Markets are volatile. The economy is shaky. The financial news from other parts of the world is troubling. Clearly, this is a time of change.
Whenever we go through times like these, there are a lot of competing opinions on how investors might use change to their advantage. Here's mine.
I believe one of the best ways to profit from change is to watch how the wealthy respond to it. I've often noticed that one of the distinguishing features of successful high-net-worth individuals is the ability to anticipate change. Simply put, the wealthy are able to see the implications of current events - the dangers and the opportunities - more clearly than the average investor.
Over the past few weeks, there have been three "inflection points" that my high-net-worth clients and I have paid particular attention to. They are:
1. The loonie is now at par
On April 6, the loonie hit an intra-day high of $1.0012 (U.S.) against the greenback. Given the relative strength of Canada's fiscal position compared to the U.S., the move was highly anticipated. Unlike the last time the loonie soared, however, most analysts believe parity is the "new reality," and the dollar will be strong for some time.
2. Bill Gross says U.S. government bond market looks vulnerable
In the first week of April, trend-setting bond manager Bill Gross (who manages the mammoth $200-billion Pimco Total Return fund) issued his influential monthly economic commentary. In it, he declares the 30-year bull market for government bonds is over. As Mr. Gross explains, U.S. interest rates are going up - an inevitable result of the ballooning U.S. federal debt - and government bond prices are going down. The only question is when.
3. Mortgage rates are rising
On March 29, Royal Bank, TD Canada Trust and Laurentian Bank announced they would raise the rate on their benchmark 5-year closed mortgage by 60 basis points. (A basis point is 1/100th of a percentage point.) While rates remain relatively low, the jump signals the end of the "cheap money" era. Going forward, it will likely cost a lot more to borrow.
Many of the high-net-worth investors I know and work with are taking steps right now to respond to these events. What specifically are they doing?
Shortening duration on government bonds
Wealthy investors are starting to hedge their positions in long-term government bonds. First, and most obviously, they are reducing their holdings of long-term Treasuries, and shortening the average duration of their Treasury portfolios. So instead of holding bonds that mature in seven years or longer, they're holding bonds that mature in three to five.
Secondly, some wealthy investors are starting to short long-term Treasury bonds with the intention of profiting from a possible coming bear market for bonds. Their preferred way to do this has been through the purchase of an inverse long-term government bond ETF.
Thirdly, the wealthy are deploying capital to third-party money managers who can go long on the short end of the bond market, and short on the long end. Given the volatility we're likely to see in the future, the wealthy believe their portfolios will be better served by managers with multiple tools in the toolbox.
(Let me be clear: the above only applies to government bonds. In relative terms, high-yield bonds continue to look reasonably good, as do pockets of the investment-grade corporate bond market. Both of these types of bonds, especially high yield, are less sensitive to interest rate movements, because their values are more closely tied to the health of the issuing company.)
Shifting loonies to greenbacks
Almost all of the successful high-net-worth individuals I know are contrarian, opportunistic thinkers. So it doesn't surprise me to know that at a time when most investors are dumping U.S. dollar-denominated holdings in favour of the Canadian dollar, the wealthy are beginning to convert portions of their Canadian dollar-denominated holdings into U.S. dollars.
Our clients have been busy searching for U.S. dollar-denominated opportunities. Some are looking at distressed real estate south of the border. Others are looking at high-yield corporate bonds denominated in U.S. dollars. Many of them are starting to build positions in common stock of U.S. companies.
Locking in rates now
With interest rates likely to rise in the near future, the wealthy are doing the logical thing: shifting variable/floating-rate debt into fixed-rate loans, and extending terms of their current loans.
True, a residential mortgage is usually not a significant issue for a high-net-worth individual. But a business loan, or an investment line of credit, or a loan on a vacation property - these can be. By locking in this debt now, while rates are still relatively low, they can avoid getting caught in the middle of a continuing string of rate hikes.