Bonds don't get a lot of love these days, and the lack of affection is somewhat justified. With persistently low interest rates, bonds have left income-oriented investors starved for yield. Interest rates could stay that way for a while longer in developed markets like Canada, the United States and Europe. With economic growth weak and the spectre of deflation looming, central bankers in these countries have been in no rush to raise rates. Whenever central banks decide to reverse course, bonds stand to take a hit; because bond prices and yields move in opposite directions, rising interest rates lead to lower bond prices. In ultra-low rate environments, rising interest rates take a heavier toll than they would otherwise.
Even if bonds aren't loveable, they still can play useful roles in a portfolio. When stocks zig, bonds usually zag. As the S&P/TSX Composite Index fell nearly 9% in 2011, for example, the FTSE TMX Canada Bond Index rose almost 10%. In a lousy year for Canadian stocks, investors who held a healthy slug of Canadian bonds didn't fare too badly.
Of course, this paints bonds with too broad a brush. Not every bond sector is immune to turbulence. High-yield bonds usually rise and fall with equity markets, for instance. Even commonly-perceived safe havens like government bonds will behave differently depending on the issuer's creditworthiness, fiscal and monetary policies, and exchange rates. The risk profile of Canadian or U.S. government bonds is a lot different than, say, Argentina's or Ukraine's.
This isn't an argument against riskier bond sectors. They can diversify a bond portfolio just as bonds diversify an equity portfolio. They also can juice returns. More-volatile niche players shouldn't be at the core of the portfolio, though. The core of your portfolio should be its backbone, arguing for steady, plain-vanilla playing this role. Investors can reserve a smaller part of their portfolio for racier options.
Core
Beutel Goodman Income 
: Manager Bruce Corneil and his team employ a conservative approach. They only hold investment-grade bonds and limit exposure to corporate bonds to 50% of the portfolio. In recent years, the team has been on guard against the threat of rising interest rates and have kept the portfolio's duration -- a measure of interest rate sensitivity -- well below that of the TMX benchmark. Corneil believes central banks' loose monetary policies will eventually spur strong economic growth, leading to higher rates. Such cautiousness has come at a price, with the fund lagging the benchmark and its rivals in the Canadian Fixed Income category by significant margins in 2012 and 2013. Even so, the fund still sports a sterling long-term record. Moroever, Corneil and his team are among the most seasoned managers in the business and are part-and-parcel of Beutel's strong investment culture. This fund remains a favourite especially for cautious types.
PH&N Bond and PH&N Total Return Bond : Among Canadian bond investors, PH&N stands out with its level of management expertise spanning both government and corporate bonds. While most rivals lack sophisticated tools to manage risk, PH&N's in-house risk-management software, BondLab, helps it analyze trades and exposures at the portfolio and security level. Moreover, the 0.59% management-expense ratio on the D-series gives it a meaningful competitive edge. PH&N Total Return Bond's allocation to high-yield issues gives investors access to a PH&N strong suit, but cautious types may find PH&N Bond, which focuses on investment-grade, more appealing.
TD Canadian Bond and TD Canadian Core Plus Bond 
: TD gives PH&N a run for its money in the risk-management department, but the real strength of these funds come from their process. TD analysts assign credit ratings independent of ratings agencies and construct an approved list of issuers that portfolio managers can choose from. This imposes discipline in the process and prevents managers from falling in love with issuers. TD Canadian Bond focuses on investment-grade government and corporate bonds, while TD Canadian Core Plus Bond can keep up to 20% in high-yield bonds.
Explore
PIMCO Monthly Income : Launched in 2011, this offering is a relative newcomer to Canada, but PIMCO has run a fund with a similar strategy in the U.S. since 2007 with terrific results. Manager Alfred Murata harnesses PIMCO's vast resources to invest primarily in U.S. asset-backed and mortgage-backed bonds -- a PIMCO specialty -- and secondarily in emerging market and high-yield bonds. This unusual mix means it behaves much differently than the Canadian bond market, making it a terrific diversifier. Murata is especially careful that the fund's monthly income distributions come from actual returns rather than return on capital, as is often the case with other monthly income funds. (The fund sets its distribution target on a rolling 12-month basis according to market conditions.) Given its quirky portfolio, though, this fund won't be core material for most Canadian investors.
Manulife Strategic Income 
: This fund lands in the High Yield Fixed Income category, though the label is a bit misleading. In addition to high-yield, this fund will also hold investment-grade bonds, asset-backed securities, as well as developed and emerging market government bonds. Manager Dan Janis decides upon a mix by looking at macroeconomic factors, though he's guided by some limits; the fund's high-yield stake can range between 30% and 50%. Given low default rates and strong corporate balance sheets, the portfolio has been at the higher end of that range lately. Over time, calls like these have paid off handsomely. A veteran team and strong research resources boost our confidence in the fund. Its 2.06% MER is a high hurdle to overcome, but as the only medalist in its category, we still think it has an advantage over is rivals.
Templeton Global Bond : There may be no better global bond investor than manager Michael Hasenstab, who along with co-manager Sonal Desai has been named Morningstar Manager of the Year both in Canada and the U.S. Hasenstab has been so successful partly because he thinks long term and isn't afraid to go against the herd. He recently picked up Ukrainian government bonds, which investors abandoned as the conflict with Russia heated up. Bets like these don't always work out, but his long-term record is tough to beat. This fund is a much better deal when sold through fee-only planners; Franklin recently cut its F series MER by 0.5%, which should bring it down to around 1.08%. Franklin didn't cut expenses on the commission-based A series, though. Its 2.2% MER remains among the highest in the category.
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