With the low return landscape expected to run for some time, investors are scrambling to every corner of the market in an attempt to generate yield. In their desperate search for returns, certain investors have taken to replacing bonds with high paying dividend equities in their portfolios. For Tyler Mordy, President & CIO at Forstrong Global, it’s a strategy that is problematic on several levels.
“In implementing that strategy, investors are effectively replacing the shock absorbing part of the portfolio with an equity exposure,” Mordy says. “I think a better approach, and one that is facilitated through the widespread nature of ETFs, is based around not giving up on the only free lunch in finance, which is diversification.”
Rather than replacing bonds with equities, Mordy advises investors to look further afield for income oriented asset classes that will push up a portfolio’s yield without the need to give up on diversification. He identified REITs, utilities and emerging market debt as being particularly effective in the modern environment.
REITs are growing in popularity among Canadian investors and have performed well across the globe in recent times. Although it’s a sector that highly sensitive to interest rates, Mordy does not believe the current trend of interest rate hikes will impact REITs significantly. “Our macro view is that we are not going to have rates rise dramatically, it will be a slow, glacial rise in global rates overtime, which is not the worst situation,” Mordy says. “It does allow companies reliant on interest rates to manage their risk better – the tide has turned and central banks are scrambling to normalize interest rates.”
Despite limited opportunities, and more investor education and information available than ever before, Canadians remain overly invested in the domestic market. There is a reluctance to embrace opportunities in emerging market debt, and it could prove costly.
“A lot of emerging market countries have reasonable interest rates, low debt levels and, one can conclude, rising credit quality,” Mordy says. “Emerging market debt should be a structural or strategic component of every investor portfolio, and the percentage should change based on your risk tolerance and objectives. It is one of the best areas in the world to generate yield and yet the average investor in Canada has limited emerging market exposure.”
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