Municipal bonds help finance the infrastructure and development of the city or township they are issued. In Quebec, municipal bonds can be a particularly attractive investment opportunity since they offer the highest yield of any security issued by a Canadian government body without necessarily higher risk.
In this article, we’ll explain why Quebec municipal bonds offer a safe and generally more profitable return than their non-Quebec counterparts. Here’s how “muni” bonds in Quebec work, and how they can help boost your fixed-income portfolio.
The municipal financing system in Quebec vs. other provinces
The financing system of Quebec municipalities is significantly different than that of other Canadian municipalities, benefitting investors.
In most provinces outside Quebec, smaller municipalities pool their financing needs to obtain favourable credit ratings and reduce their members’ borrowing costs. For example, participating local governments in the Municipal Finance Authority of BC (MFA) try to obtain a collective lower financing rate, which translates to a less advantageous return for investors.
In Quebec, it works very differently. Smaller issuers use an auction system to address their financing needs.
Since financing comes in small, auctionable parcels, Quebec issuers retain their autonomy and forgo paying for a credit rating agency such as Moody’s, Fitch, DBRS or Standard and Poor’s. In the absence of a credit rating, however, they must offer a more attractive yield to investors to compensate.
As a result, unrated Quebec municipal bonds usually offer significantly higher yields than other government securities with solid credit ratings.
Risk and returns
It is important to note that the absence of a credit rating does not mean an increased risk of default. The provincial government tacitly guarantees municipal bonds. In financial difficulties, the Quebec government places municipalities in trusteeship until their financial situation is rectified.
In addition to the Quebec government’s tacit guarantee, investors can diversify their investments by investing in several municipalities for added security.
Flexibility
In addition to favourable interest rates, municipal bonds allow you to take advantage of maturities of up to 10 years to build your portfolio. So you can lock in a desirable interest rate for a long period if it’s in your interest.
Unlike Guaranteed Investment Certificates (GICs), which cannot be transferred or sold before their maturity date, it is possible to sell part or all of an investment in municipal bonds prematurely, should your plans change. There is a well-organized secondary market for selling these bonds if you need your funds early. Remember, however, that the prices of these bonds will be affected by interest rates prevailing at the time of sale, to reflect current market yields.
Should you invest in Quebec municipal bonds?
Quebec municipal bonds are an excellent choice for investors seeking :
- Safety: tacit guarantee from the provincial government;
- Attractive yield: superior to government securities with a credit rating;
- Flexibility: maturities and liquidity.
Investors can benefit from the unique way Quebec’s municipal bond financing is structured. After all, obtaining a debt rating is expensive—certainly more expensive than giving investors a higher yield—and even though Quebec muni bonds are unrated, the risk is extremely low. Furthermore, while the cities and townships don’t explicitly promise financial backing from the Quebec provincial government, there is implicit backing, assuring investors their investments are secure.
We always recommend that investors use an independent portfolio manager to support their investment decisions. An independent portfolio manager has the luxury of shopping around for securities at any dealer. He or she can also combine the needs of several clients to achieve economies of scale in the buying and selling of securities, which can translate to even greater returns for the investor.
