It's good to be wealthy. It's better to stay wealthy.
That's the creed for many high-net-worth investors who have reached a point where dreams of becoming multibillionaire Warren Buffett have given way to the attitudes of laid-back musician and "parrothead" leader Jimmy Buffett.
Before heading to Margaritaville, some of them find their way to Craig Machel's Toronto office. He's a portfolio manager with Richardson GMP who specializes in creating hedges for high-net-worth clients who want to stay that way.
"We're less at the whims and volatility and temperament of the public markets. We can drive our own destiny and be more assured of returns," Mr. Machel says.
His strategy makes wealth preservation a priority over big market returns. "We aim to build more effectively diversified portfolios beyond stocks and bonds. We collect yield, we manage volatility and then we aim for capital growth," he says.
Achieving safety and capital growth is no easy task these days. Fixed-income bond yields are at rock-bottom as the global economy dithers and central banks keep interest rates down. At the same time, volatile equity markets are providing little relief for those who rely on secure returns.
To combat that volatility, Mr. Machel's arsenal includes a variety of hedge strategies for changing market conditions. His objective is to generate consistent returns regardless of the broader market direction with the right mix of reliable yield strategies, defensive hedge funds and equities with potential for growth.
One strategy that has been successful generates yields by investing in private real estate – specifically, family apartments with little turnover and student-designated apartments with high occupancy rates.
"We own apartment buildings or typically stable rental units. We're not after capital growth. We're after yield first and that 'de-risks' things" he says.
Annual yields from private real estate holdings typically run in the 7-per-cent range, he says. The portfolio of apartments spans the country but avoids more volatile markets.
Economist have been warning condominium prices in some major urban centres such as Vancouver and Toronto are rising too fast and could be headed for a correction. "We don't suspect we will suffer much if real estate values fall in Canada. It's apartments."
Another interesting hedge Mr. Machel employs for his wealthier clients involves mergers and arbitrage – but not the highly leveraged, speculative deals we often read about. He invests through another firm that only invests in companies that have already announced takeovers, mergers or corporate restructuring.
"Their leverage is minimal. They don't speculate. They only work in announced trades and announced reorganizations. They will pass on a lot of deals," he says. "They will investigate the deal, they will speak to the players involved and find how they can profit in that trade."
For some skittish high-net-worth investors, that level of safety might not be enough. Many opt to put some or all of their savings in annuities – insurance products that guarantee fixed returns along with the principal.
Annuities are like defined-benefit pension plans. Holders receive a regular allowance for the rest of their lives no matter what the markets do. Annuities can be tailored to an individual's risk tolerance, return expectations and life expectancy.
"There is definitely a part for annuities to play for higher-net-worth individuals," says Matthew Williams, head of defined contribution and retirement at Franklin Templeton Investments in Toronto.
The recipient's present health is often factored into the decision. "Everyone has their own unique set of circumstances. Everyone's circumstances are not necessarily simple. They are often complex."
What kind of annuity they choose "is driven by their desire or need for income versus the longevity they think they will have, versus the likelihood they want to have at least a portion of their capital transferred to the next generation," Mr. Williams says.
Annuities can provide a specific payment amount for a specific period of time. If the holder dies before the end of the period, a beneficiary could receive the remainder of the payments for that time. "You would be buying a 10- or 15-year term-certain annuity and blending it together with a lifetime annuity that might have a protected term, for example," he says.
Payouts are determined by complicated formulas based on the amount invested and actuarial calculations. While annuities are considered safe, there is a risk if the holder dies early.
"If you purchase a lifetime annuity, and if you die early, the insurance company will retain the capital. That risk obviously goes down the longer the annuitant survives," Mr. Williams says. "The risk then shifts from the annuitant back to the insurance company to continue to pay the income stream."
As always, safety has a price. Annuities are correlated to interest rates, which means returns are low. A tax efficient annuity will generally pay an annual yield in the lower single digits.
"Annuities are largely fixed income. The insurance companies are buying long-dated bonds and having very low exposure to growth assets," he says.
"We're in a much lower real-interest-rate environment than what we have been in history. You can reasonably expect that the internal rate of return generated by an insurance company on an annuity book is going to be lower than what it would have been 15 or 20 years ago."