There may be substantial risks to holding fixed income investments that do not have individual maturity dates. The goal here is to introduce a concrete investment strategy that may help investors in an environment of rising interest rates.
Most investors will be familiar with a Guaranteed Investment Certificates (GICs). These are certificates of deposit that are issued by financial institutions which offer a fixed rate of return over a set period of time. By locking in the funds for the term of the GIC, the buyer usually receives a higher return than they would receive on a comparable government bond of equal term duration. GICs do not offer capital gain potential but pay interest which is either paid periodically or compounded over the length of the term. GICs are usually considered to by lower risk investments due to the absence of volatility and the insurance coverage offered by Canada Deposit Insurance Corporation (CDIC) for GIC terms of up to 5 years. Details of this insurance may be found at www.cdic.ca.
Interest rates have been extremely low for the past decade and the yields on guaranteed investments have been marginal. Many investors have been weary to invest capital at such low interest rates and may have looked for higher yields in other parts of the securities market. We have now started to see some of the potential volatility in some of these other areas of the market due to increasing interest rates. The strategy of a GIC Ladder appears to be a disciplined approach to dealing with a portion of the fixed income weighting of the portfolio. This structure is not meant to be the entire portfolio but a strong foundation that may protect against future changes in interest rates and offer greater portfolio stability.
Instead of waiting for a certain level of interest rates, investors may consider creating a ladder of GICs of different maturities. Once the ladder is created, the foundation will be in place to track interest rates higher and to always maintain a portion of the portfolio in lower risk securities. This strategy should also reduce volatility and potentially limit stress in difficult markets as investors are able to easily identify the portion and percentage of their portfolio that is not variable. It is also potentially one of the strategies that may protect against inflation over the longer term.
The GIC Ladder
Here is a hypothetical example of a $100,000.00 5-Year GIC Ladder purchased on January 1, 2017.
$20,000.00 1.55% 1-Year Annual Compound GIC (matures January 1, 2018)
$20,000.00 1.75% 2-Year Annual Compound GIC (matures January 1, 2019)
$20,000.00 1.95% 3-Year Annual Compound GIC (matures January 1, 2020)
$20,000.00 2.10% 4-Year Annual Compound GIC (matures January 1, 2021)
$20,000.00 2.26% 5-Year Annual Compound GIC (matures January 1, 2022)
In this example, each step of the GIC Ladder has an initial equal investment of $20,000.00. The average yield of the portfolio at inception is 1.92%. This may appear moderate but it is approximately double the current yield on a comparable government bond portfolio of equal duration and more than the current yield of a Government of Canada 10-year bond. The GIC portfolio also does not have the same variable return and volatility of a bond portfolio of equal duration.
On January 1st of each year, $20,000.00 will mature and a new 5-Year GIC will be purchased with the proceeds. If interest rates have risen, this strategy will capture the new higher rates. The yield of the ladder will also naturally increase over time as the lower duration GICs roll off and are replaced by new 5-Year GICs. For example, if on January 1, 2018 a new $20,000.00 5-Year Annual Compound GIC is purchased at a yield of 2.50% with the proceeds of the maturing GIC, the yield on the portfolio would rise to 2.11%. This is due not only to the purchase of the new GIC at a higher interest rate but the fact that the 1-Year GIC at 1.55% has matured and is no longer part of the yield calculation.
- The inclusion of a GIC Ladder should Increase the predictability and stability of an overall portfolio.
- A GIC Ladder would usually make up a portion of an investment portfolio. The balance would be invested in high quality individual equities and investment grade bonds with individual maturity dates.
- In a rising interest rate environment, GICs may efficiently track interest rates and inflation higher. The yields are moderate now but they are higher than comparable bond yields.
- The goal of this strategy is to protect capital. GICs do not offer the same risks in a rising rate environment as some other fixed income alternatives such as Bond funds, Bond ETFs, Strip Bonds, Perpetual Preferred Shares etc.
- Consider finding an advisor that may help create and implement the strategy as part of an overall portfolio. Investors might also consider shopping for GIC yields as the yields offered at some institutions are not always the best rates.
- This strategy utilizes 1-5 Year GICs that are not connected to any other securities market (i.e. these are not index inked).