You have likely already read Anthony’s article “The role of monetary policy on markets.”

The article paints a complicated picture for fixed income. Low yields mean minimal returns and you still face interest rate risk, which will put downward pressure on bond prices. This presents a dilemma for investors who have a fixed income mandate in their portfolios. Do you move to all-equities? Do you stand pat? Can you minimize downside risk in your fixed income without increasing overall portfolio risk?

We will present three different options: risk on, risk off, and status quo. Please note that your individual situation may call for any of these three scenarios. If you have had a review meeting with us in the last 6-9 months, you may recall discussions of these themes as they relate to your portfolio.

“Risk On” Strategy: This strategy is generally intended for investors with more than 7 years until retirement (accumulation phase) and/or for investors with a higher appetite for risk. Most growth / accumulation phase portfolios have ~80-85% equities and ~15-20% fixed income. The investor with higher risk tolerance may opt to go all-equities with no fixed income, or they may opt to trim their fixed income position temporarily (a tactical re-allocation) to a lower amount (5-10%).

The primary benefit with this strategy is a reduced interest rate risk in the portfolio. Additionally, re-allocating to increase equities offers the possibility of greater long-term returns. The primary drawback with this strategy is a greater percentage of the portfolio is exposed to an equities pullback – the primary reason why this strategy is suited to non-retired investors and higher-risk investors.

“Risk Off” Strategy: This strategy is generally intended for investors approaching retirement, are already retired, and for more conservative investors. Let’s focus for the moment on pre- and post-retirees.

Most retirement portfolios are ~60-70% equities and ~30-40% fixed income. Because of the higher bond content of a retirement portfolio, interest rate risk is a larger concern; however, increasing growth-oriented equities may also be sub-optimal. A strategy worth consideration would be minimizing the bond position in favour of a mix of defensive equities (low volatility funds, dividend funds, etc), inflation hedges (i.e. precious metals, real estate and infrastructure, commodity funds) and an increased cash wedge position.

The primary benefit with this strategy, again, is reduced interest rate risk. Additionally, an increased cash wedge protects the portfolio from erosion during a lengthy equity market pullback; lastly, the defensive equities and/or inflation hedges are designed to reduce correlation to equities within a portfolio.

Status Quo: This strategy essentially entails doing nothing. This strategy can be used by investors of any age or of any risk tolerance. Consider a hypothetical, a long-retired investor. This investor’s portfolio consists of a small RRIF, a maximized TFSA, and a substantial non-registered account, to go along with their CPP, OAS, and work pension income. To respect an overall 70 equities / 30 fixed income mix, the non-registered account has a notable amount of fixed income exposure; moreover, the non-registered account’s underlying holdings are all in significant gain positions.

In this situation, the interest rate risk the investor faces must be weighed against the capital gains tax implications of selling off high-gain positions. Ultimately, this investor may pay more in capital gains tax (a crystalized cost) than they would face on a temporary basis if rates rise and their fixed income temporarily declined.

As always, every investor’s circumstances are a little different. A retired investor may find it most prudent to adopt a “risk on” strategy; a 40-year-old investor may be best off considering a “risk down” strategy. An investor with a high-risk tolerance may already be 100% invested in equities and simply maintain status quo. We are here to help guide you through these decisions. Do not hesitate to contact us about your portfolio.