When does it really matter if the federal government buys your stocks?
There are three ways to invest in stocks: buy them at a market price, buy them with cash, and buy them from a bank.
But all three are costly, leaving the average investor without the flexibility to make sound investment decisions, says Peter Lappin, a senior economist at the University of Calgary’s School of Public Policy.
If the federal treasury wants to buy a company, Lappis says, it must first pay its share of its dividend to the government.
If it doesn’t, the government can buy the company outright, paying a fixed price per share.
If an investment company wants to exit, it has to pay the price of a sale to another buyer.
And if the government wants to sell its stake, it can do so at whatever price is necessary to recoup its investment.
For example, if the company has a debt obligation, a company may be able to buy it for a fixed, and thus higher, price.
But the buyer of the company can only be paid a fixed percentage of its capital.
And the government cannot buy a stake at a discount if it has a negative interest rate, says Lappi.
If that were the case, the federal Treasury could simply buy the stock at a price that it deemed appropriate.
But Lappa says that is unlikely to happen.
Investors are not well-served by having the Treasury make a decision to buy shares at a discounted price, he says.
Investors don’t know how much interest rates will be and they are not confident that the Treasury will continue to pay interest rates that are at least as high as it is today, he said.
Lapp’s conclusion is based on a recent study by the Bank of Montreal.
In the paper, which is a review of recent history, Lapin, Michael Caffery, and Benjamin Leibowitz of BMO Capital Markets wrote that the Canadian government could be better served by buying its shareholdings at the discount that is appropriate for a company’s current market value.
The authors also noted that Canadian companies typically are subject to market risk.
“This is the key reason that many investors would prefer to buy Canadian government debt securities when the rate of interest is at its lowest level,” they wrote.
They noted that the federal debt securities market is highly volatile and that, despite having the lowest rate of corporate tax in the OECD, interest rates on bonds are higher than those on stocks.
And, despite the fact that bonds have a relatively low cost of capital, investors are reluctant to buy them because of their risk profile, they wrote in the paper.
So what is a prudent strategy?
If the government is willing to pay for its share, it should pay a dividend to Canada’s public pension fund, which would fund the government’s capital needs.
It would then hold on to those shares for up to 25 years.
The government should also buy its share in another company or institution.
This would give it a chance to sell the company.
If no company or other institution is willing, the Treasury should buy a third company or an ETF.
But if a company or ETF is a good bet, the taxpayer should also put money in it, says Scott Henderson, a vice-president at Investec Wealth Management Inc. Investors should not invest in the company or the ETF, says Henderson, since the taxpayer will have to pay a premium to buy the shares.
Investment options for stocks and bonds are diverse, and they depend on what is available, says Chris Levett, president of the Canadian Securities Administrators Association.
For example, investors should not buy stocks with a high rate of inflation, says Leveff.
A common mistake is to buy bonds that have an inflation rate that is higher than that of the overall economy, says Michael T. Dolan, director of equity research at TD Securities Inc. TD uses inflation data to predict future interest rates and it does so by comparing bond prices to their yields.
The company also uses data from its own investment bank to measure the value of its holdings.
If its inflation rate is higher, the bank thinks the value is less than what it is.
Dolan also suggests buying stocks with lower interest rates than the market will bear.
In a similar vein, if a stock or bond has a positive rate of return, that should not be a surprise, says Dolan.
If you want to invest more in the stock, then take a riskier option.
Investors who are willing to take the risk will often do so if the underlying stock is less risky, says Rana Fazl, chief investment officer at CIBC Wealth Management.
There are other reasons to buy stocks, says Fazal.
For instance, investors who are comfortable with their exposure to the stock market, which can fluctuate from month to month, can afford to buy more.
And, as investors grow wealthier, they should diversify