In last week's blog, the team mentioned how the bond market has already reflected many expected future rate hikes, which can been witnessed in our domestic GIC market. Over the past 6 months, GIC rates have increased substantially. Comparing the levels from the Fall of 2021, the 1 year GIC rate has gone from 0.55% to 3.25%. For a 5 year GIC, the rate has increased from 1.85% to 4%.
In this blog, we discuss why you may prefer GICs or why you may prefer bonds.
Reasons to Prefer GIC:
CDIC Insurance: This insurance is provided by the Government of Canada and covers GIC investments under $100k. This protection also provides investors some peace of mind if purchase GICs from smaller issuers like Credit Unions, Trusts, and ‘second-tier banks’ banks (i.e. Schedule II banks). These issuers may be able to offer higher yields of ≈0.30% above the “big 5” Canadian bank GIC rates. Our clients often access these higher yields through our inventory of CDIC-backed issuers.
Idiosyncratic pricing: GIC rates are set deliberately by the issuer, instead of being determined solely by market forces. When a financial institution require deposits to meet certain capital levels, it can attract new deposits by offering higher GIC rates. Therefore, active monitoring of GICs can provide opportunities to increase returns meaningfully above the ‘average’ bond or GIC.
Always available: Those who have tried to buy bonds know that access and inventory often feel limiting. The pricing and availability of bonds usually favor institutional investors rather than retail investors. In contrast, GICs are always available to purchase when you want them.
Reasons to Prefer Bonds
Superior liquidity: One of the benefits of bonds is that they have a large, active secondary market to sell into. Secondary bond markets are considerably more liquid than the secondary GIC market. Therefore, bonds offer better access to your funds should they be required unexpectedly.
Potential tax efficiency: Over the past year, many bonds have been priced at a discount, offering investors the opportunity to collect interest coupons while purchasing a bond below par (i.e. <$100) and holding it to maturity. Embedded is a benefit for taxable clients as the gain earned from letting the bond mature back to $100 is considered a capital gain for tax purposes. We now see yields from discounted bonds starting to climb higher than GICs. When including the tax advantage of these discounted bonds, the tax-equivalent return looks even more attractive.
Greater diversification: Bonds have a much wider range of credit quality, duration, and sector exposure than GICs. Therefore, they are better suited to help create a well-diversified fixed income portfolio. In the current environment, it has been a necessity to be nimble and actively manage the characteristics of one’s bond portfolio.
In our opinion, GICs provide better value for investments under the CDIC protection limit of $100k and for investors who do not require immediate liquidity. On the other hand, bonds can provide better value for larger taxable portfolios or clients that may need access to those funds before maturity. Speak to your advisor to review your fixed income holdings and how to make the most of this relatively higher-yielding environment.
The strategies and advice in this newsletter are provided for general guidance. Readers should consult their own Investment Advisor when planning to implement a strategy. This will ensure that your own circumstances have been considered properly and that any action is taken based upon the latest available information. Interest rates, market conditions, special offers, tax rulings, and other investment factors are subject to change