HOW TO PLAY IT-Fed's taper portends year of the bond picker

Fri Dec 20, 2013 4:16pm EST
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* Bond bull market over, tough environment seen in 2014

* Asset managers favor emerging market debt, preferred shares, high-yield

* Stay in short-duration debt to limit risks

By Andrea Hopkins

TORONTO, Dec 20 (Reuters) - It's been years since fixed income offered investors the "safe and stable" side of a portfolio, but Canadian asset managers believe the waves created by the Federal Reserve's tapering may make investing in bonds an especially bumpy ride in 2014.

The year ahead has been billed as one in which interest rates start creeping back to historical norms and the 30-year bond bull market comes to an end. But with economic growth still sub-par, Canadian money managers say there is money to be made in fixed income if investors pick the right spots.

"Our forecast is not for a bear market for fixed income in 2014, but we are at the initial stages at a rate normalization process, so I think it will be quite a challenging year," said Ilias Lagopoulos, a fixed-income strategist at RBC Dominion Securities.

After years of record lows, the yields on U.S. and Canadian 10-year bonds are expected to climb to around 3.4 percent or 3.5 percent by the end of 2014, Lagopoulos said, high enough to hurt investors who own government of Canada or Treasury bonds.

The bulk of the motion in fixed income in 2014 will come from the Fed, as it tapers its asset purchase program and removes stimulus from the economy. The U.S. central bank announced the beginning of the process this week, and the tapering could extend into 2015 as the U.S. economy improves.   Continued...