“It appears interest rates will stay low for the next ten years,” said Bruce Flatt, CEO of Brookfield Asset Management. This is a rather bold prediction, considering that just last year investors were told to prepare for rising interest rates.
Over the long-term (or the 10-year period that Flatt is referencing), interest rates may be held back for several reasons, including persistently low inflation, slower growth in the labour force, an aging population that requires safe assets, and the desire of governments to keep interest rates low to assist them in financing the budgetary deficits around the globe that are spiraling out of control.
Inflation is one of the biggest determinants of future interest rate levels. Since 2012, inflation in the U.S. and Canada has held steadily below 2%. This phenomenon is not limited to North America; low inflation rates have been observed for most OECD countries. On a simplistic level, central banks use interest rates as a tool to cool inflation. If low inflation continues, there will be a limited need to raise interest rates.
Low interest rates are a benefit to risk-seekers. They allow individuals and businesses to borrow more money than they would otherwise be able to afford. This increased borrowing capacity can be used to buy houses, make investments, acquire other companies and increase capital spending. Unfortunately, low interest rates punish retirees. Those looking for a comfortable retirement may be forced to accept a lot more risk through the assumption of market volatility to achieve reasonable rates of return.
If Flatt is correct, low interest rates will have significant implications for our clients and the investments we choose for them. After fees, taxes and inflation, few clients will be satisfied with a portfolio that is overweight in corporate and government bonds. Each morning, we get an email from our bond desk showing us available issues and their yields. Currently, reasonable quality corporate bonds that mature ten years from now offer a yield of 3%. The safest bonds, those issued by the Canadian Government mature in ten years and offer a paltry yield of just 1.48%. This is most unreasonable.
Many of our retiree clients require at least 4% a year from their portfolio. If the bulk of their portfolios are invested in 3% and 1.48% yielding bonds, those clients will be dipping into principal very quickly and run the risk of running out of money. As a result, we must allocate more of their capital to assets that have a chance to earn returns in excess of their spending requirements.
Our favourite asset class contains shares of good quality companies that have a history of profitability. These companies must grow their dividends or have a skillset of successfully reinvesting their cash flows into growth opportunities. For us, the ideal company is one that not only has a growing dividend and strong reinvestment opportunities, but also delivers organic revenue growth. It just so happens that Flatt’s company, Brookfield Asset Management, fits the bill on all accounts.
Brookfield is the world’s largest manager of real asset investment funds, such as real estate, power generation and toll roads to name a few. Its funds generate strong returns by increasing rents and fees on the assets each year. Brookfield is able to participate in the growth of those assets by co-investing in the funds, and uses its scale to acquire new assets around the globe.
Brookfield has raised its dividend every year since 2012 as well as spinning out several of its subsidiaries to shareholders in the form of a stock dividend. Brookfield believes that many investors will look to increase their ownership of real assets as an alternative to low yielding bonds. Brookfield should benefit from this trend given its size and past success as well as its global footprint.
In an era of low interest rates, we aim to own productive assets, such as Brookfield Asset Management, that give our clients the opportunity to earn above average returns. More volatility is certainly in store for those who choose to follow that path. However, we believe the outcome will be well worth the bumpy journey.