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Bond prices have dropped sharply but their yields have risen to the 5-per-cent level or more.

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With the Bank of Canada appearing to pause its steady interest rate-hike march at a benchmark of 5 per cent following 11 consecutive hikes since March 2022, BlackRock Inc.’s iShares Core Canadian Universe Bond Index ETF XBB-T experienced the most inflows in its history in October – almost a whopping $1-billion.

The exchange-traded fund’s (ETF) next highest month of inflows was $500-million in August 2023. In short, bonds are back in style.

“That is quite compelling and showing us that flows are starting to build momentum and clients are becoming much more interested in taking advantage of these yield levels,” says Rachel Siu, director and head of Canadian fixed-income strategy for BlackRock Canada.

“Investors [are] recognizing that as yields have moved higher [recently], this is probably a good buying opportunity.”

Market watchers have lamented the rapid increase in interest rates by central banks globally aiming to tame skyrocketing inflation. However, the jump to 5 per cent from the rock-bottom levels during the COVID-19 pandemic and earlier have been a boon to investors and savers looking for conservative investments with a decent return.

Guaranteed investment certificates (GICs) now return around 5 per cent, and while bond prices have dropped sharply, their yields have risen to the 5-per-cent level or more. That means bonds are on sale – with a low price but a solid yield.

“It’s been a meaningful regime change in the past almost two years,” Ms. Siu explains.

“It’s changing the dynamic in terms of how investors think about equities and fixed income and how they can build a portfolio [with] a wider range of different asset classes to accomplish objectives.”

New products in the market

Some investors are moving back into core holdings that include more secure government bonds or high-quality corporate bonds, she says.

In the past two years, many clients turned to cash and cash alternatives to cover their fixed-income needs. Now, many are revising that strategy, Ms. Siu says. That includes RBC iShares’ launch in May of six new RBC iShares Target Maturity Bond ETFs, which invest in government bonds and have a set duration target year ranging from 2024 to 2029.

Other fund companies have also added to their fixed-income lineup to take advantage of the current environment and offer investors new fixed- income products.

In September, Horizons ETFs Management (Canada) Inc. launched three new ETFs as part of its premium yield suite, which uses an actively managed options program to generate higher yields on U.S. Treasuries.

Horizons Short-Term U.S. Treasury Premium Yield ETF SPAY-T focuses on a short-term duration of less than three years, Horizons Mid-Term U.S. Treasury Premium Yield ETF MPAY-T duration is five to 10 years and Horizons Long-Term U.S. Treasury Premium Yield ETF LPAY-T is 10 years or more.

Combined, these funds have more than $100-million in assets under management to date, says Vernon Roberts, options strategist at Horizons ETFs.

“We’re at an interesting inflection point,” Mr. Roberts says. “Many people want to hope that this rate cycle of raising rates is over.”

The last time rates were this high was in 2006.

The new funds sell both calls and put options. A call option gives the buyer a right to buy an investment at a pre-defined price on a certain date, and a put option gives an investor the same right to sell. Investors earn money from the premium they receive for writing the option, and if the underlying security rises or falls below the strike price, depending on if it’s a put or call option.

“We’re capturing premium, but also capturing more of the upside,” Mr. Roberts explains.

“The way this product [lineup] has been structured, they’re flexible if rates go down, or the exposure of the fund can be positioned in such a way that it can benefit from either action.”

If rates go up, they can sell more calls, and take advantage of bond prices going down, he adds. And if rates go down, they could sell more puts to take advantage of bond prices going up.

Volatility in the bond market

But not all portfolio managers think the fixed income market is on solid ground yet – or that central banks are done raising rates or are ready to cut them anytime soon.

Trixie Rowein, senior portfolio manager and financial advisor with PAX Portfolio Advisory at Raymond James Ltd. in Edmonton, isn’t ready to shift clients’ assets into fixed-income ETFs.

“A pause could last 12 months,” she says, “and the next cut could be in 12 months.”

A report from Charles Schwab Corp. found that during the past 14 interest rate cycles since the late 1920s, the shortest time from a Fed hike to a cut was 59 days in 1929 after the stock market crash, and the longest was 874 days – almost two-and-a-half years – following the May 1981 rate hike trying to tame high inflation.

Right now, Ms. Rowein says her firm is focusing on having only about 10 per cent of portfolios in fixed income because of the volatility in what’s supposed to be a low-risk asset that acts as a ballast.

Instead, she and her team are turning to GICs or money market funds that are paying upward of 5 per cent.

“Then, I don’t have to worry about any volatility whatsoever,” she adds.

For taxable accounts, a more tax-efficient option is to buy “the beaten up, big dividend payers like BCE Inc. BCE-T, or even the utilities, that are trading like a quasi-proxy for bonds,” she says.

Those investors can collect dividends patiently while they wait for dividend stock prices to improve, she adds.

Risk of interest rates staying higher for longer

All year, market watchers have been predicting that central banks are done raising rates and a rate cut was around the corner, but they’ve been wrong, Ms. Rowein says.

“The last thing we want to do is get caught making a fixed income call that rates are going to be dropping and fixed income is going to rally,” she says. “We save that kind of risk-reward for the equity portion.”

William Chin, portfolio manager and chief technical analyst at Caldwell Investment Management Ltd. in Toronto, manages the firm’s Tactical Sovereign Bond Fund, which is up 3.8 per cent year-to-date and focuses its investments on Canadian and U.S. government bonds.

He advises investors to scrutinize the array of fixed-income ETFs available as they can vary widely in holdings and may not meet investment goals or risk profiles. He also says they focus on quality federal government bonds over corporate bonds.

As we get further into a higher interest rate environment in which financial liquidity is tighter, there’s more chance that companies could face financial challenges, which could impact their bonds, he says.

The current level of interest rates “is more normal, historically,” he explains.

“Fixed income is attractive, but you just have to stay short in duration from one to three years,” he says.

“The risk is for interest rates to stay higher for longer,” especially with central banks adamant that they will get inflation down to 2 per cent even as we see wage hikes, housing and prices of staple goods remain high.

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