Sun Life Adds Junk Bonds to Offset Rate Decline

Sun Life Financial Inc. (SLF) is altering its investment mandate to add high-yield bonds to the C$115 billion ($117 billion) of assets it oversees as the lowest interest rates since at least 1950 sap investment income.

“One thing that we had not considered historically but we do have the ability to do now is to think about making allocations to the high-yield market,” Chief Investment Officer Stephen Peacher said in a Jan. 9 interview at Bloomberg’s Toronto office. Peacher called it “the best risk-adjusted asset class in the market for the last five years.”
Enlarge image Sun Life to Add Junk Bonds Thwarting Rate Decline

A man walks inside of the Sun Life Financial Inc. office on Bay Street in Toronto, Ontario. Photographer: Brent Lewin/Bloomberg

Declining interest rates around the world are draining income for insurers and pension funds that often aim for minimum annual returns of about 8 percent on investments. That’s pushing investors into riskier markets such as high-yield bonds, which attracted $72.4 billion of fund inflows in 2012 while equity allocations shrunk, according to data compiled by Cambridge, Massachusetts-based EPFR Global.

“To the extent people can get outside the government bond market they should do it,” Peacher said.

Sun Life, Canada’s third-largest insurer, has less than 1 percent of assets devoted to junk bonds, compared with an average of 3 percent to 4 percent earmarked by U.S. life and property insurers, according to Barclays Capital. Of the life insurers, Symetra Financial Corp. (SYA), Unum Group (UNM) and Aflac Inc. (AFL) had the most exposure to high-yield corporate bonds as a percentage of book value in September.
Top Performer

High-yield bonds were the best-performing company bonds worldwide last year, gaining 18.8 percent versus 10.8 percent for investment-grade peers and 4.4 percent for global governments, according to Bank of America Merrill Lynch index data. Average global government bond yields of 1.3 percent are near a record low of 1.23 percent on Dec. 5, the index shows.

Relative yields of global high-yield bonds issued by Canadian firms declined to 496 basis points yesterday, the lowest since April 2010, Bank of America Merrill Lynch index data show. Peacher said he can afford to wait for prices to decline before buying.

“We don’t have to be there so we can time our purchase,” he said. “We should be able to ride through any downturns and we should be able to be fairly opportunistic about what we buy into that market, and I want to take advantage of that.”

Low rates may encourage speculative-grade companies with weaker balance sheets to borrow, posing a risk to investors by creating an asset bubble, he said.
Big Risk

“I think that that’s the big risk for the high-yield market,” Peacher said. “You have to be comfortable that the new bonds being sold aren’t creating a profile for the market that’s about to blow. And I don’t think we’re there yet.”

The Toronto-based insurer pared cash reserves to C$6.5 billion at the end of the third quarter from C$12 billion at the beginning of the financial crisis through purchases of corporate bonds, private placements and mortgage securities.

Sun Life’s investments in high-yield will start in “hundreds of millions” of dollars, said Peacher, who oversaw Putnam Investments LLC’s high-yield portfolios. He joined Sun Life in 2009 and is based in Wellesley Hills, Massachusetts.

Elsewhere in credit markets, the extra yield investors demand to hold bonds of investment-grade Canadian companies narrowed one basis point yesterday from a day earlier to 130 basis points, according to Bank of America Merrill Lynch data. Yields rose to 2.99 percent from 2.97 percent.
Private Placements

Provincial bond spreads declined to 72 basis points, while yields increased to 2.64 percent from 2.61 percent, Merrill data show.

Provincial bonds, yielding an average 50 basis points more than pre-crisis levels, are among the most attractive securities in Canada, Peacher said, citing Quebec’s issue of C$500 million of 10-year notes Jan. 8 which offered a spread of 103.5 basis points to government debt. Ontario, Canada’s most populous province, sold C$1 billion in 2.1 percent bonds maturing in 2018 yesterday, priced to yield 59.5 basis points over government. Prince Edward Island, the smallest region, raised C$125 million in 40-year bonds at 113 basis points over government debt.

The insurer has about C$18 billion in private placements, which are securities sold to a relatively small number of investors. It’s boosting these less-liquid investments as it requires less cash to back its insurance liabilities. Such investments include machinery leases, infrastructure projects and commercial mortgages, Peacher said.
Post-War Low

Apart from provincial debt, most of the firm’s investments this year will avoid low-yielding government debt, Peacher said. Canadian government bonds trailed most world peers except Japan, the U.S. and Switzerland last year, according to Bloomberg’s EFFAS Bond Index, as accommodative policies by central banks around the world dimmed Canada’s safety appeal.

The Canadian 10-year yield reached 1.565 percent on July 23, the lowest since at least 1950. The 2.75 percent note due in June 2022 yielded 1.97 percent at 10:30 a.m. in Toronto, down 8 cents to C$106.71.

Sun Life’s investments are predominantly investment-grade, Peacher said. Any speculative-grade holdings are so-called fallen angels that have been downgraded, or holdings inherited from portfolios it’s acquired.

“We could buy a below-investment grade, individual investment but to go out and make an allocation in that sector, it just was not in line with our policies,” Peacher said.

Sun Life will target BB rated securities in its high-yield purchases to avoid higher capital charges for lower-rated securities, he said.

“It’s a wonderful asset class,” Peacher said. “You end up going through a year or two of terror but then it always comes back. The big coupons make up for a lot of bills, and as long as you’re not forced to sell when default rates go to 10 percent you’re fine.”