By Portfolio Solutions Group | Jan. 25, 2024
In this series of articles, Portfolio Solutions Group (PSG) discusses some of the fundamentals of investing and how they contribute to PSG performance. PSG combines the basics principals of bond-investing with active management to benefit from higher interest rates and generate strong returns in their mandates. Access the expertise of PSG with their funds:
What drove the strong bond returns in the fourth quarter of 2023? Have PSG mandates benefitted from this strength?
Between October and November of 2023, the FTSE Canada Universe Bond Index total return was 4.68%, with November alone returning 4.29%. That’s in sharp contrast to the 2022 returns of -12.5% and the 2021 returns of -2.5%. So what’s going on with bonds? Let’s review the components of bond returns.
A bond’s return is made of changes in the bond’s price and coupon payments. The price of the bond can be influenced by several factors, including changes in interest rates, inflation expectations, credit quality of the issuer, as well as the time to maturity.
The most significant factor impacting bond prices is prevailing interest rates. Bond prices and the movement of interest rates have an inverse relationship. If interest rates rise (as they did in 2022 and 2023), the present value of coupon payments are discounted at the higher prevailing rate causing bonds prices to decrease. Conversely, if interest rates fall, bond prices will increase.
For example, in 2022, central banks around the world increased overnight interest rates to combat inflation. In turn, market participants demanded higher interest rates across longer maturities as well. This continued into 2023.
In the fourth quarter of 2023, lower inflation numbers emerged globally. Expectations about future overnight rate increases shifted to a pause in monetary policy and then to a belief that central bankers could cut overnight rates in the second half of 2024. These changes in sentiment were a primary driver of bond price increases.
PSG mandates have benefitted substantially from the strength in bonds, especially mandates such as conservative and moderate which have larger fixed income positions. PSG has benefitted in 2023 from active positions overweight in short-term fixed income and corporate bonds. The active management within the underlying fixed income funds has further helped.
Looking for more insights about the fundamentals of investing? Check out PSG back to basics series: bond investing as interest rates change.
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The views expressed in this commentary are those of Portfolio Solutions Group as of Jan.25, 2024 and are subject to change without notice. Portfolio Solution Group (PSG) is a division of Canada Life Investment Management Ltd. This commentary is presented only as a general source of information and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide tax or legal advice.
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