“GRANOLAS” – Europe’s Answer to the “M7”
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With the Bank of Canada (BoC) finally relenting on nearly three years of interest rate hikes, which led to generationally high interest rates, is it time for fixed income investors to consider “locking-in” these high rates before they potentially decline?
The 0.25% rate cut delivered by the BoC on June 5, 2024, marked a shift in monetary policy from the previous historical tightening cycle. Further easing could spell the end of the inverted yield curve (i.e. short-term rates higher than long-term rates), which would reduce the relative value of cash and cash alternatives, which for the last two years have generated very high yields compared to the rest of the fixed income yield curve. With the potential for further declining interest rates, cash and cash alternative investment vehicles could return to their traditional roles as a “safe haven” rather than a source of attractive income.
The “big six” Canadian banks were the primary beneficiaries of approximately C$350B of pandemic-era savings, most of which found their way into GICs, earning around 5% interest1. High Interest Savings Account (HISA) ETFs also benefited from combined net flows of over $18B in 2022 and 2023, with yields peaking above 5%2. Lenders may find it challenging to continue paying attractive rates if the BoC continues to cut rates, as it may lower their profit margins. The big banks already took bold cost-cutting steps last year to preserve profits even as loan loss provisions rose3, so their appetite to continue subsidizing HISA ETFs may dissipate. Data provided by the BoC4.
For HISA ETFs, the rate cut cycle represents a second headwind to yields – recall that as of January 31, 2024, new liquidity requirements from the Office of the Superintendent of Financial Institutions (OSFI) took effect, which reclassified deposits from HISA ETFs as unsecured wholesale funding with 100% run-off on bank balance sheets5. This OSFI ruling, along with the BoC rate cut, means lower rates earned on deposits from HISA ETFs.
Current market expectations forecast an additional two rate cuts from the BoC before the end of 2024. That means that the current interest rates earned on GICs and HISA ETFs are likely to continue to trend lower.
So, if rates drift lower as expected, how can investors best “lock in” at today’s rates?
Guardian Capital LP offers a suite of target maturity bond funds, GuardBondsTM, that are available in mutual fund and ETF units and are designed to provide income over a pre-determined time horizon by investing in a portfolio consisting primarily of investment-grade bonds with effective maturities in successive years from 2024 to 2027, and which are hand-picked by the Fixed Income team at Guardian Capital LP.
The two charts below show that the impact of interest rate cuts on A and AA-rated investment grade fixed income, generally issuances rated A or above, has been relatively muted. The spread on corporate bonds – that is the difference in yield between an A or AA rated bond and an equivalent government bond – has not declined much at all. On A rated bonds it has declined less than 20 bps after the recent BoC cut and is virtually unchanged in the AA segment.
The GuardBondsTM strategies aim to achieve a potentially better risk-reward profile where investors “lock in” a higher yield by investing today in target maturity funds that hold corporate bonds to their maturity date. “Locked-in” in the sense that it is possible to achieve the current level of yield by purchasing one of these target maturity GuardBondsTM now and hold to maturity, even if the current yield-to-maturity of these strategies varies slightly over time.
Simulated Example – For Illustrative Purposes Only.
*Use of Simulated Model Examples – The forecast model has been prepared for illustrative purposes only, to help show the potential impact of interest rate declines and potential investment outcomes. Simulated returns are not the returns of any particular investor, account or portfolio and there is no guarantee that these same results will be achieved by investors. The reliance on hypothetical, simulated returns come with inherent risks and limitations. There are frequently material differences between hypothetical results and the actual results achieved by a particular investment strategy. Hypothetical performance calculations cannot account for the impact of certain financial or market risks on actual holdings or trading. There are numerous other factors related to the markets in general, and the implementation of any specific investment strategy, which cannot be fully accounted for the in the preparation of hypothetical results; all of which can adversely affect actual results. Hypothetical, simulated performance is not indicative of future results, and no representation is being made that any investor will, or is likely, to achieve gains, losses or outcomes similar to those illustrated. Please consider these and other factors carefully and do not place undue reliance on modeled or forward-looking information. This illustration is not intended to represent the investment experience of any particular investor.
Key considerations and benefits of the GuardBondsTM target maturity funds:
Held to maturity, just like a bond
Greater certainty of income
Tax-efficient
Speak with your Financial Advisor about how GuardBonds™ may be incorporated into your broader investment portfolio or visit guardbonds.com to learn more.
1 Reuters, Battle for Canadian bank deposits seen heating up as rate cuts loom, Rates & Bonds, published March 21, 2024. https://www.reuters.com/markets/rates-bonds/battle-canadian-bank-deposits-seen-heating-up-rate-cuts-loom-2024-03-21/
2 National Bank of Canada, Canadian ETF Flows, Financial Markets, ETF Research & Strategy, published May 2, 2024 https://cetfa.ca/wp-content/uploads/2024/05/April-Canadian-Flows.pdf
3 CBC News, Big banks announce layoffs and more bad loans as TD, Royal and CIBC post quarterly results, Business, November 20, 2023. https://www.cbc.ca/news/business/bank-earnings-1.7044654
4 Bank of Canada, Interest rates posted for selected products by the major chartered banks, Statistics, published June 12, 2024. https://www.bankofcanada.ca/rates/banking-and-financial-statistics/posted-interest-rates-offered-by-chartered-banks/#download
5 Investment Executive, HISA ETFs adjust to new era as OSFI liquidity rules take effect, New, published January 14, 2024. https://www.investmentexecutive.com/news/products/hisa-etfs-adjust-to-new-era-as-osfi-liquidity-rules-take-effect/
DISCLAIMER
This commentary is for general informational purposes only and does not constitute investment, financial, legal, accounting, tax advice or a recommendation to buy, sell or hold a security. It shall under no circumstances be considered an offer or solicitation to deal in any product or security mentioned herein. It is only intended for the audience to whom it has been distributed and may not be reproduced or redistributed without the consent of Guardian Capital LP. This information is not intended for distribution into any jurisdiction where such distribution is restricted by law or regulation.
Please read the prospectus, Fund Facts or ETF Facts before investing. Important information, including a summary of the risks, about each Fund is contained in its respective offering documents. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund and exchange traded fund (ETF) investments. You will usually pay brokerage fees to your dealer if you purchase or sell units of an ETF on a stock exchange. If the units are purchased or sold on a stock exchange, investors may pay more than the current net asset value when buying units of the ETF and may receive less than the current net asset value when selling them. Mutual fund and ETF securities, including money market funds, are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. Mutual funds and ETFs are not guaranteed, their values change frequently, and past performance may not be repeated
The opinions expressed are as of the date of publication and are subject to change without notice. Assumptions, opinions and estimates are provided for illustrative purposes only and are subject to significant limitations. Reliance upon this information is at the sole discretion of the reader. The opinions expressed are as of the published date and are subject to change without notice. Assumptions, opinions and estimates are provided for illustrative purposes only and are subject to significant limitations. Reliance upon this information is at the sole discretion of the reader. This document includes information concerning financial markets that were developed at a particular point in time. This information is subject to change at any time, without notice and without update. This commentary may also include forward-looking statements concerning anticipated results, circumstances, and expectations regarding future events. Forward-looking statements require assumptions to be made and are, therefore, subject to inherent risks and uncertainties. There is a significant risk that predictions and other forward-looking statements will not prove to be accurate. Investing involves risk. Equity markets are volatile and will increase and decrease in response to economic, political, regulatory and other developments. Investments in foreign securities involve certain risks that differ from the risks of investing in domestic securities. Adverse political, economic, social or other conditions in a foreign country may make the stocks of that country difficult or impossible to sell. It is more difficult to obtain reliable information about some foreign securities. The costs of investing in some foreign markets may be higher than investing in domestic markets. Investments in foreign securities also are subject to currency fluctuations. The risks and potential rewards are usually greater for small companies and companies located in emerging markets. Bond markets and fixed-income securities are sensitive to interest rate movements. Inflation, credit and default risks are all associated with fixed income securities. Diversification may not protect against market risk and loss of principal may result. Index returns are for information purposes only and do not represent actual strategy or fund performance. Index performance returns do not reflect the impact of management fees, transaction costs or expenses. Certain information contained in this document has been obtained from external parties, which we believe to be reliable; however, we cannot guarantee its accuracy.
Guardian Capital LP is the manager of GuardBondsTM, and also manages portfolios for defined benefit and defined contribution pension plans, insurance companies, foundations, endowments and investment funds. Guardian Capital LP is a wholly owned subsidiary of Guardian Capital Group Limited, a publicly traded firm listed on the Toronto Stock Exchange. For further information on Guardian Capital LP or its affiliates, please visit www.guardiancapital.com. All trademarks, registered and unregistered, are owned by Guardian Capital Group Limited and are used under license.
Published date: June 28, 2024
