Allan Bush
April 07, 2021
Alternative Investments in a Zero Rate Environment
We know that many Canadian investors need to live off the income from their capital. And we believe the most effective way to do this is to invest in dividend-paying stocks or fixed income to create steady cash flow – buy chickens and benefit from the eggs they lay. Employing this philosophy, we can be less concerned with the day-to-day price of an individual stock or bond and the impact it will have on a portfolio, as long as that same stock or bond is paying a consistent dividend or interest to the investor.
This is the central theme in our investment philosophy which has worked extremely well over the years and we are pleased to say that the families we work with have benefited from this way of investing. It’s not much of a stretch to agree that higher underlying interest rates makes it easier to satisfy income generation needs in any portfolio. But what if rates aren’t high enough to meet your needs… what do you do then?
Over the past several years we’ve seen a steady decline in interest rates and they have been sitting at multigenerational lows for an extended period of time. Many experts use a government’s 10-year bond as a representation of the “risk free” rate in a country due to its high liquidity. If we look at the Canadian 10-year bond yield chart from tradingeconomics.com, we can visually see the dilemma facing Canadian investors looking for fixed income.
As the interest rate’s decline has become a “less temporary” condition, we’ve seen an ever-increasing amount of interest in alternatives. Many of these alternatives fall into a category referred to as “non-traditional” investments which is an extremely broad description that covers a wide range of options. So let’s see if we can simplify a few of the ideas into digestible nuggets that might be of interest to you.
Traditional investments, as retail investors have come to know them, tend to fall into a short list of categories: stocks, bonds, mutual funds and ETF’s. Each of these categories offer exposure to equity and fixed income vehicles or markets cited as major indices from around the world.
Non-traditional investments on a broad scale fall into two main categories; alternative asset classes and alternative strategies.
Alternative asset classes tend to be things like:
- Real estate
- Commodities
- Private equity/debt
- Infrastructure
Who’s kidding who, if we were still able to get 8-10% returns from guaranteed investments or even from investment grade bonds, there really wouldn’t be much of a need to even consider alternatives to your traditional portfolio selections. Unfortunately, those rates are not reality in today’s market, so we need to think outside of the box to try and deliver these type of returns from the income generating components of your portfolio. As we examine the alternatives to traditional fixed income it’s probably worthwhile to make note that there is a difference between types of cash flow. The truth is that not all cash flows are equal and recognizing the difference matters.
Distinguishing between dividends, interest and return of capital can make a big difference in the types of securities you are looking at, the amount of tax paid on the cash flow and the consistency of the income stream. It is important never to confuse a cash flow stream with a guaranteed income stream from a traditional fixed income security. And as much as they appear the same as the money hits your account, the mechanics behind them are very different.
All risk levels are not equal either, so it’s important to understand that when venturing off of the path we’ve historically been on, we need to be aware that “there really is no such thing as a free lunch”. In this case, that means that if the cash flow rate is higher than we find in our traditional choices, then there is some other level of “risk” we need to be aware of before we decide whether it is acceptable or not for your family. We can’t let income streams be the only factor we look at when we examine these types of alternatives. A large part of our role as your trusted advisor is to vet any and all options and ensure that we present you with all the relevant information so that you are never in a position to make a choice without all of the facts and a level of comfort. We’re always here to talk about your financial plan and any questions you may have.