In a paper released last year by the Bank of Canada, senior analyst James Hately explained that Maples are thriving precisely because they have been tailored to Canadian institutional investors’ needs for quality and lack of exposure to foreign exchange risk. Scotiabank corporate bond analyst Robert Follis estimates that $10 billion of Maples were issued in 2005 and $23 billion in 2006. Another $11.3 billion were issued in the first two months of 2007, notes Daniel Child, managing director for credit trading at Scotiabank in Toronto. “We are 67% ahead of where we were at the end of February in 2006,” Child explains.
Behind the growth of the Maples market are two events. First, the elimination of the foreign property rule in the 2005 federal budget expanded the appetite of many pension plans for foreign assets. Second, the Canadian bond market was hungry for fresh debt as a result of paydowns of federal debt and a drastic drop in net issuance of new debt by Canadian corporations that were awash in cash. According to Dow Jones Capital Markets Report, net bond issuance in the Canadian domestic market was $7.7 billion in 2006 compared to $18.3 billion in 2005. Maples arrived just in the nick of time for the needs of institutional investors. But Maples have added some fresh wrinkles to bond management.
Global in origin, Maples are sensitive to foreign credit conditions. For example, the Morgan Stanley $2.5 billion issue retreated significantly, widening its spread over Canada, in the wake of the sub-prime lending problems that appear to be affecting many U.S. banks. But other advantages go with the foreign exposure, say managers.
Steve Locke, senior portfolio manager for fixed income at Howson Tattersall Investment Counsel Ltd. in Toronto, was an early adopter of Maples. He bought into the market in late 2004, ahead of the elimination of foreign property limits. “We found them reasonably attractive for yield relative to Canadian domestic corporates for equivalent risk,” he explained. “Moreover, it gives us a chance to diversify our portfolio.”
Diversification has been available by buying foreign currency denominated bonds and accepting exchange risk on coupons and redemption. But as Robert Palombi, director of fixed income research at Standard & Poor’s in Toronto, notes, Maples eliminate foreign currency exposure. “They offer ways to get global exposure with no currency risk. And that makes them appealing to risk-averse bond buyers and, in general, conservative investors with a home-country bias.”
MAPLES’ APPEAL
In fact, it is by risk exposure that the Canadian Maples market can be understood. Investors who want low volatility, high liquidity, familiarity with issuers and risk contained to Canada are not attracted to Maples. As Randy LeClair, senior vice-president and portfolio manager for AIC Investment Services in Burlington, Ont., notes, “In the past, issues got orphaned and were left to mature without much secondary market support.” Investors willing to accept potential liquidity issues and transitory volatility are likely to be attracted to the potential yield advantages of Maples, he adds. Maples, he says, are fine for buy-and-hold investors, pension funds and life insurance companies. But for mutual funds and active managers that may have to meet redemptions, the liquidity issue is not going away, he adds. Moreover, he notes, if Canadian interest rates were to rise well above those in foreign issuers’ markets, the supply of Maples might dry up.
There is, of course, a stronger appeal in Maples than just current yield. Maples issued by quasi-sovereigns, such as financial institutions backed by governments, have added exposure to AAA credits in Canadian dollars. As Palombi notes, 40% of outstanding Maples have been triple A, 25% double A and 35% single. And most of the Maples, 92% in fact, have been under 10-year terms. Only 8% have been over 10 years, including an Austrian sovereign due in 2034 and a Norwegian Kommunalbanken AS due in 2037.
Some institutional investors are buying Maples for spread. Says Michael McHugh, portfolio manager for fixed income at Dynamic Funds in Toronto who is responsible for $2.4 billion of bonds, “We have bought one issue for the advantages of diversification in specific sectors such as financial services. There are more European and U.S. companies than are available in Canada.”
PITFALLS
It is not a free ride, he notes. There are issues of liquidity and volatility, he explains. “There are fewer dealers making markets in Maples. Major dealers such as RBC Capital Markets, Merrill Lynch and HSBC have made markets while other dealers have participated to add liquidity to the markets. Liquidity issues are complicated by the fact that there are fewer buyers for Maples than for other conventional corporates. Last of all, it is difficult for investors to add to existing positions [in one bond or name] because of limited issuance. There are only 90 names in the Maples market, and most issues are $200 to $300 million.”
Valuations on Maples are more complex than for a domestic corporate issue, McHugh adds. “When valuing a Maple, you have to compare the spread in the native currency, price the swap relative to the credit curve in the native currency and, as well, the spread has to be evaluated relative to comparable Canadian issuers,” he explains.
There are also problems of volatility due to lack of depth of the market. And there is a special problem, information risk, characteristic of foreign bonds, McHugh says. “Information for a Maple issue can be harder to access. There is a risk that there could be an information vacuum. A corporate Maple could be exposed to a negative credit event, but the news might reach Canada a day or two later, and the spreads would be priced in by that time.” In the end, McHugh says, “the extra spread in Maples is not a free ride. Investors must be aware of the specific risk of Maples and do their pencil work.”
The Maples market is institutional. The market could grow, says John Carswell, president of Canso Investment Counsel in Toronto, a corporate bond manager. He notes that many Maples issues were not Qualified Investments eligible for RRSPs and other registered plans such as deferred profit-sharing plans. However, the federal budget of March 19 made major changes in the rules.
The federal budget has expanded the field of qualified investments substantially, Carswell notes. “The budget allows every investment grade issuer, which includes all Maple bonds that have been issued thus far, to meet the test for Qualified Investments. The rule that they must be issued by an entity that trades on a prescribed stock exchange has been expanded so that any bond of an investment grade issuer of an issue greater than $25 million will qualify.”
It is not clear that sub-investment grade debt, which represents the vast majority of global bonds, will meet the test for Qualified Investments, Carswell says. “There are ambiguities in the proposed expansion of qualification that need to be clarified in respect of what is a public security.”
Will expanding Maples to include junk bonds be a good thing for the Maples market? “It would not be a bad thing,” Carswell says. “If Canadians can invest in junk stocks as long as they are listed on a prescribed exchange, why restrict qualified bonds to investment grade?” Risk diversification should be the choice of the investor, he says. Moreover, as Daljit Seran, director of fixed income investments for Credit Union Members Insurance Services, CUMIS for short, says, “The market probably will not be so receptive to sub-investment-grade Maples. There are ample investment-grade Maples available at desirable spreads relative to comparable domestic corporate bonds.” Indeed, Maples are thriving because of their quality and ease of use. Bringing global junk to the market wearing a Canadian flag might be killing the golden goose.
For now, Maples have added diversification in the form of new names in the market, higher quality corporate debt and foreign exchange-free investment opportunities for Canadian plan sponsors.
Andrew Allentuck is the author of Bonds for Canadians, published last year by John Wiley & Sons. andrewallentuck@mts.net
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