“The start of 2021 is very similar to how 2020 began,” says Ditkofsky, vice-president at CAMI, who joined the firm in September 2008, after working for two years as a credit analyst for CIBC World Markets. “Yields are very low and corporate spreads, or the extra yield for holding corporate bonds, are also very low. This doesn’t look like a great backdrop for bonds going into 2021. But we know that 2020 played out extremely well—because corporate spreads recovered in the back half of the year due to aggressive stimuli and a favorable outlook, thanks to the vaccines. But looking ahead for 2021, our expectations are different.”

Ditkofsky notes that his firm’s expectations for the economy changed mid-way through 2020. “The stimuli were more than enough to offset the pandemic. We predicted a V-shaped recovery in the latter half of 2020. This year we expect growth to exceed consensus. We are forecasting growth for Canada in 2021 in excess of 6%,” says Ditkofsky, who works alongside Patrick O’Toole, vice-president, global fixed income, and Jean Gauthier, managing director and chief investment officer. “That [growth rate] has not been seen since 1973—it’s a big number.”

Eye on Interest Rates
The economy will pick up steam thanks to increased household savings and pent-up demand by consumers. But it will also lead to slightly higher interest rates. “We believe there will be better entry points mid-year to enter the bond market and have better returns,” says Ditkofsky, who earned an MBA at University of Western Ontario and a bachelor of commerce at Concordia University. “But barring any unforeseen circumstances, it will be difficult for bond market returns. They will likely be in the low single digits—which we said last year, too. But it won’t be the same as 2020, given the expectations for the economy.”

Currently, the Fed funds rate is 0%, and the Bank of Canada’s overnight rate is 0.25%. Moreover, both central banks have stated they will keep their rates unchanged until 2023. “We don’t see any rate hikes priced into the market in the near term. And the central banks’ tone is unlikely to change given that the economy remains fragile,” says Ditkofsky, adding that millions are out of work and many people are dependent on government transfers and low interest rates. “Stimulus is the key to keeping the economy stable for now.”

Moreover, he notes that the Federal Reserve’s new policy of using averages for measuring inflation will also act as a brake on raising rates. “They [central banks] want to avoid taking their foot off the gas pedal too early.” In addition, he believes that central bank purchases of government bonds will also have an impact on keeping bond yields from rising too much, and it’s important to monitor policy statements to determine if there is any change in outlook which might lead to higher rates and lower bond prices.

Risks to Watch
On the other side of the coin, there are a couple of risks that need watching carefully. First, elevated COVID-19 infection rates could lead to further lock-downs. “That could see lower interest rates, which means higher bond prices. But corporate bond yields would perform poorly as credit spreads would also rise in that type of environment,” observes Ditkofsky, adding that equities would also get hurt. “But I believe governments would step in again to support the economy, and the market. The damage would be contained.”

The second risk is higher-than-expected inflation which would push interest rates much higher, and send bond prices lower. Still, he notes that both Canada and the U.S. have run significant deficits to support their economies.

Areas of Interest
From a strategic viewpoint, Ditkofsky and his colleagues are favouring corporate bonds, since they account for about 60% of the portfolio, or almost double the weight in the benchmark FTSE Canada Universe Bond Index. The balance is split between 23% federal, 14.5% provincial bonds and 2.5% cash.

The bulk of the corporate bond weight is in investment-grade bonds, plus 8.5% high yield bonds. “Given our strong outlook for the economy, we believe this makes sense. Corporate bonds will continue to outperform government bonds over the next 12 months.” Ditkofsky notes that although the benchmark has a yield of about 1.2%, his fund generates yield that is 0.7% higher because of the emphasis on investment grade corporate and high-yield bonds.

As for duration, the managers are maintaining a fairly neutral duration of 8.5 years. “But we tend to be tactical and see duration as a tool to drive active returns. It’s not uncommon to be plus or minus a half year relative to the benchmark, to take advantage of short-term interest rate movements and if we see opportunities in a technical situation where bond yields move sharply in a short period.” Currently, from a tactical standpoint, the portfolio is over-weighted to the mid-term area of the yield curve.

Running a portfolio with about 250 individual corporate bonds from about 150 issuers, Ditkofsky likes securities such as Granite REIT. “It has a solid portfolio that is focused on e-commerce and has been fairly resilient during the pandemic. Historically, it was very exposed to Magna International, but it has diversified away from them. Among their largest tenants is Amazon.” The bond, which matures in 2031, has a yield of 2.35%.

Another favourite is Mattamy Homes Ltd., a privately-held real estate developer, which has a bond maturing in 2027 that is yielding 3.5%. “It’s one of Canada’s largest home builders and has significant land holdings in the Greater Toronto Area. It has a fairly stable credit profile.”

Year-to-date (Feb. 12), the fund is down 1.86%, versus the Canadian Fixed Income category which is down 1.66%. This is largely attributable to yields creeping higher. “It’s not surprising given the economic backdrop. But we believe the market will offer better entry points in the next quarter that will support better returns,” says Ditkofsky, adding that investors should lower their expectations for this year.