With the latest interest rate increases we have been buying 2-to-4-year bonds paying 6.25 to 6.60% and looking at some paying 6.75%. This is a long way from the low rates from 2020 so our patience is paying off. Additionally, some bank equities are now paying 5 to 7.5% dividends.
Strategy Update Highlights
- I have asked RBC Capital Markets to create equity linked notes* paying over 9.25% with 40% downside protection . This is not something I have seen before. We are currently assessing these notes and will likely add them to our portfolio.
- Our conservative fixed income stance has paid off over the past 2.5 years. We are adding bonds at much higher rates and yields that have not been seen in over 16 years. On a tax-equivalent basis these yields are even better.
- While it may sound illogical, as worries over the negative impact of rate hikes start to take hold, we are finding that equity valuations are becoming more and more attractive. As this dramatic series of rate hikes likely approaches its end, the impacts of the rate hikes look as though they should run their course over the next 2 to 3 quarters. With that being said, I am getting more interested in increasing our equity weighting closer to our target weight.
Fixed Income:
By early 2022 our fixed income portfolio was massively restructured by moving mostly into short term bonds and money market
investments. This strategy worked and deflected much of the negative effects of the US and Canadian central banks’ large interest rate increases. After making these changes I said I would look to extend terms and move back into fixed income ETFs, indexes, funds, and alternative investments over 18 to 24 months. We have now begun this process as we are likely nearly finished with the rate hikes. As medium- and longer-term rates began increasing we sold off part of our July 2024 RBC bond and asked RBC Capital Markets to create 2 RBC notes. These notes are like bonds but can be called/redeemed at RBC’s discretion. In the last week of September, I asked RBC Capital Markets to create a 6.25% RBC note callable after two years and semi-annually thereafter. If the note is not called it will continue to pay 6.25% for up to 8 additional years. The following week, after rates had increased further, I asked RBC Capital Markets to create a note like the first note but with longer call protection – a 10-year 6.60% RBC note callable after 4 years. I am currently looking at selling some of our March 2024 Bank of Montreal bond exposure to buy into 3 and/or 5-year BMO notes locked in at 6.75% or higher.
After what was arguably the worst period ever for fixed income, we are now able to deploy the cash we held in reserve. In some of the ETFs and global bond investments we are seeing the potential for 6% yields plus capital gains. Our patience has paid off. While we are not out of the woods with the potential for more interest rate hikes, our bonds are outstripping GICs, and we are getting exposure for fixed income that we have not seen for over 16 years.
As I stated in last quarter’s Strategy Update, after the next one or two 0.25% Canadian and US central bank rate hikes, the short-term bond yields listed above are not likely to rise significantly more. While I did pause moving back into indexes and actively managed bond portfolios, I do believe that over the next one to three quarters, bond managers will be able to generate higher bond returns in some areas. In addition to buying bonds directly, we anticipate the portfolios will restart buying back into specialized bond funds and fixed income ETFs as well.
Equities:
In anticipation of rising rates, we also reduced equity exposure earlier last year and equities are still underweight relative to long term targets. Equities are at a 44% portfolio weight, on average, which is significantly underweight our 63% target. Additionally, we insured 25% of the Canadian equity portfolio from a drop greater than 12% with put protection. With the recent drop in the TSX 60 index this insurance has been advantageous.
We reduced our overall bank exposure over the past year and since then banks have sold off significantly. We are now looking to increase our bank exposure along with other financial services or insurance companies over the next few quarters.
Many Canadian equity dividend yields are now well over 5.50% after seeing share price drops due to rising interest rates. These higher dividend paying equities are now looking more appealing. Utilities, banks, financials, and telecoms prices are also getting more attractive. Additionally real estate investment trusts, overall, are not yet at a level that I find attractive enough.
Conclusion:
Please remember that our current portfolio positioning evolved over the past 2 to 3 years in anticipation of rising interest rates. We are now able to take advantage of this over the coming quarters. Our team will continue following our conservative investment process as we navigate the ever-changing equity markets, interest rates changes, inflation, and the geopolitical environment.
As always, we appreciate and value your trust. Please do not hesitate to contact us if you need anything. We are currently available to meet by phone, Webex, or in person.
*Structured Notes are financial products created to provide leverage, enhanced returns, principal protection, risk management and customized access to an asset class or type of investment. These products are completely customizable from term to maturity and currency denomination to performance metrics. RBC Capital Markets designs and issues a range of structured note strategies to meet client investment objectives.
** Here’s the fine print and there’s a lot of it…
Currency can add return when the Canadian dollar goes down but reduce returns when the Canadian dollar goes up for non-currency hedged US and international investments. Also, please remember that your US accounts report values in US dollars.
Securities or investment strategies mentioned in this newsletter may not be suitable for all investors or portfolios. The information contained in this strategy update is not intended as a recommendation directed to a particular investor or class of investors and is not intended as a recommendation in view of the particular circumstances of a specific investor, class of investors or a specific portfolio. Options, and other strategies mentioned, may not be suitable for all investors. You should not take any action with respect to any securities or investment strategy mentioned in this newsletter without first consulting your own Portfolio Manager or in order to ascertain whether the securities or investment strategy mentioned are suitable in your particular circumstances. This information is not a substitute for obtaining professional advice from your Portfolio Manager. The commentary, opinions, and conclusions, if any, included in this newsletter represent the personal and subjective view of Daniel Kelly who is not employed as an analyst and do not purport to represent the views of RBC Dominion Securities Inc. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. Investment Trust Units are sold by RBC Dominion Securities Inc. There may be commissions, trailing commissions, management fees and expenses associated with Investment Trust investments. Please read the prospectus before investing. Investment Trusts are not guaranteed, their values change frequently, and past performance may not be repeated. (Keep reading, there’s only 7 more sentences to go.) This commentary is based on information that is believed to be accurate at the time of writing and is subject to change. All opinions and estimates contained in this report constitute RBC Dominion Securities Inc.’s judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. Interest rates, market conditions and other investment factors are subject to change. Past performance may not be repeated. The information provided is intended only to illustrate certain historical returns and is not intended to reflect future values or returns. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ®Registered trademarks of Royal Bank of Canada. Used under licence. ©2023 Royal Bank of Canada. All rights reserved.
Investment portfolios are not guaranteed, and past performance is no indication of future returns. In addition to these portfolios not being a guaranteed investment, there can also be significant fluctuations in the value of the portfolio. Did anyone read this far?