BlackRock Tells Bond Buyers to Flee Canada’s New Normal

BlackRock Inc. (BLK), the world’s largest asset manager, recommends clients seeking to beat benchmark returns move money outside of Canada as the central bank enters an era of low interest rates amid stifled economic growth.

The Canadian economy will expand just enough to spark rate increases, which erode the value of existing bonds, but not enough to raise rates to levels where new bonds provide the kind of returns investors are used to, according to Aubrey Basdeo, head of BlackRock’s Canadian fixed-income business.

“If you want excess returns, you have to look outside of Canada,” Basdeo said in an interview at BlackRock’s Toronto office.

Bank of Canada Governor Stephen Poloz said this month interest rates in the world’s 11th-largest economy probably won’t need to be as high as they were in the past to maintain full output, leaving bond investors facing lower coupon payments. BlackRock recommends investing abroad, where bond holders will benefit from higher “normal” rates when the world economy eventually recovers from the 2008 credit crisis.

The central bank, which has kept its benchmark policy rate at 1 percent since September 2010, will increase borrowing costs beginning in the second half of 2015, according to the median forecast of economists in a Bloomberg News survey. Poloz reiterated this month the direction of the next move will depend on economic data.

Next Decade

Canada’s stable financial system sheltered it from the worst of the 2008 crisis and helped it resume economic growth faster than other nations, making the country’s debt a haven for global capital. Canadian bonds returned 66 percent in the decade that ended last year, compared to the broader global bond market’s 50 percent return, according to Bank of America Merrill Lynch indexes.

“The next decade is not going to look like the last decade,” said Noel Archard, head of BlackRock’s Canadian business, which manages C$147 billion ($137 billion). “You’re getting to the heart of where some investors are going, which is looking a little more globally.”

That doesn’t mean entirely abandoning Canadian fixed income, which still offers safety, Archard said. It means being more picky about Canadian debt investments to maximize return, and complementing them with higher-yielding foreign securities that may be more risky, he said.

Emerging market corporate debt has returned 9 percent this year, while Canadian corporate debt has returned 5.5 percent, according to Bank of America Merrill Lynch data.

Cheap Debt

The Bank of Canada is researching the possibility the economy’s so-called neutral interest rate, the level that keeps the economy at full output, will be lower as the economy recovers, Poloz said in a CBC Radio interview last week.

Canada’s consumers, grappling with bloated household balance sheets after loading up on historically cheap debt for the past half-decade, will feel the pinch more quickly than before when the central bank starts raising interest rates, as it eventually will, Poloz said. That will more effectively slow the economy than past rate increases, he said.

While the neutral rate in the 1990s was between 4.5 percent and 5 percent, and in the 2000s was about 4 percent, it will probably be between 3 percent and 3.5 percent over the next decade, according to Craig Alexander, chief economist at Toronto-Dominon Bank.

BlackRock’s Basdeo said Canada is shifting toward an economy propelled by exporters rather than consumers, and that shift will be slow because of an aging population and because the currency, driven higher by demand for safety, is making manufacturers less competitive.

Economic Growth

Canada’s annual economic growth will average about 2.4 percent through 2016, compared with 2.6 percent in the U.S. and 2.1 percent among Group of 10 countries, according to the median forecasts of economists surveyed by Bloomberg News. The BRICS nations -- Brazil, Russia, India, China and South Africa -- will average 5.6 percent growth in that period, separate surveys show.

“Fifteen years ago everyone was flogging that, really, your equities should not just be the domestic footprint, you really should be thinking about emerging markets,” Archard said. “We’re starting to see that evolution in the fixed-income space.”

To contact the reporter on this story: Ari Altstedter in Toronto at aaltstedter@bloomberg.net

To contact the editors responsible for this story: Dave Liedtka at dliedtka@bloomberg.net Chris Fournier, Greg Storey

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