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Fixed-income conundrum: Where can bond investments go when yields are low?

Corporate bonds can provide an answer, when credit and interest rate risks are successfully managed

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The response of central banks to the COVID-19 pandemic has only placed a sharper focus on an unusual fixed-income landscape, with broad markets demonstrating historically low yields concurrent with historically high duration.

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“Since the early 1980s, interest rates have followed a general trend of decline,” says Timothy Hicks, chief investment officer at Lysander Funds Limited., an experienced, Canadian, employee-owned investment fund manager that offers diversification through funds invested in fixed income in the form of higher yielding corporate bonds. “For most people under 50 today, five-year mortgage rates in excess of 20 per cent and the idea that long-term government bonds provided excellent returns would be unthinkable.”

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Today’s bond market is characterized by high duration and low yields. With rising possibilities for long-term inflation, investors are increasingly concerned that the return on such investments could easily be eclipsed.

“Central bank rates have been artificially lowered for a long time in response to economic challenges,” Hicks says. “But we also have government spending on a scale we haven’t seen since World War II. Deficits are off the charts and there’s no real political will to reduce government spending. People have money to spend as we’re facing supply chain challenges and product shortages. Together, those factors have people thinking about inflation in a way they haven’t for quite some time.”

While long-term government bonds present little to no credit risk, even a little unexpected inflation could easily overwhelm their modest return profile. For investors who want to emphasize the lowest credit risk possible, this may be enough.

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However, Lysander’s response to these market conditions is to offer funds where the portfolios include carefully selected corporate fixed-income bonds that can offer higher yields, significant collateral, and a favourable position to receive compensation in case of default.

“These bonds are signed and explicit loan contracts,” says Hicks. “This can include security over certain assets, and an acknowledgment of exactly where you sit at the table to be repaid if there’s any corporate restructuring required. It’s OK if you’re not at the top of the food chain, as long as you don’t unduly expose your portfolio to bonds that could have significant downside in a bankruptcy.”

Hicks notes that in times such as these, it can be valuable to think more broadly of fixed income in terms of debt instruments. In typical fixed income, a company pays the bond holder a fixed dollar amount for a specified length of time and then pays the principal back. However, the value of the bond itself would go down as interest rates rise.

“But there’s also another category of debt where the coupons are floating, not fixed, and change according to interest rates,” he says. “If you believe rates are going to rise, bonds offering floating rate interest are interesting to look at. With these products, coupon payments may increase over time.”

With investors facing challenging economic environments at the close of 2021 and uncertainty regarding what 2022 holds, Lysander believes that investors could benefit from an active bond manager who is judicious in bond selection and nimble enough to adapt to rapidly shifting economic forces.

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“Lysander seeks to offer funds where the portfolio contains a healthy mix of corporate bond assets by consistently focusing on the downside of each bond agreement,” Hicks says. “Essentially, assembling the right mix of best returns and worst-case scenarios are the conditions required for success.”

For more information on Lysander Funds, visit: www.lysanderfunds.com

The views and information expressed in this article are for informational purposes only. They are not intended as investment, financial, legal, accounting, tax or other advice and should not be relied upon in that regard. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.

®Lysander Funds is a registered trademark of Lysander Funds Limited.

This story was created by Content Works, Postmedia’s commercial content division, on behalf of Lysander Funds Ltd., who is a member and content provider of this publication.

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