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Look beyond Canadian bonds at global gains

When veteran global bond manager David Hoffman speaks to Canadian pension funds or other institutional players, his message is low-key but clear: The long bull run for Canadian government bonds has run its course, and it's time for investors to start looking elsewhere.

"Canada has been sort of a blessed country from a bond investors' point of view since the late nineties," says Mr. Hoffman, managing director for global fixed income at Brandywine Global. "But there is no longer anything distinguished about it, relative to other markets."

As someone who runs a global fixed-income fund for a living, he acknowledges that there is a certain self-interest behind his argument.

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He also agrees that diversification was not a big selling point in the past. "You couldn't look a pension fund in the face and say, 'You were wrong not diversifying out of Canada.' Because it worked."

Indeed, the Canadian and Australian bond markets have been the world's leading performers over the past 17 years, in both U.S. and Canadian-dollar terms. But today, "looking for a more diversified source of return is probably a healthy thing to do. I'm not saying it [the Canadian market] should be cheap. The fundamentals are good. But it's no longer compelling, in the sense that one should be self-satisfied and say I don't need to look elsewhere for opportunity."

He makes the same case to U.S. clients, warning them to avoid following the risk-averse herd into markets whose main – or even sole – attraction is a perceived safe perch in a turbulent world.

Sitting on a large pile of U.S. Treasury or Canadian government bonds doesn't make a lot of sense, he says. "I think you can still make money by moving around the world. In the U.S., if you're going to buy a 10-year bond, you're probably not going to make much more than 2 per cent if you hold it for 10 years. And in the short term, you could have zero return, because it doesn't take much to wipe out that 2 per cent."

Philadelphia-based Brandywine, an arm of Legg Mason, manages about $31-billion (U.S.) worth of assets, more than two-thirds of which is on the fixed income side.

Mr. Hoffman's fund once had a huge bet on Canadian bonds. In 1995, when many international investors were worried about the outcome of the Quebec referendum or fretting about Ottawa's poor fiscal record and battered currency, government bonds and a smattering of other Canadian issues accounted for about 18 per cent of Brandywine's global portfolio. And the total had risen to 23 per cent by the late 1990s, when then Liberal finance minister Paul Martin was getting the fiscal house in order.

Brandywine began cutting its heavy Canadian exposure in the early 2000s, although it still had a fat wager on the loonie. These days, the currency simply isn't attractive at current levels, Mr. Hoffman says. "It doesn't mean that the Canadian dollar is going to collapse any time soon, and I'm not predicting that. I'm just saying the odds of rallying are also really slim."

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Surveying the rest of the world, he dismisses other major industrial countries as overpriced and underperforming. Brandywine holds no Japanese or core European bonds in its portfolio. In fact, Mr. Hoffman has a bet against Germany and a much larger short position in French bonds. France has failed to tackle key fiscal and economic problems. Yet its sovereign bonds trade close to comparable German bonds, when they should be treated more like Spain's, he says. Noting that Spanish and even Greek bonds have rallied recently, he says drily that "liquidity does marvelous things."

Instead, he recommends being extremely selective. His fund's biggest weighting (14 per cent of the total portfolio) is Mexico, which has been a decent performer and stands to do even better if the U.S. can keep its economic recovery on the rails. Other favourites include Brazil (long on the bonds, but hedged on the currency); Poland; South Korea; Turkey; Malaysia; Hungary; and small currency wagers on India and Russia. "We have liked the markets that have been paying higher yields because they could afford to. But a lot of those have rallied a lot. Unfortunately, there aren't as many screaming bargains in the world right now."

But before ringing off, he has some final thoughts about Canada. Noting recent bullish predictions for the commodity-linked loonie, he says "things can go right for a long time. But eventually, you end up creating the seeds of some kind of reversal. It doesn't mean you go back to where you were in '95, because lots of policies have changed, structural things are better. You're even exporting your central banker, because you don't need him any more."

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About the Author
Senior Economics Writer and Global Markets Columnist

Brian Milner is a senior economics writer and global markets columnist. In a long career at The Globe and Mail, he has covered diverse business beats, including international trade, the automotive industry, media, debt markets, banking and the business side of sports. More

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