The fallout from Europe’s escalating debt crisis has been a boon for Canadian companies that need to boost their cash reserves.
Global investors have flocked to havens such as the United States and the United Kingdom, pushing their government bond yields to below 2 per cent. Yields are considered a measure of risk: The lower they are, the less nervous investors are.
The Canadian government, too, has benefitted from the drop, making life easier for Canadian companies. Interest rates for corporate debt are derived from government bond yields, so the farther yields drop, the cheaper it is for companies to raise cash.
On Wednesday, Bell Canada sold $1-billion of debt at its lowest rate in 65 years. On Thursday, oil sands giant Canadian Natural Resources hopped on the same train, selling $500-million of debt that pays just 3.05 per cent annually, another extremely low rate.
While these yields are beneficial to issuers, they are also skewing the market’s risk-return dynamic. In every facet of finance, the bigger the risk that investors take, the better their return is supposed to be.
In some respects, this still holds true in bond markets. Riskier companies have to shell out more than the 3.35 per cent Bell will now pay annually on its new debt. Because all yields have dropped, however, a high-risk issuer that once had to pay 14 per cent can now pay about 8 per cent – and some people argue the systemic market risk is just as high. Last month, higher-yield issuer Aimia Inc. (previously known as Groupe Aeroplan) sold debt with a 5.6-per-cent interest rate, its lowest ever.
This fundamental problem worries high-yield bond manager Barry Allan, who earlier this week held a conference call to explain how complex the issue has become.
His company, Marret Asset Management, runs a flagship fund that until Wednesday was supposed to offer investors an 8-per-cent return annually. He has had to cut the fund’s distribution because the high-yield products in which he invests simply don’t pay what they used to, so much so that the fund isn’t even earning the 8 per cent it pays out.
Because Canada and the U.S. are seeing such low rates, Mr. Allan worries that investors aren’t adequately compensated for the chance of losing their money. “The risk in the marketplace well exceeds the returns available,” he said on a conference call with money managers. “People are reaching for yield and taking risks that they don’t want to take.”
The search for yield isn’t new; investors have long sought out securities such as real estate investment trusts and pipeline stocks that pay big dividends. But the bond market is much bigger than the stock market, and sizable funds have to go fishing for yield in the bigger pond.
The problem is that the pickings for Canadian high-yield debt are slim, and heavy demand with limited supply is pushing prices higher. (Yields move in the opposite direction of prices.) “Mutual funds are chasing the same kind of debt that is already scant,” said Jean-François Godin, a fixed-income analyst at Desjardins Securities.
The market isn’t totally out of whack, however. As Europe’s debt concerns deepen, corporate spreads over government bonds have widened, meaning investors have been demanding more interest for the risk of investing in a company rather than a supposedly safer government bond. Still, the total interest rate they are paid has fallen because government rates have plunged so fast that they more than compensate for bigger spreads.
Mr. Allan is shocked that investors are willing to accept rock-bottom rates, because he’s worried that Europe’s woes will eventually be repeated in Japan and the United States. “We fundamentally believe that we’re in a global sovereign-debt crisis.”