Don’t sweat the small stuff

Investors need to learn to live with short-term shocks and accept that they will have little impact on the long-term performance of a diversified portfolio, according to the manager of the country’s largest bond fund.

“The North American economy, and the Canadian economy in particular, are much more stable that you perceive,” says Satish Rai, lead manager of the $6.3 billion TD Canadian Bond Fund, speaking at TD Mutual Funds’ annual advisor summit in Markham, Ontario.

While many investors expect the Canadian dollar to eventually correct and trade lower, Rai says the 85 cent loonie is in the middle of its long-term historical trading range.

Based on purchasing power, he says the dollar is fairly valued, considering the many strengths of Canada’s economy: low inflation; budgetary and trade surpluses; and a massive store of the commodities the world needs to fuel economic expansion. All of which makes Canada more resilient during tougher economic times.

Even the U.S., with its much talked about twin deficits and reliance on imported energy has proven to be flexible in the long run.

“Think of all the stuff that has happened in the past 10 years,” Rai says. “We had September 11, Long Term Capital, the tech meltdown, we had all these problems, yet the volatility in the U.S. economy was only 2%.”

Too many investors pay too close attention to minutiae, he says, resulting in irrational decisions that can harm long-term performance. Monthly fluctuations in consumer sentiment, for example, regularly make the headlines, but have little bearing on the overall economy.

Even the more major events are open to interpretation. This week’s rate hikes from the Bank of Canada, for example, are actually a good thing he says, as they indicate that the Bank of Canada is serious about maintaining its target inflation rate of between 1% and 3%.

“If you’re the captain of a ship, and you see an iceberg coming, you want to change course,” Rai says. “That’s why Governor Dodge raised rates the other day. To be honest, I think that’s a great thing, not a bad thing. The more he raises rates, the more confidence I have that he’s plotting a course around those icebergs.”

Currently, the U.S. is the only major industrialized state without an official inflation target, though Alan Greenspan has indicated that the Fed will not tolerate excessive inflation.

“Interest rates are very low today in Canada and the United States — they’re basically around 4% at the short end, the 10-years and for the long term,” says Satish Rai. “Just because they’re low today, it doesn’t mean they’re going up.”

He points to the highs of the early 1980s as the true anomaly, not today’s low interest rates. Even if nominal rates rise, yields are likely to remain tame thanks to the surging demand aging baby-boomers compete with pension funds for issues with higher guaranteed returns.

“For the next five or 10 years, the real rate environment will be much lower than it has been in the past 20 years,” Rai says. “I’m not saying it will go down, but we don’t see an environment where there will be a secular move up in rates.”

Over the past decade, fixed income investors have become accustomed to returns between 8% and 10%. Rai says such expectations are unrealistic and that clients need to adjust their thinking.

“For those customers looking for higher rates of return, they’re going to have to go up the risk curve,” he says. “They’re going to have to accept the additional downside, to get the upside that they want.”