Fixed Income Investing in a Low Yield World: High Yield Bonds Still Part of the Solution Fall 2012
U.S. 10-Year Treasury Yields October 5, 2012 16 14 12 10 8 6 4 2 1.74% 0 Jan-82 Feb-86 Mar-90 May-94 Jun-98 Jul-02 Aug-06 Oct-10 Source: Bloomberg
High Yield Bonds Are Part of the Solution 1 Provide excess return potential compared to government and other high quality bonds
HY Bond Returns Over the Long Term Returns January 1990 July 2012 Return Volatility Sharpe Ratio High Yield Bonds 9.4% 8.6 0.68 U.S. 10-Year Treasury Bond 7.0% 7.4 0.46 S&P 500 8.5% 15.2 0.32 As of date: July 31, 2012 Source: Credit Suisse, BAML Indices, S&P 500
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
Why Are HY Bond Returns so Strong in 2012? Significant fund flows Organic demand Continued search for yield Strong company fundamentals
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
Protection From Rising Interest Rates 12 10 8 6 6 6.9 7.7 U.S. Treasury Bonds U.S. Investment Grade U.S. High Yield 6.3 9.5 10.5 8.5 4 2 0-2 -0.3 0.4 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)
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
Fixed Income Portfolio Diversification Correlation with U.S. Treasuries January 1994 Sept 2012 Correlation U.S. Investment Grade 0.65 U.S. High Yield -0.12 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
What Next?
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?
Long-Term Outlook Constructive Credit risk is low
Strong Company Fundamentals Defaults Are Low Source: JPMorgan
Long-Term Outlook Constructive Credit risk is low Relative value attractive
Fixed Income Alternatives 7% 6% Yields Across Fixed Income Oct. 5, 2012 6.45% 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
Valuation Still Attractive Recent Spreads October 5, 2012 BofA ML HY Master II Index
Long-Term Outlook Constructive Credit risk is low Relative value attractive Low government yields provide support coupon remains attractive
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
Long-Term Outlook Constructive Credit risk is low Relative value attractive Low government yields provide support coupon remains attractive Some protection from rising rates
RBC High Yield Bond Fund
Objective Above average income with some capital growth Return advantage versus DEX Universe Bond Index Low volatility Capital preservation
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
Credit Quality 60 50 RBC High Yield Bond Fund Credit Rating Distribution Oct. 5, 2012 49.4 % of Portfolio 40 30 20 16.1 23.3 10 8.8 0 1.3 0 0.7 AAA/Cash AA A BBB BB B CCC Ratings Source: RBC GAM
Geographic Distribution October 5, 2012 4.0% 8.8% 20.8% Canada 20.8% United States 66.0% Other 4.0% Cash 8.8% 66.0% Source: RBC GAM
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
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 24.8 (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
Valuations U.S. Companies in Solid Financial Position Improving balance sheets and almost $2 Trillion in cash indicate flexibility/ability to withstand shocks 100 80 60 % 40 20 United States Nonfinancial Corporate Balance Sheets Debt-Equity (LHS) Interest Coverage (RHS) 24 2.0 20 16 12 8 4 Times Interest Earned $ Trillion 1.5 1.0 0.5 U.S. Corporate Cash Balances Nonfarm Nonfinancial Corporations (NSA, $Tril.) Last Plot: $1.81 Trillion 0 0 1980 1985 1990 1995 2000 2005 2010 2015 Source: Federal Reserve, Haver Analytics 0.0 1980 1985 1990 1995 2000 2005 2010 2015 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 89 94 99 1903 08 13 17 22 27 31 36 41 45 50 55 59 64 69 73 78 83 87 92 97 2001 06 11 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
The Economy U.S. Economic Data Continues to Surpass Expectations 150 U.S. Economic Surprises Are Positive Index, 1 Std Dev=100 100 50 0-50 -100 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
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 4 3 2 1 0-1 -2 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 -3 1963 1969 1975 1981 1987 1993 1999 2005 2011 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 60 40 20 0-20 -40 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
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
Inventories Of Homes For Sale Are Down To Pre-Crisis Levels Source: Empirical Research Partners Analysis
In Part Because The Incentive To Speculate Is High 4 % Rent-to-Home Price Ratio 2 0 (2) (4) (6) (8) 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 Source: Empirical Research Partners Analysis
Improving Home Turnover Usually Leads To Rising Prices Source: National Association of Realtors, Census Bureau, Empirical Research Partners Analysis
Home Builders Survey Suggests Improving Activity Ahead Source: Wolfe Trahan & Co. Portfolio Strategy
And An Improving Employment Outlook Source: Wolfe Trahan & Co. Portfolio Strategy
And A Rising Stock Market Source: Wolfe Trahan & Co. Portfolio Strategy
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
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 500 400 300 200 100 International Profits (Bil. $) 0% 0 1950 1965 1980 1995 2010 International Profits as % of Total International Profits (Bil. $) Source: Citi Investment Research
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
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 500 400 300 200 100 International Profits (Bil. $) 0% 0 1950 1965 1980 1995 2010 International Profits as % of Total International Profits (Bil. $) Source: Citi Investment Research
10 Companies That Control Approx. 90% of What You Buy
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