Bank of Canada Governor Stephen Poloz isn’t the only one taking out insurance against an energy-driven collapse in Canada’s economy.
The oil plunge that threatens to tip Alberta into recession and may send the nation’s currency to new lows has Mawer Investment Management Ltd. buying global debt to shield itself from the same energy plunge that prompted the Bank of Canada to take out “insurance” with a January rate cut.
“We want bonds to be the insurance within the portfolio that provides stability and income against an equity market correction someday,” said James Redpath, who will manage a new fund launched today by Calgary-based Mawer to buy foreign bonds and gain exposure to U.S. dollars, British pounds and the euro.
From its vantage point in Alberta’s biggest city and energy hub, Mawer has a front-row seat to the damage left by crude’s decline. The Canadian dollar has fallen alongside the price of the nation’s biggest export, sliding 12 percent versus the greenback in the past year to trade at C$1.23 per U.S. dollar, or 81 U.S. cents.
“You could easily get into a situation where Canada is perceived as very risky and you have a bit of a banking crisis, and your currency gets in the glue and you’re dealing with a 60 cent Canadian dollar,” said Paul Moroz, the deputy chief investment officer at Mawer, which runs C$30 billion ($24 billion) in stocks and bonds.
Even as oil prices rebound somewhat, the effects of the downturn will linger, with 30,000 workers expected to lose their jobs this year, according to government estimates. Canada’s economy shrank 0.6 percent in the first quarter, the first contraction in four years and the largest since the 2009 recession. The Bank of Canada has cut its forecast for economic growth this year to 1.9 percent, down from a 2.4 percent estimate in October, because of a drop in investment.
“It could be the case that it’s low energy prices, there’s unemployment across the country, it could be a housing problem, it could be a banking problem,” Moroz said. “If we’re really honest with ourselves, we don’t know the way the next three years are gonna play out. Even if you go back 12 months, who predicted that the price of oil would drop in half?”
Housing markets overvalued by as much as 30 percent pose the biggest risk to the country’s financial system, the Bank of Canada said last week. Policy makers also warned of frothy stock markets in their Financial System Review, saying higher “interest rates could trigger a correction in Canadian equity markets because relative valuations are historically high.”
The new global bond fund is comprised of sovereign bonds with an average AA rating, the third-highest, with the top investments in U.S. dollars, British pounds, euros and Singapore dollars. It will seek to replicate the investment habits of a central bank, focusing on bonds denominated in reserve currencies such as those designated by the International Monetary Fund.
“Different diversified exposure would do relatively better if Alberta, and perhaps the rest of Canada, ends up in a recession that’s going to be a drag on the Canadian currency,” Moroz said.
Risks are rife even in a strategy of investing in sovereign debt of Group of Seven nations, as the recent bond selloff shows. With signs that Europe is emerging from an era of deflation and stagnant growth, investors drove up bond yields from Germany to the U.S., shrinking the value of G7 government bonds by about $600 billion since May 15, according to Bank of America Merrill Lynch index data.
Canada has been a good place to hide since then. Its bond market has been the best-performing as slow growth keeps inflation in check, and has been alone among G-7 countries making investors money, with a 1.5 percent return this year through June 4, according to Bank of America Merrill Lynch data.
The Mawer Canadian Bond Fund, created in 1991, has returned 1.6 percent this year and 5.7 percent over the past 12 months, according to data compiled by Bloomberg. Mawer’s assets are more than 80 percent invested in equity, with less than 20 percent in bonds.
Redpath points out that the moves that hurt global sovereign bonds helped their currencies, hedging losses for a Canadian buying bonds denominated in reserve currencies.
“A lot of the currency strength offset the move in yields,” he said.
Mawer’s new global fund will allocate less than 10 percent to Canada, using short-dated Canadian government debt as cash in reserve to invest abroad.
“In a global world, you would never have your eggs in one basket,” Moroz said. “People have a bit of a home bias. They have a whole bunch of capital sitting in a bank account exposed to the Canadian dollar, exposed to the sovereign risk of Canada. There could be a problem with it.”