Financial advisors should brace themselves for a challenging few years of fixed-income investing, according to executives with Vancouver-based Leith Wheeler Investment Counsel Ltd. who spoke at an event in Toronto on Thursday.
Although interest rates are beginning to increase slightly, it will be some time before returns reach more attractive levels, according to Jim Gilliland, Leith Wheeler’s president, CEO and head of fixed-income. He said the economy is showing encouraging signs, but the Bank of Canada is unlikely to make any drastic moves in the near term.
“Rates are gradually edging up,” Gilliland said. “I don’t think that the inflation warrants moving more aggressively, and I don’t think the sensitivity of consumers to higher rates in Canada is such that the consumption can really withstand a dramatic increase in interest rates.”
Gilliland expects the Bank of Canada to raise rates one more time this year. Even as short-term rates creep higher, he said, long-term rates will remain near their current levels.
“The real question for individuals and for advisors who are trying to solve income solutions for clients is: how do you develop strategies that work in this type of environment?” Gilliland said. “When your nominal interest rate is barely covering inflation — and after taxes, it’s not even getting close to covering inflation — how can you deliver income for clients?”
Advisors need to set clients’ expectations when it comes to income, he said.
“For individuals hoping to get 8%, 9% or 10% income,” Gilliland said, “that just isn’t available in a risk-controlled manner in today’s environment.”
Mixing some high-yield bonds into a client’s portfolio can be an effective way of increasing returns, according to Dhruv Mallick, lead manager, high yield at Leith Wheeler.
“In an environment where people are desperately searching for yield, high-yield bonds are one of the few places that really can offer opportunities,” Mallick said. He noted that high-yield bonds tend to offer returns in a range similar to that of equities, but with lower levels of volatility.
Although there are risks associated with the high-yield asset class, Mallick said, the current default rate is 2.1%, which is much lower than the historical average.
Another challenge facing investors and advisors is the negative impact of rising interest rates on the value of investors’ existing bond holdings — and on stock markets. Gilliland notes that a rise in rates tends to be accompanied by a correction in the stock market.
“You can see that the market is pretty sensitive to any move in interest rates,” he said. “You want to be a little more conservatively positioned at this point in time.”