Financial Questions for Bill Richardson Part 27

Hello everyone. Hope all is well. It’s been a while since I’ve sent out my “3 Questions” commentary to clients and advisors but I’ve been asked by a number of you to relaunch it again. Part of the challenge has been to come up with enough relevant content for the program so please keep your questions and ideas coming. Thanks.

 

Question 1: How important is asset allocation in a portfolio?

One of the more interesting statistics for investors is that 91.5% of portfolio returns come from asset allocation.  Asset allocation refers to the way in which you divide your investments among different asset classes, such as stocks, bonds, real estate, and commodities.

Traditionally, portfolios are constructed of the first three on the above list and often portfolios are split between stocks and bonds in proportion to your level of risk.

A 60/40 portfolio is a type of investment portfolio that is commonly used by investors seeking a balance between risk and return. The 60/40 portfolio typically refers to a portfolio that is comprised of 60% stocks and 40% bonds.

The idea behind a 60/40 portfolio is that by investing in both stocks and bonds, investors can achieve a balance between higher potential returns (from stocks) and lower risk (from bonds). Stocks are generally considered more volatile but have the potential for higher returns, while bonds are typically less volatile and provide income in the form of interest payments.

Now let’s address a problem that has affected many investors over the past couple of years.  One of the major asset classes (bonds) has been fraught with risk with little chance of return and to make things worse, fears have been realized.

For those who are not familiar with bonds or more specifically bond mutual funds, they generally invest in mid-term (5 – 7 years) or long-term (10 – 30 years) bonds and prices go up when interest rates decline and down when rates go up.  The longer the term, the more volatile.  On top of that in a bond fund, you are also paying a manager a fee and probably an advisor as well.

 

Question 2: Would you lend out your money and earn interest at 0.5% for 10-years and pay a manager 0.7% to manage it?”

I’m sure most would have said no but that’s what people did when they bought or held a bond fund or a balanced mutual fund. This is one of the reasons we have shied away from bond and balanced mutual funds over the past several years.

So, when 10-year Canada bond yields hit rock bottom in August of 2020 at 0.43% yield and you were paying a manager 0.7% to manage the investment and an advisor a fee as well, you were destined to lose money – GUARANTEED.  Also remember, if you own a balanced mutual fund, maybe half the money is in bonds and the fees are probably higher.

 

Question 3: Now that interest rates are higher, are bonds a more attractive investment?

Over the past several years, when bonds were yielding <1%, it was not a worthy investment in my opinion.  Now with rates in the 4-5% range, they are a better option as you can still expect a 4-5% yield on your investment whether rates go up or down. If they continue to go up, then you will net less of an overall gain but if rates start to decline, you may see high single-digit returns in bonds once again. That said, we still have a bias towards floating rate Private Debt as yields tend to be higher and rising rates tend to benefit performance and not hinder it like bonds.

At Harbourfront, we primarily used a couple of in-house funds – Rockridge (Private Debt) and Forsyth (Private Real Estate).  Private Debt usually yields a few percentage points higher than bonds and it is usually shorter-term in nature and often the returns float, which is good during times of rising rates. 

Returns have been quite steady in our Rockridge Private Debt Fund and 2022 was no different as the fund returned 6.84%. Much better than a GIC and significantly better than the -11.66% experienced in the bond market (as measured by the iShares Core Canadian Universe Bond ETF – Source YCharts).

Private Real Estate also performed well for us in 2022 with a +8.83% total return. A great result considering the stock and bond market volatility we faced along with the rising interest rate environment.

Now with rates in the 5% range, bonds are a better option than they were, so we have been selectively adding them to portfolios. That said, we continue to prefer Private Debt and Private Real Estate overall and are invested accordingly.

 

Until next time,

Bill