A low interest-rate environment may good news for borrowers but it spells disappointment for fixed-income investors.
One-year guaranteed investment certificates are paying about 1.5 per cent while those maturing in five years are yielding about 3 per cent. That is barely above the level of inflation.
How to find higher-yielding alternatives for the fixed income portion of your RRSP? Here are some pros' suggestions.
Bond funds.
In the current climate, funds are preferable to individual bonds, says financial planner Janet Freedman, head of Toronto-based Freedom Financial Planning.
"Managers with good track records do not buy and hold. They actively trade, unlike most retail brokerage accounts," says Ms. Freedman, adding that funds benefit from economies of scale. "That's how bond funds make money."
The average Canadian bond fund returned 5.4 per last year but many funds earned more than that. For example, Phillips Hager & North Bond Fund returned 6.6 per cent. And though investors have to pay management fees, funds such as PH&N's keep them relatively low, at 0.58 per cent. Its minimum initial investment is $25,000, however.
Real return bonds.
These bonds are government-backed and designed to protect investors against inflation. Their coupons and principal are adjusted semi-annually based on changes in the consumer price index. "By investing in them, you ensure that your purchasing power is maintained and always keeps pace with inflation," says Patricia Lovett-Reid, senior-vice-president at TD Waterhouse Canada Inc.
RRBs can be bought through full-service and discount brokers. However, there are some drawbacks. The minimum investment is usually $20,000 or more. They are also difficult to secure for retail investors as there are only about six individual issues, most of which are held by institutions.
Alternatively, investors can participate through funds such as TD Real Return Bond Fund, which returned 10.3 per cent last year, and Mackenzie Sentinel Real Return Bond Fund, launched last April.
Strip bonds.
Also known as strips, these bonds are derived from federal, provincial and corporate bonds. Each interest payment and the remaining principal is physically separated -- hence the moniker strip -- then priced at a discount to maturity value.
For instance, a 13-year strip yielding 5.5 per cent would cost about $50.50 and mature at $100. As a rule of thumb, the longer the term of the strip, the lower the price and the higher the yield.
Currently, one-year strips are yielding about 2.5 per cent; five-year strips are yielding 4 per cent.
One of the big advantages, says Ms. Lovett-Reid, is that "there is a very liquid secondary market. You can also make a smaller initial investment than with a conventional bond." Purchased through investment dealers or discount brokers, these instruments start as low as $3,000.
There is also considerable flexibility, since terms vary from one month to 30 years. By varying your maturities, you can minimize your re-investment risk, says Ms. Lovett-Reid."If we continue to be in a low-rate environment," she adds, "you will minimize your investment risk."
High-yield bond funds.
These products invest in a variety of corporate bonds that range from investment-grade to what is often referred to as junk bonds. They also tend to be more volatile than conventional government bonds.
Last year, the average Canadian high-yield bond fund did very well, returning 14.3 per cent, almost triple the average Canadian bond fund return of 5.4 per cent. But the underlying products are complex, experts warn.
"We recommend using the services of a professional fund manager, who can evaluate the prospects of each company and identify those situations where a superior return can be achieved without accepting an exorbitant amount of risk," says Sandra Sigurdson, portfolio strategist at Winnipeg-based Investors Group Financial Services Inc.
Ms. Sigurdson notes that, last year, fund returns were especially strong because of rising bond prices that stemmed from improving economic conditions. For example, Investors Canadian High-Yield Income Fund earned 28.7 per cent, three-quarters of which was capital gains. Going forward, she says, "we still expect a relatively high yield but not a repeat of last year."
Laddering
"If you are investing in fixed income, make sure you have a laddered strategy," says Jim Rogers, chairman of Rogers Group Financial Advisors Ltd., in Vancouver. "Don't try to predict interest rates because it's fool's game. You will be better off with a laddered structure,"
Laddering means splitting your fixed income into equal portions that mature over different terms. The chief advantage is that laddering takes the guesswork out of investing in fixed-income investments and ensures more predictable returns over the years. In Mr. Rogers' view, it is more effective than owning a bond fund, especially if rates start to climb.
"If I buy a series of laddered bonds, and hold them to maturity, I know I will have a positive return. Bond funds can lose capital," says Mr. Rogers. "Bonds, if held to maturity, will not."
© The Globe and Mail
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