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The Globe and Mail

How to make bonds a profitable part of your portfolio

Kevin Van Paassen/The Globe and Mail

Terry Carr, manager of the Manulife Corporate Bond Fund, took your questions in a live one-hour discussion Friday, May 27. Mr. Carr's $838-million fund, which is split between investment grade corporate bonds and wilder high-yield issues from Canada, the United States and elsewhere, is top-ranked by Lipper.

It has returned 8.3 per cent over the past 12 months, and in 2009, it returned an amazing 25.2 per cent. And when the stock market was melting down in 2008, cutting major indexes in half, the fund turned in a comparatively slim loss of just 8.3 per cent. (Read more about Mr. Carr here )

Mr. Carr shares his strategy on making big - yet relatively safe - returns from the bond market and provide insight on how your portfolio could benefit.

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The following is a full transcript:

11:02 Darcy Keith - Good morning everyone, I'm Darcy Keith, an editor with the Globe and Mail. Welcome to this live discussion.

11:03 Darcy Keith - Terry Carr, manager of the Manulife Corporate Bond Fund, will be joining us in just a moment.

11:03 Darcy Keith - To read more about Terry and his approach to bond investing, please click here.

11:04 [Comment From Terry Carr]/b>

Good morning

11:07 Darcy Keith - Thanks for joining us Terry, this should be a great discussion. Just to start off Terry, I'm wondering what your general view is on interest rates in Canada. Do you see the Bank of Canada hiking this summer?

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11:08 [Comment From Terry Carr]/b>

It's my pleasure to be here. I think that the Bank Of Canada will be cautious about raising rates and is likely to begin a gradual campaign in the fall

11:09 [Comment From Kesh Malik ]/b>

In a possible rising interest rate environment, is it still possible to make good returns with bonds?

11:10 [Comment From Terry Carr]/b>

Yes but it is obviously more difficult. Corporate debt and high yield will be preferred over government debt with care given to maturities of the bonds

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11:10 [Comment From Don ]/b>

Terry, where do you see the best opportunity right now in terms of either sectors or ratings?

11:11 [Comment From Terry Carr]/b>

Generally I would say that the best opportunities lie in BBB rated corporate debt and carefully selected high yield rated bonds.

11:11 [Comment From Joe R ]/b>

I'd like to buy and hold long-term corporate bonds until maturity to maximize my return. But is this possible if I purchase a bond fund rather than an individual bond?

11:13 [Comment From Terry Carr]/b>

Generally the buy and hold approach is not consistent with an active bond managers strategy because we try to add value beyond buy and hold. But exposure to intermediate and long term bonds is typically maintained but the specific holdings tend to vary over time

11:13 Darcy Keith - Just a follow up question related to this:

11:13 [Comment From BBB+ ]/b>

Good question by Joe. Do any of the bond ETFs hold their bonds to maturity? Sometimes difficult to tell from reading the prospectus.

11:15 [Comment From Terry Carr]/b>

ETF's will definitely be closer to buy and hold but will suffer from an "index less the MER fee" detriment. Hence won't out perform the asset class they represent

11:15 [Comment From Garth Doll ]/b>

Where do you see the better higher yield opportunities in today's markets - converted income trusts who have maintained yield, or higher yield corporate debt?

11:16 [Comment From Terry Carr]/b>

I would be a little bit cautious of the converted trusts initially because of their relatively new nature. Additionally, secondary market liquidity can dry up quickly

11:16 [Comment From Marc R ]/b>

What sectors of the High Yield market do you favour?

11:17 [Comment From Terry Carr]/b>

Generally we look for less cyclical sectors whose companies produce steady cash flow...

11:18 [Comment From Terry Carr]/b>

but I would say that when you are just emerging from a recession, if you can pick the survivors that are cyclicals, that is where the most money is made

11:18 [Comment From yield ]/b>

Is the preference for BBB a relative call within all of corporate credit? Investment grade credit spreads sit around 80bps; high yield is at or close to all time tight in terms of credit spread

11:20 [Comment From Terry Carr]/b>

It may be a sweet spot now, because with worries about economic weakness out there, credit spreads in high yield may temporarily widen but if you emphasize quality too much and buy AA's, you give up too much yield and bear too much interest rate risk

11:20 [Comment From ted ]/b>

as a 23 year old, I am still trying to develop a portfolio. what type of bonds and what percentage of my portfolio should they represent.

11:21 Darcy Keith - And here's a related quesiton from Jim:

11:21 [Comment From jim ]/b>

what precentage of your portfolio sould you have in bonds right now

11:21 [Comment From Terry Carr]/b>

good question. I don't think there is a simple answer to this but here goes...

11:22 [Comment From Terry Carr]/b>

Initially when you are younger it is believed that you can bear a little more risk than say someone that is already retired....

11:24 [Comment From Terry Carr]/b>

I would say that an overweight in riskier securities should combine high quality commons stocks bought through a diversified fund, high yield bond exposure bought the same way making sure that the manager hedges currency...

11:26 [Comment From Terry Carr]/b>

In terms of weighting : the equities and high yield could represent up to 2/3's of the portfolio but this ultimately depends on personal risk tolerance and near term needs for capital. Higher quality bonds and cash reserves would make up the balance.

11:27 [Comment From Guest ]/b>

Can you provide a good resource for researching and selecting high yield corporate bonds?

11:29 [Comment From Terry Carr]/b>

Very difficult for a Canadian retail investor to this. In our portfolios we typically trade with large US investment dealers and diversify significantly owning sometimes 100+ bond positions. Trading in fixed income is conducted in large sizes typically well beyond retail investors portfolio sizes

11:30 [Comment From Don ]/b>

Terry, do you own any of the Yellow Media bonds? Either way would you be a buyer on this recent big drop?

11:31 Darcy Keith - And a related question from Staphane:

11:31 [Comment From Stephane ]/b>

Yellow Media's bonds have taken a beating in the last week with no apparent news. The feb. 2015 series now yields 7,5% and is down more than 7$ to 99,25$. What is your take?

11:32 [Comment From Terry Carr]/b>

We do own some. There has been a little news lately that has knocked down the bonds (departure of one executive and one executive was forced to sell a significant shareholding) But stock has been falling fast for several months prior : so not sure if there is other bad news here. Be cautious...

11:33 [Comment From Terry Carr]/b>

Equity markets may also be nervous about deal risk in the sale of the Autotrader business

11:33 [Comment From Bob ]/b>

Bond funds seem to have lots of cash on hand,but not to nimble to react to rate changes. why is that?

11:35 [Comment From Terry Carr]/b>

Sometimes it relates to yield curve positioning which calls for cash to be held and sometimes particular funds may be experiencing redemptions so the manager maintains a liquidity reserve.

11:35 [Comment From don ]/b>

have you been a buyer of any of the recent new deals that last few weeks, especially on the energy side: savanna, connacher, barrett or flint

11:35 [Comment From Terry Carr]/b>

played Connacher...

11:37 [Comment From Terry Carr]/b>

sorry I can't comment further on recent trades do to regulatory constraints

11:37 [Comment From Pete ]/b>

What would be the advantages of investing in a high yield bond Mutual fund over say, A floating rate fund which is designed to thrive in a rising rate environment?

11:38 [Comment From Terry Carr]/b>

Generally floating rate funds are much lower yield at any given time so there is a give up in current yield as a trade off for the hope of higher yields down the road

11:39 [Comment From BBB+ ]/b>

What are your thoughts on the capital structure arbitrage approach to high yield debt investing, where you take a long position on a company's debt and a smaller short position on its equity?

11:41 [Comment From Terry Carr]/b>

Can work at times but realize that the two instruments are positively correlated and that correlation varies over time so the hedge ratio strategy needs to be carefully constructed and monitored closely

11:41 [Comment From Dennis ]/b>

How do you feel about preferreds as an alternative to bonds? Are they likely to be less affected in a rising rate environment?

11:43 [Comment From Terry Carr]/b>

Preferred interest rate sensitivity relative to bonds depends on the relative term to maturities. Short dated prefs will be less sensitive to interest rates than long bonds and perpetual prefs will be more rate sensitive...

11:45 [Comment From Terry Carr]/b>

Keep in mind as well that prefs generally yield less than bonds and are junior in the capital structure relative to bonds in the same company. The advantage that they have for retail investors is that they can be traded in some sizes.

11:45 [Comment From CDO ]/b>

Do you have an allocation to ABS?

11:46 [Comment From Terry Carr]/b>

very small. Generally we have maintained a very high quality bias. This helped a lot obviously in 2008. That being said, the spreads are quite tight on high quality ABS

11:46 [Comment From Guest ]/b>

do you think bonds play a valid role in a young professionals portfolio who has no cash flow needs? Or should we dial up the risk in small cap value equities and keep the bond segment of our portfolio limited to shorter durations?

11:49 [Comment From Terry Carr]/b>

I would say to focus your fixed income on corporate investment grade and high yield debt if you have a strong career ahead of you and can bear the credit risk because you will get better returns than high quality short duration bonds. On the equity side, in the long run, small caps have performed very well historically.

11:49 [Comment From Pam ]/b>

I hold a number of bonds. How do you know when to sell them?

11:50 [Comment From Terry Carr]/b>

Not an easy question to answer. If they are high quality, you can always choose to hold to maturity. However, if you are worried about future interest rate increases, the longest maturity bonds would fall the most if interest rates rise

11:52 Darcy Keith - Here's a question a lot of us have on our minds with higher interest rates on the way:

11:52 [Comment From Guest ]/b>

A strategy for a rising rate environment is to simultaneously reduce the duration of one's bond portfolio while also acquiring diversified lower investment grade bonds. Your comments please?

11:53 [Comment From Terry Carr]/b>

I agree with that approach. You accomplish two things : you reduce the risk of price declines, you likely also increase your yield while the profitability of the companies you lend to improves with an improving economic outlook

11:54 Darcy Keith - And, here are a couple follow up questions relating to preferreds:

11:54 [Comment From BBB+ ]/b>

Would like to return to your point about preferred typically yielding less than bonds. It makes senses, but right now we see preferred ETFs like iShares XPF yielding over 6%. How do we account for this?

11:54 [Comment From Dennis ]/b>

I'm reluctant to invest in bonds with rates at multi-generational lows so I view prefs as a good alternative because of their tax advantages and I feel they will be less volatile. The question is will perps likely react similiar to 10, 15 or 20 yr bonds? Also, is it fair to assume that rate resets with a rate higher than the then current market are almost certain to be redeemed?

11:55 [Comment From Terry Carr]/b>

to BBB+ : that ETF's may be either levered or relatively concentrated in a narrow group of investments

11:57 [Comment From Terry Carr]/b>

Perps will react most similarly to long bonds like 30 year maturities. Rate resets will either get redeemed or have their yields reduced at the reset date if they are much higher than the current yield environment

11:58 [Comment From vernon ]/b>

What about short term bond funds vs high yield for a retired person drawing from a RRIF?

11:58 [Comment From Terry Carr]/b>

You may want to consider both. In the long run I strongly believe that high yield bonds are much lower risk than common stocks

12:00 Darcy Keith - Well, a lot of good questions and answers today. But I'm afraid we're just about out of time. Terry, any final thoughts and general advice for our audience today?

12:02 [Comment From Terry Carr]/b>

Volatility is a significant problem today and being cautious when investing and thorough is important for fixed income and equity investing. For corporate bond and high yield investing, I strongly recommend investing in a diversified way through a good fund

12:03 Darcy Keith - OK, thanks very much Terry, it's been an informative discussion. This live discussion is part of our Investor All-Stars series. This month it is on bonds and high yield. Check out the entire package here:

12:04 [Comment From Guest ]/b>

Thanks Terry, that makes sense

12:04 [Comment From Terry Carr]/b>

My pleasure. I enjoyed the chat !

12:04 Darcy Keith - Thanks again to all. Join us for another Live Discussion soon here at the Globe and Mail. Good bye!

12:04 [Comment From BBB+ ]/b>

Thanks Terry and Darcy

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