In an effort to stomp out inflationary pressures, we’ve seen central banks touting a commitment to keep interest rates “higher for longer.” But what does that mean for your portfolio? In this piece, Investment Counsellor Jessie Bobinski shares three investment options that may help mitigate volatility and fortify your capital with an extra layer of protection.
Takeaways:
- If you want to protect your capital and are planning to draw from your portfolio in the next few years, it might be time to re-assess your asset allocation.
- In today’s higher interest rate environment, money market funds provide an enticing offering at a compelling yield.
- Bonds offer a range of benefits: hedge against deflation, steady stream of income, and, in many cases, protective counterbalance to stocks.
- With a host of stable Canadian companies generating more earnings than they can reinvest, many are distributing substantial dividends to investors.
For over two years, central banks have been locked in a battle against inflation, causing interest rates to reach levels not seen in 15 years. Even though inflation has dipped significantly from its peak in 2022, it continues to exceed the targets set by the Bank of Canada and the U.S. Federal Reserve. In an effort to stomp out inflationary pressures, messaging from central banks indicates a commitment to keeping rates “higher for longer.” The result? A looming cloud of economic uncertainty and continued concerns of an impending recession.
Rather than spend excessive time on the unpredictable macroeconomic future, at Burgundy, we prefer to focus our attention on selecting high-quality companies that will help to preserve your portfolio in periods of volatility and contribute to the long-term growth of your investment capital. As we are witnessing with the impact of these higher-for-longer interest rates, volatility rises during periods of uncertainty. One way to preserve your portfolio’s value and protect it from capital encroachment is to revisit your allocation to equities, ensuring you have the appropriate asset allocation in place to meet your cash flow needs.
While we recognize that the varied economic and emotional circumstances of our clients prohibit a one-size-fits-all investment strategy, for those living off of their portfolio or planning to do so soon, we recommend holding upwards of 10 years’ worth of cash flow needs in accessible cash, money market funds, and bonds. This approach helps you to avoid selling equities at inopportune times. So, if you feel your equity weightings are a little on the high side and you are planning to draw from your portfolio over the next five to seven years, it’s probably time to revisit your strategy with your Investment Counsellor.
Let’s consider three options your Investment Counsellor can incorporate into your portfolio that deal directly with planning for the creation of a cash flow stream and ways in which you can mitigate volatility.
#1: Your Short-Term Needs
When discussing a higher interest-rate environment, one of the first considerations for many investors is money market funds, which consist of very short-term (less than one year) debt securities. Within our offerings at Burgundy, the Canadian Money Market Fund currently provides a compelling yield of 5.2%, making it an enticing option for those looking to build a cash reserve without the constraints associated with non-redeemable GICs.
While the present yield is attractive, note that in taxable accounts, the income is fully taxed as interest income. Furthermore, this yield could adjust rapidly if interest rates in Canada experience a sudden decline. Therefore, it’s important to remember that an allocation to a money market fund should primarily be used to achieve the following functions: (1) to cover your cash flow needs over a one to three-year period or (2) to act as a temporary parking spot for cash that will ultimately be deployed into a longer-term investment strategy.
#2: Don’t Forget Your Bonds
Now let’s turn to bonds. In recent years, rising interest rates have prompted negative returns, making this asset class less attractive for investors. As we enter into the final quarter of the year, we continue to experience the longest period of negative total returns in the history of North American-issued bonds. As bond losses have piled up, many have grown disheartened with this asset class.
Yet, we want to remind you why bonds should continue to be seen as a staple in a balanced investment portfolio. Bonds offer a range of benefits, including serving as a hedge against deflation, providing a steady stream of income, and, in many cases, a protective counterbalance to stocks.
With the rising prices of today, the deflation hedge might seem less significant. However, when deflation looms (think recession), bonds tend to hold their ground, making them a reliable “insurance” in your investment toolkit. Additionally, bonds tend to move in the opposite direction of stocks, meaning they can provide stability and even appreciate in value during stock market turbulence, acting as a safeguard for your portfolio.
With interest rates significantly higher than they were two years ago, bonds are now delivering an attractive steady income stream. This income generation capability is valuable, particularly when you start drawing from your investment portfolio. The Burgundy Partners’ Bond Fund currently yields an attractive 6.2%, encompassing both interest income and potential price appreciation as the bonds in the portfolio mature, leading to capital growth. This capital growth feature becomes especially beneficial when holding bonds in taxable investment accounts and is more present than ever today with many bonds trading at a discount to par value. Furthermore, in the event of declining interest rates, the bonds you own become even more appealing and may lead to an appreciation of their value and an opportunity to enjoy additional capital gain.
#3: A Place for Canadian Dividends
When seeking stability, we encourage speaking with your Investment Counsellor about the benefits of adding Canadian dividend-paying stocks to your investment portfolio. Canada is fortunate to host a selection of mature and stable companies that consistently generate more earnings than they reinvest in their businesses. As a result, they can distribute substantial and reliable cash to investors in the form of dividends.
At Burgundy, in order to take advantage of this opportunity, we offer the Burgundy Partners’ Canadian Income Fund, which applies our quality/value investment approach to this segment. With a healthy yield of 5.5%, clients enjoy tax-efficient dividend income while also benefitting from potential growth in the share prices of these high-quality companies.
Dividends serve as an effective volatility buffer, providing you with a consistent income stream without the need to sell assets for cash flow. Moreover, they tend to keep growing, even in inflationary environments, making them a valuable asset in times like today. It’s also worth highlighting that this is not just a collection of Canadian bank stocks commonly found in a dividend-paying strategy. Rather, it’s an actively managed strategy that incorporates some of the highest-quality dividend-paying companies Canada has to offer (including household names like Rogers Communications, Brookfield Asset Management, and TC Energy Corp.).
Some Final Thoughts
As you approach the need for a reliable cash flow stream or as you seek to fortify your capital with an added layer of protection, this is an ideal moment to reassess your asset allocation. Speak with your Investment Counsellor to find out more about how money market, bonds, and Canadian dividend-paying stocks may be incorporated.
This post is presented for illustrative and discussion purposes only. It is not intended to provide investment advice and does not consider unique objectives, constraints or financial needs. Under no circumstances does this post suggest that you should time the market in any way or make investment decisions based on the content. Select securities may be used as examples to illustrate Burgundy’s investment philosophy. Burgundy funds or portfolios may or may not hold such securities for the whole demonstrated period. Investors are advised that their investments are not guaranteed, their values change frequently and past performance may not be repeated. This post is not intended as an offer to invest in any investment strategy presented by Burgundy. The information contained in this post is the opinion of Burgundy Asset Management and/or its employees as of the date of the post and is subject to change without notice. Please refer to the Legal section of this website for additional information.
