Pimco Sells Provinces After Worst Rout Since ‘94: Canada Credit

Provincial bonds, touted two months ago by Pacific Investment Management Co. as a way to offset low government bond yields, are losing favor at the world’s biggest bond-fund manager amid their biggest quarterly loss since 1994.

The Canadian Total Return Fund reduced its holdings to 43 percent in May, from 51 percent in April, according to the latest available data on Newport Beach, California-based Pimco’s website. Debt of provinces and Canadian local governments such as Ontario and Nova Scotia remain the largest holdings in the fund overseen by Ed Devlin in London. He didn’t respond to a voice message late yesterday seeking comment.

Yields have soared since the start of May on speculation the Federal Reserve may scale back asset purchases that have kept borrowing costs low worldwide. Provincial bonds fared worse than Canadian federal-government and corporate bonds, in part because issuers had extended the average maturity of the securities when rates were low, making the bonds more at risk to losses because holders demand a larger yield premium on the longest-maturity fixed-rate debt as prices fall.

“People got spooked and started selling everything because they’re worried interest rates are going up,” Mark Wisniewski, who holds no provincial debt as part of the fixed-income funds he manages at Toronto-based Davis Rea Ltd., which oversees C$575 million ($547 million), said in a telephone interview yesterday. “That has an effect across the whole market.”

Fund Performance

Provincial bonds lost 2.9 percent in the second quarter, compared with declines of 2.2 percent for Canadian government and 2 percent for corporate securities, according to Bank of America Merrill Lynch index data. The quarterly drop was the steepest since a 5.3 percent slide in 1994, the worst since Merrill started tracking returns in 1992.

The Canadian Total Return Fund lost 1.7 percent in the month ended May 31, compared with a drop of 1.5 percent in the DEX Universal Bond Index that serves as the fund’s benchmark, according to data on Pimco’s website. Year-to-date, the fund is up 0.07 percent, while the DEX index is 0.35 percent higher.

Provincial bonds were yielding the most over federal-government securities this year when Devlin said in April that they offered the best value among Canadian bonds with the central bank projecting excess capacity in the economy at least into 2015.

The debt of Canada’s 10 provinces yielded 78 basis points, or 0.78 percentage point, more than benchmark government securities in April, Bank of America Merrill Lynch index data showed. Yields on 10-year government bonds were around 1.70 percent. The yield premium has narrowed to 72 basis points since then, while 10-year government bonds yielded 2.41 percent at 10 a.m. in Toronto.

Average Duration

Mark Porterfield, a spokesman for Pimco, a unit of the Munich-based insurer Allianz SE, didn’t return a call yesterday seeking comment. More than 90 percent of Pimco’s $2.04 trillion in assets as of March 31 was in bonds.

Elsewhere in credit markets, the extra yield investors demand to own the debt of Canadian investment-grade corporations rather than the federal government was unchanged yesterday from a day earlier at 126 basis points, according to a Bank of America Merrill Lynch index. Yields were steady at 3.19 percent.

Ontario, Quebec

Pimco had favored the debt of Ontario and Quebec, the nation’s two most populous provinces. They were among the governments issuing longer-maturity debt to finance budget deficits, pushing the average duration of provincial debt toward a record nine years, the Merrill Lynch data shows. Duration measures a bond’s price sensitivity to yield changes that rises with longer maturities.

Ontario, Canada’s largest provincial borrower, extended its weighted-average term to maturity to 12.4 years from 8.1 years three years ago. Even so, the province can change focus to short-term debt sales if the 30-year debt that’s led the province’s sales since 2009 loses favor, Gadi Mayman, chief executive officer of the Ontario Financing Authority, said in an interview May 31 at Bloomberg’s headquarters in New York.

The Bank of Canada has kept its benchmark interest rate at 1 percent since 2010 in the longest pause since the 1950s. Investors are increasing bets the hiatus may end next year as growth in Canada’s largest trading partner has picked up and domestic payrolls unexpectedly swelled in May. Federal Reserve Chairman Ben Bernanke told Congress on May 22 the U.S. central bank could cut the pace of its monthly purchases of $85 billion in Treasury and mortgage debt if officials see indications of sustained improvement in economic growth.

Yield Climbs

The yield on Ontario’s 4.65 percent notes due June 2041 breached 4 percent on June 25 for the first time since 2011, after climbing 40 basis points in June. The securities yielded 3.87 percent yesterday.

Ontario is trying to eliminate an C$11.7 billion budget shortfall by April 2018 as its manufacturers seek to make the most of a rebound in U.S. demand for the car parts it exports. The province plans to issue C$33.4 billion of bonds in the 12 months through April 1, compared with C$36.6 billion the previous year, according to the province’s May 2 fiscal plan.

“As part of the risk-off trades, people cut back on duration -- and used long provinces to cut back,” Hosen Marjaee, a senior managing director at Manulife Asset Management Ltd., said by phone yesterday from Toronto. “These unfortunate events have put more pressure on their finances and borrowing requirements.”

Before it's here, it's on the Bloomberg Terminal.