Provincial bonds fell 0.33%, as their longer average maturities resulted in larger price moves. Yield spreads of provincial issues were little changed in the month, including those of Quebec, which faced an election and probable change of government in early September. Corporate bonds were the best performing sector in the month, gaining 0.33%. Notwithstanding the general concern about slowing global growth, investor demand for the additional yield offered on corporate bonds drove their yield spreads 9 basis points tighter on average, resulting in better price performance. Corporate bond performance was also helped by relatively light new issuance in August.

In our opinion, there has been little change in the bond market fundamentals in the last month. Bond yields remain near record lows and not particularly attractive. However, in the current uncertain economic environment, yields may stay low for several more months. Canadian government bonds, particularly AAA-rated federal issues, are in demand because they are perceived to carry less risk than most alternatives and that demand seems unlikely to slacken in the near term. We are keeping portfolio durations, therefore, close to the benchmark.

The short term portion of the yield curve remains quite flat and expensive. Yields of 3 to 5-year bonds are unattractive because they fail to compensate investors for the additional risk they carry should rates begin to rise. Accordingly, we have de-emphasized those terms, preferring to hold bonds with 2 years or less to maturity.

Corporate bond yield spreads are attractive from a historical perspective, but may widen should economic growth falter. Weightings of corporate bonds in the portfolios are relatively high, but not at policy limits. Should spreads widen and become even more attractive, we will have capacity to add at very attractive levels. We are avoiding issuers with substantial exposure to Europe, and the funds have limited direct exposure to U.S. issuers. We are also avoiding poorly diversified financial issuers with substantial exposure to the Canadian housing sector. We continue to monitor individual holdings to minimize the potential impact of an economic downturn.

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