Time to accept reality rather than ‘cheating’ to get income

Advisors have to be careful of balanced funds moving money away from fixed income to generate returns, says industry insider

Time to accept reality rather than ‘cheating’ to get income

Investors may have to accept a dose of reality over the next five years and get used to a 4-5% return on their portfolio. Advisors, meanwhile, have to be wary of inadvertently “cheating” and reaching for income in areas that might leave them exposed to market corrections, according to an industry veteran.

Rob McClelland, senior financial planner of The McClelland Financial Group, Assante Capital Management Ltd., admitted it’s a dilemma given the current landscape and highlighted an elderly client’s situation as an example. The octogenarian is in great health, owns her own home has a successful plan but is 60% in fixed investments. Faced with getting, at most, 2% from that over the coming years, should she get more aggressive? Dropping down to a 50-50 mix in stocks and bonds might garner an extra 30 basis points, which would help, but it's not huge. McClelland said the decision comes down, ultimately, to how much inheritance she wants to leave.

He said: “You've got to be very careful. There is nothing better than bonds and cash as a diversifier against market corrections. Bonds are better, typically, because bonds actually go up in value and when you get a market correction, interest rates often pull back, so they protect it – they just don't protect it as much as they used it.

“In March of 2020, even though interest rates were still pretty low at the time, the bonds helped to cushion that blow. So advisors have to be careful that they don't suddenly start ‘cheating’ too much and move to more equities or anything else.”

McClelland warned that there is no perfect hedge out there and is reluctant to put elements into portfolios that don’t have great recent histories, like preferred shares, for example, having already reached for the likes of private equity and infrastructure.

He added: “You’re going to see a lot of what I'm going to call ‘cheating’, where balanced funds reduce the amount of money that are in bonds and start ‘cheating’ into things that are producing higher income. But at the end of the day, it's equities. There's only fixed income and equities - there's no perfect hedge out there.”

Clients, therefore, should expect lower returns, albeit a result that's better than sitting in cash. But if interest rates start moving again, then the discussion changes rapidly. The big question, of course, is when that might happen?

McClelland’s thought is that this scenario is potentially 12 months out and that governments will wait until the virus is finally under control, so they can properly assess the damage done to businesses and individuals.

Those hurt the most, though, have clearly been those on minimum wage, many of whom lost income or their job. This might prompt a change in some tax rates, McClelland said, although he urged caution to avoid the risk of cutting off growth. Central banks do appear willing, however, to let inflation come back a bit.

McClelland said: “Inflation makes the bill smaller if they don't raise interest rates. Whatever the debt is, it’s not as bad if inflation is 3% a year for the next three years."