Inflation

Inflation

The Rout in Long-Term Bonds

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By Michael J. Wiener

Special to the Financial Independence Hub

 

The total return on Vanguard’s Canadian Long-Term Bond Index ETF (VLB) since 2020 October 27 is a painful loss of 24%.  Why did I choose that particular date to report this loss?  That’s when I wrote the article Owning Today’s Long-Term Bonds is Crazy.

Did I know that the Canadian Long-Term bonds returns would be this bad over the past 18 months?

No, I didn’t.  But I did know that returns were likely to be poor over the full duration of the bonds.  Either interest rates were going to rise and long-term bonds would be clobbered (as they have), or interest rates were going to stay low and give rock-bottom yields for many years.  Either way, starting from a year and a half ago, long-term bond returns were destined to be poor.

Does this mean we should all pile into stocks?

No.  If you own bonds to blunt the volatility of stocks, you can choose short-term bonds or even high-interest savings accounts.  This is what I did back when interest rates became low.

Does that mean everyone should get out of long-term bonds?

It’s too late to avoid the pain long-term bondholders have already experienced.  I’m still choosing to avoid long-term bonds in case interest rates rise more, but the yield to maturity is now high enough that owning long-term bonds isn’t crazy.

Isn’t switching back and forth between long and short bonds just a form of active management?

Perhaps.  But it’s important to understand that bonds and stocks are very different.  Stock returns are wild and impossible to predict accurately.  There is no evidence that anyone can reliably time the stock market.  However, when you hold a (government) bond to maturity, you know exactly what you will get (in nominal terms).  When a long-term bond offers a yield well below any reasonable guess of future inflation, buying it is just locking in a near-certain loss of buying power for a long time. Continue Reading…

Infrastructure: An alternative solution for inflationary times

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By Shane Hurst

Managing Director, Portfolio Manager,

ClearBridge Investments, part of Franklin Templeton

(Sponsor Content)

Inflation has been the major theme dominating the investment world in 2022. Canada’s annual inflation rate reached 6.8% in April, representing a 31-year high. Canada is far from an outlier in this respect, with the U.S., the U.K. and many other western nations also experiencing rapid price growth over the past 12 months. In response, central banks have committed to a series of rate hikes this year, which in turn has raised the prospect of a global recession.

In this uncertain environment, market volatility has been elevated, particularly so in bond markets. Downside protection is front of mind for many investors as a result, but there are options out there to still generate returns for a portfolio without loading on risk.

Infrastructure assets, once the preserve of institutional investors, can now be a useful tool for retail investors and help in limiting risk and providing a stable income stream. Launched in Canada last year, Franklin ClearBridge Sustainable Global Infrastructure Income Fund (available as an ETF through FCII), harnesses the expertise of ClearBridge Investments, one of Franklin Templeton’s specialist investment managers. ClearBridge manages infrastructure income funds in the U.S., U.K., Australia, Europe and Canada, with global AUM of US$4 billion, as of March 31, 2022.

An asset class that makes economies function

Infrastructure as an asset class can be loosely defined as the services and facilities necessary for an economy to function. With the ClearBridge Infrastructure strategy, the portfolio is made up of regulated assets (e.g. electricity infrastructure and sewage pipes) which are characterized by stable cashflows, high income and low GDP exposure, and user-pay assets (e.g. airports, ports, railroads and toll roads) which generally provide lower income but are leveraged to GDP.

The investment team can take on a more defensive posture as circumstances dictate. For example, prior to the extreme sell-off of 2020, the strategy had a higher weighting to lower-risk regulated assets, which served it well during that period when its decline was approximately half that of its benchmark S&P Global Infrastructure Index. Continue Reading…

MoneySense ETF All-Stars 2022

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MoneySense has just published its annual feature, the ETF All-Stars 2022. For the first time in several years, I was not the lead writer on this package although I was involved in my role as Investing Editor at Large. We passed the writing reins to veteran financial freelance writer Bryan Borzykowski, who has previously written MoneySense’s annual Robo-advisor feature and is currently writing a new book to be titled ETFs for Canadians for Dummies.

As I point out in another MoneySense column, there is another ETF book published in 2021 that makes a good complement to the All-Stars package.  Reboot Your Portfolio is written by Dan Bortolotti of PWL Capital. Dan was the lead writer of the first edition of the ETF All-stars and served as a panelist for several subsequent years, along with his PWL colleague Justin Bender. In recent years, PWL advisors Ben Felix and Cameron Passmore have served as some of the panelists responsible for selecting the All-stars. The team of 8 panelists is unchanged from last year.

You can find the new edition of the All-stars by clicking here: Best ETFs in Canada for 2022.

As Bryan points out in his overview, by design, the panel didn’t make that many changes from previous years. The idea all along has been to provide a bunch of core low-cost, broadly diversified ETFs that don’t need to be changed every year. Certainly, the panel has never felt obliged to recommend brand new “theme” ETFs just for the sake of change.

Here’s my summary of the main changes:

Canadian Equities

No changes to last year’s lineup.

US Equities

The panel dropped the list of US equity ETFs from ten last year to seven this year.

International Equities

Last year’s picks return, plus the panel added three Emerging Markets ETFs: XEC, ZEM and EMXC.

Fixed Income

While Fixed Income has been a languishing asset class in recent months, the panel didn’t view this as alarming. Its previous lineup of Bond ETFs returns largely intact, with just one casualty: the panel decided to remove the Vanguard Global Bond ETF (VGAB.) For those who are nervous about more losses from rising interest rates, it continues to emphasize short-term bond ETFs like VSB and XSB

Note that in my recent MoneySense Retired Money column on the alleged Death of Bonds, I quote panelist Ben Felix, who still sees a role for fixed income in diversified portfolios. My column suggests those worried by rising rates can either park in treasury bills and wait for further interest rate hikes later this year, or ladder 1- and 2-year GICs every few months. Several 1-year GICs now pay close to 3%. That may be below the rate of inflation of late but at least  its beats losses of near 10% sustained by aggregate bond ETFs. Continue Reading…

The Ukraine war: a portfolio review

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By Duane Ledgister, vice president, CC&L

(Special to the Financial Independence Hub)

The daily escalation of the war in Ukraine is tragic, and the range of potential outcomes is unsettling. We are seeing a devastating humanitarian crisis and the human toll is immeasurable. Below we speak to some questions we have received and provide insights into how to best manage a portfolio.

Emerging market risks

Russia is one of a group of countries investors call ‘emerging markets,’ which reflects the stage of maturity and development of their economies and financial systems. Collectively, companies in emerging markets are an attractive source of growth for investors, despite their heightened risks. Stock markets in the developed world have comparatively low return expectations resulting from developed markets’ lower economic growth and higher valuations. At CC&L, our emerging markets strategy had a 2% weight to Russian stocks coming into the crisis. When considering this in the context of clients’ overall portfolios, this equates to less than one-tenth of one percent. Client portfolios have no exposure to companies in Ukraine.

What impact has the war had on portfolios?

While direct exposure to Russian and Ukrainian assets may be minimal, portfolios have not been immune to the volatility of the recent weeks caused by the war. Russia and Ukraine are important countries in the supply of commodities. Russia supplied approximately 12% of world oil and about 38% of Europe’s natural gas until the start of the war. Additionally, Russia and Ukraine — known as the breadbasket of Europe — provided roughly 25% of the world’s grain. Since the war began, commodity prices, particularly oil and gas, have shot up, acting like a tax on the global economy. This will put downward pressure on economic growth in many regions.

Context is key

It is important to understand the global economic landscape that was in place before the onset of aggression. The world was experiencing inflation levels not seen in decades, exacerbated by commodity underinvestment and global supply disruptions caused by the COVID-19 pandemic. Economic growth was riding high, boosted by the massive fiscal stimulus to offset COVID-19-related demand weakness. Continue Reading…

How to invest during high inflation

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It’s common for investors to be concerned about inflation because it brings to mind the high inflationary period of the 1970s that completely wrecked stock and bond returns. It’s also easy for investors to draw spurious conclusions about government debt and linking that to the hyperinflation that occurred in Zimbabwe or Venezuela. This article aims to set the record straight about inflation and let investors know how to invest during periods of high inflation.

Are we experiencing high Inflation?

Inflation is one of the biggest concerns as we near the end of the global pandemic and economies begin to re-open. Governments around the world spent record amounts to keep their citizens, small businesses, and corporations afloat over the past two years, while a majority of those still employed were able to save money thanks to an economy devoid of travel and entertainment.

The result was a significant uptick in savings rates, with Canada’s household savings rate reaching a high of 28.2% in July 2020.

All this money sloshing around on the sidelines has been and will continue to be deployed into goods and services, creating additional demand for a still strained global supply chain. Consumers are ready to dine out in restaurants, attend concerts, and engage in “revenge travel” to make up for lost time.

When that happens, prices tend to rise. Canada’s consumer price index (CPI) has been rising steadily since March 2021. The 12-month change in the CPI for February 2022 was 5.7% (Stats Can). That’s well above the Bank of Canada’s 2% inflation target, and even above their acceptable range of 1-3%.

Meanwhile, the U.S. inflation rate soared to 7.9% in February 2022. (Trading Economics).

Both the Federal Reserve and the Bank of Canada previously signalled they were willing to let the economy run a little hotter than usual to make sure we achieve so-called full employment. But both central banks are now in tightening mode, raising interest rates by 0.25% in March 2022 to kick-off a series of expected rate hikes for the rest of 2022.

It’s clear that high inflation has arrived and persisted for longer than expected. The question is what should investors do about it (if anything)?

How Investors should position their portfolio to deal with high Inflation

What exactly is an inflation hedge? In an episode of the Rational Reminder podcast, Benjamin Felix said an inflation hedge needs the following three characteristics:

  1. It will correlate positively with inflation, including responding to unexpected inflation.
  2. It won’t be too volatile
  3. It will have a positive real expected return

The problem, Felix said, is that asset doesn’t exist.

Continue Reading…