Stick to short term bonds, floating rate preferreds

Shorten the average term to maturity of your bond holdings, and more importantly their duration, by trading into high coupon short term bonds. Any new money you have to invest in preferred shares should be directed to floating rate issues.

Short_Term_BondsWhat to do about bonds

From a month ago, Government of Canada bond yields in general have risen, which means bond prices are lower now than four weeks ago. The change is more pronounced in the shorter maturities, where the yield increase over the period on our June 1, 2020, and June 1, 2021, bonds was 11 basis points.

The yield curve has flattened as a result of the yields on short-term bonds rising more than the yields on long-term bonds. If this trend continues, short-term rates could rise above long-term rates, causing an inverted yield curve and suggesting investors fear slowing economic growth more than rising inflation.

What does this all mean going forward? It means the bond market is forward-looking by incorporating anticipated rate changes into today’s prices.

We continue to recommend you shorten the average term to maturity of your bond holdings, and more importantly their duration, by trading into high coupon short maturities such as the Enbridge 4.77s of September 2, 2019, and the Telus 5.05s of July 23, 2020.

What to do about preferred shares

This past month, our floating-rate and straight preferred shares have lost ground. What’s more, our floating-rate issues have underperformed our straight, fixed-perpetual preferreds, falling 0.5 per cent, while the latter have lost 0.3 per cent.

Though there’s not much difference between the performance of the two types of preferreds, floating issues still stand a good chance of stronger performance over the near term. That’s because the Bank of Canada is widely expected to raise the target on its overnight interest rate at least once before the year is out. And more increases are in store for next year. If so, floaters will continue to increase their payouts in the coming quarters, making them attractive.

We still have a preference for floating-rate issue as opposed to our fixed perpetuals. Any new money you have to invest into preferred shares should be directed to them.

As for your fixed-perpetual holdings, by all means hang on to them. Just don’t buy a lot of them right now.

This is an edited version of an article that was originally published for subscribers in the August 31, 2018, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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