Why TD is making a contrarian bet on high-yield bonds

TD Asset Management Inc., which presciently moved into the safety of bonds ahead of the recent stock market tumble, is making another contrarian bet: high-yield bonds.

Bruce Cooper, who oversees $338-billion as chief investment officer of the asset management arm of Toronto-Dominion Bank, is easing into the sector that posted its worst showing since the 2008 financial crisis this year through September. While he's still avoiding energy issues, the yield pick-up offered by the market is attractive while providing a further opportunity to diversify away from volatile equity markets.

"We've been edging up our high-yield weighting," said Mr. Cooper in an interview. "We're putting a toe in. We're not jumping in with both feet." TD Asset Management returned to high yields in the past two months in "low single-digit amounts" after becoming cautious on them about a year and a half ago, he said.

TD Asset Management, which is the second-largest asset manager in Canada after Royal Bank of Canada, is making its move after jettisoning the firm's preference for stocks from 2009 to 2014 and moving deeper into debt before equity markets began to slump in the second quarter.

The same concerns that dragged down stocks – slowing Chinese growth and collapsing commodity prices – have also hammered corporate bonds. High-yield corporate bonds lost an average of 2.53 per cent in 2015 through September, the first loss since a 26.4-per-cent average retreat in 2008, according to the Bank of America Merrill Lynch U.S. high yield index.

Energy bonds have been "thwacked" especially hard, Mr. Cooper said, as the price of U.S. crude oil dropped about 55 per cent from June, 2014, highs. That's pushed spreads of energy issues out more than 300 basis points since the second quarter, compared with about 126 basis points for the index.

"When you get under the hood, if you want to take a bet on these energy companies, if you're right you'll make a lot of money," Mr. Cooper said. "But if you want to put it into high yield outside of that, the spreads have been widening, but not that much."

While Mr. Cooper's inching into high yield, Brandon Osten, who manages about $300-million as founder of Venator Capital Management Ltd., said longer durations on recent high-yield issues has made them less appealing to investors.

"High yield went from a 7 to 8 per cent proposition to a 5.5-per-cent proposition," Mr. Osten said in an interview. "So the length went out, the interest rate went down and that's a double whammy on duration."

Mr. Cooper may be buying debt for his clients, but he's no fan of it for the Canadian economy. Surging debt levels are contributing to a "grinding, low-growth" economic environment and while companies have been taking on more debt, capital investment has remained lacklustre.

Low rates

"Debt will sap economic activity as we go forward and increase volatility," he said.

As interest rates stay persistently low for years to come, the role of fixed income for investors has changed, Mr. Cooper said. It's more about providing diversification and modest income than the high coupons, capital gains of a previous era.

"Capital gains are probably not on the menu," he said.

Slower growth leads to lower returns over time and the volatility means that the path to achieving those returns is a rockier one.

"This is not an awesome recipe for my clients," he said.