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Investor Resources

The key to successful investing is being able to strike a balance between an acceptable level of risk and the client’s expectations of return for the different types of investment instruments that the client is comfortable with and that are appropriate for his or her investment goals.

For the purposes of portfolio management, investment instruments are usually divided into three asset classes: cash, fixed income, and equity.

Each asset class has its own characteristics that influence your portfolio’s risk and return. Mutual funds will be made up of individual investments from these asset classes.

The following is a list of asset classes and types of investments, in approximate and generally accepted order of risk and expected return from lowest to highest. Individual investments in each class will have varying levels of risk and return.

Cash

Cash

No explanation needed! Security is backed by the credit quality of the financial institution where the money is held.

Treasury Bills or T-bills

Short term debt instruments issued by the federal or provincial governments that matures in less than one year, with the highest liquidity and credit quality of all fixed income products. Credit ratings range from R1 high or highest credit quality, to R2 or adequate credit quality.

Commercial Paper and Bankers Acceptance

Short term debt instruments that mature in less than one year issued by a corporate borrower and guaranteed by the borrower’s bank or by secured assets. Liquidity and credit quality depend on the status of the issuer and degree of security offered. Credit ratings range from R1 high or highest credit quality, to R1 low or satisfactory credit quality. T-bills, commercial paper and bankers acceptance are often referred to as “money market.” The cash component of a portfolio also includes cashable term deposits issued by banks and other financial institutions, as well as any fixed income product maturing in less than one year.

Fixed Income

Guaranteed Investment Certificates (GICs)

GICs are issued to investors by financial institutions—banks, credit unions, and trust companies—for fixed periods of time (usually one to five years) at fixed or adjustable interest rates. GICs are not traded on financial markets like bonds; therefore the price or value after purchase will appear stable and is not subject to fluctuations due to interest rate changes. The investor will usually see a lower interest rate on GICs in comparison to bonds.

Bonds

A bond is a debt instrument whereby the investor loans money to an entity (company or government) that needs funds for a defined period of time at a specified interest rate. In exchange for your money, the entity will issue you a certificate, or bond, that states the original amount of money lent (principal or par value), the interest rate (coupon rate) you are to be paid and when your loaned funds are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually).

Bonds are traded on financial markets, and prices will fluctuate according to:

  • interest rates – bond prices go down when interest rates rise, and bond prices rise when interest rates fall
  • credit quality of the bond issuer – bond prices might fall if credit quality decreases, or prices might increase if credit quality increases
  • general market demand – when demand falls, bond prices fall

Though bond prices may fluctuate, the full principal amount of the bond will be repaid at maturity unless the issuer is in default due to poor credit quality.

Most bonds are rated for credit quality by independent ratings agencies as follows:

  • AAA or highest credit quality, AA or superior credit quality, A or satisfactory credit quality
  • BBB or adequate credit quality, BB or speculative, B or highly speculative
  • CCC or very highly speculative, CC or lower with increasing risk of default
Bonds – Government

A bond issued by a government, usually federal, provincial or municipal, or entities guaranteed by a government bonds. These bonds are not backed by assets, but by the full faith of the government issuer.

Bonds – Corporate

A bond issued by a corporation. Specific assets can back these bonds, or they can be unsecured. Corporate bonds come in other types as well, such as convertible, subordinated, floating, and fixed/floating. Corporate bonds typically offer a higher yield than government bonds, although high quality corporate bonds trade at lower yields than bonds issued by lower rated provinces.

Stripped Bonds or Zero Coupon Bonds

Zero coupon bonds are bonds (government or corporate) that do not pay interest during the life of the bonds. Instead, investors buy zero coupon bonds at a deep discount from their face value (the amount a bond will be worth when it matures or comes due). When a zero coupon bond matures, the investor will receive a lump sum equal to the initial investment plus interest that has accrued.

The maturity dates on zero coupon bonds are often long-term, and long-term maturity dates allow an investor to plan for a long-range goal, such as paying for a child’s college education or timing retirement income. With the deep discount, an investor can put up a small amount of money that can grow over many years.

Investors can purchase different kinds of zero coupon bonds in the secondary markets that have been issued from a variety of sources, including the federal government, corporations, and provincial and local government entities.

Mortgage Backed Securities or Mortgages

Mortgage Backed Securities (MBS) are an investment instrument that represents ownership of an undivided interest in a group of mortgages. Principal and interest from the individual mortgages are used to pay principal and interest on the MBS.

The Canada Mortgage and Housing (CMHC), a government agency of Canada, provides the insurance of principal and interest, as well as the guarantee of monthly payments. Good yields, monthly cash flow, and safety of principal are attractive features.

Equities

Preferred Shares

Preferred shares are often considered a fixed income instrument, but they are actually dividend paying equity instruments. They do not generally have voting rights like common shares, but they would have preference over common shares in the payment of company dividends or in the liquidation of assets if the company went out of business. These shares tend to offer a higher dividend yield than common shares and are usually purchased by investors seeking a steady stream of income as opposed to capital appreciation or growth. Preferred shares can have a convertible feature, where the investor has an option to convert to the common shares of the underlying company within specified time limits and participate in the potential growth of the company.

A redemption or call feature means the issuing company has the right to redeem or call back the shares at a specified price after a specified date. All Canadian preferred shares have this feature. Other preferred share features include:

  • Cumulative – if a company fails to pay a dividend on the preferred shares, all accumulated dividends must be paid in full to these preferred shareholders before dividends can be paid to other shareholders
  • Floating rate – instead of paying a fixed rate of dividends from year to year, these shares will pay dividends that respond to changing levels of interest rates, often pegged to the prime lending rate
Common Shares/Common Stock

Ownership of a company is divided into equal portions called shares, and collectively, these shares are referred to as stock. An investor who buys common stock is buying an ownership position in a company. If the company does well or if the shares are popular, the value of the shares may increase or profits may be distributed to common shareholders in the form of dividends. If the company does poorly or fails, the value of the shares may decrease and the shareholders may lose some or all of their money.

Some examples of frequently used terms that refer to stock are:

  • Blue Chip Stock – this term was coined in the US to describe stock in a well-established, financially sound and stable company that has demonstrated its ability to pay dividends in both good and bad times.
  • Value Stock – Stock from companies with sound financial statements that the market has undervalued.
  • Growth Stock – Stock from companies whose earnings are expected to grow at an above average rate relative to the overall market.
  • Momentum Investing – This strategy looks for stock from companies with earnings releases or price momentum in the short term, attempting to ride the wave and sell once it has peaked. It is focused on stock price movement instead of the fundamentals of the underlying companies.
  • Capitalization, or “cap,” is the amount of stock issued by a company and it’s combined value based on the market price of the stock. It is an approximate figure that will change over time. Large Cap stock is stock that is issued by the largest companies in the financial universe. Mid-cap stock is stock that might be considered “middle of the road” when it comes to size. Small-cap stock refers to a relatively small market capitalization or small company.
Derivatives

A security, such as an option or futures contract, whose value depends on the performance of an underlying security (usually the common stock). Futures contracts, forward contracts, and options are the most common types of derivatives. Derivatives are generally used by institutional and sophisticated investors to increase overall portfolio return or to hedge (offset) portfolio risk.