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With equities slumping, it’s a good time for fixed-income investment, despite a low-interest rate environment. While interest rates may change, fixed income provides other advantages for high-net-worth investors focused on capital preservation.
“I think the number one thing that bonds do in a high-net-worth portfolio is provide that capital preservation, so that if the market decides to take another downturn like it did in 2008, it really acts as the life preserver,” says Marc Lamontagne, partner, Ryan Lamontagne.
“You’re not going to get a very high rate of return out of your fixed income [portion] but just making sure that it counterbalances the volatility of the equities certainly helps.”
When dealing with a large pool of money, it’s more important for clients to have that same amount at the end of the year than making more money by adding risk, says Scott Ellison, CFP, TD Waterhouse, Halifax.
In 2011, a portfolio entirely invested in stocks would have lost about 10%, while a balanced portfolio of 50% stocks and 50% fixed income, would have broken even, he points out. If a client were entirely in bonds, they might have even made some money.
The problem with investing solely in fixed income, Ellison says, is low-interest rates.
“The current yield on a 10-year Government of Canada bond is 1.9%; half of the interest on that will be taxed,” he said. “So you’re getting 1%, and inflation is 2% to 3%; leaving all your money in fixed income is actually destroying your wealth over a period of years.”
Fixed income has become a staple for portfolios that need to generate income, says Tina Tehranchian, CFP, Assante Capital Management, Richmond Hill, Ontario.
“Fixed income adds diversification,” she said. “Last year, if your money was invested in bonds, you’d have done a lot better than the stock market. Generally because of this kind of negative correlation, it’s good from a diversification standpoint to have a fixed income component in the portfolio.”
As well as diversifying the entire portfolio, high-net-worth investors should also look at diversifying within the fixed-income segment.
“You’ve got government bonds, corporate bonds, high-yield bonds, global fixed income, and real estate investment trusts,” says Tehranchian. “It’s important to have a combination and change the strategic allocation depending on the economic situation and how you see things unfolding.”
Lamontagne recommends holding a large chunk of government bonds and “if you want to enhance the yield, you’d look at provincials, but you can also look at corporate bonds.”
On the product side, he says his firm generally uses exchange-traded funds because the cost is quite low and, because you’re dealing with institutional buyers, there’s a better spread on the bond.