Three ways to boost returns in a difficult market
These sometimes overlooked investment strategies may help boost portfolio performance.
By Phil Cutts, Vice President & Director, RBC Europe Limited, London
With the continuing slump in the world’s equities markets, many investors have shifted their attention to fixed-income securities and cash. Returns from these instruments may be low, given the current low-interest rate environment, but at least they’re positive.
Over the longer term, however, they are unlikely to keep pace with inflation. In other words, your returns may well be secure, but you will be losing purchasing power over time.
Here are some alternative strategies with the potential to generate a return on capital. Be sure to consider them in light of your investment objectives and tolerance for risk.
1 Maximise tax-advantaged opportunities
Taking advantage of investing opportunities that generate legitimate tax savings is a solid strategy in any market. But in a tepid market it becomes even more important as a way of enhancing overall returns.
Most jurisdictions offer some type of tax-advantaged savings program, for example, Individual Savings Accounts (ISAs) in the U.K. Typically, these plans either give you a tax deduction for your contributions and tax the income you receive in the future, or offer no tax deduction upfront, but don’t tax your income or capital growth when you withdraw it. Either way, these contributions can result in significant tax savings, meaning ultimately that you keep more of your investment returns.
Remember that tax-advantaged investments, like all investments, run the gamut from low to high risk. Some pension or retirement plans, for instance, offer an immediate tax benefit, for a virtually guaranteed return. At the other end of the spectrum are high-risk debt and equity securities that offer tax advantages as an incentive to investors.
2 Explore capital-protected instruments
There’s no need to limit fixed-income opportunities to conventional government issued and high-quality corporate debt. The following innovative products offer potentially higher yields with moderate additional risk:
Insurance-based products. In many jurisdictions, insurance-based products can enhance investment returns. For example, it is possible to hold a term deposit, equity portfolio, or mutual fund combined with a life insurance policy. This may be known as an insurance-wrapped bond and may not be available in all jurisdictions. If the purchaser passes away before the end of the term, the investment will pay off in full at that time. Because they’re considered an insurance product, the payments from an insurance-wrapped bond are generally taxed more favourably than payments from a conventional investment, although tax treatment may vary from jurisdiction to jurisdiction.
Structured notes. Structured notes are an investment vehicle, often with a guaranteed principal, whose returns are linked to a major market index or interest rates. The capital may be guaranteed, but not the return. Because there is a risk that investors may receive no return (beyond their capital), structured notes generally pay a higher rate of return than conventional fixed-income investments. Structured notes may have a minimum investment and may not be available in all jurisdictions. Products and tax treatment vary considerably in countries around the world. As a result, it’s always advisable to consult a qualified professional before making a decision with regard to any specific investment.
3 Alternative equity market investments
The most common type of alternative equity market investment is the hedge fund. Unlike conventional mutual funds, which typically strive for returns relative to a certain benchmark, most hedge funds have a goal of absolute returns that are unrelated to any market index.
To accomplish this, hedge funds use sophisticated investment strategies not generally available to traditional mutual funds. These investment approaches can include the use of derivatives such as options and futures, as well as leveraging (borrowing to invest) and short-selling (in which the fund sells stock that it doesn’t yet own, with a view to generating a profit by buying it later at a lower price).
There are a wide variety of hedge funds available, ranging from conservative market neutral hedge funds to aggressive merger arbitrage funds. As with all investments, the greater the potential reward, the greater the potential risk.
One risk common to all hedge funds is a lack of liquidity. While conventional mutual funds are generally redeemable daily, some hedge funds may require you to lock in your investment for as long as three years.
Be sure you fully understand what you’re getting into. With hedge funds, as with any investment, it’s important to read the fine print before you make a cash commitment.
The above are just a few examples of investment strategies that lie outside the traditional market purview. Before committing to a strategy or entering into an investment agreement, be sure to seek appropriate professional advice.
Exploring the world of old maps
I’ve heard that there’s quite a market for old maps. Is this a collectible that could appreciate in value?
There’s been a fairly steady growth in the value of antique maps over the past 30 years, ever since people began to consider maps as a form of home decoration in the early 1970s.
One of the attractions is that you can start collecting interesting maps for very little money. Massproduced maps from the 19th century, for example, can be bought for less than a few hundred dollars.
Once you start looking at hand-drawn maps from earlier centuries, the maps become rare and therefore much more valuable. Handcrafted world maps from the 15th and 16th centuries can fetch as much asUS$1.5 million. The world record was US$10 million paid by the Library of Congress in 2001 for a unique map of the world by Martin Waldseemuller, drawn in 1507. It’s the first known map to feature the word “America” on it.
The most expensive maps are generally world maps, followed by maps of America and Asia, led by market demand. Interestingly, people in some countries (such as France) just don’t seem to collect maps as enthusiastically, so depictions of their countries tend to be less expensive.
For those starting out, it’s essential to educate yourself about the market before making a purchase. Read some books on cartography. Then visit a reputable antiquarian map dealer to determine what kind of maps appeal to you. A good place to start is www.mercatormag.com, the online version of Mercator’s World, the world’s leading publication devoted to maps and map collecting. Many dealers advertise in this publication.
As with most collectibles, buying what you like is a solid strategy. For many, the joy of collecting old maps comes from the pleasure of owning a work of artistic merit that combines mathematics, history, geography, and often mythology.
Our thanks to Tom Lamb, Department Head, Books & Manuscripts at Christie’s in London. He can be reached at +44 (0)20 7389 2151.
Patience is the key in the current economic climate
Part of a series of articles featuring the managers from our global network.
Craig Wright is Vice President and Chief Economist for RBC Financial Group. Global MoneyGuide spoke with him recently about the latest trends in the global economy and what they might mean for investors in the months to come.
What is the near-term outlook for the world’s economy?
We are cautiously optimistic, although there are certainly potential risks. There is a lot of stimulus in the economy that should improve the world’s markets in the second half of 2003. That’s assuming, of course, that the geopolitical uncertainty that weighed so heavily on the economy in recent months continues to recede.
Which regions have fared the best, and the worst, in recent months?
Countries that have done relatively well through the recent period of weakness are those that used monetary and fiscal policy to shore up growth — specifically, Canada, the U.S., and the U.K. They all aggressively eased interest rates or increased government spending.
In contrast, Europe was held back because the Eurozone’s 3% ceiling on the deficit-to-GDP ratio restricted its governments’ abilities to spend, and because the European Central Bank was slow to cut interest rates. Japan continued to lag because of structural problems with its economy and the difficulty in cutting interest rates already effectively at zero.
Looking ahead for these regions, we see Canada continuing its position as growth leader among the G-7 countries, with a forecast growth rate of 3.4%, followed by the U.S. at 2.8%, and the U.K. at 2.0%. We believe Europe and Japan will lag behind, with 1.5% and 1.3% growth this year, respectively.
What is going to determine the health of the global economy in the coming year?
Every other economy in the world is dependent to some degree on what happens in the U.S. Whether it will recover this year remains an open question. There is some debate about whether the recent conflict with Iraq has caused the current weakness in the U.S. economy, or whether there are more fundamental problems at work.
What are some of those fundamental weaknesses?
For one thing, there is little sign of pent-up demand for housing or automobiles, two areas where demand traditionally helps an economy out of a recession. Also, the amount of consumer debt remains relatively high. This means that a lot of personal income is going towards servicing debt, rather than towards saving. Recent tax cuts and mortgage refinancing activity have prevented consumer spending from weakening, but growth in the months to come will depend largely on whether employment improves.
The U.S. dollar is likely to continue its depreciation because of the country’s rising current account deficit and large budget deficit. How sharp the depreciation will become depends partly on how much the war effort will increase the country’s deficit. For these reasons, we believe economic growth in the U.S. will be relatively modest through 2003.
What does this mean for investors?
In the near term, volatility will remain high, both in the equity markets and economic indicators, because of lingering uncertainties. The downgrading of concerns surrounding the situation in the Middle East should lead to lower levels of uncertainty and allow markets to gradually recover. Positive factors, such as relatively low interest rates worldwide, should help to lift global growth prospects. As a result, bonds may become overpriced, while equity prices should begin improving.
Investors need to be patient until the growth prospects pick up and the positive fundamentals can lift the markets. Investors also need to be realistic about returns they can expect from equity markets in the future, which are likely to be in the more historically normal range of 5% to 10% rather than the high double-digit returns of the late 1990s.
Craig Wright Vice President and Chief Economist for RBC Financial Group
For further information, please refer to Global Investment View, which includes an analysis of the stock, bond, and currency markets. This publication is available from your Relationship Manager.
A closer look at structured notes
In uncertain markets, secure fixed-income and cash-equivalent investments typically draw capital away from equity investments. The downside, of course, is that investors have to accept more modest returns in exchange for the increased security. One potential investment to think about is the structured note, which combines the capital protection of a fixed-income investment with the potential for greater returns.
Tapping into upside
A structured note is a medium-term (three to seven years) debt issued by a company or government agency. It offers the buyer a rate of return linked to the performance of such things as U.S. interest rates, a major market index, or a particular basket of equities.
A structured note linked to European Central Bank (ECB) interest rates, for example, might pay out a certain rate of return only as long as the ECB interest rate stays below 3.0%. So the structured note pays a return only for those days that the ECB interest rate stays below its target rate of 3.0%. For those days that the ECB interest rate goes above that specified level of 3.0%, the structured notes pays 0% return (nothing except your capital). The target ECB interest rate may also change for each year of the structured note’s existence.
Structured notes are considered riskier than conventional fixed-income vehicles in that there is a greater likelihood of the investor’s earning a 0% rate of return. For this reason, they generally offer a higher potential rate of return. This risk premium may be as much as two or three percentage points.
A note of caution
Unlike conventional bonds, structured notes are not very liquid. There may not be a market for trading them before maturity. Investors need to be sure that they can commit their funds for the full length of term.
Structured notes are available in a variety of forms, and regulations may differ from one country to the next. They may not be available in all jurisdictions. Because of the complex nature of their returns, they are suitable only for sophisticated investors. For more information, please contact your Royal Bank of Canada Global Private Banking Relationship Manager.
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