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feature “If you think rates can’t go any lower, I can tell you that current yields to maturity for Swiss bonds at five years or less are actually negative. Although this is an unlikely scenario for Canada, it’s very likely that rates will remain historically low in the near future.” Steve Zadra GICS (Guaranteed Investment Certificates) GICs offer yields usually favourable to Government of Canada bonds and can be a good option for fixed income investors. With potential government guarantees, this is an attractive choice in lieu of Canada bonds. Income options in a low interest rate economy By Steve Zadra A New Normal > Interest rates have been at historical lows for many years now, with 10-year Canadian government bonds breaching the 1.65 per cent level this June. Low rates are supposed to boost the economy by making lending cheaper and stoking economic activity. However, there is a growing countereffect to savers who are earning much less income than in the past. This is particularly troubling for the growing population entering, or already in, retirement. And if you think rates can’t go any lower, I can tell you that current yields to maturity for Swiss bonds at five years or less are actually negative! Although this is an unlikely scenario for Canada, it’s very likely that rates will remain historically low in the near future. So what are investors to do? Over the past few years, the managers of the Canada Pension Plan have increased exposure to global real estate and infrastructure assets. Some Canadians have followed suit by looking at U.S. real estate options, but for many investors the costs and time are not worthwhile, nor do they have the expertise or buying power of the CPP or other pension funds. There are a number of other options for individuals seeking passive income. Although the list below is not exhaustive, it does summarize some of the income investments that are available. Corporate Bonds With the high demand for the safety of Government of Canada bonds, good quality corporate bonds (also referred to as “investment grade bonds”) may offer a nice premium in yield to government bonds. Convertible Debentures Debentures, depending on who has issued them, will likely have more risk than a traditional corporate bond, but may provide nice yield enhancement in a diversified income portfolio. Current yields tend to range from four to seven per cent depending on the issuer and term. The conversion feature can also provide price upside if there is significant appreciation of the underlying common share. High Yield Bonds High yield bonds, also known as junk bonds, are less developed in Canada than in the U.S. Canadian investors can choose U.S.-based high yield bond exchange traded funds, providing diversification along with currency hedging. 28 outlook
Preferred Shares This investment option offers the attraction of the dividend tax credit for non-registered accounts, thereby potentially providing higher after-tax returns than equivalent-paying interest investments such as bonds. With the fear of interest rate volatility, many new preferred shares are issued as five-year rate resets. These preferred shares give investors some protection to interest rate risk over the long term as opposed to the traditional perpetual preferred. Rates offered tend to be in the 4.0 to 5.5 per cent range depending on the quality of the issuer. REITS (Real Estate Investment Trusts) REITs are publicly traded vehicles offering diversified exposure to various forms of real estate, including residential, commercial, industrial and retirement properties. This has been a fabulously performing sector as REITs have benefited from lower mortgage costs due to declining rates. Yields are approximately five to seven per cent. Royalties The most common public royalties tend to be royalties on sales from restaurant operators. For example, A&W Canada restaurants pay a royalty on their sales that flows to investors via the A&W Revenue Royalties Income Fund. There are a handful of different royalties that provide current income of approximately six to seven per cent. Equities Although investors might not think of equities when they think of income, many companies that have stable businesses provide attractive and often growing dividends. Sectors such as utilities, pipelines and telecom are excellent places to look for good income yields. Annuities Annuities are offered through insurance companies and can provide either fixed or variable amounts of lifetime income depending on the product chosen. Each income investment described above has various risk and reward characteristics that should be considered carefully and in consultation with a professional advisor. Steve Zadra is an Investment Advisor with National Bank Financial. outlook 29
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