As central banks in many of the world’s major economies gradually loosen their monetary policies in response to economic headwinds, bond prices have quietly been on the rise. This is not a new phenomenon, but it is one that consistently draws the attention of savvy investors looking to navigate shifting financial tides.

For Canadian investors, the opportunity is even more compelling. With a strong preference for domestic investments—particularly in fixed income—many are turning to the Canadian bond market to capitalize on both safety and yield. This isn’t just a reflexive play driven by familiarity or convenience. Canada’s bonds have long been a stable, attractive option, with the nation’s political and financial systems demonstrating resilience.

With short-term interest rates now on the decline, the hunt for yield is intensifying. Investors, wary of shrinking returns on traditional fixed-income products, are increasingly seeking alternatives that can offer more robust income potential. As we enter an era of lower interest rates, bonds—once sidelined in favour of riskier assets—are reclaiming their position as an essential component of a well-rounded portfolio. And for Canadian investors, the timing couldn’t be better.

Understanding the Link Between Declining Interest Rates and Bond Prices

The relationship between interest rates and bond prices is one of the most fundamental principles in fixed-income investing, yet it’s often misunderstood by those new to the market. When interest rates fall, bond prices rise—simple in theory, but profoundly impactful for investors looking to capitalize on changing monetary conditions.

The reason for this inverse relationship is based in how bonds are structured. Most bonds pay a fixed coupon rate, meaning an investor’s income doesn’t change, regardless of market conditions. However, when interest rates decline, newly issued bonds offer lower coupon rates, making existing bonds with higher rates more attractive. This drives up the price of those bonds as investors are willing to pay a premium for a higher, locked-in yield.¹

Historically, periods of declining interest rates have delivered outsized gains to bondholders. In the early 2000s and again in the aftermath of the 2008 financial crisis, central banks slashed interest rates to stimulate growth, and bond prices soared as a result.² Today, with many central banks—including the Bank of Canada—following a similar path, bond investors are once again positioned to benefit from these dynamics.³

Canadian Investors’ Fixed Income Home Bias

Canadian investors have a noted home bias in their portfolios, particularly in fixed income, with almost 80% of the Canadian fixed income ETF AUM being in domestic (Canadian) fixed income.⁴ Whether driven by a sense of familiarity, trust in domestic institutions, or the simple comfort of operating in their own currency, Canadians tend to favour their local bond market. And with good reason.

Canada’s bond market offers stability, backed by the country’s strong credit rating and political resilience. This reliability makes Canadian bonds safe harbours during periods of economic slowdown or when investors seek to hedge against global instability.⁵

With our current falling interest rates, this home bias is likely to intensify. Canadian investors know that the local bond market offers both safety and yield, making it an attractive destination for capital seeking refuge from lower-yielding, riskier assets abroad. With bond prices rising, Canadian bonds are becoming even more compelling for those who prioritize capital preservation while still capturing upside potential.

Searching for Yield: Introducing the Evolve Canadian Aggregate Bond Enhanced Yield Fund (AGG ETF)

As short-term interest rates decline, traditional fixed-income products, which once provided solid returns, are now offering slimmer pickings. This is forcing yield-hungry investors to reevaluate their strategies, and look at where reliable income can still be found.

Many investors have begun looking into more creative solutions in their hunt for yield, such as bond funds and ETFs that employ strategies aimed at enhancing income. These vehicles not only offer diversification across a wide range of bonds but are also designed to boost yield in a low-rate environment.

Products like the Evolve Canadian Aggregate Bond Enhanced Yield Fund (AGG ETF) is one such example. AGG seeks to provide investors with attractive monthly income and long-term capital appreciation by investing primarily in fixed-income ETFs or fixed-income securities primarily issued in Canada. To enhance yield, as well as to mitigate risk and reduce volatility, AGG will employ a covered call option writing program at the discretion of the Manager. This allows the fund to generate additional yield beyond the standard coupon payments from the bonds in its portfolio. It’s a strategy that has gained popularity among income-focused investors, particularly in an era of declining interest rates.

For investors with a home bias, the Evolve Canadian Aggregate Bond Enhanced Yield Fund provides an efficient way to access the stable, low-volatility returns that Canadian bonds are known for.

Investing in Canadian Bonds with AGG ETF

In a declining rate environment, savvy investors must find creative solutions in their hunt for yield. Evolve Canadian Aggregate Bond Enhanced Yield Fund (AGG ETF) offers diversified exposure to the Canadian bond market with the added benefit of tax-efficient, enhanced income.

AGG seeks to provide investors with attractive monthly income and long-term capital appreciation by investing primarily in fixed-income ETFs or fixed-income securities primarily issued in Canada. To enhance yield, as well as to mitigate risk and reduce volatility, AGG will employ a covered call option.

For more information on AGG ETF, visit our website https://evolveetfs.com/product/agg/ or click here.

Sources

1. How Bond Prices Affect Yields: A Comprehensive Guide,” Aspero, February 23, 2024; https://www.aspero.in/blog/relationship-between-bond-price-and-bond-yield/
2. Adams, M., “Federal Funds Rate History 1990 to 2024,” Forbes, September 18, 2024; https://www.forbes.com/advisor/investing/fed-funds-rate-history/
3. Mukherjee, P. & Ljunggren, D., “Bank of Canada says it’s reasonable to expect more rate cuts,” September 24, 2024; https://www.ctvnews.ca/business/bank-of-canada-says-it-s-reasonable-to-expect-more-rate-cuts-1.7050110
4. National Bank of Canada, Bloomberg as at August 31, 2024
5. Vettese, F., “Are government bonds a safe and boring investment?,” The Globe and Mail, May 9, 2023; https://www.theglobeandmail.com/investing/personal-finance/retirement/article-are-government-bonds-a-safe-and-boring-investment/

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