Fixed Income Investing in a Low Yield World: High Yield Bonds Still Part of the Solution. Fall 2012

Size: px

Start display at page:

Download "Fixed Income Investing in a Low Yield World: High Yield Bonds Still Part of the Solution. Fall 2012"

Sophie Lester
5 years ago
Views:

1 Fixed Income Investing in a Low Yield World: High Yield Bonds Still Part of the Solution Fall 2012

2 U.S. 10-Year Treasury Yields October 5, % 0 Jan-82 Feb-86 Mar-90 May-94 Jun-98 Jul-02 Aug-06 Oct-10 Source: Bloomberg

4 High Yield Bonds Are Part of the Solution 1 Provide excess return potential compared to government and other high quality bonds

5 HY Bond Returns Over the Long Term Returns January 1990 July 2012 Return Volatility Sharpe Ratio High Yield Bonds 9.4% U.S. 10-Year Treasury Bond 7.0% S&P % As of date: July 31, 2012 Source: Credit Suisse, BAML Indices, S&P 500

6 2012 HY Returns vs. Higher Quality Bonds Returns 2012 YTD High Yield Bonds 12.59% U.S. Investment Grade 9.03% U.S. 10-Year Treasury Bond 3.53% As of date: Oct. 5, 2012 Source: BAML Indices

8 Why Are HY Bond Returns so Strong in 2012? Significant fund flows Organic demand Continued search for yield Strong company fundamentals

9 High Yield Bonds Are Part of the Solution 1 Provide excess return potential compared to government and other high quality bonds 2 Provide protection against rising rates

11 Protection From Rising Interest Rates U.S. Treasury Bonds U.S. Investment Grade U.S. High Yield Total Returns Entire Period Total Returns in Rising Rate Environment Total Returns in Falling Rate Environment Source: BAML Indices (U.S, Treasuries Master Index, US Corporate Master Index, Citigroup Indices (US High Yield Index) Monthly Return History (Jan 1994 Sep 2012)

12 High Yield Bonds Are Part of the Solution 1 Provide excess return potential compared to government and other high quality bonds 2 Provide protection against rising rates 3 Diversification benefits

13 Fixed Income Portfolio Diversification Correlation with U.S. Treasuries January 1994 Sept 2012 Correlation U.S. Investment Grade 0.65 U.S. High Yield Based on monthly total return data. Index sources are the following: 1. US Treasuries: Merrill Lynch's US Treasury Master Index (G0Q0) 2. US Investment Grade: Merrill Lynch's US Corporate Master Index (C0A0) 3. US High Yield: Citigroup's US High-Yield Market Index Source: RBC GAM

14 What Next?

15 Short-Term Outlook Cautious due to seasonality and strong YTD performance Euro debt and global economic risks remain elevated High Yield bonds a crowded trade?

16 Long-Term Outlook Constructive Credit risk is low

17 Strong Company Fundamentals Defaults Are Low Source: JPMorgan

18 Long-Term Outlook Constructive Credit risk is low Relative value attractive

19 Fixed Income Alternatives 7% 6% Yields Across Fixed Income Oct. 5, % 5% 4.50% Yield 4% 3% 2.85% 2.99% 2% 1.74% 1.80% 1% 0% US 10 yr Govt CA 10 yr Govt US IG CA IG EM US HY Source: Bloomberg, RBC GAM

20 Valuation Still Attractive Recent Spreads October 5, 2012 BofA ML HY Master II Index

21 Long-Term Outlook Constructive Credit risk is low Relative value attractive Low government yields provide support coupon remains attractive

22 Coupon Advantage of High Yield Bonds 8% 7.71% 7% 6% Current Yield (%) 5% 4% 3% 2% 1.63% 4.50% 1% 0% US 10yr Treasury US Investment Grade US High Yield Source: Bloomberg, RBC GAM Oct. 5, 2012

23 Long-Term Outlook Constructive Credit risk is low Relative value attractive Low government yields provide support coupon remains attractive Some protection from rising rates

24 RBC High Yield Bond Fund

25 Objective Above average income with some capital growth Return advantage versus DEX Universe Bond Index Low volatility Capital preservation

26 Portfolio Characteristics October 5, 2012 Duration 3.23 Portfolio yield Current yield Average portfolio credit rating 3.87% 6.27% BB Asset Mix - High Yield 73.4% - Investment grade 17.4% - Cash 8.8% Marginal USD exposure Source: RBC GAM

27 Credit Quality RBC High Yield Bond Fund Credit Rating Distribution Oct. 5, % of Portfolio AAA/Cash AA A BBB BB B CCC Ratings Source: RBC GAM

Geographic Distribution October 5, 2012 4.0% 8.8% 20.8% Canada 20.

28 Geographic Distribution October 5, % 8.8% 20.8% Canada 20.8% United States 66.0% Other 4.0% Cash 8.8% 66.0% Source: RBC GAM

30 RBC High Yield Bond Fund Investment Strategies Target credit rating of BB Will invest primarily in bonds rated BBB to B in the U.S. and Canada Actively managed with ability to dial risk up or down as appropriate Shorter maturity bias Maximum 10% exposure on CCC rated bonds Currency will be hedged as policy with limited tactical FX exposure

31 Strong Company Fundamentals

Valuations U.S. Earnings Are On Sale especially if you re Canadian Canadians paid over 45x earnings to buy U.S. stocks, from here 10-year annualized returns were -1.9% (CAD) Average P/E 24.

32 Valuations U.S. Earnings Are On Sale especially if you re Canadian Canadians paid over 45x earnings to buy U.S. stocks, from here 10-year annualized returns were -1.9% (CAD) Average P/E 24.8 (CAD/USD) Average P/E 19.0 (USD) Current P/E ~14.0* Canadians paid 14x earnings, from here 10-year annualized returns were 21.9% (CAD) Source: S&P, RBC GAM *S&P 500 Index as of Mar 1, 2012/Trailing operating earnings as of Dec 31, 2011

33 Valuations U.S. Companies in Solid Financial Position Improving balance sheets and almost $2 Trillion in cash indicate flexibility/ability to withstand shocks % United States Nonfinancial Corporate Balance Sheets Debt-Equity (LHS) Interest Coverage (RHS) Times Interest Earned $ Trillion U.S. Corporate Cash Balances Nonfarm Nonfinancial Corporations (NSA, $Tril.) Last Plot: $1.81 Trillion Source: Federal Reserve, Haver Analytics Source: Federal Reserve Board, Haver Analytics, RBC GAM Data as of March 2012

Valuations S&P 500 Dividend Payout Lowest Ever 160 S&P 500 1 Dividend Payout Ratios 1871 Through January 2012 % 140 120 100 80 Low Payout = Substantial Room to Grow Dividends 60 40 20 1871 75 80 85

34 Valuations S&P 500 Dividend Payout Lowest Ever 160 S&P Dividend Payout Ratios 1871 Through January 2012 % Low Payout = Substantial Room to Grow Dividends Recessions Source: Robert Shiller, National Bureau of Economic Research, Federal Reserve Board, Standard and Poor's, Corporate Reports, Empirical Research Partners Analysis. 1 Capitalization- weighted data. Source: Empirical Research Partners

35 The Economy U.S. Economic Data Continues to Surpass Expectations 150 U.S. Economic Surprises Are Positive Index, 1 Std Dev= Positive Surprises Negative Surprises -150 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Source: Citigroup Alpha Surprise Index, RBC GAM Data as of March 2012

36 The Economy U.S. Housing Stabilizing, And May Be Rising While we believe the recovery will be quite slow, housing activity has bottomed and affordability is very good Normalized U.S. Housing Activity Normalized U.S. Housing Activity Has Bottomed Normalized Housing Activity Maximum-Minimum Band Evidence of a rebound remains tentative at best Unusually wide divergence of measures adds uncertainty Note: Simple average of normalized single-unit housing starts, single-unit building permits, existing home sales, new home sales and NAHB housing market index. Source: Haver Analytics, RBC GAM % Deviation From Fair Value U.S. Housing Affordability is Very Good Poor Affordability Good Affordability Capped Affordability Is Good Current Affordability is Excellent -60 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 Note: Calculates for 30-year fixed rate mortgage with 25% down on median single-family home price, for median household income. Current Affordability calculates the current deviation from the historical norm. Capped Affordability gauges affordability using a floor of normal borrowing rates. Source: Haver Analytics, RBC GAM Data as of March 2012

37 Valuations Purchasing Power Parity An undervalued U.S. dollar is a key indicator for Canadians investors PPP Average USD-CAD 20% bands A decade ago Higher Currency Risk Lower Currency Risk Today Source: RBC GAM, Bloomberg, March 2012

38 Inventories Of Homes For Sale Are Down To Pre-Crisis Levels Source: Empirical Research Partners Analysis

39 In Part Because The Incentive To Speculate Is High 4 % Rent-to-Home Price Ratio 2 0 (2) (4) (6) (8) Source: Empirical Research Partners Analysis

40 Improving Home Turnover Usually Leads To Rising Prices Source: National Association of Realtors, Census Bureau, Empirical Research Partners Analysis

41 Home Builders Survey Suggests Improving Activity Ahead Source: Wolfe Trahan & Co. Portfolio Strategy

42 And An Improving Employment Outlook Source: Wolfe Trahan & Co. Portfolio Strategy

43 And A Rising Stock Market Source: Wolfe Trahan & Co. Portfolio Strategy

44 U.S. Stock Markets Diversify globally - U.S. companies have significant foreign exposure 80% S&P 500 Index % International Revenue by Sector 60% 40% 20% 0% Enerygy Materials Info Tech Industrials Health Care Cons. Disc. Cons. Staples Financials Utilities Telecom Source: RBC Capital Markets Research, Capital IQ Data as of December 31, 2012

45 U.S. Stock Markets Diversify globally - U.S. companies have significant foreign exposure International Corporate Profits International as % of Total 40% 30% 20% 10% Almost a quarter of U.S. corporate profits come from beyond U.S. borders The last decade saw international profits triple International Profits (Bil. $) 0% International Profits as % of Total International Profits (Bil. $) Source: Citi Investment Research

46 U.S. Stock Markets Diversify globally - U.S. companies have significant foreign exposure 80% S&P 500 Index % International Revenue by Sector 60% 40% 20% 0% Enerygy Materials Info Tech Industrials Health Care Cons. Disc. Cons. Staples Financials Utilities Telecom Source: RBC Capital Markets Research, Capital IQ Data as of December 31, 2012

47 U.S. Stock Markets Diversify globally - U.S. companies have significant foreign exposure International Corporate Profits International as % of Total 40% 30% 20% 10% Almost a quarter of U.S. corporate profits come from beyond U.S. borders The last decade saw international profits triple International Profits (Bil. $) 0% International Profits as % of Total International Profits (Bil. $) Source: Citi Investment Research

48 10 Companies That Control Approx. 90% of What You Buy

49 DISCLAIMER: This information has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. RBC GAM takes reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when printed. Due to the possibility of human and mechanical error as well as other factors, including but not limited to technical or other inaccuracies or typographical errors or omissions, RBC GAM is not responsible for any errors or omissions contained herein. RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information. Any investment and economic outlook information contained in this report has been compiled by RBC GAM from various sources. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by RBC GAM, its affiliates or any other person as to its accuracy, completeness or correctness. RBC GAM and its affiliates assume no responsibility for any errors or omissions. A NOTE ON FORWARD-LOOKING STATEMENTS This report may contain forward-looking statements about the Fund, its future performance, strategies or prospects, and possible future Fund action. The words may, could, should, would, suspect, outlook, believe, plan, anticipate, estimate, expect, intend, forecast, objective and similar expressions are intended to identify forward-looking statements. Forwardlooking statements are not guarantees of future performance. Forward-looking statements involve inherent risks and uncertainties, both about the Fund and general economic factors, so it is possible that predictions, forecasts, projections and other forwardlooking statements will not be achieved. We caution you not to place undue reliance on these statements as a number of important factors could cause actual events or results to differ materially from those expressed or implied in any forward-looking statement made in relation to the Fund. These factors include, but are not limited to, general economic, political and market factors in Canada, the United States and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological changes, changes in laws and regulations, judicial or regulatory judgments, legal proceedings and catastrophic events. The above list of important factors that may affect future results is not exhaustive. Before making any investment decisions, we encourage you to consider these and other factors. / Trademark(s) of Royal Bank of Canada. Used under licence. RBC Global Asset Management Inc. 2012

RBC Dominion Securities Inc. Festive Lunch November 12 th, 2015

RBC Dominion Securities Inc. Festive Lunch November 12 th, 2015 2012 Total Returns Paul Alofs President & CEO 2 A peek inside the Economics Department 2012 Total Returns 3 Focus on Four Themes The U.S.