Hunt for Yield Leads to Canada Hospitals, Universities DebtBy
Long-dated bonds outperform corporate index amid tight credit
‘Market not cheap anymore,’ and A ratings draw foreign demand
Investors who own the debt of McGill University, University of Toronto and Canada’s biggest hospitals are reaping the rewards midway through a year defined by a global search for yield.
Canadian health-care bonds have a 7 percent total return this year, and services -- a sector dominated by universities -- have a total return of 6 percent, according to data compiled by Bloomberg. Those beat the 3.3 percent return by an index of Canadian corporate bonds. The performance comes as the yield over government debt that investors demand to hold corporate bonds hovers around the lowest level in more than two years.
“You start looking for extra yield in other places, so people will think, ‘Maybe I’ll go buy some of these hospital notes,’" said Patrick O’Toole, a portfolio manager at CIBC Asset Management, who helps manage C$64 billion ($48 billion) in fixed income assets. His firm owns health-care bonds including Hospital Infrastructure Partners NOH Partnership. The broader market "is not cheap anymore,” he said.
Hospital and university bonds have benefited from their long maturities in a year of lower government-bond yields and a sustained global bid for Canadian corporate bonds. Foreign investors purchased a record C$38.8 billion of Canadian securities in February, according to the most recent Statistics Canada data.
Bonds in the hospital and university space generally carry a A or AA credit rating, a bucket for index-followers that has shrunk over recent years due to downgrades, O’Toole said. About 33 percent of Canadian corporates had A ratings at the end of 2016, compared to around 41 percent at the end of 2013, he said.
Canada’s best-of-the-G7 economic growth and moderate deficits also make it look attractive to foreign investors, according to Paul Gardner at Avenue Investment Management Inc.
“We’re considered desirable now, despite the fact that there’s noise in the resource sector and the housing sector,” Gardner, a partner and portfolio manager with Avenue Investment, said by phone from Toronto. Large global managers have been upping their allocations to Canada from the typical 2 percent of a global index to around 4 percent, with persistent weakness in the Canadian dollar making it especially attractive, he said.
Many of these bonds are also attractive due to their strong connection to municipal and provincial governments, Gardner said. They are often issued to fund a public-private partnership. But a potential risk for investors is construction risk -- that the project will go overtime or over budget -- and the bonds can require a week of credit analysis to understand their complex structures and the project, O’Toole said.
“There’s usually enough protection for bondholders -- you don’t sweat it too much,” he said. For example, project contractors provide various guarantees during construction and bondholders are generally given the right to step in if necessary, he said.
The risk-reward is a compelling opportunity relative to other infrastructure bonds, O’Toole said. Plenary Health Care Partnerships Humber LP has a credit spread around 160 basis points compared to a Hydro One Ltd. bond with a spread around 140 basis points, he said. “Both solid names," he said. "Might as well take the extra spread.”
Even if the Bank of Canada ends up raising interest rates sooner than originally expected, as indicated by the Bank of Canada’s surprisingly bullish tone Monday, bonds at the long end of the yield curve likely won’t rise dramatically, O’Toole said. The Canada 30-year government yield sits at 2.1 percent.
“All we’re kind of hoping for is that spreads hold in the next year,” O’Toole said. “If they tighten, that’s a bonus.”