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U.S. Recession Scorecard
Top 30 Global Ideas for 2022
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Top 30 Global Ideas for 2022 Third-Quarter Update
In this note, we present our Top 30 Global Ideas for Q3 2022. This list remains one of high-conviction, long-term ideas, with quarterly updates that enable dynamic changes into names that we think offer higher- conviction upside potential.
Since publishing our Q2 update on April 4, 2022, the Top 30 list has delivered a total return of -17.4% (in USD terms) versus our benchmark, the MSCI World Index, at-15.6%. Year-to-date, the list has delivered a total return of -14.0%, above the benchmark at -20.1%, and since inception of our quarterly list at year-end 2019, the Top 30 has delivered a total return of +20.8%, above the benchmark at +13.2%.
Recession risk, rising rates and inflation remain key areas of focus across sectors. As of our latest US Equity Strategy RBC Macroscope update (published June 6, 2022), on a 6-12 month view, our Strategy team continues to believe that stock market leadership is transitioning from Value to Growth and that defensive areas have started to look over-owned and overvalued, while acknowledging near-term risks to that view should equities start to price in a full recession.
With the changes to the Top 30 list this quarter, we switch into best ideas that we also view as offering more attractive positioning against the current macro backdrop. On an equal-weighted basis, we increase the Top 30 list’s Real Estate and Utilities exposure to overweight versus the MSCI World Index, maintain a modestly overweight position in Financials, and remain notably overweight Energy and Industrials, driven by the inclusion of individual high-conviction names under coverage.
In Real Estate, we add Communications Infrastructure company American Tower (AMT US), which we think is well positioned to benefit from mobile 5G spending by its carrier customers, with accelerating site leasing trends in its core US market as well as many of its international markets. In 2023 and beyond, we believe AMT should post 10%+ AFFO/share growth and an attractive dividend, coupled with inflation protection in most of its international markets given its CPI-linked lease escalators.
In Utilities, we add independent power producer The AES Corporation (AES US). We believe AES offers a compelling decarbonization story, potential to become a leader in the clean energy producer space, and attractive valuation relative to defensive utility peers.
In Health Care, we add Lonza Group (LONN SW), which we think is positioned to benefit from multi-year structural tailwinds in biologic pharmaceutical manufacturing. We see life science funding concerns as overblown for CDMOs, and our recent supply/demand analysis suggests the long-term growth outlook is de- risked. In our view, the shares appear attractively valued at current levels vs. peers and due to the high return on incremental invested capital (25-30%), as well as opportunities to invest using its strong balance sheet. We remove robotic-assisted surgery company Intuitive Surgical (ISRG US) as we see potential for a tightening of hospital capital spending in the near term, elongating sales cycles. That said, we maintain an Outperform rating and continue to view ISRG as uniquely positioned for a multi-year runway of growth.
In Information Technology we replace Twilio (TWLO US) with Veeva Systems (VEEV US), which we view as offering defensive attributes (Veeva sells mission critical software to life sciences, a defensive industry), multiple growth drivers, a leading financial model, and reasonable valuation.
In Consumer Discretionary, we remove Amazon.com (AMZN US) as we see risk to H2/22 outlook in the event of marginal consumer softness and associated excess capacity, while maintaining an Outperform rating. In Materials, we remove building solutions manufacturer Louisiana-Pacific (LPX US) given potential for near-term headwinds associated with higher interest rates and slowing North American housing growth, while our long- term positive thesis remains intact.
This report contains further detail on our investment thesis for each of the names on the Q3/22 list beginning on page 7. We encourage you to reach out to our team to continue the dialogue regarding their investment ideas.
We see our fundamental work being increasingly augmented by our four flagship research products: RBC FusionTM, RBC TM, RBC ElementsTM, and RBC ESG StratifyTM. RBC Fusion offers peer-reviewed, unique reports on our highest-conviction, most-differentiated calls. RBC Imagine is a series of fundamental research reports focused on disruptive forces that we believe will transform the world. Our RBC Elements work features proprietary insights generated in collaboration with our internal data science team. With RBC ESG Stratify, we separate the signal from the noise on ESG matters with precise, analytical research.
Since publishing our Q2 update on April 4, 2022, the Top 30 list has delivered a total return of -17.4% (in USD terms) versus our benchmark, the MSCI World Index, at-15.6%. Year-to-date, the list has delivered a total return of -14.0%, above the benchmark at -20.1%, and since inception of our quarterly list at year-end 2019, the Top 30 has delivered a total return of +20.8%, above the benchmark at +13.2%.
Recession risk, rising rates and inflation remain key areas of focus across sectors. As of our latest US Equity Strategy RBC Macroscope update (published June 6, 2022), on a 6-12 month view, our Strategy team continues to believe that stock market leadership is transitioning from Value to Growth and that defensive areas have started to look over-owned and overvalued, while acknowledging near-term risks to that view should equities start to price in a full recession.
With the changes to the Top 30 list this quarter, we switch into best ideas that we also view as offering more attractive positioning against the current macro backdrop. On an equal-weighted basis, we increase the Top 30 list’s Real Estate and Utilities exposure to overweight versus the MSCI World Index, maintain a modestly overweight position in Financials, and remain notably overweight Energy and Industrials, driven by the inclusion of individual high-conviction names under coverage.
In Real Estate, we add Communications Infrastructure company American Tower (AMT US), which we think is well positioned to benefit from mobile 5G spending by its carrier customers, with accelerating site leasing trends in its core US market as well as many of its international markets. In 2023 and beyond, we believe AMT should post 10%+ AFFO/share growth and an attractive dividend, coupled with inflation protection in most of its international markets given its CPI-linked lease escalators.
In Utilities, we add independent power producer The AES Corporation (AES US). We believe AES offers a compelling decarbonization story, potential to become a leader in the clean energy producer space, and attractive valuation relative to defensive utility peers.
In Health Care, we add Lonza Group (LONN SW), which we think is positioned to benefit from multi-year structural tailwinds in biologic pharmaceutical manufacturing. We see life science funding concerns as overblown for CDMOs, and our recent supply/demand analysis suggests the long-term growth outlook is de- risked. In our view, the shares appear attractively valued at current levels vs. peers and due to the high return on incremental invested capital (25-30%), as well as opportunities to invest using its strong balance sheet. We remove robotic-assisted surgery company Intuitive Surgical (ISRG US) as we see potential for a tightening of hospital capital spending in the near term, elongating sales cycles. That said, we maintain an Outperform rating and continue to view ISRG as uniquely positioned for a multi-year runway of growth.
In Information Technology we replace Twilio (TWLO US) with Veeva Systems (VEEV US), which we view as offering defensive attributes (Veeva sells mission critical software to life sciences, a defensive industry), multiple growth drivers, a leading financial model, and reasonable valuation.
In Consumer Discretionary, we remove Amazon.com (AMZN US) as we see risk to H2/22 outlook in the event of marginal consumer softness and associated excess capacity, while maintaining an Outperform rating. In Materials, we remove building solutions manufacturer Louisiana-Pacific (LPX US) given potential for near-term headwinds associated with higher interest rates and slowing North American housing growth, while our long- term positive thesis remains intact.
This report contains further detail on our investment thesis for each of the names on the Q3/22 list beginning on page 7. We encourage you to reach out to our team to continue the dialogue regarding their investment ideas.
We see our fundamental work being increasingly augmented by our four flagship research products: RBC FusionTM, RBC TM, RBC ElementsTM, and RBC ESG StratifyTM. RBC Fusion offers peer-reviewed, unique reports on our highest-conviction, most-differentiated calls. RBC Imagine is a series of fundamental research reports focused on disruptive forces that we believe will transform the world. Our RBC Elements work features proprietary insights generated in collaboration with our internal data science team. With RBC ESG Stratify, we separate the signal from the noise on ESG matters with precise, analytical research.
Top 30 Global Ideas for 2022 — Changes this Quarter
Additions: The AES Corporation (AES US), American Tower (AMT US), Lonza Group (LONN SW), Veeva Systems (VEEV US)
Deletions: Amazon.com (AMZN US), Intuitive Surgical (ISRG US), Louisiana-Pacific (LPX US), Twilio (TWLO US)
Top 30 Global Ideas for 2022 — Pricing Data
Notes:
1 Subsequent to the July 4, 2022 pricing of the Top 30 Global Ideas for 2022, ADS’s price target was lowered to EUR 205.00 (from EUR 265.00) on July 5, 2022.
2 AltaGas Ltd. (TSX: ALA) has agreed to sell its Alaskan Utilities to TriSummit Utilities Inc. announced on May 26, 2022. RBC Capital Markets served as financial advisor to AltaGas. The transaction is anticipated to close no later than the first quarter of 2023 and will be subject to customary closing conditions, including State regulatory approvals. This research report and the information herein is not intended to provide voting advice, serve as an endorsement of the transaction or result in procurement, withholding or revocation of a proxy or any other action by a security holder.
3 This security is restricted pursuant to RBC Capital Markets policy and, as a result, its continued inclusion in the Top 30 Global Ideas list has not been reviewed or confirmed as of the date hereof.
Past performance is not necessarily indicative of future performance. Price performance does not take into account relevant costs, including commissions and interest charges or other applicable expenses that may be associated with transactions in these shares.
Top 30 Global Ideas for 2022 — Changes This Quarter
Note: Past performance is not necessarily indicative of future performance. Price performance does not take into account relevant costs, including commissions and interest charges or other applicable expenses that may be associated with transactions in these shares.
Source: Bloomberg and RBC Capital Markets
Top 30 Global Ideas — Performance Summary
Although the Top 30 is not intended to be a relative product, having been created to capture RBC Capital Markets’ best ideas on an absolute basis, we compare the performance of the Top 30 to the MSCI Developed World Index and regional indices to provide context for its returns. See the performance tables below for Q2 2022 (April 4, 2022 to July 4, 2022) and since inception (December 2019).
Notes: Q2 2022 performance calculated from the time of publishing the Top 30 Q2 2022 update before market open on April 4, 2022, to market close on July 4, 2022. Past performance is not necessarily indicative of future performance. Price performance does not take into account relevant costs, including commissions and interest charges or other applicable expenses that may be associated with transactions in these shares.
1 This security is restricted pursuant to RBC Capital Markets policy and, as a result, its continued inclusion in the Top 30 Global Ideas list has not been reviewed or confirmed as of the date hereof.
Source: Bloomberg and RBC Capital Markets
IMPORTANT DISCLOSURES FF Global Capital does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2022
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An unusual economic cycle shifts gears
What Do Rising Interest Rates Mean for Your Money?
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Although rising interest rates make it more expensive for consumers and businesses to borrow, retirees and others who seek income could benefit from higher yields on savings accounts and CDs.
What Do Rising Interest Rates Mean for Your Money?
On March 16, 2022, the Federal Open Market Committee (FOMC) of the Federal Reserve raised the benchmark federal funds rate by 0.25% to a target range of 0.25% to 0.50%. This is the beginning of a series of increases that the FOMC expects to carry out over the next two years to combat high inflation. 1
Along with announcing the current increase, the FOMC released economic projections that suggest the equivalent of six additional 0.25% increases in 2022, followed by three or four more increases in 2023.2 Keep in mind that these are only projections, based on current conditions, and may not come to pass. However, they provide a helpful picture of the potential direction of U.S. interest rates.
What is the federal funds rate?
The federal funds rate is the interest rate at which banks lend funds to each other overnight to maintain legally required reserves within the Federal Reserve System. The FOMC sets a target range, usually a 0.25% spread, and then sets two specific rates that act as a floor and a ceiling to push the funds rate into that target range. The rate may vary slightly from day to day, but it generally stays within the target range.
Although the federal funds rate is an internal rate within the Federal Reserve System, it serves as a benchmark for many short-term rates set by banks and can influence longer-term rates as well.
Why does the Fed adjust the federal funds rate?
The Federal Reserve and the FOMC operate under a dual mandate to conduct monetary policies that foster maximum employment and price stability. Adjusting the federal funds rate is the Fed’s primary tool to influence economic growth and inflation.
The FOMC lowers the federal funds rate to stimulate the economy by making it easier for businesses and consumers to borrow, and raises the rate to combat inflation by making borrowing more expensive. In March 2020, when the U.S. economy was devastated by the pandemic, the Committee quickly dropped the rate to its rock-bottom level of 0.00%–0.25% and has kept it there for two years as the economy recovered.
The FOMC has set a 2% annual inflation goal as consistent with healthy economic growth. The Committee considered it appropriate for inflation to run above 2% for some time in order to balance the extended period when it ran below 2% and give the economy more time to grow in a low-rate environment. However, the steadily increasing inflation levels over the last year — with no sign of easing — have forced the Fed to change course and tighten monetary policy.
How will consumer interest rates be affected?
The prime rate, which commercial banks charge their best customers, is tied directly to the federal funds rate and generally runs about 3% above it. Though actual rates can vary widely, small-business loans, adjustable-rate mortgages, home-equity lines of credit, auto loans, credit cards, and other forms of consumer credit are often linked to the prime rate, so the rates on these types of loans typically increase with the federal funds rate. Fed rate hikes might also put upward pressure on interest rates for new fixed-rate home mortgages, but these rates are not tied directly to the federal funds rate or the prime rate.
Although rising interest rates make it more expensive for consumers and businesses to borrow, retirees and others who seek income could eventually benefit from higher yields on savings accounts and certificates of deposit (CDs). Banks typically raise rates charged on loans more quickly than they raise rates paid on deposits, but an extended series of rate increases should filter down to savers over time.
What about bond investments?
Interest-rate changes can have a broad effect on investments, but the impact tends to be more pronounced in the short term as markets adjust to the new level.
When interest rates rise, the value of existing bonds typically falls. Put simply, investors would prefer a newer bond paying a higher interest rate than an existing bond paying a lower rate. Longer-term bonds tend to fluctuate more than those with shorter maturities because investors may be reluctant to tie up their money for an extended period if they anticipate higher yields in the future.
Bonds redeemed prior to maturity may be worth more or less than their original value, but when a bond is held to maturity, the bond owner would receive the face value and interest, unless the issuer defaults. Thus, rising interest rates should not affect the return on a bond you hold to maturity, but may affect the price of a bond you want to sell on the secondary market before it reaches maturity.
Although the rising-rate environment may have a negative impact on bonds you currently hold and want to sell, it might also offer more appealing rates for future bond purchases.
Bond funds are subject to the same inflation, interest rate, and credit risks associated with their underlying bonds. Thus, falling bond values due to rising rates can adversely affect a bond fund’s performance. However, as underlying bonds mature and are replaced by higher-yielding bonds within a rising interest-rate environment, the fund’s yield and/or share value could potentially increase over the long term.
When interest rates rise, the value of existing bonds typically falls. Put simply, investors would prefer a newer bond paying a higher interest rate than an existing bond paying a lower rate. Longer-term bonds tend to fluctuate more than those with shorter maturities because investors may be reluctant to tie up their money for an extended period if they anticipate higher yields in the future.
Bonds redeemed prior to maturity may be worth more or less than their original value, but when a bond is held to maturity, the bond owner would receive the face value and interest, unless the issuer defaults. Thus, rising interest rates should not affect the return on a bond you hold to maturity, but may affect the price of a bond you want to sell on the secondary market before it reaches maturity.
Although the rising-rate environment may have a negative impact on bonds you currently hold and want to sell, it might also offer more appealing rates for future bond purchases.
Bond funds are subject to the same inflation, interest rate, and credit risks associated with their underlying bonds. Thus, falling bond values due to rising rates can adversely affect a bond fund’s performance. However, as underlying bonds mature and are replaced by higher-yielding bonds within a rising interest-rate environment, the fund’s yield and/or share value could potentially increase over the long term.
How will the stock market react?
Equities may also be affected by rising rates, though not as directly as bonds. Stock prices are closely tied to earnings growth, so many corporations stand to benefit from a more robust economy, even with higher interest rates. On the other hand, companies that rely on heavy borrowing will likely face higher costs going forward, which could affect their bottom lines.
The stock market reacted positively to the initial rate hike and the projected path forward, but investors will be watching closely to see how the economy performs as interest rates adjust — and whether the increases are working to tame inflation.3
The market may continue to react, positively or negatively, to the government’s inflation reports or the Fed’s interest-rate decisions, but any reaction is typically temporary. As always, it’s important to maintain a long-term perspective and make sound investment decisions based on your own financial goals, time horizon, and risk tolerance.
The FDIC insures CDs and bank savings accounts, which generally provide a fixed rate of return, up to $250,000 per depositor, per insured institution. The return and principal value of stocks and investment funds fluctuate with market conditions. Shares, when sold, may be worth more or less than their original cost. Investments offering the potential for higher rates of return also involve higher risk.
Investment funds are sold by prospectus. Please consider the fund’s objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
The stock market reacted positively to the initial rate hike and the projected path forward, but investors will be watching closely to see how the economy performs as interest rates adjust — and whether the increases are working to tame inflation.3
The market may continue to react, positively or negatively, to the government’s inflation reports or the Fed’s interest-rate decisions, but any reaction is typically temporary. As always, it’s important to maintain a long-term perspective and make sound investment decisions based on your own financial goals, time horizon, and risk tolerance.
The FDIC insures CDs and bank savings accounts, which generally provide a fixed rate of return, up to $250,000 per depositor, per insured institution. The return and principal value of stocks and investment funds fluctuate with market conditions. Shares, when sold, may be worth more or less than their original cost. Investments offering the potential for higher rates of return also involve higher risk.
Investment funds are sold by prospectus. Please consider the fund’s objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
1–2) Federal Reserve, March 16, 2022
3) The Wall Street Journal, March 17, 2022
IMPORTANT DISCLOSURES FF Global Capital does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2022
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A different kind of inflationary environment
The RBC Macroscope
Managing Bond Risks When Interest Rates Rise
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Managing bond risks when interest rates rise
After dropping the benchmark federal funds rate to a rock-bottom range of 0%–0.25% early in the pandemic, the Federal Open Market Committee has begun raising the rate toward more typical historical levels in response to high inflation. At its March 2022 meeting, the Committee raised the funds rate to 0.25%–0.50% and projected the equivalent of six more quarter-percentage-point increases in 2022 and three or four more in 2023.1
Raising the federal funds rate places upward pressure on a wide range of interest rates, including the cost of borrowing through bond issues. Regardless of the rate environment, however, bonds are a mainstay for investors who want to generate income or dampen the effects of stock market volatility on their portfolios. You may have questions about how higher rates could affect your fixed-income investments and what you can do to help mitigate the effect in your portfolio.
Raising the federal funds rate places upward pressure on a wide range of interest rates, including the cost of borrowing through bond issues. Regardless of the rate environment, however, bonds are a mainstay for investors who want to generate income or dampen the effects of stock market volatility on their portfolios. You may have questions about how higher rates could affect your fixed-income investments and what you can do to help mitigate the effect in your portfolio.
Rate sensitivity
When interest rates rise, the value of existing bonds typically falls, because investors would prefer to buy new bonds with higher yields. In a rising rate environment, investors may be hesitant to tie up funds for a long period, so bonds with longer maturity dates are generally more sensitive to rate changes than shorter-dated bonds. Thus, one way to address interest-rate sensitivity in your portfolio is to hold short- and medium-term bonds. However, keep in mind that although these bonds may be less sensitive to rate changes, they will generally offer a lower yield than longer-term bonds.
A more specific measure of interest-rate sensitivity is called duration. A bond’s duration is derived from a complex calculation that includes the maturity date, the present value of principal and interest to be received in the future, and other factors. To estimate the impact of a rate change on a bond investment, multiply the duration by the expected percentage change in interest rates. For example, if interest rates rise by 1%, a bond or bond fund with a three-year duration might be expected to lose roughly 3% in value; one with a seven-year duration might fall by about 7%. Your investment professional or brokerage firm can provide information about the duration of your bond investments.
If two bonds have the same maturity, the bond with the higher yield will typically have a shorter duration. For this reason, U.S. Treasuries tend to be more rate sensitive than corporate bonds of similar maturities. Treasury securities, which are backed by the federal government as to the timely payment of principal and interest, are considered lower risk and thus can pay lower rates of interest than corporate bonds. A five-year Treasury bond has a duration of less than five years, reflecting income payments received prior to maturity. However, a five-year corporate bond with a higher yield has an even shorter duration.
When a bond is held to maturity, the bond owner would receive the face value and interest, unless the issuer defaults. However, bonds redeemed prior to maturity may be worth more or less than their original value. Thus, rising interest rates should not affect the return on a bond you hold to maturity, but may affect the price of a bond you want to sell on the secondary market before it reaches maturity.
A more specific measure of interest-rate sensitivity is called duration. A bond’s duration is derived from a complex calculation that includes the maturity date, the present value of principal and interest to be received in the future, and other factors. To estimate the impact of a rate change on a bond investment, multiply the duration by the expected percentage change in interest rates. For example, if interest rates rise by 1%, a bond or bond fund with a three-year duration might be expected to lose roughly 3% in value; one with a seven-year duration might fall by about 7%. Your investment professional or brokerage firm can provide information about the duration of your bond investments.
If two bonds have the same maturity, the bond with the higher yield will typically have a shorter duration. For this reason, U.S. Treasuries tend to be more rate sensitive than corporate bonds of similar maturities. Treasury securities, which are backed by the federal government as to the timely payment of principal and interest, are considered lower risk and thus can pay lower rates of interest than corporate bonds. A five-year Treasury bond has a duration of less than five years, reflecting income payments received prior to maturity. However, a five-year corporate bond with a higher yield has an even shorter duration.
When a bond is held to maturity, the bond owner would receive the face value and interest, unless the issuer defaults. However, bonds redeemed prior to maturity may be worth more or less than their original value. Thus, rising interest rates should not affect the return on a bond you hold to maturity, but may affect the price of a bond you want to sell on the secondary market before it reaches maturity.
Bond ladders
Owning a diversified mix of bond types and maturities can help reduce the level of risk in the fixed-income portion of your portfolio. One structured way to take this risk management approach is to construct a bond ladder, a portfolio of bonds with maturities that are spaced at regular intervals over a certain number of years. For example, a five-year ladder might have 20% of the bonds mature each year.
Bond ladders may vary in size and structure, and could include different types of bonds depending on an investor’s time horizon, risk tolerance, and goals. As bonds in the lowest rung of the ladder mature, the funds are often reinvested at the long end of the ladder. By doing so, investors may be able to increase their cash flow by capturing higher yields on new issues. A ladder might also be part of a withdrawal strategy in which the returned principal from maturing bonds provides retirement income. In the current situation, with rates projected to rise over a two- to three-year period, it might make sense to create a short bond ladder now and a longer ladder when rates appear to have stabilized. Keep in mind that the anticipated path of the federal funds rate is only a projection, based on current conditions, and may not come to pass. The actual direction of interest rates might change.
Bond ladders may vary in size and structure, and could include different types of bonds depending on an investor’s time horizon, risk tolerance, and goals. As bonds in the lowest rung of the ladder mature, the funds are often reinvested at the long end of the ladder. By doing so, investors may be able to increase their cash flow by capturing higher yields on new issues. A ladder might also be part of a withdrawal strategy in which the returned principal from maturing bonds provides retirement income. In the current situation, with rates projected to rise over a two- to three-year period, it might make sense to create a short bond ladder now and a longer ladder when rates appear to have stabilized. Keep in mind that the anticipated path of the federal funds rate is only a projection, based on current conditions, and may not come to pass. The actual direction of interest rates might change.
Laddering ETFs and UITs
Building a ladder with individual bonds provides certainty as long as the bonds are held to maturity, but it can be expensive. Individual bonds typically require a minimum purchase of at least $5,000 in face value, so creating a diversified bond ladder might require a sizable investment. Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss.
A similar approach involves laddering bond exchange-traded funds (ETFs) that have defined maturity dates. These funds, typically called target-maturity funds, generally hold many bonds that mature in the same year the ETF will liquidate and return assets to shareholders. Target maturity ETFs may enhance diversification and provide liquidity, but unlike individual bonds, the income payments and final distribution rate are not fully predictable.
Another option is to purchase unit investment trusts (UITs) with staggered termination dates. Bond-based UITs typically hold a varied portfolio of bonds with maturity dates that coincide with the trust termination date, at which point you could reinvest the proceeds as you wish. The UIT sponsor may offer investors the opportunity to roll over the proceeds to a new UIT, which typically incurs an additional sales charge.
Bond funds
Bond funds — mutual funds and ETFs composed mostly of bonds and other debt instruments — are subject to the same inflation, interest rate, and credit risks associated with their underlying bonds. Thus, falling bond prices due to rising rates can adversely affect a bond fund’s performance. Because longer-term bonds are generally more sensitive to rising rates, funds that hold short- or medium-term bonds may be more stable as rates increase.
Bond funds do not have set maturity dates (with the exception of the target maturity ETFs discussed above), because they typically hold bonds with varying maturities, and they can buy and sell bonds before they mature. So you might consider the fund’s duration, which takes into account the durations of the underlying bonds. The longer the duration, the more sensitive a fund is to changes in interest rates. You can usually find duration with other information about a bond fund. Although helpful as a general guideline, duration is best used when comparing funds with similar types of underlying bonds.
A fund’s sensitivity to interest rates is only one aspect of its value — fund performance can be driven by a variety of dynamics in the market and the broader economy. Moreover, as underlying bonds mature and are replaced by higher-yielding bonds in a rising interest rate environment, the fund’s yield and/or share value could potentially increase over the long term. Even in the short term, interest paid by the fund could help moderate any losses in share value.
It’s also important to remember that fund managers might respond differently if falling bond prices adversely affect a fund’s performance. Some might try to preserve the fund’s asset value at the expense of its yield by reducing interest payments. Others might emphasize preserving a fund’s yield at the expense of its asset value by investing in bonds of longer duration or lower credit quality that pay higher interest but carry greater risk. Information on a fund’s management, objectives, and flexibility in meeting those objectives is spelled out in the prospectus and also may be available with other fund information online.
The return and principal value of individual bonds, UIT units, and mutual fund and ETF shares fluctuate with changes in market conditions. Fund shares and UIT units, when sold, and bonds redeemed prior to maturity may be worth more or less than their original cost. ETFs typically have lower expense ratios than mutual funds, but you may pay a brokerage commission whenever you buy or sell ETFs, so your overall costs could be higher, especially if you trade frequently. Supply and demand for ETF shares may cause them to trade at a premium or a discount relative to the value of the underlying shares. UITs may carry additional risks, including the potential for a downturn in the financial condition of the issuers of the underlying securities. There may be tax consequences associated with the termination of the UIT and rolling over an investment into a successive UIT. There is no assurance that working with a financial professional will improve investment results.
Bond funds do not have set maturity dates (with the exception of the target maturity ETFs discussed above), because they typically hold bonds with varying maturities, and they can buy and sell bonds before they mature. So you might consider the fund’s duration, which takes into account the durations of the underlying bonds. The longer the duration, the more sensitive a fund is to changes in interest rates. You can usually find duration with other information about a bond fund. Although helpful as a general guideline, duration is best used when comparing funds with similar types of underlying bonds.
A fund’s sensitivity to interest rates is only one aspect of its value — fund performance can be driven by a variety of dynamics in the market and the broader economy. Moreover, as underlying bonds mature and are replaced by higher-yielding bonds in a rising interest rate environment, the fund’s yield and/or share value could potentially increase over the long term. Even in the short term, interest paid by the fund could help moderate any losses in share value.
It’s also important to remember that fund managers might respond differently if falling bond prices adversely affect a fund’s performance. Some might try to preserve the fund’s asset value at the expense of its yield by reducing interest payments. Others might emphasize preserving a fund’s yield at the expense of its asset value by investing in bonds of longer duration or lower credit quality that pay higher interest but carry greater risk. Information on a fund’s management, objectives, and flexibility in meeting those objectives is spelled out in the prospectus and also may be available with other fund information online.
The return and principal value of individual bonds, UIT units, and mutual fund and ETF shares fluctuate with changes in market conditions. Fund shares and UIT units, when sold, and bonds redeemed prior to maturity may be worth more or less than their original cost. ETFs typically have lower expense ratios than mutual funds, but you may pay a brokerage commission whenever you buy or sell ETFs, so your overall costs could be higher, especially if you trade frequently. Supply and demand for ETF shares may cause them to trade at a premium or a discount relative to the value of the underlying shares. UITs may carry additional risks, including the potential for a downturn in the financial condition of the issuers of the underlying securities. There may be tax consequences associated with the termination of the UIT and rolling over an investment into a successive UIT. There is no assurance that working with a financial professional will improve investment results.
1) Federal Reserve, March 16, 2022
IMPORTANT DISCLOSURES FF Global Capital does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2022
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Special Report: Spheres of influence
Handling Market Volatility
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Handling market volatility
Conventional wisdom says that what goes up must come down. But even if you view market volatility as a normal occurrence, it can be tough to handle when your money is at stake. Though there’s no foolproof way to handle the ups and downs of the stock market, the following common-sense tips can help.
Don't put your eggs all in one basket
Diversifying your investment portfolio is one of the key tools for trying to manage market volatility. Because asset classes often perform differently under different market conditions, spreading your assets across a variety of investments such as stocks, bonds, and cash alternatives has the potential to help reduce your overall risk. Ideally, a decline in one type of asset will be balanced out by a gain in another, though diversification can’t eliminate the possibility of market loss.
One way to diversify your portfolio is through asset allocation. Asset allocation involves identifying the asset classes that are appropriate for you and allocating a certain percentage of your investment dollars to each class (e.g., 70% to stocks, 20% to bonds, 10% to cash alternatives). A worksheet or an interactive tool may suggest a model or sample allocation based on your investment objectives, risk tolerance level, and investment time horizon, but that shouldn’t be a substitute for expert advice.
Focus on the forest, not on the trees
As the market goes up and down, it’s easy to become too focused on day-to-day returns. Instead, keep your eyes on your long-term investing goals and your overall portfolio. Although only you can decide how much investment risk you can handle, if you still have years to invest, don’t overestimate the effect of
short-term price fluctuations on your portfolio.
Look before you leap
When the market goes down and investment losses pile up, you may be tempted to pull out of the stock market altogether and look for less volatile investments. The modest returns that typically accompany low-risk investments may seem attractive when more risky investments are posting negative returns.
But before you leap into a different investment strategy, make sure you’re doing it for the right reasons. How you choose to invest your money should be consistent with your goals and time horizon.
For instance, putting a larger percentage of your investment dollars into vehicles that offer asset preservation and liquidity (the opportunity to easily access your funds) may be the right strategy for you if your investment goals are short term and you’ll need the money soon, or if you’re growing close to reaching a long-term goal such as retirement. But if you still have years to invest, keep in mind that stocks have historically outperformed stable-value investments over time, although past performance is no guarantee of future results. If you move most or all of your investment dollars into conservative investments, you’ve not only locked in any losses you might have, but you’ve also sacrificed the potential for higher returns. Investments seeking to achieve higher rates of return also involve a higher degree of risk.
Look for the silver lining
A down market, like every cloud, has a silver lining. The silver lining of a down market is the opportunity to buy shares of stock at lower prices.
One of the ways you can do this is by using
dollar-cost averaging. With dollar-cost averaging, you don’t try to “time the market” by buying shares at the moment when the price is lowest. In fact, you don’t worry about price at all. Instead, you invest a specific amount of money at regular intervals over time. When the price is higher, your investment dollars buy fewer shares of an investment, but when the price is lower, the same dollar amount will buy you more shares. A workplace savings plan, such as a 401(k) plan in which the same amount is deducted from each paycheck and invested through the plan, is one of the
The right approach during all kinds of markets is to be realistic. Have a plan, stick with it, and strike a comfortable balance between risk and return.
most well-known examples of dollar-cost averaging in action.
For example, let’s say that you decided to invest $300 each month. As the illustration shows, your regular monthly investment of $300 bought more shares when the price was low and fewer shares when the price was high:
Although dollar-cost averaging can’t guarantee you a profit or avoid a loss, a regular fixed dollar investment may result in a lower average price per share over time, assuming you continue to invest through all types of market conditions.
(This hypothetical example is for illustrative purposes only and does not represent the performance of any particular investment. Actual results will vary.)
Making dollar-cost averaging work for you
• Get started as soon as possible. The longer you have to ride out the ups and downs of the market, the more opportunity you have to build a sizable investment account over time.
• Stick with it. Dollar-cost averaging is a long-term investment strategy. Make sure you have the financial resources and the discipline to invest continuously through all types of market conditions, regardless of price fluctuations.
• Take advantage of automatic deductions. Having your investment contributions deducted and invested automatically makes the process easy and convenient.
• Stick with it. Dollar-cost averaging is a long-term investment strategy. Make sure you have the financial resources and the discipline to invest continuously through all types of market conditions, regardless of price fluctuations.
• Take advantage of automatic deductions. Having your investment contributions deducted and invested automatically makes the process easy and convenient.
Don't stick your head in the sand
While focusing too much on short-term gains or losses is unwise, so is ignoring your investments. You should check your portfolio at least once a year — more frequently if the market is particularly volatile or when there have been significant changes in your life.
You may need to rebalance your portfolio to bring it back in line with your investment goals and risk tolerance. Rebalancing involves selling some investments in order to buy others. Investors should keep in mind that selling investments could result in a tax liability. Don’t hesitate to get expert help if you need it to decide which investment options are right for you.
Don't count your chickens before they hatch
As the market recovers from a down cycle, elation quickly sets in. If the upswing lasts long enough, it’s easy to believe that investing in the stock market is a sure thing. But, of course, it never is. As many investors have learned the hard way, becoming overly optimistic about investing during the good times can be as detrimental as worrying too much during the bad times. The right approach during all kinds of markets is to be realistic. Have a plan, stick with it, and strike a comfortable balance between risk and return.
IMPORTANT DISCLOSURES FF Global Capital does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2022
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