By Joel Kranc

We see it, we’re living it, and it’s all around us. Inflationary pressures, not seen in decades, have gripped the economy, while stock markets remain volatile, often to the downside. Talk of recession is also making the headlines, and despite Finance Minister Chrystia Freeland’s suggestion to unsubscribe to Disney+ to save money, investors are looking for investments to ride out this market environment.

Institutional investors are providing hints of their strategies as seen by such large players as the Ontario Teachers’ Pension Plan. OTPP, which manages C$243 billion ($177 billion), is raising its holdings of inflation-protected debt, along with some investment-grade and junk notes, the fund’s president and CEO, Jo Taylor, said, according to a Bloomberg report.

Also reported in the press was Canada’s second largest pension fund Caisse de dépôt et placement du Québec looking for opportunities in global fixed income assets after a recent sell-off.

“Fixed income assets are definitely more attractive than they were couple of months ago,” Caisse’s executive vice president Vincent Delisle said in an interview. Caisse, which oversees about C$391.6 billion ($285 billion) in assets, says it sees opportunities in private credit, where non-banking institutions provide loans to companies.

Why now? What is the thinking behind a move towards fixed income and the bond markets that was absent a year or two ago?

“Plans with inflation-linked liabilities have traditionally hedged this by using inflation-sensitive assets such as real return/inflation linked bonds,” says Katie Pries, President and CEO of Northern Trust Canada. “The Canadian federal government, however, recently announced that it would stop issuing Real Return Bonds (RRBs), which have a coupon linked to the level of the consumer price index, effective immediately due to lower demand. We expect Canadian pension funds to look at non-Canadian inflation linked bonds and continue to invest in other inflation sensitive assets such as infrastructure and real estate.”

However it’s not only inflation and economic forces influencing large investors. The Bank of Canada’s move to thwart some of those issues is also changing investment strategy, as a result. Pries says, “Rising interest rates have resulted in higher discount rates and general funding level improvement. With better funding the dynamic investment (glide path) strategies, which are common in the pension plan landscape, have resulted in de-risking towards liability-hedging (bonds) assets with some plans looking into the purchase of annuities to address future liabilities.”

In fact, Canadian Pension plan investments witnessed modest gains during the third quarter as both stock and bond markets responded to the magnitude and pace of interest rate hikes around the world, according to the Northern Trust Canada Universe. The median Canadian Pension Plan returned 0.76% for the quarter and -14.75% year to date as of September 30, 2022.

Also, The Canadian Fixed Income market, as measured by the FTSE Canada Universe Bond Index, advanced 0.5% for the quarter. Provincial bonds outperformed corporate and federal bonds, while long-term bonds outpaced both short-term and medium-term bonds.

Inflation and economic conditions are driving investors to “safe-haven buying” opportunities. A bond trader at a large Canadian pension fund told CAIPforum,  “Each investor will have a different mandate, which will drive the flexibility they may have to time investment. That said, higher yields have driven safe-haven buying by a number of investors, particularly in the front-end of the yield curve. As we get closer to terminal rates, this buying behavior has become more prevalent, whilst floating rate note buying has also been meaningful through the first half of this year.”

According to the bond trader, losses in the bond market through the first half of the year led to generally greater caution as it pertained to deployment by the investor base. However, “This impacted liquidity in the secondary market, as well as interest in primary transactions.  As we’ve gotten closer to terminal rates, we’ve seen some buying re-emerge – particularly in the front-end of the yield curve – whilst there is also some rotation into bonds from the equity market.,” he explains.

The Bank of Canada has hinted there still may be interest rate increases with potential easing in 2023. While inflation remains high, and investors seek safe havens in a volatile market, the fixed income market may be the investment of choice for large institutional investors.