Canadian High Yield Market
In prior articles, Bond Capital has used US high yield benchmarks as a proxy for riskier private debt, but what about in Canada? The yield on Canadian bonds continues to decline, and recent rate cuts by the Bank of Canada may cause them to stay low longer. Market speculation is that the US Federal Reserve may start raising interest rates in the fall, and we saw the beginning of this trend in the rise of high yield rates back in our spring article. As interest rates rise, the value of the bonds declines – which means that investing in US bonds may be less desirable than investing in markets where benchmark interest rates are steady or falling as they are in Canada today.
While Canada does not really have a high yield debt market, we do have a small, thinly traded market for convertible debentures. Convertible debentures are loans with the option to convert to equity at a predetermined share price (“strike price”). A convertible debenture’s value will mimic a company’s share price when the share price is trading above the strike price, otherwise it will trade like debt. Thus, to compare the Canadian convertible debenture market to the US high yield marketing, we stripped out convertible debentures trading like the underlying equity value (depicted below), to create a proxy for a Canadian high yield bond set.
Canadian proxy high yield is comparable to its US counterpart
While the yields on US and the Canadian proxy of high yield debt is similar, the spread over the respective government bonds is 1.1% higher in Canada. This will be the result of the smaller size of companies in the Canadian market, lack of liquidity in the market and due to the fact that these are convertible debentures which are more exotic. Canadian convertible debentures make for an interesting alternative if you are looking for yield.