By Miles Clyne
From about September 2013 to February 2015, long-term Canadian bonds had an extraordinary run with gains of around 23%. Long-term bonds are now struggling to hold onto those gains. The chart below is the Canadian long-term bond ETF XLB, which is a proxy for a basket of long-term Canadian issued government bonds.
If you look at the chart, almost half of the gain, was almost a vertical line, a race for the top. The old saying “when fools rush in” comes to mind. When we talk about government bonds, especially Canadian Government Bonds, we think of prudent safe investments. But just like when any investment starts to run uncontrollably, the Greater Fool Theory can kick in for some or many investors. To get the degree of rally that occurred in one of Canada’s largest asset classes, there were a lot of investors rushing in.
The Greater Fool Theory
Suggests that a person would buy something at a foolish price, expecting someone (a greater fool) to pay even a higher price. But the party is almost assuredly to end, and not well for many.
But maybe these folks weren’t just trying to jump on a gravy train and make a quick buck. Maybe there was logic behind buying into an asset class at historic low interest rate levels? Often government bonds can be a safe haven in times of uncertainty. Money from equity investments will flow to bonds in a flight to safety when equity markets are correcting. The aggressive rally in Long-term Bonds coincides very closely with the start of the choppiness in the equity markets (blue line-equities vs. white line-long-term bonds).
Without a doubt, something is a foot in the markets. From about mid-April (see last vertical line), both the bond and equity markets have been falling, making it very difficult to make returns whether you own bonds, equities or both. From Mid-April to Mid-June the S&P TSX Composite has fallen about 4.5% and long-term bonds over 7%.
For our investors, we have done exceptionally well over this period, with only minor losses in our bond strategy through mid-June of about 1.5% and our best case equity portfolio was up over 10%. These time frames are measured from the peak as shown in the graph of mid-April to mid-June.
What Is An Investor To Do?
Pretty easy from my sofa to quarterback this play. You nor I will rarely, if ever, be absolutely right. Getting more approximately right is the game plan. Our bonds strategy has done extremely well from a risk return perspective because of our screening process of the bond managers. We got to choose from almost the full universe of managers and their strategies. We had already determined the type of players (managers & strategies) we wanted on our team and they were on the field, regardless of where interest rates head or what the Greater Fools think is a way to make money and or be safe, we will be in the game. Our Core equity strategies follow the same process. So we know we have great players on the field at all times for our clients, regardless of the opposition they will face.
When you have great depth of players both offensively and defensively, you get to watch the game unfold in all of its glory, knowing your team has very high odds of winning. You have to have a way to stack your team, much like you would do if you were in sports pool where you get to choose your team. Investing is not about being in the game as most would have you believe, it is about winning the game. We come to win.