If you hate drama in your portfolio, GICs beat bond ETFs.
Guaranteed investment certificates have been their usual selves during the financial market turmoil of 2020, which means they paid interest on schedule and held their value. In the worst of it, back in March, some investors fretted about the risk of losing money if their GIC issuer became insolvent and deposit insurance proved inadequate or faulty. But these worries reflected a generalized anxiety, not an actual risk in the financial system.
Diversified bond exchange-traded funds had a bad patch in March before finding their footing. They fell in price for a brief period, partly because investors were selling everything in sight out of pure fear and partly because the corporate bonds they hold came under particular selling pressure. If you held a diversified bond ETF as a portfolio stabilizer, you were probably in shock for a short period of time.
GICs certainly seemed the better choice at the worst of the financial market volatility. But if you look at the first four months of 2020 in total, you’ll see that bond ETFs have more than recovered from their earlier setback. Across the board, bond ETFs were up between 3 to 13 per cent on a total return basis, which means interest plus share price changes.
Your actual return from bond ETFs depended on what was in the portfolio. A diversified bond ETF holding government and corporate bonds with a mix of short, medium and long maturity dates would have made you about 5 per cent for the year to April 30. A diversified short-term bond ETF would have been in the 3 per cent range. A fund holding only government bonds would have delivered returns around 13 per cent.
Interest rates have been falling since late February, a result of central bank efforts to support the economy with lower borrowing costs and concern in the bond market about recession. When interest rates fall, the price of bonds and bond ETFs rises. This explains the sizable total return for bond ETFs so far in 2020. The interest portion is modest, but the share price changes have been strong.
GICs pay interest only and don’t change in price. On maturity, the principal you invested is handed back to you. If you’re a no-drama investor, this total predictability is exactly what you want.
Bond ETFs, as we’ve seen, cannot match GICs for predictability. But they made up for it by delivering better returns when rates were falling.
-- Rob Carrick
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Rudderless after a rally, stock markets look for next catalyst
Global equity markets have shuffled up about 1 per cent this month despite the world starting to re-open after the coronavirus-driven lockdowns and U.S. and European economic data showing glimmers of a recovery. The sideways movement is in sharp contrast to the roughly 30 per cent rally in late March and April, when investors were able to shrug off far more dire economic data and look towards recovery backed by government support. Investors say the explanation partly lies in the failure of the market’s collective wisdom. Stock markets misread how fast growth may rebound. And now they need a new catalyst, such as a vaccine or substantial new stimulus, before they can decide whether to flee or hold the course. But it is proving to be elusive. Saikat Chatterjee, Sujata Rao and Megan Davies of Reuters report. (for everyone)
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A ‘deep value’ stock pick from my students
Once again, with the 2019-20 school year at its end (and despite the challenges of the past few months), Dr. George Athanassakos’ Ivey value investing students submitted their final stock picks and analysis, which are a very important element of his value investing classes. As has always been the case for young students/investors, it is much easier to find “deep value” stocks (those Ben Graham would have liked, and which have been largely shunned by investors over the past several years), than finding “quality” stocks (those that would appeal to Warren Buffett). A Graham-type stock that students worked on that got his attention, Fonar Corp. (FONR-Nasdaq), is profiled here. (For everyone)
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Ask Globe Investor
Question: I was attracted by Capital Power Corp.’s (CPX) yield of more than 7 per cent, but the dividend payout ratio is 258 per cent. This is clearly unsustainable, yet Capital Power continues to raise its dividend each year. Why do you own shares of a company that is paying out far more than it makes?
Answer: I own Capital Power (personally and in my model Yield Hog Dividend Growth Portfolio) because the dividend is actually very sustainable. You just have to measure the payout ratio the correct way.
The bloated payout figure you provided is based on Capital Power’s earnings. I can only assume you got the figure from a financial website that generates payout ratio figures automatically. Problem is, a power producer’s earnings can be depressed by accounting charges such as accelerated depreciation that don’t affect the actual cash flow of the business. That can make the payout ratio (dividends per share divided by earnings per share) look unsustainably high. It can also make the price-to-earnings multiple (share price divided by earnings per share) look dangerously high as well.
That’s why, depending on the sector, companies and analysts often prefer to measure the dividend payout ratio based on cash flow instead of earnings. Instead of relying on financial websites that do not provide any context or explanation for their figures, I always recommend that investors go straight to the source. Most companies make this information available, and it is important for investors to read it.
On Capital Power’s website, you’ll find a PDF of a recent investor presentation. Page 22 has a colourful chart that shows Capital Power’s adjusted funds from operations (or AFFO, a cash flow measure) rising more or less steadily from 2015 through 2020. Note that dividend payments have been less than 50 per cent of AFFO every year. In 2020, the payout ratio is expected to fall to just 40 per cent – below Capital Power’s long-term AFFO payout ratio target of 45 per cent to 55 per cent.
So, in Capital Power’s case, the dividend appears to be quite sustainable. In fact, the company has indicated that it aims to raise the dividend by 7 per cent in both 2020 and 2021, with an increase of 5 per cent projected for 2022. Dividend increases aren’t official until they are declared by the board, but Capital Power – which has hiked its payment for the past six consecutive years – is sending a strong signal that its dividend is not only sustainable, but will likely continue to grow.
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What’s up in the days ahead
This weekend, we take an indepth look at where markets stand in Canada and abroad - and what’s likely to come next. And Rob Carrick looks at the blindly simple tweak your retirement investments need to survive pandemics and all other disasters.
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Compiled by Globe Investor Staff