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More yield, low risk with muni bonds

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Looking for better bond yields, but don’t want the added risk of corporates? Non-rated Quebec municipal bonds (usually referred to as “munis”) may be the right choice.

François Bourdon, chief investment solutions officer at Fiera Capital in Montreal, notes that with the exception of bonds issued by Montreal, Quebec City and Laval, municipal debt in Quebec is unrated, which naturally means higher yields.

He says the main reason these bonds aren’t rated has to do with cost. It’s expensive to get debt rated—more expensive than giving investors a higher yield.

So, while the bonds are unrated, the risk to investors is relatively low. Chances of default are remote, and while cities don’t have an explicit promise of financial backing from the Quebec provincial government, there is implicit backing, says Bourdon. All non-rated Quebec munis have the same yield, regardless of credit quality.

The main risk is if the province runs into financial problems and becomes unable to rescue a city that falls under duress at the same time. This is where professional credit analysis and security selection come into play. It’s an essential step in risk management because it helps weed out the cities that are more likely to rely on provincial help in tough times, which may not be there if the province is also struggling.

A bond from a non-rated Quebec muni issuer, such as the City of Sherbrooke, will get you about 85 basis points more than Toronto’s rated bonds.

“That’s why we’re focusing on non-rated,” notes Bourdon. But rated munis still have a place in your portfolio, he adds, since they’re more liquid and can therefore be more readily cashed out when needed.

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