June 06, 2011

Increasing Income and Reducing Portfolio Volatility Amid Low Interest Rates

Given the low yields available on fixed-income investments today and the volatile equity market conditions experienced over the past several years, many investors are looking for options that provide stable income necessary  to plan for their expenses, while exposing themselves to a manageable amount of investment risk.

This is a fundamental issue and not a passing trend. The reality is that if investors want more predictability, they will have to reduce their expectations for returns. In the current investment climate, investors are wise to seek an investment that offers a relatively attractive level of income at a moderate level of risk.

The typical “Balanced” portfolio provides diversification of currencies and countries and industries and asset classes, and strives to provide the best total return (capital gains plus dividends plus bond coupon payments) over time.  While equities have provided higher returns historically, and promise to provide them in future, the amount of risk or volatility over shorter periods of time may not meet every investor’s needs.  A simple solution is to reduce the amount of equities in a portfolio, but the downside to this approach is that the yields available in the bond markets are less than compelling right now.  Another solution is to add more investments with higher yields. However, the quality of the holdings could be sacrificed.

We suggest building a portfolio that targets high quality, higher yielding investments, with a lower emphasis on maximizing capital gains.  It could hold fixed income securities, preferred shares, and dividend-paying Canadian equities.  The dividends will provide tax advantages.

Income-oriented products are gaining popularity in the Canadian market and new funds in this category are being launched on a regular basis.  The natural question for potential investors to ask is, “What should I look for that is distinct from the other funds?”

We believe there are several elements an investor should look for when seeking out a fund that is distinct from others.  First, any such fund should provide a sustainable source of income.  We do not chase yield and will only hold investments that meet our long-term risk management requirements.

The second element concerns management fees. We appreciate that interest rates are low in Canada right now and investors are struggling to find investments that bring them sufficient and stable income. So we believe that management fees need to be low to reflect this low-yield environment.

For more information, please contact your Portfolio Manager.

The article is not intended to provide advice, recommendations or offers to buy or sell any product or service. The information provided in this report is compiled from our own research and is based on assumptions that we believe to be reasonable and accurate at the time the report was written, but is subject to change without notice.

Jonathon Palfrey

Managing Principal, Portfolio Manager - Private Clients & Foundations