The death of the Canadian income trust phenomenon has given the Canadian high yield market a new lease on life.
Despite being around for decades, the market for high-yield bonds—formerly known as junk bonds—has stayed relatively small in Canada, especially in comparison to the market south of the border. But if experts at the recent Canada Forum are to be believed, the high-yield market in Canada is now growing at a rapid clip.
Of the many reasons for its gain, the loss of the Canadian income trust is said to be at the top.
“One of the biggest reasons why the Canadian market has not developed as much as the U.S. market over the last number of years has been the income trust base,” said Dan Bastasic, senior vice-president, investments and co-lead on Mackenzie Financial’s Sentinel Investment Team. “That’s gone, so we should see a much better, bigger, more diversified growing high-yield market going forward.”
With the income trust market gone, there’s an awful lot of money out there that’s chasing yield, he said. With the leading edge of boomers heading into retirement, that demand is not disappearing any time soon.
Jean-François Pruneau, chief financial officer of Quebecor Media—a large issuer of high yield debt—agrees, but feels the junk bond market’s sustainability will depend on its ability to take some hard knocks. “It’s really in the first tough time that we’re going to hit that we will know if this market is a mistake,” he said. “It’s really then that we’re going to know.”
Pruneau says that for the market to survive tough times it will need support from the investor base, dealers, and market makers.
His cautious optimism is shared by Barry Allan, founder and chief executive officer, Marret Asset Management Inc. “It’s beautiful, wonderful when spreads are narrow,” said Allan. “When spreads start to widen and default rates start to rise, that’s when you start to see [its sustainability].”
The U.S. market, inevitably, provides a ready reference point for the Canadian high yield market. The panel of experts sliced and diced both markets to provide a comprehensive comparison. Although there were occasional disagreements, there seemed to be a general consensus that the Canadian high yield market has a long way to go to catch up.
It all starts with the size.
High yield debt accounts for nearly 22% of the total U.S. bond market, compared to just 8% in Canada. That, says Bastasic, means Canada is clearly underdeveloped. But with the Canadian income trusts now consigned to the dust bin, the high yield market will continue to develop, he added.
“We are still just a fraction of what is going on in the U.S. market,” said Michael Wolff, managing director, head of Canadian high yield, TD Securities. “Pick 2010—really the record year for the last decade—in both [countries]; the U.S. did about 625 deals totalling about $300 billion and Canada did 14 deals totalling $3.5 billion.”
However, with lower default rates among Canadian companies, the northern market has an edge over the U.S.
“Canada is a country of oligopolies; there’s four or five companies in virtually every industry,” said Allan, whereas “in the U.S. [there are] 25 to 30 companies in every industry.”
In a smaller market like Canada, if a company defaults it might be quite advantageous for its competitors, he added, while in the U.S. a single default would have less of an impact on a given sector.
But America’s market breadth has it own advantages; easy access to the market is chief among them, at least for the issuer. “It’s always important to access the market very quickly, and because of this standardization that exists in the U.S. market, you can certainly access [capital] more quickly,” said Pruneau.
Unlike Canada, he adds, it is common to meet an investor whose sole responsibility would be high yield securities.
Liquidity is yet another important aspect to investing, particularly for mutual funds in the high yield space. It becomes even more important at the two extremes of the market cycle: when the high yield market is about to take off and when the economy is about to turn over.
The subject of liquidity brought out the first real disagreements among the panellists.
“Liquidity for me, [is] much better in Canada; and I don’t think you can discount how important that is,” said Bastasic. “And that’s where the bankers’ role has really improved over the last year or two in Canada.”
But Allan argues liquidity is relative, and maintains it is better in the U.S. “When you’re comparing spreads between the two countries, you have to reflect that liquidity is lower in Canada than it is in the United States.”
Allan stresses market liquidity isn’t just about size. “It has a lot to do with the diversity of the funds in the United States. Canada is primarily a long-only mutual fund market whereas the U.S. has six or seven different asset classes—some long-short, some long-only, some are equity-related, and some are balanced.”
The more diverse the investor base is the more likely they are to have different views and different desires and, therefore, more reasons to trade and greater liquidity, he reasoned.