Float above GICs with Floating Rate Notes
What do you prefer, high interest rates, or low?

For a long time, it has been accepted wisdom that low interest rates are best. Low interest rates allow us to borrow more cheaply. Businesses can invest more, because their cost of capital falls. Governments have access to lower rates for financing projects and social programs. Consumers also benefit from lower rates on mortgages and consumer loans. Stock markets generally like lower rates as well, because they help prop up economic growth, reduce corporations' interest costs, and make the eternal comparison between bonds and stocks a little more favourable towards stocks.

Unfortunately, low rates have a downside: for investors in GICs and other fixed-income investments, low rates can dramatically reduce income payments. I have seen cases where individuals had been living off the income of GICs purchased years earlier, only to see their income halved when they had to renew their GICs at lower rates. There is a remarkably similar problem for pension funds. In fact, a prolonged period of low interest rates could wreak havoc with the ability of pension funds to deliver the returns they need in order to stay properly financed. If a pension fund needs returns of 6% to be able to fulfill its pension obligations, but can only get 4%, they will be in trouble.

But what about higher rates? On the plus side, they are good news to investors in fixed-income securities such as bonds and GICs. But on the other hand, they tend to restrict economic growth, raise the cost of investment for corporations, and can often put a serious dent in the property market. High rates can also wreak havoc on an existing portfolio of bonds and other income investments, not to mention what effect it can have on the stock market and real estate markets.

So what is the investor to do? What can you do to extract every cent out of fixed-income investments, while at the same time not taking on a large amount of risk? What if you like GICs for their safety, but need greater returns, even while you fear the higher risk associated with bonds or the stock market? Trying to guess which way rates are going can be very dangerous. Betting everything on rates moving one way or the other can result in significant losses if you happen to guess wrong.

Fortunately, there's a relatively new type of investment that can do well in either type of environment, called Floating Rate Notes, or FRNs for short. FRNs can at least partly mitigate the effect of low or high rates: that's perhaps why I regard them as one of the finest ways to beat GICs, without a whole lot more risk.

Like their name implies, the return on FRNs float or vary according to current interest rates. Most of us are familiar with variable or adjustable rate mortgages, where the interest rate on the mortgage fluctuates along with interest rates. Floating Rate Notes act in exactly the same fashion, except that instead of the amount you pay fluctuating with rates, the amount you receive fluctuates. So you are never locked-in to low rates. What makes FRNs different is that, because they are often issued by corporations, the interest paid is significantly higher than that you would receive with GICs.

Another benefit of FRNs is the diversification they can add to your portfolio. FRNs don't move in price the same way bonds can. In fact, FRNs are not highly correlated with other asset classes. If a portfolio designed to generate income has FRNs included, the volatility should decrease and investors should see more stability of returns over time. That adds up to a lot more peace of mind.

A favourite fund of mine in this asset class is the GGOF Floating Rate Income Fund, managed by Guardian Group of Funds (GGOF). GGOF has been managing income funds since 1962, and is well recognized for its 9 income funds. I feel perfectly content putting clients' low-risk funds into this fund, because I know that a sudden increase in interest rates won't result in capital losses.

This fund generates a higher rate of income in the form of monthly payments than is generally currently available in GICs, with some potential for capital appreciation. And you have protection against rising interest rates. Best of all, unlike a GIC, you are not locked-in to this investment. You can get out and switch to another investment or liquidate your investment whenever you like. Please refer to the enclosed information sheet for more specific information on this fund.

If you'd like more information on this fund, or would just like a review of your fixed-income investments with an eye to generating as much income as possible in a low rate environment, feel free to give me a call at any time, with no obligation whatsoever. Our team is devoted to providing you with superior advice. We aim to protect your capital, while still beating inflation and taxes. We provide high levels of service, and stay in regular contact with our clients through portfolio updates and mailings. If you would like to meet with us for a confidential, no-obligation assessment, call (905) 704 6650. It would be well worth your time to get a second opinion and hear what we can offer.

Sincerely,

Scott Swallow, HBA, MBA, CIM