Fifty Shades of Safe: An Investment Perspective

Recent market volatility is reminding people of the Financial Crisis. A lot of people do not have fond memories of the downward movement of their investment portfolio during the Financial Crisis.  So there is no surprise that in my business there is more and more questions about “safe” places to invest.

“Safe” means different things to different people.

“Safe” to someone who cannot handle any risk to their investment means Canada Savings Bonds, Provincial Bonds,  Term Deposits, Money Market Funds, Guaranteed Investment Certificate (GICs) or Treasury Bills.  This version of “safe” is very safe, but this version also typically only yields 1-1.2% return on your money.  For most people, this shade of “safe” is a little too safe.

“Safe” may involve investment grade corporate bonds.   These types of bonds are issued  by a company (instead of by a government).  As a result, the interest rates offered on these bonds are higher bonds issued by a government, because investment grade bonds are not guaranteed by a government.  Within this class, you have different shades of “safe”, as the corporate entity offering the bond may be very creditworthy (e.g. credit rating* of AAA or AA), or less creditworthy (e.g. credit rating of A or BBB). You can buy investment grade bonds directly or through an investment grade corporate bond fund.   Yields for investment grade bonds can range from 1.2% to 5%, depending on the credit rating of the company and the time to maturity (the shorter the time to the bond maturity , the lower the yield).

Another option for increased yield within a “safe” investment can involve mortgage funds.  Once again, there are various types of mortgage funds, all carrying different levels of risk.   Most exchange traded mortgage funds invest in a combination of commercial (industrial, office, multi-use complexes) and residential mortgages.  The fund is in essence the lender (instead of a bank), and the investor offers the investment dollars to form part of the loan.   The riskier mortgages tend to be more concentrated on residential mortgage offering secondary lending (e.g. there is already a first mortgage on the property, and the borrower needs more money and so a 2nd or 3rd mortgage is secured).  The higher the yield a mortgage fund offers, the greater the credit risk (risk of the mortgage being repaid).  For mortgage funds that do very little to no secondary lending, the yield can be 2% to 5%.  For mortgage funds doing more significant secondary lending, the yield can go as high as 8% to 10%.

If mortgages are not your thing, how about index-linked GICs.  These products offer you a share of any increase in a linked market index (e.g. S&P 500 or TSX 60) in the form of interest income, and they promise you repayment of your capital if the linked market index goes down.  The catch?  If there is market upside, you only share in a percentage of the growth and you may be capped (e.g. 5%).  And in the downside you get 0% whereas you could have gotten 1% or more with some other options noted above.  These are very popular, and are typically sold as a 2 year, 3 year or 5 year offering.

The above addressed only fixed income investment options.  What about “safe” options for your equity investments.  For investors who do not like a lot of risk in their equity portfolios, I like to introduce them to segregated funds.  Segregated funds are mutual funds sold with insurance guarantees.  The insurance guarantees can protect up to 100% of your investment if you hold the fund to maturity (typically 15 years) or if you prematurely pass away.  Guarantees can take a lot of the downside value risk out of equities, and allow you to stay invested for the long-term.  Some segregated funds also guarantee a minimum withdrawal from an investment for the rest of the investors life, to replicate the feel of a pension plan.  Segregated funds can have higher expenses associated with them then mutual funds (to pay for the guarantees), but certain offerings allow reduced expenses where you deposit minimum amounts.   And in some cases the higher fees are worth it to gain the comfort of the guarantees.

Bear in mind that most of the above noted investment options are marked to market, which means they are revalued by the market for any changes in the underlying interest rate, equity market, or creditworthiness of the company that issued the bond or borrows the mortgage.  As such, there are “safe” investments that can still go down in market value but offer you an attractive yield.

Also, “safe” requires an appropriate investment strategy that is suitable to the investor and appropriately diversified. That may mean for one investor a combination of the above is suitable, whereas for another they should only be invested in GICs.  To properly address “safe” is to ensure you, as an investor, are supported by an investment advisor who has you best interests and risk tolerances as their number one priority, and can guide you to an investment strategy that meets the most important definition of “safe”…..yours!

* credit rating used by S&P or Fitch, ignoring + or – differentiators.

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