| by Scott Ronalds Rarely is there a dull day in the stock markets these days. Especially with a Twitter-happy American president, new wave of "unicorn" IPOs, abundance of mergers & acquisitions, and mounting tensions in the Middle East. But this piece is about an asset class less flashy — bonds. More specifically, it's an update on our Income Fund. As a refresher, the Income Fund is a diversified portfolio of bonds (75% target weight) and dividend-paying stocks (25%). We structured the fund this way with the goal of providing bond-beating returns over the medium to long term (which it's done over the past 3, 5, and 10 years) along with a more well-rounded stream of income. Some of our retired clients use it as a "paycheque" fund and it's also the largest holding in our Founders Fund. While bonds don't get the same attention that stocks do, it's interesting times in bondland nonetheless and an update is timely. After steadily raising interest rates last year, the Bank of Canada has pumped the brakes this year and bond yields have fallen back, leading to strong returns over the past six months (recall that when yields fall, bond prices rise). The 10-year Government of Canada benchmark bond yield reached 2.6% last October but has fallen to 1.7% today. This may not sound like much of a decline, but it's a big move in a low rate environment. In fact, it's led to a 6.3% gain in the bond market over the six months ending April 30th. This type of return isn't sustainable with rates as low as they are, so we're more cautious than normal. We've had the fund positioned quite defensively over the past few quarters, as our manager (Connor, Clark & Lunn) has felt that bond yields aren't particularly attractive and risks are building in some segments of the market, notably the corporate sector. Global economic growth is slowing which could spell trouble for more leveraged companies (those with high amounts of debt). More recently, we've "buttoned down" the fund even further. Here's what this means in plain English: - We have a larger-than-normal position in Government of Canada bonds, which now make up 30% of the fund (in the past, they've comprised less than 5%). These securities offer lower yields than other types of bonds, but they provide the greatest safety. As Tom said in a recent post, government bonds are the best diversifier a portfolio can have.
- The fund's weighting in corporate bonds is close to an all-time low (25%). Our focus here is on high-quality companies such as utilities (e.g. Hydro One) and banks.
- High yield bonds make up only 2% of the fund, which is also close to an all-time low. What's more, our high yield investments are focused on higher-rated securities (we're giving up some yield for greater safety) and those that have good liquidity, meaning they're easy to buy and sell.
- Stocks make up 22% of the fund, which is modestly below our long-term target.
- Our stock strategy has become more defensive, with a focus on larger, more stable companies. Examples include food retailers such as Loblaw Companies and Metro, telecoms including Rogers and Telus, and utilities such as Fortis and Brookfield Infrastructure Partners.
The fund is more positioned for capital preservation than growth right now. It's still earning a steady stream of income from diversified sources (federal & provincial bonds, corporate & high yield bonds, dividend stocks, and real estate investment trusts), but we're less likely to see similar price gains in the fund's bond investments than we did over the past half year (the fund gained 7.0% after fees over the 6 months ending April 30th). We're confident that the Income Fund will continue to be a bond beater going forward. Our caveat to investors, though, is that it may not take much to beat bonds in a world of low interest rates. Management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The indicated rates of return are the historical annual total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns.
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