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The Hurdles Facing Foundations Have Never Been Higher

Responding to a higher disbursement obligation in a lower return environment

In light of the Government of Canada's decision to increase the disbursement quota for foundations, we believe foundation executives and trustees should look to “Active Credit” to improve the return potential of their fixed income allocation.

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What Should An Allocator Do With Their Core Bond Portfolio?

Faced with a challenging return environment, pension and endowment investors are presented with some difficult choices. We believe that a thoughtful unbundling of the fixed income allocation can help investors preserve liquidity needs and generate more income than a traditional core allocation without increasing portfolio risk.

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2021 Sustainability Report

At RPIA, 2021 was an important year for our ESG evolution as we refined our ESG philosophy and began our own ESG journey. Our 2021 Sustainability Report details how we continue to incorporate ESG into our firm operations, investment management philosophy, and our goals for 2022.

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Cover for RPIA 2021 Sustainability Report
 
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Our Solutions

Our Solutions

We serve a broad range of investors through a variety of solutions catering to their unique investment goals. We apply our differentiated active skillset in all our strategies, which vary from low-risk to higher-risk. Although our toolkit and risk/return levels vary across our suite of products, our credit expertise, proprietary technology, and rigorous risk management is applied throughout. We have collaborated closely with institutional investors in developing several of our strategies to ensure that the portfolio mandate aligns with their long-term investment objectives.

RPIA Develops Carbon-Reduced Fixed Income Solution

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Investment Process

Investment Process

RPIA's approach is to apply a highly active, dynamic investment process that enables us to consistently extract value from the global credit market, driven by security selection. Investors do not need to compromise on credit quality or sacrifice liquidity to improve their portfolio returns. Our active approach can be distilled into four steps:

1. The Investment Committee uses their expertise and experience to collaborate and identify a key theme based on prevailing macroeconomic conditions.

2. The Credit Research Team conducts deep-dive research to determine the most compelling issuer, drawing from their knowledge of the sectors each team member covers.

3. We utilize our proprietary technology and expertise to identify the most attractively priced bond within that issuer's capital structure

4. The Portfolio Management Team sizes the position accordingly within the strategy based on factors such as conviction level, existing exposures, and liquidity considerations to name a few.

The entire process is overseen by our independent Risk Management Team and Committee who analyze policy constraints, stress testing, and concentrations across strategies.

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Our Strategies

Our Strategies

RPIA offers a range of investment strategies reflecting our investors' diverse risk and return objectives. Our flagship institutional long-only strategy is RP Broad Corporate Bond, which has evolved into a suite of strategies for specific goals in collaboration with investors. In addition to our institutional-focused mandates, we also offer absolute return-focused strategies.

1. Long-Only Strategies

  • RP Broad Corporate Bond
  • RP Broad Corporate Bond (BBB, Carbon-Reduced)

2. Alternative Credit & Fixed Income

  • RP Debt Opportunities
  • RP Select Opportunities
  • RP Fixed Income Plus

3. Mutual Funds

  • RP Strategic Income Plus Fund
  • RP Alternative Global Bond Fund
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ESG

ESG

RPIA considers Environmental, Social, and Governance ("ESG") factors when making investment decisions for all the strategies we manage. When we include these factors alongside traditional financial metrics, we can think more broadly about risk and make more prudent investment decisions. In other words, it is in the best interests of our investors to integrate ESG into our process. Through our in-depth credit research, we are in regular communication with the management teams of the issuers in which we invest. We have also partnered with an institutional investor to design a strategy that targets specific ESG outcomes and, in this case, an Environmental outcome. We have been a signatory to UN PRI since 2018 and have several other industry memberships ( learn more).

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Explore Our Funds

RP Broad Corporate Bond

This actively managed credit strategy's primary objective is to outperform the FTSE Canada All Corporate Bond Index net of fees in a risk-controlled manner. The strategy aims to add value through superior credit selection across global credit markets and avoid uncompensated interest rate risk by remaining duration-neutral versus the benchmark.

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RP Broad Corporate Bond (BBB, Carbon Reduced)

An actively managed credit strategy whose primary objective is to outperform the FTSE Canada Corporate BBB Index net of fees by 100 bps on an annualized basis. The strategy extends on our longstanding Broad Corporate Bond investment process by including explicit ESG targets. Investments in tobacco and munitions are prohibited, and the strategy aims to keep the carbon intensity at least 30% lower than the index.

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Market Commentary

Relative Merits: Bonds vs. GICs in a Higher Yield Environment

May, 2022

Q1 2022 was the worst quarter for fixed income in four decades as central banks commenced tighter monetary regimes to combat persistently high inflation. In response, bond yields spiked, sending bond prices sharply lower given the classic inverse relationship.

The upside to this challenging scenario is that the upheaval in yields has created an opportunity for fixed income investors to purchase bonds and GICs at the most attractive yield levels in many years. In response to the increase in GIC yields, investors are wondering if they should utilize GICs instead of bonds as a source of safe income. But are they the best option? 

This article considers the different roles that bonds and GICs play in a portfolio, along with potential advantages and disadvantages to consider when making an allocation. At this juncture, there are three key reasons why investors should favour bonds over GICs:

  1. Greater Return Potential
  2. Tax Efficiency
  3. Superior Liquidity
 

The Role of GICs and Bonds in Portfolios

Investors may hold GICs and bonds for a variety of purposes, including:

  • A long-term strategic allocation that provides income and stability 
  • A transitory placeholder that will be invested in higher return-seeking assets in the future

While the use case is often lumped together, it is essential to view these asset classes as distinct. GICs have historically been utilized as a transitory allocation to provide a risk-free level of income while also generally guaranteeing a low or negative real return. The recent market volatility has made investors believe that GICs can be a substitute for bonds over the long term.

However, bonds can play a more robust role in a portfolio. Historically, bonds have provided better total returns due to higher yields, capital appreciation opportunities, and tax efficiencies without sacrificing long-term capital preservation or liquidity.
 

The table below compares some key attributes to consider when comparing the two:

Table comparing some key attributes to consider when comparing bonds and GICs

*Based on GIC rates compiled by RBC Dominion Securities Inc. as of May 2022.

Bonds Preserve Capital and Provide Better Returns

Over any reasonable time horizon, the historical return of the FTSE Canada All Corporate Bond Index has eclipsed the return on the average 3-year GIC rate. This is particularly true after bond markets experience volatility and reprice lower due to the tailwind of higher yields and more considerable capital appreciation opportunities. 

The chart below illustrates that investors pay significant opportunity costs, especially in the long run, when they are lured into investing in GICs after periods of market volatility

Difference between rolling 3yr total return of the FTSE Canada All Corporate Bond Index vs. 3yr GIC Rate

Source: FTSE Russell, Bank of Canada. Data as of April 29th, 2022.

GICs Never Go Down But They Also Never Go Up

One of the main reasons bonds outperform GICs over longer periods such as 3 and 5 years, is that bonds are largely “self-correcting.” As yields go up and prices come down, having the flexibility to capture higher running yields enables investors to retrieve some of that lost capital. GICs’ inherent aversion to mark-to-market risk is alluring, but remember, an investor forgoes the ability to capture higher yields when they lock in the prevailing GIC yield. 

In addition, bonds can play an active role in protecting capital when equity markets experience drawdowns. It is easy to get caught up in recency bias and believe that bonds and equities will continue to lose money together as is the case today, but traditionally, this has not been the case.

Fixed Income and GIC Returns During Equity Market Volatility Chart: Credit can provide ballast and greater returns relative to GICs during equity volatility

Source: Bank of Canada, FTSE Russell, S&P Global.

Canadian equities have lost more than 5% in 14 quarters since 1999. The average quarterly return of Canadian equities, bonds, and GICs during these quarters are:

  • S&P/TSX Composite = -12.1%
  • FTSE Canada Universe Bond Index = +2.6%
  • 3-Year GICs = +0.5%

Overall, bonds tend to provide an inversely correlated return stream to equities and insulate investors' portfolios during times of equity turmoil, while also outpacing the return of GICs.

Discounted Bonds Retain More Yield After Taxes

An important consideration when calculating total returns is the need to adjust for taxes. GIC returns are sourced 100% from coupon payments, which are taxable in non-registered accounts at an investor’s full marginal tax rate. 

On the other hand, a bond’s total return consists of both interest/coupon payments and capital appreciation and can be more tax-efficient, particularly when purchased at a discount to its original issue price (usually $100 Par).

To illustrate, we have provided an example of a 3-year GIC vs. a 3-year corporate bond trading at a $5 discount to its original Par value

An example of a 3-year GIC vs. a 3-year corporate bond trading at a $5 discount to its original Par value

Source: Bloomberg, RBC Dominion Securities. Data as of May 4th, 2022.
3-Year GIC coupon rate is based on GIC rates compiled by RBC Dominion Securities Inc. as of May 2022. 

The yield to maturity for this specific bond is 3.92%, split as ~2.24% per year from coupon payments and the remaining 1.68% from an upward move in the bond price as it gets closer to its maturity date and repayment of principal.

The yield that an investor collects from the non-coupon related increase in the bond price is taxed beneficially as a capital gain and ultimately leads to a better after-tax return for a taxable investor relative to holding a GIC with a similar yield.  

Bonds Provide Liquidity at a Reasonable Cost

Bonds are liquid, publicly traded instruments that are generally traded over the counter (OTC) through dealers. Transaction costs are not standardized like they are for equities that are traded on an exchange. Instead, transaction costs are embedded into the dealer's bid-offer spread and typically have a minimal impact on prices for liquid investment-grade bonds.

Non-cashable/non-redeemable GICs are almost always required to be held until maturity. To break a contract early, you would have to demonstrate significant financial hardship, and even then, there is no guarantee that an issuing financial institution would let you redeem. If the issuer does agree to break the contract, there are usually substantial penalties which often include the loss of some or all of your accrued interest.

For clients who prefer higher liquidity, a daily traded mutual fund or monthly redeemable investment fund might be a more agreeable way to pursue higher yields and returns. Particularly if the allocation has a longer strategic role in a broader portfolio setting that has been tuned to achieve pre-defined financial goals. 

Putting it All Together

For decades, bonds have been a resilient and consistent asset class that has provided investors with sought-after stability. Although the recent volatility has been unfortunate, it has given bonds the ability to once again offer longer-term protection and a return profile that is now more likely to keep pace with inflation over the next few years. 

We believe this is a critical period for investors to move closer to a neutral weight in bonds as the higher forward yields and capital appreciation opportunities can now compensate investors over the intermediate and longer-term. Simple logic would dictate that the time to buy bonds is when inflation measures are above average considering higher yields are available as compensation for that risk, particularly when you have a long investment horizon and the chance of inflation being lower in the next few years is more likely. 

 
 

 

 

Important Information

The information presented herein is for informational purposes only. It does not provide financial, legal, accounting, tax, investment, or other advice and should not be acted or relied upon in that regard without seeking the appropriate professional advice. The information is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does RP Investment Advisors LP (“RPIA”) assume any responsibility or liability whatsoever. The information provided may be subject to change and RPIA does not undertake any obligation to communicate revisions or updates to the information presented. Unless otherwise stated, the source for all information is RPIA. This document does not form the basis of any offer or solicitation for the purchase or sale of securities. Products and services of RPIA are only available in jurisdictions where they may be lawfully offered and to investors who qualify under applicable regulation.

Unlike GICs, RPIA-managed funds or strategies are not guaranteed and carry the risk of financial loss. “Forward-Looking” statements are based on assumptions made by RPIA regarding its opinion and investment strategies in certain market conditions and are subject to a number of mitigating factors. Economic and market conditions may change, which may materially impact actual future events and as a result RPIA’s views, the success of RPIA’s intended strategies as well as its actual course of conduct. 

 

 

ESG Articles

Relative Merits: Bonds vs. GICs in a Higher Yield Environment

May, 2022

Q1 2022 was the worst quarter for fixed income in four decades as central banks commenced tighter monetary regimes to combat persistently high inflation. In response, bond yields spiked, sending bond prices sharply lower given the classic inverse relationship.

The upside to this challenging scenario is that the upheaval in yields has created an opportunity for fixed income investors to purchase bonds and GICs at the most attractive yield levels in many years. In response to the increase in GIC yields, investors are wondering if they should utilize GICs instead of bonds as a source of safe income. But are they the best option? 

This article considers the different roles that bonds and GICs play in a portfolio, along with potential advantages and disadvantages to consider when making an allocation. At this juncture, there are three key reasons why investors should favour bonds over GICs:

  1. Greater Return Potential
  2. Tax Efficiency
  3. Superior Liquidity
 

The Role of GICs and Bonds in Portfolios

Investors may hold GICs and bonds for a variety of purposes, including:

  • A long-term strategic allocation that provides income and stability 
  • A transitory placeholder that will be invested in higher return-seeking assets in the future

While the use case is often lumped together, it is essential to view these asset classes as distinct. GICs have historically been utilized as a transitory allocation to provide a risk-free level of income while also generally guaranteeing a low or negative real return. The recent market volatility has made investors believe that GICs can be a substitute for bonds over the long term.

However, bonds can play a more robust role in a portfolio. Historically, bonds have provided better total returns due to higher yields, capital appreciation opportunities, and tax efficiencies without sacrificing long-term capital preservation or liquidity.
 

The table below compares some key attributes to consider when comparing the two:

Table comparing some key attributes to consider when comparing bonds and GICs

*Based on GIC rates compiled by RBC Dominion Securities Inc. as of May 2022.

Bonds Preserve Capital and Provide Better Returns

Over any reasonable time horizon, the historical return of the FTSE Canada All Corporate Bond Index has eclipsed the return on the average 3-year GIC rate. This is particularly true after bond markets experience volatility and reprice lower due to the tailwind of higher yields and more considerable capital appreciation opportunities. 

The chart below illustrates that investors pay significant opportunity costs, especially in the long run, when they are lured into investing in GICs after periods of market volatility

Difference between rolling 3yr total return of the FTSE Canada All Corporate Bond Index vs. 3yr GIC Rate

Source: FTSE Russell, Bank of Canada. Data as of April 29th, 2022.

GICs Never Go Down But They Also Never Go Up

One of the main reasons bonds outperform GICs over longer periods such as 3 and 5 years, is that bonds are largely “self-correcting.” As yields go up and prices come down, having the flexibility to capture higher running yields enables investors to retrieve some of that lost capital. GICs’ inherent aversion to mark-to-market risk is alluring, but remember, an investor forgoes the ability to capture higher yields when they lock in the prevailing GIC yield. 

In addition, bonds can play an active role in protecting capital when equity markets experience drawdowns. It is easy to get caught up in recency bias and believe that bonds and equities will continue to lose money together as is the case today, but traditionally, this has not been the case.

Fixed Income and GIC Returns During Equity Market Volatility Chart: Credit can provide ballast and greater returns relative to GICs during equity volatility

Source: Bank of Canada, FTSE Russell, S&P Global.

Canadian equities have lost more than 5% in 14 quarters since 1999. The average quarterly return of Canadian equities, bonds, and GICs during these quarters are:

  • S&P/TSX Composite = -12.1%
  • FTSE Canada Universe Bond Index = +2.6%
  • 3-Year GICs = +0.5%

Overall, bonds tend to provide an inversely correlated return stream to equities and insulate investors' portfolios during times of equity turmoil, while also outpacing the return of GICs.

Discounted Bonds Retain More Yield After Taxes

An important consideration when calculating total returns is the need to adjust for taxes. GIC returns are sourced 100% from coupon payments, which are taxable in non-registered accounts at an investor’s full marginal tax rate. 

On the other hand, a bond’s total return consists of both interest/coupon payments and capital appreciation and can be more tax-efficient, particularly when purchased at a discount to its original issue price (usually $100 Par).

To illustrate, we have provided an example of a 3-year GIC vs. a 3-year corporate bond trading at a $5 discount to its original Par value

An example of a 3-year GIC vs. a 3-year corporate bond trading at a $5 discount to its original Par value

Source: Bloomberg, RBC Dominion Securities. Data as of May 4th, 2022.
3-Year GIC coupon rate is based on GIC rates compiled by RBC Dominion Securities Inc. as of May 2022. 

The yield to maturity for this specific bond is 3.92%, split as ~2.24% per year from coupon payments and the remaining 1.68% from an upward move in the bond price as it gets closer to its maturity date and repayment of principal.

The yield that an investor collects from the non-coupon related increase in the bond price is taxed beneficially as a capital gain and ultimately leads to a better after-tax return for a taxable investor relative to holding a GIC with a similar yield.  

Bonds Provide Liquidity at a Reasonable Cost

Bonds are liquid, publicly traded instruments that are generally traded over the counter (OTC) through dealers. Transaction costs are not standardized like they are for equities that are traded on an exchange. Instead, transaction costs are embedded into the dealer's bid-offer spread and typically have a minimal impact on prices for liquid investment-grade bonds.

Non-cashable/non-redeemable GICs are almost always required to be held until maturity. To break a contract early, you would have to demonstrate significant financial hardship, and even then, there is no guarantee that an issuing financial institution would let you redeem. If the issuer does agree to break the contract, there are usually substantial penalties which often include the loss of some or all of your accrued interest.

For clients who prefer higher liquidity, a daily traded mutual fund or monthly redeemable investment fund might be a more agreeable way to pursue higher yields and returns. Particularly if the allocation has a longer strategic role in a broader portfolio setting that has been tuned to achieve pre-defined financial goals. 

Putting it All Together

For decades, bonds have been a resilient and consistent asset class that has provided investors with sought-after stability. Although the recent volatility has been unfortunate, it has given bonds the ability to once again offer longer-term protection and a return profile that is now more likely to keep pace with inflation over the next few years. 

We believe this is a critical period for investors to move closer to a neutral weight in bonds as the higher forward yields and capital appreciation opportunities can now compensate investors over the intermediate and longer-term. Simple logic would dictate that the time to buy bonds is when inflation measures are above average considering higher yields are available as compensation for that risk, particularly when you have a long investment horizon and the chance of inflation being lower in the next few years is more likely. 

 
 

 

 

Important Information

The information presented herein is for informational purposes only. It does not provide financial, legal, accounting, tax, investment, or other advice and should not be acted or relied upon in that regard without seeking the appropriate professional advice. The information is drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does RP Investment Advisors LP (“RPIA”) assume any responsibility or liability whatsoever. The information provided may be subject to change and RPIA does not undertake any obligation to communicate revisions or updates to the information presented. Unless otherwise stated, the source for all information is RPIA. This document does not form the basis of any offer or solicitation for the purchase or sale of securities. Products and services of RPIA are only available in jurisdictions where they may be lawfully offered and to investors who qualify under applicable regulation.

Unlike GICs, RPIA-managed funds or strategies are not guaranteed and carry the risk of financial loss. “Forward-Looking” statements are based on assumptions made by RPIA regarding its opinion and investment strategies in certain market conditions and are subject to a number of mitigating factors. Economic and market conditions may change, which may materially impact actual future events and as a result RPIA’s views, the success of RPIA’s intended strategies as well as its actual course of conduct. 

 

 

Relationship Team

 
Headshot of Liam O'Sullivan

Principal, Co-Head of Client Portfolio Management

Headshot of Ann Glazier Rothwell

Principal, Co-Head of Client Portfolio Management

Headshot of Zach Barsky

Vice President, Client Portfolio Management