Q&A: Why is fund falling in value?

Question: I have over 30 per cent of my total retirement savings invested in the
TD Real Return Bond Fund. Although I am very satisfied with the returns from this
fund through the years, I am puzzled by its performance over the last six months.
During this period of higher inflation, the fund’s share price has actually
fallen by approximately 9 per cent. Why? – D.R.

Gordon Pape answers: Real return bonds usually have medium
to long maturities. For example, 41 per cent of the bonds in this portfolio
do not mature until after 2030 (some as late as 2036) while another 30 per cent
mature between 2020 and 2029. Long-term bonds are especially vulnerable to interest
rate increases and that is exactly what we have seen here. Higher rates have
resulted in lower market valuations for the bonds and the portfolio’s net asset
value (NAV) has declined accordingly.

In TD’s monthly report on the fund, the company notes that real return
bonds continued to underperform regular bonds during May. The managers go on
to say: “Medium-term fundamentals for real return bonds remain solid,
with stable economic growth and relatively low short-trm interest rates. Real
yields have reached a level where capital gains are not expected to meaningfully
enhance performance.”

Interpretation: much of the strong performance of this fund in recent years
was fuelled by capital gains in the bond market. The managers believe we are
unlikely to see a repeat of that going forward so your return will be primarily
yield. At the time of writing, the yield for the Real Return Bond Index was
1.9 per cent annually plus the rate of inflation, which was running at 2.4 per
cent in May. On that basis, the outlook is for a return in the vicinity of 4.3
per cent over the next 12 months.

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