TD Canadian Bond's strength lies in knowing its limits

The management team has proven its ability to add value by focusing on credit selection.

Shehryar Khan, CFA 10 April, 2018 | 5:00PM
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The bond team at TD Asset Management (TDAM) likes to keep it simple when it comes to managing TD Canadian Bond. The managers focus on preserving their investors' capital and on their expertise in credit selection. By focusing on a lever where they have a proven ability to add value, and less so on trying to forecast future interest movements by managing the portfolio's duration, the fund improves its prospects of outperforming its benchmark -- the FTSE TMX Canada Universe Bond Index -- and passively-managed ETFs like  BMO Aggregate Bond ETF (ZAG). Combined with a strong performance track record and competitive costs, this fund merits strong consideration for investors seeking actively managed domestic bond exposure.

TDAM follows a team approach toward portfolio management, with Rob Pemberton, who joined the firm in 2000, heading the fixed-income team and serving as lead manager. He is backed by a deep 22-person portfolio management team and an independent 15-person credit research team. This approach minimizes the reliance on any one person and cultivates continuity of process in the event of staff turnover. The bond team is one of the largest in Canada with ample resources at their disposal.

Daily, biweekly and monthly meetings with other groups at TDAM help the team identify and debate macroeconomic themes. Management doesn't explicitly target a duration for the portfolio; rather, the fund's duration is an outcome of the team's yield-curve assessment and positioning.

The credit team's most unique element, and the one that demonstrably added the most value, is the internal credit rating that is generated independent of any external rating service. The team's credit ratings frequently differ from those of the established rating providers and are accompanied by a visibility horizon that indicates how far into the future the analyst is comfortable forecasting this rating. Portfolio managers may only invest in credits on the approved list, adding a crucial check to ensure that a macro view does not overwrite the bottom-up fundamentals that the credit team is assessing.

When we met with the team in January, their view that credit spreads were tighter than in previous years led them to their lowest allocation to corporate bonds in many years. Instead, the team has found value in provincials, specifically in Alberta where economic concerns resulted in a sell-off despite strong fundamentals, giving the team an opportunity to add to their position in the province's bonds.

Bond management is a game of inches, and over the last 10 years through February 2018, TD Canadian Bond has underperformed its benchmark by 0.15 percentage points, as it returned 4.24% per year over that span. The fund did so with less volatility, however, resulting in identical risk-adjusted metrics, landing the fund in the top quartile as it commendably managed years of central-bank mandated low interest rates. Considering the average fund in the Canadian Fixed Income category returned 3.56% over the same span, the fund's track record stands out against its peers.

In an asset class with small potential excess returns and small absolute returns in the current low-yield environment, low fees are even more important. With a management-expense ratio of 1.10% for the Investor series, the fund costs rank in the top quintile in a category where the median MER is 1.46% for the commission-based distribution channel. The F series that targets fee-based advisors has an MER of 0.61% that comfortably ranks in the cheapest quintile among its relevant peers. For do-it-yourself investors, the D-series is also attractively priced at 0.94%.

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Shehryar Khan, CFA

Shehryar Khan, CFA  Shehryar Khan, CFA, is a senior investment analyst for Morningstar’s Investment Management group.

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