmark is FTSE TMX Canada 365-Day T-Bill Index
MFA Financial Forum – March 22, 2018 25MFA Bond Fund
Material De-Risking Since Oil Price Shock
March 31, 2016 December 31, 2017
Portfolio Duration: 2.58 yrs Portfolio Duration: 2.71 yrs
Benchmark2 Duration: 2.80 yrs Benchmark2 Duration: 2.78 yrs
Relative -0.22 yrs Relative -0.07 yrs
Portfolio Yield2: 1.43% Portfolio Yield2: 2.02%
Benchmark3 Yield2: 1.21% Benchmark3 Yield2: 2.05%
Incremental +0.22% Incremental -0.03%
1 NHA Mortgage Backed Securities 1 NHA Mortgage Backed Securities
2 Gross of fee 2 Gross of fee
3 Benchmark is FTSE TMX Canada Short Term Bond Index 3 Benchmark is FTSE TMX Canada Short Term Bond Index
MFA Financial Forum – March 22, 2018 26Questions?
Disclaimer This presentation is intended for institutional investors only. This document has been provided by Phillips, Hager & North Investment Management (PH&N IM) for information purposes only and may not be reproduced, distributed or published without the written consent of PH&N IM. It is not intended to provide professional advice and should not be relied upon in that regard. PH&N IM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. PH&N IM reserves the right at any time and without notice to change, amend or cease publication of the information. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by PH&N IM, its affiliates or any other person as to its accuracy, completeness or correctness. We assume no responsibility for any errors or omissions. This information is not intended to be an offer or solicitation to buy or sell securities or to participate in or subscribe for any service. No securities are being offered, except pursuant and subject to the respective offering documents and subscription materials, which shall be provided to qualified investors. This document is for general information only and is not, nor does it purport to be, a complete description of an investment in any RBC, PH&N or BlueBay funds. If there is an inconsistency between this document and the respective offering documents, the provisions of the respective offering documents shall prevail. Commissions, trailing commissions, management fees and expenses all may be associated with the funds mentioned in this presentation. Please read the offering materials for a particular fund before investing. The performance data provided are historical returns, they are not intended to reflect future values of any of the funds or returns on investment in these funds mentioned in this presentation. Further, the performance data provided assumes reinvestment of distributions only and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. The unit values of non-money market funds change frequently. For money market funds, there can be no assurances that the fund will be able to maintain its net asset value per unit at a constant amount or that the full amount of your investment in the fund will be returned to you. Mutual fund securities are not guaranteed by the Canada Deposit Insurance Corporation or by any other government deposit insurer. Past performance may not be repeated. The amount of risk associated with any particular investment depends largely on the investor’s own circumstances. Investors should consult their professional advisors/consultants regarding the suitability of the investment solutions mentioned in this presentation. This document may contain forward-looking statements about general economic factors which are not guarantees of future performance. Forward-looking statements involve inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward- looking statement. All opinions in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility. PH&N IM is a division of RBC Global Asset Management Inc. (RBC GAM Inc.). RBC GAM Inc. is the manager and principal portfolio adviser of the Phillips, Hager & North (PH&N) investment funds and RBC Funds. RBC Global Asset Management is the asset management division of Royal Bank of Canada (RBC) which includes RBC GAM Inc., RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, the asset management division of RBC Investment Management (Asia) Limited, and BlueBay Asset Management LLP, which are separate, but affiliated subsidiaries of RBC. ®/™ Trademark(s) of Royal Bank of Canada. Used under licence. © RBC Global Asset Management Inc., 2018. MFA Financial Forum – March 22, 2018 28
VANCOUVER TORONTO MONTRÉAL Waterfront Centre,20th Floor 22ndFloor 6th Floor, North Wing 200 Burrard Street 155 Wellington St. West 1 Place Ville Marie Vancouver, British Columbia Toronto, Ontario Montréal, Québec V6C 3N5 Canada M5V 3K7 Canada H3B 1Z5 Canada T 604-408-6000 T 416-974-2710 T 514-876-1256
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