Numerous stock markets have been making record highs recently, so why aren’t some Canadian investors feeling like they’re getting “peak” performance from their portfolio? Kim Parlee talks with Ingrid Macintosh, Head of Mutual Fund Strategy at TD Asset Management, about how a rising interest rate environment and the right level of risk can impact your portfolio’s bottom line.
Well, the Dow, the NASDAQ, the Russell 2000 all seem to be making new highs week after week, thanks in part to historically low interest rates since 2009. But for some Canadian investors, they may not be seeing peak performance in their own portfolios lately. So what's the disconnect? Why is that?
To find out earlier, I spoke with Ingrid Macintosh. She's Head of Mutual Funds Strategy and Client Portfolio Management.
Canadian investors typically have a mix of equities and fixed income. For the Canadian investor, the mix in their portfolio of fixed income is actually part of the headwind that they're seeing in their total portfolio return. Similarly, a portion of their equity portfolio may be giving them a little bit of a drag as well.
So the interesting thing with this as well is there's been some unusual things that have happened over the past for a while. The fixed income portion of the portfolio has not performed over the last few years the way that it normally does. Although, it's been in a good way.
It's been the great way. So typically when Canadian investors look at their portfolios, the equity component is there to provide the growth in their portfolio. The fixed income component is there to provide that safety and stability, and as they approach retirement, really, the income in their portfolio.
To your point more recently in recent years, we've seen the fixed income and the equity portions giving client's growth. In fact, outsized returns and fixed income.
That changed in the past quarter.
Yes. So let's take a look at what has happened in the past. I know you finance folks like to talk about regression back to the mean. Like, things getting back to normal. So I've got a chart here. Let's bring it up.
And this is taking a look at Canadian fixed income returns and yields. Why is this chart important?
Well, I think it's really important for investors to understand how fixed income behaves in their portfolios. So what you see here in the chart with the bars is the component of returns from fixed income. Namely, the income return in blue and then the price return in green. And both those elements make up the fixed income return.
When interest rates are declining, you're getting an outsized return. Because as bond yields or interest rates go down, bond prices go up. So clients have been benefiting from this outsized price return in their portfolios. However, as those yields have been coming down, that long term consistent income proportion has been declining.
So really in five years to 2012, people are getting north of 6% return on their fixed income, which was outsized. In more recent years, that's been coming down. And in the most recent quarter, we had a real turnaround in fixed income portfolios, which has provided that performance shock, if you will, or return shock.
So what do you do? I mean, so people are seeing this performance shock and return shock. So then what? How should they be looking at that, first off? And then should they be doing something about it?
So the first part is understanding what happens. So in the last quarter, in the third quarter of this year, the Bank of Canada raised rates for two times, the first time in seven years. So what really happened there was the market returned, and there was a negative price event in their portfolios, which has ported itself into their returns. Yes, it's not comfortable in the short run. But in the longer run, it actually means that this sort of penalty that we've had on savers from emergency interest rates or central bank policy is starting to be relieved, and we'll now start to see a better environment for fixed income investors going forward.
And I think more importantly, though, is to understand-- do investors have the right mix in their portfolios? And what should they do at this stage?
It's interesting. Because I mean obviously if you're 35, it's one conversation. If you're 55, if you're 75-- so what have you seen again across from everyone you talk to? What's happening when they're seeing this shock with 35-year-olds? Are they allocated properly for where they are in their life?
Well, that's exactly the right question. They say younger investors, when they think about how they invest, they think really in two ways. The first is risk. How do I feel about risk? Am I comfortable taking risk? Can I take risk? And less so they tend to think about, what's my time horizon?
Because really over the long term, investors have time to recover from that short term market volatility.
And also make it more in return.
And make it more in return. Exactly. So if you're a younger investor, you should be thinking about the long term. And you should be more comfortable taking equities, taking that equity exposure for that growth of your portfolio over the long term. However, what typically happens is people who don't feel comfortable with investing, they stay nice and close to home, and they stay more comfortable in fixed income. As we look forward with the interest rate environment, yes, they don't have market risk in their portfolio, but they do have that risk of not having enough.
And it's funny, too, because I think sometimes risk-- and this is from years of doing this-- people think about risk in terms of the volatility and not actually the risk of-- will you actually have enough money to retire?
Exactly. And we've talked about this a number of times before in our parents' generation, that those sort of long term interest rates were such that if you built that nice nest egg, you had a comfortable run rate. We're not there now. We have a much lower return on our fixed income securities. And we need to think about how we take that exposure differently.
What about the other end of the spectrum, let's go from 35 to say 65 or 75?
Right. This is where I do get some concern about sort of investor reaction. So if you look at your fixed income portfolio and you see that you've got this lower, possibly even negative return following the Bank of Canada rate hike, you may compare that to an equity return and think, oh, I've got risk here. I need to move away, and I need to take on more risk precisely when you shouldn't be. In fact, sit down and say, what are my long term goals? Will the return profile based on the mix of equity and fixed income I have be enough to meet my needs?
If not, do I need to move out the risk curve? But certainly it shouldn't be a knee jerk reaction doing something where they're taking on more risk without understanding why they're doing that.
So I guess the first thing is, again, so we go back to the beginning of this when you're hearing headlines, markets, new all time highs over and over and over again. And you get your statement, and they're not matching. You should be asking yourself, what? The following questions?
So what's in my portfolio? What is the mix? Where are these returns coming from?
But again on the fixed income piece, don't be alarmed. Don't panic. It's actually just really almost a resetting of price in the fixed income portfolios. And going forward, that yield environment is more important.
If you do look at your portfolios and think maybe you don't have the right mix for the long term--
You're too young.
You're too young to be sitting in a very conservative lower term portfolio. Maybe think about what level of risk you're comfortable with in conjunction with understanding what your time horizon is.
And that was Ingrid Macintosh. She's Head of Mutual Fund Strategy and Client Portfolio Management at TD Asset Management.