Bond Fund Commentary
Portfolio Advisor: Industrial Alliance Investment Management
Inc.
Fund Commentary - December 31, 2011
The 2011 economic year ended on a fragile note due to the
European sovereign debt crisis, which is continuing to have
repercussions on financial markets worldwide, overshadowing any
positive economic news. In the second half of 2011, the financial
markets witnessed a significant resurgence in equity market
volatility as concerns of a Greek debt default reached their peak.
Additionally, the market began to focus its attention on Italy
which also experienced a significant increase in their government
bond yields.
With the dramatic spike in equity market volatility in the second
half of 2011, investors sought to place assets in what they
considered safe havens, U.S. and Canadian bonds. Bond yields
dropped during the year, while prices climbed, pushing up bond
returns. Provincial bonds offered the best performance in 2011,
with a 13.2% return, followed by federal government bonds at 8.4%
and corporate bonds at 8.2%. Given the decline in the yield curve,
long-term bonds (10 years or more) offered spectacular performance
of 18.1%, followed by medium-term bonds and short-terms bonds,
which posted returns of 10.9% and 4.7% respectively. During the
year, the Bank of Canada kept its target rate at 1.0% as conditions
in global financial markets have deteriorated due to the deepening
sovereign debt crisis in Europe. Inflation data remains within the
3% upper limit of the Bank of Canada's target range. The Bank of
Canada has indicated the next interest rate increase may not come
until later in 2012. The U.S. Federal Reserve has also maintained
its low interest rates policy throughout 2011, indicating that it
will keep rates low until they see sustained economic improvement.
However, interest rates still remain low by historical standards.
Despite a good first quarter, the Fund underperformed the
benchmark, DEX Universe Bond Index, in 2011. The Fund's shorter
duration relative to its index was a detractor to performance. In
the second and third quarter, longer dated bond maturities
outperformed shorter maturities.
In addition, the Fund's overweighting of higher quality corporate
bonds underperformed lower quality corporate bonds while being
underweight in provincial holdings detracted from relative
performance given their outperformance in comparison to federal and
corporate bonds in 2011. The Portfolio Advisor has reduced the
Fund's exposure to corporate bonds and will be on the lookout for
investment opportunities in the government-issued securities space.
The Fund's duration remains shorter than the benchmark as a
defensive strategy against the potential for rising interest
rates.