Global macro headwinds have been causing interest rates to remain low, leaving the world in a “lower for longer” rate environment. But there are strategies to help institutional investors improve their investment outcomes.
Fixed income
Government of Canada bond yields have been trending down since the early 1980s and are currently at their lowest point in close to 60 years. Given the current interest rate environment, the return on these bonds is expected to be quite low, with potentially negative real returns. It’s unlikely that interest income will provide investors with the income they need. These bonds should be viewed in the context of portfolio stability and safety as opposed to growing wealth.
And, although credit spreads have significantly narrowed in the past five years, high-quality corporate bonds are still an attractive option for fixed income investors looking to preserve real purchasing power.
Equities
In the current environment, equities will perform relatively well compared to bonds for several reasons.
First, the economic forecast suggests that economic growth, particularly in the U.S., will likely accelerate. There is a well-supported level of optimism in the U.S. economy as several indicators—house prices, auto sales and employment growth—continue to improve, leading to an increase in consumer credit growth and helping to repair previously damaged transmission mechanisms.
Second, equity valuations remain attractive, specifically compared to fixed income. For instance, dividend yields remain attractive relative to bond yields, and dividend income will increasingly replace interest income as a means by which investors will meet their current income needs and grow assets over time.
Third, while the possibility of extreme outcomes remains a concern, the global liquidity backdrop remains plentiful and continues to be supportive for equities.
Opportunities to consider
Despite the ongoing challenges created by low interest rates and slower economic growth, there remain some innovative strategies for institutional investors to consider.
For investors ready to increase their equity weighting, they could look at low-volatility equity portfolios. They’re designed to achieve a less-volatile return path than traditional equity portfolios. Emphasizing high-quality dividend growth stocks is another way to meet current income needs and grow assets over time.
Target return-based strategies, which are more goal-oriented and seek to achieve a consistent positive real rate of return with minimal downside risk, are another possibility.
Although lower rates are likely here for longer, investors can still find value even in these challenging circumstances.
Bruce Cooper is vice-chair and Les Grober is managing director with TD Asset Management. These are the views of the authors and not necessarily that of Benefits Canada.