In this week’s rerun, we travel back to May 2008 for a brief look at the negative sentiment and opportunities in the corporate bond market at the time. As it turns out, the soil was fertile indeed.

Irrational Nervousness = Fertile Soil
Published May 1, 2008

The managers of our funds report to us formally once every quarter.  In the Income Fund report from Connor, Clark & Lunn, there was a chart that is a great indication of what the capital markets are going through.

It shows the extra yield an investor receives from owning a Canadian agency bond (i.e. Farm Credit Corp) compared to a conventional Government of Canada bond.  While these bonds are explicitly guaranteed by the Federal Government, they typically trade at a higher yield – approximately 10 basis points (bps) or a tenth of 1% - because they are not as liquid as Canada bonds.  Big investment managers who are moving a lot of money around prefer to use the more tradable Canada’s.

But as you can see, the nervousness in the markets has led to the spread widening to over 50 bps.  This to me is a huge indication of how nervous investors are.  I may not think it’s rational that TD Bank bonds trade at 150-200 bps above Canada’s (I don’t), but without knowing what’s going to happen in the banking sector, a spread of that size may be warranted.  With agency bonds, however, there is no credit risk.  No credit analysis can justify the current spread.  It’s just plain irrational nervousness.

Our Income Fund is more than 50% invested in corporate bonds at this stage.  CC&L feels very strongly that we’ve been given a once in 10 or 20 year opportunity to buy good quality corporates.  Undoubtedly not all of their selections will work out as they hope, but the agency spread chart tells me they are planting seeds in very fertile ground.