One portfolio manager sees a resurgence in short-term bonds occurring this year.iStockPhoto / Getty Images
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In a period of market volatility, higher interest rates and inflation, more high-net-worth investors desire higher yield and income-producing products for their portfolios that go beyond the traditional stocks or bonds, according to a new report from Investor Economics.
Covered-call exchange-traded funds (ETFs) and private credit are two types of investments investors mention in particular, says Carlos Cardone, managing director of Toronto-based Investor Economics, an ISS Market Intelligence business.
Covered-call strategies are designed to provide exposure to a portfolio of stocks while writing covered calls against them to earn premiums, says Darcie Crowe, senior portfolio manager and senior wealth advisor with Crowe Private Wealth at Canaccord Genuity Wealth Management Canada in Vancouver. She cautions clients to look beyond the attractive yield.
Some clients don’t fully recognize the downside risks of the strategies, along with the fees involved. They also don’t understand they’re sacrificing some of the upside in exchange for income, she adds.
“We want to make sure clients are looking at it from a total return perspective,” Ms. Crowe says. “If we have a positive outlook on the underlying stocks, our preference is typically to hold them for the long term, collect the dividends and not cap the upside potential through a covered-call strategy.”
Andrew Feindel, portfolio manager and investment advisor with Richie Feindel Wealth Management at Richardson Wealth Ltd. in Toronto, says clients need to comprehend all the nuances of what they’re buying. He recently landed a few clients who had a bunch of covered calls.
“They didn’t understand why they weren’t protected when markets went down,” Mr. Feindel says. “There’s this whole idea that covered calls protect you and they don’t. If the markets go down, you’ll lose that amount. When the markets go up, you just got a higher dividend because you’re receiving those options.”
Private credit offers strong yields but also higher risk
In terms of private credit, Ms. Crowe says it has been a popular asset class for high-net-worth clients for several years, as some move away from the traditional 60/40 equity-bond portfolio to explore alternatives.
“They’re looking for products that can be included in a portfolio to generate income through a diversified return stream,” she says.
Ms. Crowe positions it for a “very unique investor profile.” For starters, the investor must be accredited to have access to these products and have a minimum amount to invest in them – typically around $25,000.
Private credit funds provide access to a portfolio of loans, typically to private corporations in the small- to mid-cap space, Ms. Crowe explains, noting that interest rates are typically higher than traditional bank loans.
“Private credit portfolios would be considered higher risk because, usually, the loans within these portfolios are made to companies that aren’t able to access loans from the bank for a variety of reasons,” she adds.
While private credit offers strong yields, the underlying loans are illiquid and have what Ms. Crowe calls “the opposite characteristics of high-interest savings accounts, in many aspects,” which clients can access at any time. In this case, private credit redemptions are typically available on a quarterly basis, sometimes longer, and often have a minimum initial hold period of up to a year.
“It’s important for clients to know that this is a long-term investment horizon,” she says. “It needs to be used specifically in those situations in which clients have no need to draw on those funds in the immediate term.”
Mr. Feindel expects to see more of these types of funds, especially as institutions add to their private equity exposure in pension plans.
“It will become democratized in the sense that it’s not just institutions anymore but individuals purchasing,” he says.
Opportunities in private real estate, preferred shares and bonds
Another trend Ms. Crowe has seen is more investment toward private real estate portfolios. She notes that multi-family residential real estate has been a strong performer and provides attractive yields and cash flow, while also having a limited correlation to equity markets.
“Given the strong rents we have seen in Canada, they have demonstrated solid net operating income growth over the past several years,” she says.
Rate-reset preferred shares are another asset class Ms. Crowe likes due to the attractive tax-efficient yield. She says high-quality companies have preferred share dividend yields ranging from 6 to 8 per cent.
“These preferred shares will typically reset their dividend payment every five years based on a spread above a government bond with a similar term,” she says.
“Looking ahead, many of these preferred shares are going to be resetting at yields significantly higher than at their previous reset date, when government bond yields were exceptionally low.”
That creates a great opportunity for strong yield, in addition to capital gains potential as dividends reset higher, she adds.
Meanwhile, Mr. Feindel sees a resurgence in short-term bonds occurring this year.
He says the average bond lost 14 per cent last year, which he notes was “not just their worst year on record,” but the worst year by far due to rising interest rates and other factors.
Now that interest rates may stabilize, there could be an opportunity for a closer look.
“A lot of them are paying 5.8 per cent right now, yield to maturity, and then they’ll likely do well when interest rates start going down,” he adds.
Investor Economics’ Mr. Cardone also says not to count out traditional fixed-income products.
“If we can continue to see this environment where inflation has been easing, and have stable interest rates, we’re going to start to see a massive comeback to fixed income,” he says.
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