After the worst year ever for value investing, where can we turn?

In late October the Financial Times ran a shocking headline: “COVID condemns value investing to worst run in two centuries.” The pandemic, they said, compounded a decade of struggles for the popular investment strategy that favours bargain stocks over expensive, growth-oriented equities. Even the dividend yields that kept value so attractive have failed to manifest for investors at this time. So, after perhaps the worst year of performance in value investing history, what analogous asset classes can offer similar opportunities for investors?

Warren Aarons will tell you that, while not perfectly analogous, Private Mortgage Investment Corporations (MICs) can do some of the job. The VP of Investor Relations at Canadian Mortgages Inc. (CMI) points to these investable products tied to personal mortgages and backed by real estate assets as carrying the right mix of collateral, yield preservation that past generations of investors turned to value stocks to provide.

“Owning shares in a MIC offers the investor exposure to a pool of diversified mortgage loan obligations in which a borrower pays a fixed interest rate to borrow the funds for a determined period of time,” Aarons says. “MICs offer borrowers mortgage financing through the mortgage brokerage space in Canada, and many MICs are not priced daily and do not exhibit market price fluctuations in the value of their shares. With interest rates in Canada remaining at historical lows, the targeted yields offered by MICs to investors can be attractive when considered as part of an investors’ portfolio. MICs have demonstrated a low correlation to the broad equity markets. Because a MIC is composed of a pool of mortgages with fixed rates and set times to maturity, the valuation of a MIC calculated at various times throughout the year should show little price fluctuation between time periods.”

Aarons is not promising the whole world in his case for MICs but says a small allocation to them within a diversified portfolio may work to enhance yield and reduce volatility, two things investors need now. He points to a strong year in MIC performance, thanks to Canadian mortgage holders prioritizing debt servicing during the pandemic, as burgeoning evidence that MICs can perform as an income generation vehicle during a time of volatility.

A barrier for advisors in shifting some value allocation to MICs will inevitably be one of communication. The dividend yields are typically desired most by an older investor class who may not be as familiar with MICs as they are with value stocks that had performed for them in the past. Aarons says that conversation needs to revolve around diversification in an era of flux. He says advisors should stress the income MICs offer and the collateral offered by Canadian real estate and the Canadian mortgage payer.

“The conversation comes baseline from the understanding of a mortgage and what a mortgage means to a borrower,” Aarons says. “That’s an area the retail investor audience understands pretty well. Connect their investment in a MIC to that pool of mortgages, and they’ll relate to the MIC. If the investor can understand the borrower’s needs, combined with the obligation that the borrower pledges to, I think the investor will understand the MIC and how it can serve their investment objectives.”