National Post - Financial Post Magazine
Fixed-income strategies need to change with the times
With the prospect of rising interest rates on the horizon, it’s time for Canadian investors to consider diversifying their fixed-income portfolios. Although many have been relatively content with the status quo in recent months, low yields will soon start to work against investors when those increases come into play.
It’s an opportune time to review fixed-income holdings both inside and outside of Canada as a way to mitigate risk and improve yields, especially since rate increases will be much slower than in past cycles, says Aubrey Basdeo, managing director, fixed-income portfolio management group, BlackRock Asset Management Canada Limited in Toronto (BlackRock Canada). “Usually it happens pretty fast after a recession, but this time it will be in a more gradual fashion.”
“The Bank of Canada will not be raising rates for at least a year,” says Camilla Sutton, managing director and chief currency strategist with Scotiabank Global Banking and Markets in Toronto. “That also means a fixed-income portfolio is at risk of losing value because the yields are far too low to generate enough income for retirement. You have to consider ways to balance returns and risk.”
There are three key approaches investors can use to diversify their portfolios: shortening the duration of their holdings, incorporating floating rate notes, or increasing exposure in investment grade short-term corporate bonds.
Shortening the duration of holdings is the most conservative option. Basdeo advises investors to consider reducing holdings that have a duration of more than five years. “Any longer and you could generate a loss if rates rise. By reducing duration to between three and five years, you can protect yourself against that.”
Increasing exposure in floating-rate notes allows an investor to absorb interest rate risk while benefiting from increases when they happen. Corporate bonds can also be advantageous in a rising rate environment, since positive earnings will increase the premiums and offset interest rate increases.
An affordable and flexible way to diversify on the fixed-income side and offset the effects of rising interest rates is exchangetraded funds (ETFs). Available options include a range of floatingrate, corporate bond and short-duration funds. “They have the added advantage of providing transparency and liquidity,” Basdeo says. “Bonds are traded over the counter, while ETFs are listed products that trade like a stock.”
They also provide a less costly way to move in and out of a wider spectrum of fixed-income holdings, including global and emerging markets, he adds.
ETFs are an effective and efficient way for investors to maintain exposure in fixed-income holdings while hedging risk, says Bob Stammers, director of investor education for the CFA Institute in New York. “It’s much easier to get into diversifying. Because they trade like equities, the nice thing is you can get in and out in minutes at whatever the prevailing price may be.”
When investors think about rising interest rates, they need to consider all the factors that come into play, Basdeo says. “While ETFs can give you the flexibility you need without having to know the price of individual bonds, you should also put the effort into understanding what you are purchasing.”