GIC or bond fund: How do you choose the best investment for your money?

Ashleay: Hello and welcome to the “In Your Interest!” podcast. My name is Ashleay and I'm, as usual, with my colleague Sébastien Mc Mahon, chief strategist. And this week's guest is Hugo Noury, Director and Associate Portfolio Manager for Fixed Income. And we'll be talking about GICs and bond funds. So hi, gentlemen!

Hugo: Hi, guys!

Sébastien: Hello Hugo! Before we get started, what's a GIC?

Hugo: A GIC is a type of investment, I'd say, that is offered by financial institutions. It guarantees you a return and, generally speaking, it's for a determined period.

Sébastien: So, GIC stands for guaranteed investment certificate.

Hugo: Exactly.

Sébastien: Okay. So, you're a manager in fixed income. And, you know, when people think about fixed income, they tend to confuse, to put everything together like GICs and bond funds and all of these together. Those are very different beasts. So, you'll be here to maybe try to make some sense of all of these products.

Ashleay: And maybe you can start by explaining exactly what it is you do. What's your role?

Hugo: Yeah, with pleasure. So maybe just a quick reminder that Alexander Morin was on this podcast a few months ago, and he talked a lot with you guys about what bond portfolio managers do in their day. So maybe just to go back to what the team is: we are a team of active management for bond funds, here at iA Global Asset Management. And the main task I do would be security analysis, critical assessments of portfolio positioning, and the main part of my job is idea generation. And to create these ideas we need to analyze a lot of stuff but create transaction to put them into the portfolios.

Sébastien: So the daily management of a bond fund is what you do. And maybe just before we dig into the differences between a GIC and a bond fund. So, a GIC, as you said, it's a type of investment that's offered by financial institutions. You deposit a sum of money for a determined period, and there's a rate of return that's guaranteed and known at the beginning by the financial institution. Now, a bond fund…

Hugo: Yeah, a bond fund, I'd say, it's a type of investment that invests mainly in bonds. And for those who are a bit less knowledgeable about bonds, a bond is a debt security that is issued by either government, municipalities, or companies to finance their activities. And when you buy a bond, you are essentially lending money to the issuer in exchange for a periodic interest rate payment and the repayment of the initial loan at maturity.

Sébastien: Okay, so that's one thing that's important for people to understand. When you look at the government deficit and the debt of a government, you say: “Who owns that debt?” Well, it's you, I, everyone's pension funds. There are bonds in there – I was talking about the diversification equities and bonds – well, the bonds are, for the most part, are governments’?

Hugo: Governments are the most part because of the size of it.

Sébastien: Yeah.

Hugo: But after that you could have provincials and corporate debts.

Sébastien: Yes, like businesses also. When they borrow on the market, you know this is what’s in your bond portfolio. So, the prices of these assets evolve through time through interest rate movements, what's going on in the macro economy, the perceived solvability of governments and businesses and all of that. Thus, all of the work that you do to pick the right assets at the right time, it's not just, you know, putting the bonds in there and just clipping the coupons. It's more complicated.

Hugo : Exactly. A bit more complicated.

Sébastien: A bit more, yeah! And the main factors that someone should consider when they’re hesitating between investing in a GIC or a bond fund for their investments?

Hugo: I'd say there would be a lot. But let's talk maybe about two specific factors here. So, the rate of return: of course, the GIC, it's in the name, basically. You have a guaranteed return, so it's probably a bit more accessible to investors preferring prediction and stability. On the other hand, bond funds can offer higher total returns in the medium to long term, but they are also a bit more likely to fluctuate based on the market. So, the second factor would be the risk of it: GICs are generally considered a very low risk investment.

Sébastien: Here risk equals volatility.

Hugo: Let's call it volatility, not necessarily risk of losing your money here. So, volatility, in the short term, you can see bond funds fluctuate a bit more than you can see a GIC because the GIC doesn't really depend on market fluctuations. It's a guaranteed rate.

Sébastien: You can maybe put your money in a GIC and you know you're going to get 4% over the next 12 months. For a bond fund, question mark.

Hugo: Yeah. Question mark. But in the medium term, generally bond funds would perform a bit better than the GICs. But yes, of course, in the short term you can see the differences.

Ashleay: Hence the expression “buy bonds, wear diamonds!”

Hugo: Yeah!

Ashleay: I listen! So, Hugo, what would be the best choice for your investments?

Hugo: So, I’d say that the best choice is a bit of a complicated question here. It really depends on what your objective is. There are two different types of investments, even if it's both fixed income. I'd say that the final choice will really depend on: “Do you have a high risk tolerance or a low risk tolerance?” “Do you have a longer investment horizon or a shorter investment horizon?” So, one key advantage for GICs, I'd say, is the security. You are assured of receiving a return on your investment. So, I'd say the type of investment that makes you especially prone to cash management and for upcoming disbursements. So, that would be more on the short horizon. So, that would be more GICs here. And if you were to be invested in the long term, so for your retirement, let's say, I'd say I'd be more inclined to accept a little bit more volatility to have the possibility of earning a little more bang for your buck, let's say. So, bond funds would be more suited for you in that case. And maybe, I think that would be the nice time to talk about that here. I'd say there's a danger for investors to be excessively cautious compared to their investment profile. So that's not a concept we often talk about, but not taking enough risk by having too much cash or GICs in your portfolio, for example, it can be just as risky as taking disproportionate risk relative to one's ability. So, we are used to the disproportionate risk type of thing, because if I was to be like a prudent investor profile, I wouldn't in my right mind put 10% of my assets in Bitcoin, let's say. But on the other hand, we are talking about the capacity. So, via the investor profile you could have some capacity, but not the willingness or the ease to take the risk. And this could be the subject of the entire podcast, that's not the point to do that here… But in short, I'd say guaranteeing a lower return with GICs – because that's basically what you're doing: guaranteeing a return – and if you have too much GICs or cash, it could present the risk of not achieving your longer-term financial goals. So, absence or insufficient risk would be a risk in itself.

Ashleay: Absolutely.

Sébastien: And it's a kind of a philosophical question about risk, you know. Risk in the short run, you see your account going up or down based on the market fluctuations, but the expectations for return over the long run are higher for a bond fund. So, easier to reach your long-term objectives. But in the short run, you know, what kind of volatility can you take and still, you know, not take any decision that will be detrimental to your long term well-being. Kind of ties in with the conversations that we've had multiple times about the importance of having a financial advisor by your side. What to pick and when depends on everyone.

Hugo: Yeah.

Ashleay: And you mentioned market fluctuations earlier as a difference between GICs and a bond fund. Can you tell us a bit more about it?

Hugo: Yeah. So GICs are, I'd say, bulletproof to market fluctuation since they are guaranteed. So even if markets were to fluctuate a lot – let's say 2020 would be a great example with the Covid – if you were to be invested in GICs, your GIC and your return would be the same. But on the other hand, bond funds are more sensitive to market fluctuations due to, I'd say, two main points: so you have the interest rate risk, which is a bit of bond geek math, so, I wouldn't go deep into that, but let's just say when interest rates fall, the value of your existing bond increases…

Ashleay: Right.

Hugo: …so if you own bonds with your bond fund, the price of the bond fund increases too. And the second risk would be the credit risk. Credit risk here is the likelihood that your bond issuer will not repay its debt. So the higher the probability that the issuer will repay its debt, the higher the price of the bond would be. Let's just keep it at that. So, it’s important to understand here that they can offer higher total returns than GICs for the bond funds over a long period, but that comes with a slightly higher level of risk. And risk would mean, if I tie into Sébastien’s question earlier, volatility would be a better word for it, but it's really related to their sensitivity to market fluctuations.

Sébastien: Okay. So, we cannot have a bond portfolio manager here without asking for an outlook. So, your outlook for 2024?

Hugo: Yeah of course. So…2024. We continue to have, as a team, a positive view on the asset class. I'd say bond yields currently available on the market are at a very high level. That's a level basically that we haven't seen since 2010. So almost 15 years for 10-year Canada bonds. So just to be sure, unlike stocks, when we talk about high level in bond geek language, it means we like it! It implies being paid more for your investment.

Ashleay: Right.

Hugo: The higher it is, the higher we like it. So, bonds offer an attractive risk return profile in our opinion for 2024. And what confirms this point of view is that we expect economic growth and inflation in Canada to continue to slow down in 2024. The Bank of Canada told us… the data that we've seen in the last couple of weeks told us that, it kind of points towards the start of the cycle for lowering rates for the Bank of Canada.

Sébastien: Yeah. And as a general rule of thumb, rate cuts are positive for returns on the bond portfolio.

Hugo: Exactly.

Sébastien: Okay.

Ashleay: Great. Well, that's all for today. Thank you Sébastien. And thank you Hugo.

Sébastien: Thank you, Ashleay. Thank you, Hugo.

Ashleay: You guys informed us on the best investment methods. Thank you also to all of our listeners. You may always contact us if you have any questions. And we will see you all next week. Loved this podcast? Want to know more about economic news? Follow our “In Your Interest!” podcast, available on all platforms, visit the economic news page on ia.ca or follow us on social media.