BAY STREET-With Canada rates rising, bond buyers go corporate

* Big investors see corporate debt outperforming

* Rate hikes seen moderate, reflecting improving economy

* Provinces, high yield also seen beating Canada bonds

By Jeffrey Hodgson

TORONTO, May 30 (BestGrowthStock) – Big bond investors are laying
bets that Canadian corporate debt will offer superior returns
as the Bank of Canada abandons record-low interest rates and
kicks off the first tightening cycle of the decade.

An improving economy, the main reason for the likely rate
hike, is why many fixed-income fund managers see corporate debt
outperforming lower-yielding Canadian government bonds. But
they also highlight healthy corporate balance sheets and
attractive investment opportunities in bonds.

“It’s not a bad thing that the Bank of Canada is going to
raise interest rates … this is in response to a very strong
economy,” said William John, a bond fund manager with Phillips
Hager & North, a unit of Royal Bank of Canada (RY.TO: ).

“It shouldn’t be something that should scare people away
from good quality investments … That doesn’t make corporate
debt less attractive,” added Vancouver-based John.

A Reuters poll released on Thursday showed 32 of 40 global
forecasters expect the Bank of Canada to raise rates by 25
basis points on June 1, [CA/POLL](POLL20: ) making it the first
G7 central bank to start nudging crisis-level rates higher.

A rise would bring the overnight rate to 0.5 percent, still
low by historical standards.

The price of many bonds, particularly shorter-term issues,
tends to fall when interest rates rise, as coupons become less
attractive compared with rising yields elsewhere. But the
impact varies, depending on the type of security.

“Generally, government securities, government of Canada
paper is affected most directly when they raise rates. There’s
a bit of cushion in provincials and more of a cushion in
corporate debt against that rate rise,” said Terry Carr, head
of Canadian fixed income for MFC Global Investment Management,
a unit of Manulife Financial Corp. (MFC.TO: )

Carr, who helps manage about C$16 billion ($15.2 billion)
in fixed-income assets, said his team is “very underweight”
Canadian government bonds, favoring provincial and corporate
debt and high-yield or junk bonds where its mandates allow.

BALANCE SHEETS, YIELDS APPEAL

Many mid-term corporate bonds (CA/CORP: ) now yield about 135
to 150 basis points over similar Canadian government bonds,
well above the 40 to 60 basis point spreads seen in 2004 to
2006. Junk bonds can yield 500 to 700 basis points more.

That means a bond due 2014 issued by a blue chip firm like
phone company Telus Corp (T.TO: ) yields 3.799 percent.

“The spread levels, the actual yield that we’re getting
from buying a corporate bond versus the federal government bond
in the same term, are similar to previous recessionary times in
Canada,” said Heather McOuatt, lead manager of Bissett Bond
Fund for Franklin Templeton Investments.

Calgary-based McOuatt, who is also overweight Canadian
corporate bonds, said the issues were “very, very fairly
valued” in view of the risk they offered.

Canadian bond fund managers said Europe’s debt crisis and
other global developments are the biggest single threat to
their forecasts, as provincial, corporate and high-yield debt
are only likely to outperform if the recovery holds.

A resumption of the financial crisis would likely see bond
investors pile back into the safety of Canadian government
bonds, causing spreads to less credit-worthy issues to widen.

“If we somehow slip back into recession, then I think all
bets are off,” said MFC’s Carr.

But nobody expects a rapid rise in benchmark interest rates
as the Bank of Canada watches developments abroad.

“The Bank of Canada is not going to be very aggressive at
this stage. They’re quite aware of what’s going on globally,
what’s going on in Europe,” said Tom Nakamura, a bond portfolio
manager with AGF Management Ltd (AGFb.TO: ).

Investment Analysis

($1=$1.05 Canadian)
(Editing by Rob Wilson)

BAY STREET-With Canada rates rising, bond buyers go corporate