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Manage Risk Efficiently for Retirees

BMO Retirement Portfolios offer a hassle-free solution to give retirees what they need: growth potential, smoother returns, and more capital protection.

October 2021

Photo of Mark Raes

Mark Raes

MD, Head of Products, BMO Global Asset Management

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Key Takeaways

  • Canadian inflation hits 4.4% in September as gas prices rise
  • Holding equities as dividends increase over time is a hedge against inflation concerns
  • Reduce portfolio volatility with lower risk equities and payoff strategies
  • Optimize fixed income with shorter duration and more credit

With recent market volatility and looming inflation causing concern for retirees, the importance of protecting investments while leaving room for growth is a challenge for Advisors.

Most Funds in the marketplace are designed as long-term accumulation strategies. BMO Retirement Portfolios stand out from the crowd by solving for decumulation needs for Advisors looking to keep money working with a reduced risk budget.

1. We’re told inflation will be “transitory,” but that could be three months or three years. What does the economic data suggest to you?

MR Traditional measures of inflation have been high in 2021, but that’s to be expected given the global pandemic. When people say “transitory,” they believe supply will catch up with demand now that vaccines have been rolled out. What we are experiencing, however, are persistent supply chain disruptions caused primarily by displaced workers. Another reason to expect that inflation might be lasting is that the U.S. Federal Reserve said it would target rather than contain inflation at 2%, which means they expect it to go over. This was a pretty strong signal to the marketplace. With Canadian inflation at 4.4% this month, we are seeing signs of inflation in our personal lives – for example, anyone who has filled up their gas tank or been to the grocery store recently will have noticed higher prices.

If higher inflation proves to be persistent, it will be a cause for concern for Advisors who own fixed income-focused balanced funds or traditional bond funds. Remember, real returns are calculated as coupon rates minus inflation, which means long-term inflation could erode the future value of your coupon payments. BMO Retirement Portfolios seek to actively protect capital by using risk reduction sleeves on both the equity and (especially important, in this case) fixed income sides.

2. How do the BMO Retirement Portfolios help manage risks in a rising rate environment?

MR The easiest way to deal with inflation is by having equity exposure in your book. In a period of reasonable inflation – not runaway inflation – the stock market actually does quite well. This is because low to moderate inflation implies an expanding economy, where corporate balance sheets, earnings and cash flow are doing well. Given that companies tend to increase dividends when earnings are growing, equities offer income-oriented investors inflation protection relative to bonds. Think about it this way: the more your clients worry about inflation, the less attractive fixed income looks relative to equities to those investors. BMO Retirement Portfolios include lower-risk equities, through vehicles such as low volatility and quality ETFs, which means you won’t be exposed to full market volatility.

We also use the fixed income risk reduction sleeve for shorter duration and more credit exposure compared to a full market bond fund. This gives the portfolios some protection from inflation on the bond side. Of course, the flipside is we don’t want to leave the fund vulnerable to rising interest rates – the trick is finding a balance between short and long duration. If you think the Fed will be hawkish next year and move to flatten the yield curve, you perhaps want less short duration. On the other hand, if your concern is inflation, rising rates and a steepening curve, then this fixed income sleeve really helps manage downside risk. That said, the fund also adds some risk by going further into the credit universe and allocating 30% to BBB bonds. The extra yield from corporate bonds helps to mitigate the impact of rising interest rates. We have found this is a sweet spot in fixed income, because there are higher yields that exist within the investment grade space; you don’t have to sacrifice too much quality to get those yields.

3. What are the advantages of a plug-and-play retirement solution?

MR Think of all the bells and whistles that are under the hood. Rebalancing is an obvious one, as is the option activity used within the equity risk reduction sleeve, where we sell excess upside to fund protection against market downturns. An Advisor could execute all the trades themselves, but Advisors are better off focusing on their clients rather than resetting options. Cost is another factor; it can be expensive to build a globally diversified portfolio with derivative protection through individual trades. Instead, you can get one-ticket access to domestic, U.S., International and Emerging Markets, with the ideal series and purchase options for Canadian retirees.

4. How do the portfolios balance the dual goals of downside protection and income generation?

MR Our Retirement Portfolios come in three different versions – Balanced, Income and Conservative – to help align with a client’s specific risk profile. You can choose the solution that is a better fit with their needs, in terms of how much growth they need from the portfolio. That’s the first win. Second, you are not getting full market exposure within any of the three sleeves mentioned above. This might be a comfort to retired clients who are drawing down their portfolios, and are concerned about shrinking their capital base. The era when retirees could fund their expenses by simply buying a 10-year bond and collecting the coupon is gone. It’s no longer feasible unless they want to earn 1% or 2% before tax, so there has to be some focus on income and growth. I should add that the portfolios are designed to stand alone, but an Advisor can add satellite positions to tilt the overall exposure using individual securities, ETFs or other funds.

5. Mark, one last question. We like to end by asking for book recommendations that have shaped the way you think. What would you suggest for our Advisor audience?

MR A business book that grabbed my attention was Billion Dollar Whale by Tom Wright and Bradley Hope. It’s a really good read on how the financial system was fooled by one rogue investor. My general interest pick, however, is Talking to Strangers by Malcolm Gladwell. It is a captivating look at how our personal perceptions of others are formed, and what we can do to overcome our unconscious assumptions.

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BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.

Commissions, trailing commissions (if applicable), management fees and expenses all may be associated with mutual fund investments. Please read the ETF facts, fund facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

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