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Debt Vs. Equity Investing

26 May 2020

When it comes to value-creation, alternative investments have unique advantages over traditional assets. Their ability to generate positive returns throughout the economic cycle–and insulate against general market panics–have made alternatives a staple of many investment portfolios.

The coronavirus crisis has created valuation challenges across many segments of the investment universe. More and more, fund managers and individual investors are pivoting to alternatives to mitigate risk and reduce overall portfolio drawdown. Now that coronavirus has derailed the longest bull market in history, a basic portfolio anchored by traditional stock and bond exposure is no longer sufficient.

Within alternative investments, debt instruments such as bonds, mortgages, and fixed payments are among the least risky. These assets are bought and sold in the debt market, which is independent of physical exchanges. In this market, transactions are usually made between brokers and institutions, as well as individual investors. Equity markets, on the other hand, are where individual stocks are bought and sold. These securities represent ownership in a publicly-traded company. Some of the most prominent equity exchanges include the New York Stock Exchange, London Stock Exchange, and Toronto Stock Exchange.

When compared to equities, debt investments offer consistent returns, less volatility, and more predictability over time. The trade-off for this relative stability is a lower potential return on investment.

When investors purchase equities, they are assuming more risk for the opportunity to earn higher returns. Investors who bought near the floor of the 2008 financial crisis earned more than 300% over 12 years if we use the S&P 500 Index as a benchmark. But in an environment of political and economic instability–like the one we are experiencing now–appetite for risk diminishes as capital preservation and predictability become paramount.

There’s strong reason to believe that the pivot away from equities will continue as investors reassess their risk profiles. When you factor a generational recession, a double-digit percentage decline in earnings, and the resumption of trade hostilities, risk assets are less attractive today than they were even a year ago.

But compensating with a debt-investment strategy isn’t as easy as it sounds. Bond yields are at historic lows and could decline even further as central banks continue to slash interest rates and experiment with unconventional monetary policy. Imagine buying a 10-year U.S. Treasury bond with a yield of 0.5%–something that would have seemed unthinkable years ago, came to fruition early in March as demand for government bonds surged amid the corona-crisis.

Rather than invest in low-yielding government and corporate bonds, many investors are seeking both direct and indirect exposure to real estate as an alternative to traditional bond investments in the search for yield. This includes investing in residential mortgages that provide the stability of debt-instruments with the added liquidity and growth of equities. Mortgage Investment Corporations (MICs) that pool capital from private investors and use it to invest in private mortgages are one such vehicle.

Mortgage markets have not been immune to the coronavirus crisis, but the strength and stability of the Canadian landscape suggest this segment will be one of the first to rebound post-pandemic. According to the 2019 State of the Mortgage Market report, Canadians are prudent with their spending habits on real estate and continue to see homeownership as an important element in their long-term financial success.

There’s never been a better time to explore Canada’s residential real estate market. Visit Canadian Lending to speak to an advisor and learn about investing in one of the world’s most lucrative mortgage markets.

Debt Vs. Equity Investing

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