Quarterly Report
Second Quarter 2010
During the second quarter of 2010, the DEX Universe bond index returned 2.9%. The Fund’s underperformance of 60 basis points relative to the index for the second quarter is due entirely to an overweight position in corporate bonds. The duration of the portfolio was maintained fairly close to the index, except for two occasions, where the fund manager employed a tactical rates strategy to capitalize on a temporary rise in short term bond yields. This was affected by selling short-dated bonds and buying very short-dated bonds and floating rate notes. However, portfolio duration was returned close to the index by quarter end, with the outcome proving beneficial to performance.
Strong demand for yield and concern about the global economy during the second quarter of 2010 resulted in broad strength throughout the bond market. Corporate bonds underperformed the broader bond market as corporate credit yield spreads widened with weakness in equity markets, but this was partly mitigated by term structure and security selection.
Economic growth and inflation are in line with Bank of Canada forecasts reducing the need for rates at emergency levels. Despite the 25 basis points rate hike in June, the bond market has reduced expectations for an extensive hiking campaign, as the US Federal Reserve is unlikely to hike until 2011 and global macroeconomic recovery remains tentative. While long-term federal government bonds provided the best sub-sector return of 6.8%, the weakest sub-sector, short-term corporate bonds, managed to provide a positive return of 1.5%.
Currently, lower Government of Canada bond yields appear less compelling relative to our expectations for further Bank of Canada rate hikes over the next 12 months. Although our overweight position in corporate bonds negatively impacted performance in the second quarter of 2010 we have maintained this overweight in order to generate higher portfolio yield than the index.
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