With trillions of dollars getting pumped into the pandemic-plagued global economy, cash is getting cheaper by the day. The low interest rates that come with such a massive oversupply of money are good news for borrowers, but not so good for investors looking for a safe way to grow their savings during troubled equity markets.
Marc Goldfried, chief investment officer and head of fixed-income at Canoe Financial in Toronto, says already rock-bottom yields resulting from low interest rates will find new lows.
“With the amount of economic devastation that’s going to be reported over the next few months, we could see a world in which interest rates collapse to zero across the yield curve,” he says.
For savers, that means smaller returns on fixed-income products like bonds and guaranteed investment certificates (GICs). Yields on GICs, for example, have rarely topped 2.5 per cent since the last round of emergency stimulus spending in the wake of the 2008 global financial crisis.
Regardless, Mr. Goldfried says fixed income still has a place in every retirement portfolio – especially in the months and years ahead, when the fallout from COVID-19 wreaks havoc on stock markets.
“Bonds aren’t dead. Fixed income isn’t dead,” he says. “It is still an asset class you should own for all the right reasons: capital preservation, enhancement of income and to lower your overall correlation to equity market volatility.”
Mr. Goldfried oversees a series of bond funds with different strategies to meet various investment objectives, but financial advisors can also create their own fixed-income portfolios for investors. The type of fixed income varies according to an individual’s risk tolerance and how soon they will need to draw on those investments for income.
“The construct in a diversified portfolio is that your fixed income is supposed to provide some returns for downside protection during periods of volatility,” he says.
Although finding decent yields will be challenging, Mr. Goldfried says investment-grade corporate bonds could offer value. Bonds are rated according to default risk, with safe government bonds generally rated as higher ‘A’ and safe corporate bonds rated as lower ‘A’ or in the ‘B’ range. As such, higher-rated bonds tend to have lower yields.
“You want a very light exposure to corporate bonds. If you do own corporate bonds, they should be [rated] A-minus or higher. I would avoid the BBB sector,” he says.
Mr. Goldfried expects many B-rated corporate bonds to be downgraded to high-yield, or junk, as the extent of the economic damage is tallied.
Meanwhile, current high-yield bonds, which have high payouts and low ratings, are “nowhere close to pricing in the amount of default risk,” he says.
Canoe’s fixed-income portfolios favour Canada’s big banks and regulated utilities such as Hydro One Ltd. (H-T) while avoiding energy and pipelines.
As bonds with longer maturities tend to pay higher yields because they’re exposed to shifts in financial markets for a longer period of time, advisors and investors who believe inflation will boost rates will often ladder short durations over frequent maturities to create more opportunities to get the best going rate. In contrast, Mr. Goldfried says he’s keeping his maturities long.
“Pandemics generally create deflation, not inflation,” he says. “I’m not looking at three- or five-year bonds as a way to protect downside. It’s the 10- and 30-year bonds that are going to give you the kind of price appreciation to provide real return versus equity market volatility.”
Paul Gardner, partner and portfolio manager at Avenue Investment Management Inc. in Toronto, isn’t worried about inflation either. He says with so much debt swishing around global financial markets, governments and central banks will do everything they can to cap interest rates – much like they did after the Second World War.
“That’s the only way we see out of it. Otherwise, there are going to be real problems,” he says.
Mr. Gardner manages the income portion of Avenue Equity Portfolio and that has meant turning to riskier investments for better yields, including preferred shares and dividend stocks. He cautions that investors who venture into the stock market for income could see the value of their investments decline during bear markets.
As such, he advises advisors and investors to continue laddering maturities, but not to be afraid to stretch them out over longer periods of time if the yield curve steepens and yields are higher for longer terms.
“The risk/reward is favoured to the short to medium term, but we might stay down here for a long time so you might lag for a fair bit,” he says.
Federal government bonds, which currently yield less than 1 per cent, should be avoided, Mr. Gardner says, adding that some provincial and corporate bonds have value provided they’re rated investment grade.
“The high-yield market can offer some real volatility for someone who is risk averse, but investment-grade bonds should give you [yields of] 3 to 4 per cent,” he says.