With the Bank of Canada signalling that interest rates are on a downward track, it’s time to get real about investing in guaranteed investment certificates.
GICs paying roughly 5 per cent – even 6 per cent was briefly available – are a legitimate choice for risk-averse investors seeking a reasonable rate of return. But GIC rates are set to move lower in the months ahead, which means a shift in thinking is required. Can you meet your financial planning and investment goals on 3 to 4 per cent returns before tax? After tax, the interest income from GICs is worth even less in non-registered accounts because it’s taxed like regular income.
For now, though, alternative banks still offer up to 5.4 per cent on GICs with terms of one and, to a lesser extent, two years. Saven Financial, available to Ontario residents, offered 5 per cent for terms of three, four and five years as well. By comparison, the big banks had special rates on one-year GICs between 4.5 and 5 per cent. Royal Bank of Canada, for example, offered a one-year rate of 4.9 per cent..
If you invest in GICs through an online brokerage, 5 per cent one-year GICs were still available as of late this week from issuers such as Fairstone Bank, General Bank of Canada, HomeEquity Bank and Versabank. All are members of Canada Deposit Insurance Corp.
The comparative yield from bonds highlights the value remaining in GICs. Corporate bonds with a BBB rating or better and maturities in the next 12 to 18 months offered yields of 4.4 per cent at best late this week, while Government of Canada bonds offered 3.9 per cent at best.
Cash-like investments have kept up pretty well with GICs in the past year - similar rates with vastly better liquidity. But the Bank of Canada’s move this week is widening the gap. Investment savings accounts, used by investors who want to safely park cash in their account, have already or can be expected to cut returns by the same 0.25 of a percentage point that the Bank of Canada trimmed its overnight rate.
Locking into a one-year GIC paying 5 per cent reduces your flexibility compared to cash equivalents, but it guarantees you a return of nearly double the latest inflation rate with zero concerns about stock or bond market volatility. Returns like this will look great if the Bank of Canada does the expected in lowering rates a few more times this year.
-- Rob Carrick, personal finance columnist
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The Rundown
Markets are underestimating how much the BoC will cut rates in the next 12 months
The Bank of Canada needs to cut interest rates by far more than the 75 basis points priced in by next May, argues Dylan Smith, senior economist with Rosenberg Research. That means investors should buy government of Canada bonds, and overweight the TSX sectors that benefit from sustained Canadian dollar weakness. He outlines them here, while explaining why the central bank needs to act aggressively on easing monetary policy. Meanwhile, our Scott Barlow reports on the near-record hedge fund bearishness on the Canadian dollar, and what it may mean for future moves in the loonie.
Nvidia’s stunning gains increasingly power Wall Street’s record run
Reuters reports on how a rally that has propelled U.S. equities to record highs increasingly rests on red-hot chip maker Nvidia and a handful of other giant stocks, reviving concerns that the market’s performance has become tied to a cluster of companies.
The wiggle room around 2 per cent inflation targets
This week’s milestone Canadian and European interest rate cuts dispel any notion that hitting 2 per cent inflation targets spot on is a precondition for central bank moves or indeed sensible - and may guide thinking on the Federal Reserve and Bank of England too. Mike Dolan of Reuters explains.
Others (for subscribers)
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Number Cruncher: Eight Canadian retailers poised to benefit from falling interest rates
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Ted Dixon: Insiders buy as Allied Gold slides
Monica Rizk: Bullish on Louisiana-Pacific Corp.
Friday’s analyst upgrades and downgrades
Thursday’s analyst upgrades and downgrades
Globe Advisor
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Ask Globe Investor
Question: Regarding John Heinzl’s recent column about A&W Revenue Royalties Income Fund (AW-UN-T), it would be interesting to know what its payout ratio is compared to peers. My cursory research suggests A&W’s payout ratio is in excess of 100 per cent, and I wonder if this high payout ratio is the cause of its poor share price performance.
Answer: Because of the seasonality of the restaurant business, the dividend payout ratio for A&W and other royalty funds varies considerably throughout the year. The timing of income taxes can also affect the payout ratio.
In A&W Revenue Royalties’ first quarter ended March 24, which is typically the burger chain’s slowest sales period, the payout ratio was 114 per cent. This indicates that the fund’s royalty income, which is based on a percentage of sales at A&W’s restaurants in the “royalty pool”, was not sufficient to cover its distributions in the first three months of the year.
However, in the previous three quarters, when A&W’s sales are typically stronger, the payout ratio averaged a much more manageable 86.7 per cent.
Putting all four quarters together, the payout ratio for the 12 months ended March 24 was 91.9 per cent, which indicates that A&W Revenue Royalties’ current distribution of 16 cents a month, or $1.92 annually, is well covered by the royalty income the fund generates.
Similarly, fellow restaurant royalty company Pizza Pizza Royalty Corp. had a payout ratio of 122 per cent for the three months ended March 31. “System sales for the quarter ended March 31 have generally been the softest and historically results in a payout ratio over 100 per cent,” the company said when it announced first-quarter results in May.
For 2023 as a whole, however, Pizza Pizza Royalty’s payout ratio was 97 per cent – again, indicating that its dividend is sustainable, barring a sudden downturn in its sales as happened during the COVID-19 pandemic when it and other royalty funds slashed their dividends.
When gauging the sustainability of a restaurant royalty company’s dividend, always look at the payout ratio on an annualized basis. You can usually find this information in the investor relations section of the company’s website.
--John Heinzl (E-mail questions to jheinzl@globeandmail.com)
What’s up in the days ahead
The wealth management industry has taken to telling everyday Canadian investors that they ought to be dabbling in alternatives, like real estate, commodities and infrastructure, to round out their retirement plans. Ian McGugan will tell us why investors should just ignore all the hype. And David Berman will give us his latest thoughts on Canadian banks following this week’s Bank of Canada rate cut.
Which way to look first? World market themes for the week ahead
Click here to see the Globe Investor earnings and economic news calendar.
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Compiled by Darcy Keith of The Globe and Mail