42% cut in returns sends advisors scrambling

An industry icon is the latest to lower expectations for equity returns – inspiring some advisors to use an investment once dismissed as a chronic underperformer

42% cut in returns sends advisors scrambling
Vanguard founder John Bogle recently cut his projection for U.S. stocks over the next decade by 42%, reducing the annual return he expects for equities from 7% down to 4%.

With an aging population craving yield in a low interest rate environment, outside-the-box investment ideas increasingly are what’s needed to keep clients happy.

At first glance, fixed income isn’t the solution either.

In October, three fund indices generated negative returns: Canadian Fixed Income, Canadian Long Term Fixed Income, and Canadian Inflation-Protected Fixed Income, declining 0.3%, 0.7%, and 1.6%, respectively. However, two areas of fixed income strength in October were the preferred shares and high-yield fund indices, up 5.6% and 1.7%, respectively.

Still, a closer look at that segment is pointing to higher yields through an amalgamation of key product types.

“My overall take would be there are a lot less risky ways to make 4% [Bogle’s equity projection]. I think there are definitely opportunities in the preferred space,” Andrew Torres, chief investment officer for Lawrence Park Asset Management, a Toronto firm specializing in fixed income credit strategies, told WP in an email. “But I still prefer some of the US and European bank hybrids to the Canadian NVCC issues. Canadian banks have more NVCC capital to raise in the next couple of years, and it’s not clear to me there is sufficient demand at the yields currently on offer.”

Combine a fixed-income product with an equity kicker and Bob’s your uncle, you’ve got a hybrid bond. Torres has two attractive possibilities in this area.

“Bank America has a USD hybrid bond ($100 par) which has a 6.1% coupon until 2025 and trades at a price around 101.75.   Beyond that date it floats at LIBOR+3.89%,” Torres told WP. “The current yield is around 6% (yield-to-call 5.875%). It’s rated Ba2 by Moody’s and has a USD 1.9Bn float, so very liquid.  Since the deal was launched in March it has returned 5.3% (9.1% annualized).”

A second possibility is a US dollar contingent convertible, or “CoCo” for short.

“Barclays Bank has a USD “CoCo” (European equivalent of NVCC), which pays an 8.25% coupon to Dec-2018, and then resets at 5y+6.70%,” said Torres. “It trades at a premium, $107, but offers a 7.7% current yield (5.76% yield-to-call) with a very high likelihood of getting called. Not rated by Moody’s but carrying a BB+ rating by Fitch.  So far in 2015 it has returned roughly 10.9% (13% annualized).”