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  • Writer's pictureChris Bolton

Looking for Yield in All the Right Places



After a challenging 2022, fixed income investors have experienced a much stronger start to 2023. Year-to-date one of the most widely followed bond indices (FTSE Canada Universe Bond Index™) is up 3.51% as of January 26, 2023. (This index declined by 11.69% in 2022.) While there are numerous factors at play, ultimately, in almost any free market prices increase when demand exceeds supply.


Demand


In 2022, the Bank of Canada embarked on one of the most ambitious tightening cycles in its history. The overnight rate started the year at 0.25% and was raised to 4.25% by year-end. At the most recent meeting on January 25, 2023, the Bank of Canada raised the overnight rate by another 0.25% (to 4.50%). However, perhaps more importantly, they indicated that they expect “to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases”. We believe fixed income investors are increasingly comfortable that the tightening cycle is at an end (or at least close to the end) and are more comfortable committing capital to the fixed income market. This has also led to increased demand for fixed income products.


As shown in Figure 1, investors poured over $7.8 billion into Canadian-listed ETFs in December. The flows were driven predominantly by fixed-income ETFs which totaled nearly $6.0 billion (about 77% of the total).


Figure 1: Canadian ETF Net Creations by Asset Class

Source: Bloomberg, Scotiabank GBM


As liquidity in the bond market tends to be poor during the last few weeks of December, we believe some of this money may have waited until January to be deployed (this is probably more true for actively managed ETFs than for passively managed ETFs).


It should be noted that domestic fixed income mutual funds had net outflows in December of about $1.1 billion in December and that flows in fixed income ETFs have been more muted (but still positive) thus far in 2023. At the same time, while real time mutual fund flow data is not available, historically RRSP investors tend to allocate more money to most asset classes (including fixed income) in January and February each year.


Supply


On the other hand, new supply of Canadian corporate credit has not been as high as some might have anticipated. In Canada, financial institutions (specifically the big 6 banks) are historically the most active issuers of corporate credit. However, thus far this year they have been more active issuers outside of Canada.


Figure 2: Year-to-Date Canadian Bank Debt Issuance By Currency

Source: Bloomberg, Cumberland Investment Counsel

As of January 27, 2023. Excludes Certificates of Deposit and Yankee Certificates of Deposit. Includes issuance by the “Big 6” Canadian banks and Fédération des caisses Desjardins du Québec.

Foreign Exchange rates as of January 27, 2023.


In addition, at this time of year many companies enter a so called “blackout” period that either prohibit them from issuing fixed income products or at least make it a bit more complicated. Many companies that have a year-end (or quarter-end) of December 31 are currently working with the auditors to finalize their financial statements before they are reported to the public. During this period, many companies enter a “blackout” period where they don’t meet with investors, don’t buyback their own stock and don’t issue new securities.


According to Bloomberg, of the members of the S&P/TSX Composite, 135 companies (more than 57% of the index) are scheduled to report their financial results (and thereby end their blackout period) between February 2 and February 24. We think many of these companies will seek to take advantage of lower borrowing costs and issue new bonds between the time they have reported and the start of spring break in much of Ontario (March 13, 2023). All things equal, more supply should lead to lower prices/higher yields.

Kipling Strategic Income Fund


As always, within the fund we are maintaining our discipline and will be looking to take advantage of opportunities if our forecast for increased supply in February and early March is correct.


On another note, we are pleased to announce that we have increased the monthly distribution rates on our units. The monthly distribution on the M Series increases to $0.037/unit from $0.0281/unit. The monthly distribution on the A Series increases to $0.036/unit from $0.0275/unit. Both increases are in excess of 30%. These distribution levels represent a yield of approximately 4.50% based on the Net Asset Value per unit on January 6, 2023.


As of January 27, 2023, the cash-on-cash yield of the fund is approximately 5.8% and the yield-to-maturity is approximately 7.4%. Both figures are before fees. While we cannot make promises or guarantees, these figures indicate there may be the potential for an additional special distribution in December 2023.

As always, we thank you for your trusting us with your capital.

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