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It’s no secret to anyone that the Bank of Canada might raise its key interest rate once again this year. While the impact of said rate increases on borrowing costs generates considerable talk, they also affect your investments and their returns.
The Bank of Canada’s role consists in “fostering Canada’s economic and financial prosperity”. Moreover, the Bank of Canada manages the inflation rate to ensure the Canadian economy stays the course. This is a key part of the regulatory mechanism. In order to maintain inflation within a 1% to 3% range, it adjusts its key interest rate accordingly. When the economy undergoes a downturn and inflation is weak, the Bank of Canada lowers this rate to encourage spending. Conversely, when the economy is in full swing and inflation keeps pace and moves upward, it raises its key interest rate to curb any hype.
THE IMPACT ON YOUR INVESTMENTS
Key interest rate fluctuations are among the elements that affect interest rates set by financial institutions. These rates usually keep pace with said fluctuations, thereby impacting borrowing costs at the individual and corporate level. Moreover, those fluctuations also affect your investments, with each type of investment reacting differently.
Since early 2018, key interest rate increases have had a clear impact on bonds. Their prices are decreasing. This is basically the effects of supply and demand, as investors consider new bonds issued at a higher nominal rate more attractive than those already on the market. As a result, the latter’s value goes down to reflect this new reality.
Your bonds’ maturity also influences their sensitivity to interest rate fluctuations, with long-term bonds being particularly vulnerable.
Your bonds’ maturity also influences their sensitivity to interest rate fluctuations, with long-term bonds being particularly vulnerable. Consequently, when rates are raised, these securities react more strongly, as do their price and returns.
While interest rate fluctuations don’t have such a direct impact on equities, higher borrowing costs impede indebted companies, as their repayment costs go up as well. As a result, their profits take a hit.
Moreover, when interest rates are raised, dividend-paying equities become less attractive, as it may become just as profitable and less risky to choose bonds, instead.
Interest rate fluctuations also affect our currency’s value. Influencing factors include increased foreign interest in Canadian government bonds when interest rates go up. By purchasing such bonds with Canadian dollars, these foreign buyers put pressure on the currency’s demand, thereby increasing its value. Meanwhile, Canadian investors holding foreign investments see their value drop as a result of a stronger Canadian dollar.
Clearly, interest rate fluctuations don’t have the same impact on each type of investment. This means the best way to protect your investments from such fluctuations is to diversify your portfolio.
To this end, FERIQUE Fund Management launched the FERIQUE Diversified Income Fund in 2016. A high percentage of FERIQUE Fund Management’s clients hold fixed-income securities and are thereby exposed to the risks linked to Canadian bonds. This Fund was added to help avoid the risks stemming from Canadian interest rate fluctuations, including persistent weakness or hikes. Its strategy focuses on the use of various income sources with a diversified geographical allocation. As a result, the Fund holds Canadian and global bonds, preferred shares and dividend-paying securities.
Diversification is the cornerstone of any sound financial strategy. FERIQUE Funds expose investors to various geographical sectors or asset classes in order to build a well-diversified portfolio. FERIQUE Fund Management also features five turnkey Portfolio solutions, each adapted to a different type of investor with a distinct risk tolerance profile. These Portfolios also follow the same investment diversification strategy.
For more information on FERIQUE Funds and Portfolios, visit our website. To discuss with one of the Mutual Fund Representatives at the Advisory Services of FÉRIQUE Investment Services:
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