Bonds have been a staple of modern investment portfolios for many decades. Because of their defensive nature and income-producing capabilities, wealth advisors recommend that investors allocate a portion of their capital to bonds. However, the rise of alternative investments has given investors more options in meeting these goals — without the interest-rate risk, price volatility and duration mismatch that often comes with bonds. In this article, we will explore the viability of mortgages as an alternative to traditional bonds in the context of Canada’s economic landscape in 2024 and beyond.
Year after year, alternative investments are among the top investment themes under consideration by the wealth management industry. According to a recent survey from The Journal of Financial Planning, nearly 30% of investment professionals are actively searching for or already investing in alternative investments on behalf of their clients.
The data certainly bears this out. Globally, the value of alternative assets under management eclipsed $13.3 trillion in 2021 and is forecast to reach $23.2 trillion by 2026, according to Preqin. The category under real estate, which includes mortgages, is among the fastest-growing segments of alternatives.
As the name implies, alternative investments are a broad category of financial assets outside of stocks, bonds, and cash. They include real estate, mortgages, private equity, hedge funds, commodities, and tangible assets. Looking ahead to 2024, alternatives have garnered the most interest among private equity investors.
Historically, mortgage investment opportunities were the exclusive domain of institutions and high-net-worth individuals. Technological innovations and the growth of non-bank financial services providers – driven by demand for alternative financing solutions – have opened mortgage investing to a wider audience of institutional and retail investors.
Much like in previous years, investors in 2024 are looking to alternatives to help lower volatility, increase returns, and broaden their portfolio diversification. As the collapse of Silicon Valley Bank (SVB) in 2023 demonstrated, investors are also increasingly sensitive to interest rate risk in the bond market. In the case of SVB, the bank failed to match the duration of loans with the duration of assets, which eventually led to its downfall. While this was an extreme case, interest rate volatility is expected to persist as central banks shift their focus from fighting inflation to stabilizing the economy.
Following a challenging macro backdrop over the past two years, 2024 brings its own set of risks and challenges. For many investors, alternatives will help them through the volatility.
Key Trends for 2024
While central banks have largely succeeded in cooling inflation, 2024 is expected to be a challenging year for economic growth. According to the International Monetary Fund, growth in advanced economies will weaken slightly this year. U.S. gross domestic product (GDP) is forecast to grow a meager 1.5% this year. In Canada, growth is forecast to be even weaker at 1.4%.
Against this backdrop, markets are increasingly forecasting multiple interest rate cuts, as central banks look to avoid a recession. In the U.S., the Federal Reserve has penciled in three rate cuts this calendar year. However, major banks think steeper cuts are on the table, with UBS forecasting a 275 basis-point cut and ING calling for a 150 basis-point reduction.
Meanwhile, the Bank of Canada is expected to cut rates by a full percentage point this year, according to Capital Markets.
According to economists, central banks will have leeway to reduce interest rates because inflation has moderated from its multi-decade highs. However, headline inflation in the United States and Canada remains well above central bank targets, largely due to persistently high rent, housing, and mortgage servicing costs.
The North American housing market is expected to improve this year, as lower interest rates boost mortgage affordability. The U.S. is coming off its worst year for home sales in nearly three decades, while Canada posted its lowest annual sales activity since 2008. Canada arguably faces more interest rate volatility, as 80% of all mortgages that were outstanding in March 2022 are up for renewal this year. According to the Bank of Canada, monthly mortgage payments will rise by as much as 54% for some borrowers by 2027.
Across North America, the major sticking point for the housing sector will be supply. In the U.S. and Canada, housing supply remains at critically low levels, which has put upward pressure on prices even as demand weakened.
Benefits of Alternative Investing
Despite facing a challenging environment, investors can greatly benefit from alternative investments that have a low correlation to traditional markets. As JP Morgan market strategist Meera Pandit notes, “Alternatives can provide alpha, income, and diversification, but not necessarily all in one asset.”
Exposure to real estate — whether through direct ownership or indirectly via private mortgages — can provide income and diversification. However, given the current conditions in the housing sector, mortgages provide a distinct advantage in 2024. Working with borrowers who need mortgage financing and have a solid track record of making payments seems like a better value proposition than buying property, financing it at higher rates, and renting it out to tenants in today’s market.
Owning real estate carries high overhead expenses, such as insurance, mortgage payments, and utilities, and requires more hands-on involvement, including tenant management. On the other hand, mortgage investing provides a potentially higher source of income without additional costs or liquidity constraints. Mortgage investing provides direct cash flow and the ability to earn regular dividends. That means you don’t have to wait for a property to appreciate in value before making meaningful returns. Historically, the top-performing mortgage portfolios generate between 6% and 16% in net annual returns. Also, with the right provider, mortgage investing can be completely hands-free.
Alternatives — Not an Either/Or
Alternative investments, such as mortgages, are a way to supplement traditional portfolios comprised of stocks and bonds. Although traditional portfolio construction methods, such as the 60/40 strategy, have come under attack in recent years, alternatives are not an either/or proposition. Investors can still pursue traditional investments — alternatives merely provide another avenue of growth and diversification, especially when traditional markets underperform. Alternatives are a dynamic segment of the financial markets, so it’s important to stay informed and adaptable to market changes. At CMI Financial Group, we’ve spent the better part of two decades growing our private mortgage portfolio and providing investors with high-quality alternative investment opportunities. We’re one of Canada’s fastest-growing non-bank financial services providers, with more than $2.5 billion in successful mortgage placements. To learn more about our alternative investment opportunities and to get started with private mortgage investing, contact us today to schedule a free consultation.