The "Great" Rotation into Fixed Income?

I wanted to share a recent article covering Barron's recent round table discussions on Fixed Income and investment trends.

An even greater rotation into fixed income? Quite a thought, as we're constantly being told that the opposite is occuring... But let's look at the bigger picture.

Every day, more than a thousand Canadian boomers turn 65. The trend is expected to continue for the next 17 years. And as they enter into the drawdown period, they're looking for ways to turn their nest eggs into retirement income.

This has resulted in the need to fundamentally shift their asset mixes, Rick Headrick, president of Sun Life Global Investments, told a lunchtime audience at an advisor event recently.

"In 2000, 70% of portfolio holdings were sitting in equities, while only 14% were in the income categories," he says. "Today 44% is allocated to fixed income."

The other major investment trend, he adds, is corporate-class bonds. For non-registered assets, it's a tax-efficient way to draw income out. In fact, last year, the bulk of net flows into corporate class were allocated to fixed income.

So for all the talk of the great rotation into equities, current flows suggest if there's any rotation, it's into fixed income.

"Equity funds have been in net redemption each of the last four years," says Headrick. "Certainly there's been a flight to safety as well, but it's also because of that thirst for yield."

Corporate class' first major advantage is the ability to switch between funds within the structure. If you wanted to trim your Canadian equity weighting, and move more into emerging markets, you could do that within corporate class without triggering a tax event.

Another big advantage: efficient taxable distributions. A corporate mutual fund company can pay out Canadian dividends, which are taxed more favourably than interest income or foreign dividends. Also, on redemption, only 50% of capital gains are taxable.

The structure can cancel out gains and losses for tax purposes. (If you have one fund sitting in a gain position and another in loss, they offset each other.)

But these advantages can come at a cost.

Corporate class fixed-income funds have higher fees relative to the mutual fund trust version. But that's ok because tax efficiencies more than offset those higher fees.

Headrick notes another wrinkle in the form of the disconnect between investors' risk appetite and their return expectations:

"Currently only 22% of investors are willing to take on more risk to get a higher return, yet 40% expect their investments to yield 5% to 7%, he says.

That means the traditional asset mix of fixed income and Canadian equities won't cut it.

"Investors need to diversify into infrastructure (toll roads, airports, etc.), real estate, emerging market debt and other non-traditional asset classes to create sustainable income in retirement," he asserts.

Something that we tend to fully agree with.

Please give me a call/email if you would like to discuss your current asset mix, investment policies, or to review what options in the non-traditional space are available to you.

Best Regards and Safe Investing!

Eric

Recent market volatility isn’t necessarily all bad news…

Recent market volatility isn’t necessarily all bad news…

With the end of quantitative easing in sight, we remain optimistic on equities and concerned about bonds:

• On June 19, Ben Bernanke and the members of the Federal Open Market Committee (FOMC) signaled the tapering of bond purchases by the U.S. Federal Reserve.
• The statement triggered the biggest two‐day decline in stocks in the last few years. However, in our view, the tapering of bond purchase means that the economy is improving. If the economy is improving then that will be good for corporate earnings and therefore good for stocks and commodities, and bad for bonds and gold.
• We believe the correction we have been expecting is currently underway and this will soon represent a good buying opportunity. We remain optimistic on the outlook for equities, continuing to prefer the U.S. over Canada for the balance of 2013.

Tapering is coming:

• The increase in bonds yields after the June 19 FOMC statement was no surprise as one of the largest buyer of bonds since the recession has just signaled their intentions to slow down the purchases and possibly end the purchases in 2014. With increased borrowing costs due to higher interest rates, the cost of borrowing is outweighing the benefits of holding stock positions with borrowed money and therefore funds that buy stocks with borrowed money decided to sell their stock positions and payback their loans.
• Global equity markets have been declining since Fed Chairman Bernanke’s testimony to Congress on May 22. In this testimony, Bernanke made it clear that the FOMC “is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes.” This 1‐2‐3 punch triggered sharp declines in virtually every asset class, except the U.S. dollar.
• Broadly speaking, improving economic trends bode well for corporate earnings growth, and with valuation still attractive, U.S. equities remain our favourite asset class. In this environment, our preferred U.S. sectors remain Financials, Industrials, Technology, and Healthcare. We expect some additional softness for Telcos, Utilities, REITs, and Consumer Staples.
• Gold has succumbed to the fact that inflation around the world remains subdued and that the U.S. could soon stop “printing money.” Copper and other base metals are flirting with technical support levels as investors re-evaluate China’s economic growth.

U.S. still on recovery path; China’s recovery may be delayed

• Recent U.S. economic data has been mixed but still supportive of an improving trend. Retail sales for May, which provide tangible evidence of improving consumer confidence, were better than expected. In sharp contrast to the U.S., Canadian April retail sales were weak and declined when auto sales are excluded. Headline inflation for May was also lower than expected.
• After weak trade data earlier this month, Chinese manufacturing activity showed further contraction. Based on recent commentary from the new leadership it appears that they are comfortable with the current level of economic growth (7%‐8%). Furthermore, the new leadership has voiced a preference to move the country toward a sustainable growth model by focusing on financial, social, and environmental reforms, and a gradual transition away from an export‐centric economy to a domestic‐centric economy.