Bond Fund Commentary
Portfolio Advisor: Industrial Alliance Investment Management
Inc.
Fund Commentary - June 30, 2011
One year later, the same issues that were making headlines at
this time in 2010 are again in the spotlight: Greece's sovereign
debt troubles, doubts over the economic recovery in the U.S., and
inflation. Since 2010, however, the effects of the tsunami in Japan
and geopolitical trouble in the Middle East have been added to the
mix.
The optimism that seemed to have been crystallizing at the start
of the year took a turn toward caution in the second quarter. The
first quarter's positive returns were wiped out and became the
second quarter's losses. Weak economic data in the United States,
the measures China has taken to contain inflation, instability in
the Middle East, and sovereign debt troubles in Europe sapped the
optimism of stock market investors. As a result, investors modified
their portfolios by turning to less cyclical sectors, and the bond
market took advantage of this climate of uncertainty, once
again.
The Canadian bond market has benefited from the poor economic
news and from the uncertainty surrounding Greece's troubles, making
gains in the second quarter as the yield curve declined. All bond
terms along the yield curve generated positive returns. The medium-
to long-term bonds achieved the best returns. Thus, bond managers
who favoured medium-term securities achieved the best returns, with
a gain of 2.70%, followed by longer-term bonds, up 2.48%, and
finally short-term bonds, which earned 1.77%.
Among corporate issuers, A-rated bonds generated the best return
for the quarter with 3.21%, followed by BBB-rated bonds with 2.42%,
while higher quality, AAA/AA-rated bonds ended the quarter with
2.39%.
Overall, the DEX Universe Bond Index, representing the Canadian
bond market, was up 2.2% year-to-date, with second quarter returns
erasing the slight loss recorded in the first three months of
2011.
In the next 12 months, the Portfolio Advisor expects a slight
uptick in the interest rate curve, which should have an impact on
the bond market, given the inverse relationship between interest
rates and bond prices. Thus, the Portfolio Advisor believes that
bond returns will be rather modest for the next 12 months.
The Fund detracted value when comparing it to its benchmark in
the first six months of the year. The Fund's shorter duration,
compared to that of its benchmark, was a drag on performance,
mostly in the second quarter, as longer maturities outperformed
shorter maturities. Another source of detraction came from the
Fund's overweighting of higher-quality corporate bonds since these
underperformed the lower quality corporate bonds, as mentioned
earlier. The Fund's underweight in provincial holdings was also a
mixed bag, being positive in the first quarter, and then detracting
value in the second.
The Portfolio Advisor lengthened the duration of the Portfolio
slightly and purchased real return bonds (RRBs) in the second
quarter as a protection against inflation, but sold them by quarter
end as the outlook became tamer. The different sectors were
slightly repositioned so that the Fund has reduced its corporate
weightings slightly, and increased its positions in both the
federal and provincial sectors.