“Spend more” is the consensus among Western governments, even as risk is rising on the corporate side. As the team at leading Canadian institutional investment management firm Canso Investment Counsel wrote in their latest Corporate Bond Newsletter, investment grade corporate bond spreads are the tightest they have been since 2005, and investors are demanding less and less compensation for increased risk. Canso’s team is doing the opposite, instead continuing to favour quality and liquidity until paid adequately for risk.
Click here for the full Corporate Bond Newsletter.
Across the world, everyone’s spending
Interest rates have been on the rise since the end of the first quarter of 2025, particularly at the long end of the curve. As the Canso team pointed out, the yield curve has gone from deeply inverted 12 months ago to something much steeper today. “Politicians have learnt that more money is always more popular than less,” the team wrote.
The newsletter noted that deficit spending is undoubtedly the consensus of Western governments, including that of Donald Trump and his Republican Party in the United States. The bond market has taken notice of the growing debt load, pushing long interest rates higher not only in North America, but in Europe and Japan as well. The U.S. Republicans’ “One Big Beautiful Bill Act” will extend tax cuts. Meanwhile, in Canada, newly elected Prime Minister Mark Carney inherits fiscal books deeply in the red, even as he signals significant capital investment from the federal government to invigorate a weary economy. Across the pond, the UK abandoned £5 billion (~$9.2 billion) in welfare reforms at the last minute, which should bring a tear to any responsible conservative’s eye. And even the Germans, notable fiscal stalwarts, are looking to remove borrowing caps and introduce a €1 trillion (~$1.6 trillion) stimulus plan.
Two goodbyes: Warren Buffett and the LATAM ‘good little bond’
The Canso team called out a special retirement in the July Bond newsletter: the 94-year-old CEO of Berkshire Hathaway, Warren Buffett, who announced that he would be stepping down at the end of this year, and will be succeeded as CEO by Alberta-born Greg Abel.
The authors of the newsletter appreciated a track record whose longevity and superiority may never be replicated. “From 1965 through 2024, the Oracle of Omaha reports a compounded annual gain of 19.9% versus 10.4% for the S&P 500, dividends included,” the team wrote. “Over 60 years of compounding, we can see how stark that differential becomes.”
The team also called out a good news story: a goodbye to a so-called “good little bond” as LATAM Airlines called their 13.375% senior secured notes due 2029 at the “make-whole” price.
“Coming to the market at an inopportune time for the borrower proved lucrative for the lender,” they wrote. “The 2029 notes we purchased were issued at a price of $93.103 to yield 15%. As investors, our job is not to avoid risk, but to ensure that we are compensated for the risks we take on. And if we risk our clients’ capital in times of uncertainty, we don’t want to be called away at par in 6 months if the business or the markets improve. And improve they did. LATAM Airlines emerged from bankruptcy at the end of 2022 into a resurgent travel market, allowing the company to quickly return to profitability.”
Important to Canso’s investment was protecting its economics through appropriate call protection. The 2029 notes were part of a three-tranche financing that also included a 2027 bond and a 2027 syndicated term loan. The 2027 maturities carried a two-year non-call protection and were called at first opportunity last October. Meanwhile, the 2029 bond carried an additional year of protection, granting Canso an extra 12 months receiving a “not so little” 13.375% coupon, at which point the bond would be callable at $110.
We are finding very few opportunities within high yield, at any rating.
Canso Investment Counsel
The newsletter added that LATAM is taking advantage of favourable markets and paying out the full economics early. The company was able to refinance the 2029 issue with a 2031 secured note that carries a much lower coupon of 7.625%. In addition, they have reduced the collateral backing the new notes, releasing some of the cargo business assets from the security package. “A terrific outcome for the borrower, but less attractive from our perspective,” the newsletter noted. “The credit cycle is alive and well.”
Risk premia are tight, and LRCNs will reset
The Canso team warns that risk premia for investment grade bonds in the U.S. are now the tightest they have been since 2005, despite the fact that the index had about 10% less in BBB-rated bonds than it does today (35% vs 45%). “Investors demand less and less compensation for the added default risk,” they note.
BBB bonds continue to outperform in Canada as well, particularly at the long end of the credit curve, even as valuations are now more expensive than they were in January.
“A development in the corporate bond market that we will be watching closely in the back-half of this year is the first limited recourse capital notes (LRCNs) are scheduled to hit their reset dates,” the team pointed out. When that happens, issuers can determine whether they will call the notes at par or leave them outstanding for at least five more years, and the Canso team noted that the choice will have major implications for the growing asset class.
“The good news for investors, if the LRCNs remain outstanding, is that they will see a significant rise in their coupon payments. The bad news for investors is that, if the banks are not interested in calling outstanding LRCNs, these securities will begin to be priced to future call dates, or even their final maturity date,” they wrote.
Meanwhile, credit spreads in the high yield market also peaked in early April and have recovered nearly all of the widening. “High yield bonds are priced for perfection, and we continue to question whether the trade is too asymmetric at these levels,” the Canso team warned. “On one hand, investors hope to collect a reasonable running yield; on the other, the possibility of price volatility and capital loss through defaults or liability management transactions looms large.”
Despite the changing composition of the high yield market, the Canso team remains unconvinced. Instead, they are focused on bottom-up security selection and pricing individual credit risk. “We are finding very few opportunities within high yield, at any rating,” they wrote.
Another development on which the Canso team is keeping an eye is the proliferation of Distressed Exchanges, or Liability Management Exercises (LMEs) transactions, which were historically used by private equity-sponsored companies on the verge of bankruptcy to inflict pain on rival private creditors, in hopes of staving off a payment default. “They have now spilled over into high rated, cash flow positive, public equities,” the newsletter noted. “Years of weakening creditor protections and excess liquidity provided the backdrop for this to happen.”
So, what is a bond investor to do? The Canso team continues to assert that it is as important now as ever to do proper due diligence and understand what you are buying. At current valuations for fixed income investors, the upside is limited. “In this market environment, we will continue to favour quality and liquidity until paid for the risks,” the authors concluded.
This story was created by Canadian Family Offices’ commercial content division on behalf of Canso Investment Counsel Ltd., which is a member and content provider of this publication.