RPT-BAY STREET-With Canada rates rising bond buyers go corporate

(Repeats May 30 column)

* Big investors see corporate debt outperforming

* Rate hikes seen moderate, reflecting improving economy

* Provinces, high yield also seen beating Canada bonds

By Jeffrey Hodgson

TORONTO, May 30 (Reuters) - Big bond investors are laying bets that Canadian corporate debt will offer superior returns as the Bank of Canada abandons record-low interest rates and kicks off the first tightening cycle of the decade.

An improving economy, the main reason for the likely rate hike, is why many fixed-income fund managers see corporate debt outperforming lower-yielding Canadian government bonds. But they also highlight healthy corporate balance sheets and attractive investment opportunities in bonds.

"It's not a bad thing that the Bank of Canada is going to raise interest rates ... this is in response to a very strong economy," said William John, a bond fund manager with Phillips Hager & North, a unit of Royal Bank of Canada (RY.TO).

"It shouldn't be something that should scare people away from good quality investments ... That doesn't make corporate debt less attractive," added Vancouver-based John.

A Reuters poll released on Thursday showed 32 of 40 global forecasters expect the Bank of Canada to raise rates by 25 basis points on June 1, [CA/POLL]POLL20 making it the first G7 central bank to start nudging crisis-level rates higher.

A rise would bring the overnight rate to 0.5 percent, still low by historical standards.

The price of many bonds, particularly shorter-term issues, tends to fall when interest rates rise, as coupons become less attractive compared with rising yields elsewhere. But the impact varies, depending on the type of security.

"Generally, government securities, government of Canada paper is affected most directly when they raise rates. There's a bit of cushion in provincials and more of a cushion in corporate debt against that rate rise," said Terry Carr, head of Canadian fixed income for MFC Global Investment Management, a unit of Manulife Financial Corp. (MFC.TO)

Carr, who helps manage about C$16 billion ($15.2 billion) in fixed-income assets, said his team is "very underweight" Canadian government bonds, favoring provincial and corporate debt and high-yield or junk bonds where its mandates allow.

BALANCE SHEETS, YIELDS APPEAL

Many mid-term corporate bonds <CA/CORP> now yield about 135 to 150 basis points over similar Canadian government bonds, well above the 40 to 60 basis point spreads seen in 2004 to 2006. Junk bonds can yield 500 to 700 basis points more.

That means a bond due 2014 issued by a blue chip firm like phone company Telus Corp (T.TO) yields 3.799 percent.

"The spread levels, the actual yield that we're getting from buying a corporate bond versus the federal government bond in the same term, are similar to previous recessionary times in Canada," said Heather McOuatt, lead manager of Bissett Bond Fund for Franklin Templeton Investments.

Calgary-based McOuatt, who is also overweight Canadian corporate bonds, said the issues were "very, very fairly valued" in view of the risk they offered.

Canadian bond fund managers said Europe's debt crisis and other global developments are the biggest single threat to their forecasts, as provincial, corporate and high-yield debt are only likely to outperform if the recovery holds.

A resumption of the financial crisis would likely see bond investors pile back into the safety of Canadian government bonds, causing spreads to less credit-worthy issues to widen.

"If we somehow slip back into recession, then I think all bets are off," said MFC's Carr.

But nobody expects a rapid rise in benchmark interest rates as the Bank of Canada watches developments abroad.

"The Bank of Canada is not going to be very aggressive at this stage. They're quite aware of what's going on globally, what's going on in Europe," said Tom Nakamura, a bond portfolio manager with AGF Management Ltd (AGFb.TO).

($1=$1.05 Canadian) (Editing by Rob Wilson)