The demise of RRBs in Canada

What happened and why?

On November 3, the Government of Canada (GoC) announced in its 2022 Fall Economic Statement that it “has decided to cease issuance of real return bonds (RRBs) effective immediately.” The reason cited was low demand for RRBs.

The move was a surprise to bond dealers and is unprecedented among G7 countries with an inflation- linked bond market. Prior to the announcement, RRBs were expected to make up 0.5% ($1.4B) of GoC bonds issued in the current fiscal year, and 6% of 30-year GoC bonds issued¹. For comparison, in Q2 2022, US Treasury Inflation-Protected Securities (TIPS) made up 4% of US Treasury bonds issued, and 38% of 30-Year US Treasury bonds issued². The next Canadian RRB auction was scheduled for December 1, 2022.

What does this mean for the Target Date Funds (TDF) and Target Risk Funds (TRF) in the Canadian industry?

Some Fund Managers prefer RRBs in their managed solutions (such as TDFs and TRFs), primarily for two reasons:

• RRBs provide a degree of inflation protection. These bonds have their principals continuously raised to offset the impact of rises in inflation, as measured by the CPI. Furthermore, their nominal, semi- annual coupon payments are based on their inflation adjusted principals.
• The long-dated nature of the RRB market in Canada provides long duration exposure to portfolios.

This recent announcement could potentially impact any TDF and TRF with an allocation to RRBs. Fund Managers now essentially have two options:

• If they prefer to maintain their current strategic allocation to RRBs, they will have to buy them from the secondary market. In doing so, particular attention will have to be paid towards spreads and indirect trading costs.
• They can review their strategic asset allocation to RRBs and either reduce or remove the allocation, and invest in other asset classes for inflation protection.

What does this mean for Granite Target Date and Granite Target Risk Funds?

This announcement has minimal to no impact to Sun Life Granite Series of Funds. The Multi-Asset Solutions Team does not have a dedicated allocation to RRBs, as their preference is to use other asset classes to mitigate inflation risk, including real assets and equities. The team also gives our underlying managers discretion to opportunistically invest in off-benchmark exposures, including those that may provide inflation awareness such as inflation linked bonds of other countries (e.g., US TIPS).

¹ Update on the 2022-23 Debt Management Strategy, Government of Canada

² Fiscal Year 2022 Q2 Report, U.S. Office of Debt Management