Interest rates and your investments

One of the dilemmas facing investors during this drawn-out bear market is where to find safe haven securities. Stocks have been a minefield for the most part, although it has been possible to find some winners with careful selection. Interest rates have been so low that you need a microscope to see your profits on traditional income securities. In recent months, the mattress has looked like an increasingly attractive place to stash your money.

Among the few profitable areas have been income trusts, many of which have prospered recently. The average Canadian income trusts mutual fund showed an annual gain of 15.9% over the past three years (to Feb. 28). Rising interest rates could change this situation, however, especially if the Bank of Canada continues to tighten the screws.

Here are some of the things to watch for in the coming months.

Low-risk securities like GICs, term deposits, and money market funds will become more attractive if rates continue to rise. Investors are desperate for places to put their money where they aren’t going to have to cope with declining balances each month. The higher interest rates go, the more appealing these securities will look, eecially if international tensions continue or escalate.

Income trusts may lose steam. Although the market reaction was muted immediately following last month’s rate hike, income trusts tend to be interest-sensitive. If rates continue to move higher, look for the market prices of many income trusts to pull back. The reason is that trusts carry more risk than securities like bonds and GICs and therefore must offer premium yields to compensate. As spreads between bond/GIC yields and income trust yields begin to narrow, trust prices may fall to compensate. Also, the profits of energy trusts may be adversely affected by a rising Canadian dollar.

Bonds are a question mark. Normally, higher interest rates would be bad news for the bond markets. However, there’s a push-me-pull-you effect taking place. Canadian bond prices moved up immediately following the March rate increase as foreign money was attracted by our higher rates and our strengthening dollar. If the loonie continues to climb in value, this pattern could continue for a while. Once again, it makes the case for holding a respectable percentage of bonds or bond funds in your portfolio. Short-term issues continue to carry the least risk.

Equities should continue to be approached with caution and emphasis should be placed on top-quality companies that are trading at reasonable prices. We should see a surge in stock prices if the Iraq situation is resolved quickly and oil prices come back to earth, but nothing is certain at this stage.

Summing up, investors need to stay alert right now and respond to a fluid situation. You can’t afford to play ostrich.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail financial newsletter that features some of Canada’s top investment experts.