Deploy cash into bonds, before moving it into the equity space: BMO's Adatia
The Canadian Bond Investors’ Association, which represents managers of over $1.2 trillion (US$900 billion) of assets, is asking Canada’s finance department to reverse its decision to cease the issuance of inflation-linked bonds.
The government decided to stop the issuance of new real-return bonds after consulting market participants, citing weak demand, Finance Minister Chrystia Freeland said in a budget update released early this month. The decision is coming at the “worst possible timing for investors” due to historic levels of inflation and after the consultation “failed to identify the fundamental sources of demand” for such securities, the industry group said in a Nov. 14 memorandum.
“The CBIA calls on the Department of Finance to reconsider this hasty decision and take time to evaluate this complex situation,” the association said. “Consideration should not only be given to the reinstatement of the original program but also to taking steps to improve the market structure.”
Insurance companies and pension plans are natural investors of real-return bonds due to the nature of their liabilities as some of their contractual promises have frequently been tied to the consumer price index, the CBIA said. While some of the larger institutions may find alternatives, smaller investors offering products such as indexed annuities may face “higher volatility and risk for participant members,” it said.
“The decision to cancel the Real-Return Bonds (RRB) program was taken because demand for this sector is too low to justify maintaining it. This decision was not related to the current inflation environment,” said Caroline Feggans, a spokesperson for the Department of Finance, in an emailed reply to questions. “RRBs have suffered from low-demand long before the current inflation environment. The government undertook extensive consultations in 2019, which showed poor demand for real-return bonds. This was reinforced in recent debt management strategy consultations.”
The market for Canadian real-return bonds is small -- just $48.6 billion outstanding, according to data compiled by Bloomberg. The longest-dated issue matures in 2054.
The real-return market is used to value pension plan liabilities, so without available long-dated inflation-linked bonds corresponding to the liabilities, valuation methods would be put into question, the CBIA memo said.
“Eliminating RRBs not only reduces the diversity of funding by excluding certain market participants,” the memo said, it “also alters the perception of all market participants that the Government of Canada is not confident that it can deal with the inflation problem.”