Three things to do to brace for tough markets
So far 2018 is looking likely to be a tough year for investors with cash outperforming both bonds and stocks for the first time since 1993. We calculate that the S&P TSX is down 3.7 per cent this year while FTSE TMX Universe Bond Index is down slightly at 0.1 per cent.
This isn’t supposed to happen as bonds typically soften the blow to equities but today’s situation is a bit of a unique one as central banks look to finally withdraw their monetary support a decade after the financial crisis. We think this is the case closer to home, as our central bank has brushed off the collapse in Canadian oil prices and instead focused on other areas of the economy to justify what we believe to be an overly hawkish position.
As a result, they have sent bond yields on the front-end spiking to the point that the yield curve is flirting with inversion, which is typically an early warning sign of an upcoming recession.
That said, the selloff in equities isn’t constrained to Canada so those with global portfolios have also been affected.
For example, using a global balanced benchmark of 40 per cent FTSE Bond Universe, 20 per cent U.S. equities, 20 per cent EAFE and 30 per cent Canadian equities we calculate Canadian investors would be down approximately 1.0 per cent this year (in Canadian dollar terms), which is slightly better than the 2.3 per cent loss for a passive Canadian balanced portfolio.
While these numbers were much worse in October, there are still plenty of things your manager or financial advisor should be doing with your portfolio. While we can’t speak for others, there are three strategies that we have deployed that we have found worked particularly well during similar 1 market environments. Tax-loss selling and portfolio high grading
The low-hanging fruit involves trimming back losing positions and refocusing on those segments of a particular sector or market that offer a more promising outlook. This can involve moving into companies with stronger balance sheets and a protected market share. It can also mean transitioning to those sectors that currently have tailwinds or strong support as opposed to those facing significant risks or headwinds.
2 Rebalancing and looking for value opportunities Periodic portfolio rebalancing is a prudent thing to do but more so after large market moves. For example, EAFE markets have had a terrible year this year losing nearly 6 per cent and so it is likely that most investors would now be in an underweight position. According to BoA Merrill Lynch, the underperformance of global equities outside of the U.S. is nearly a 2 standard deviation event and has never traded at such a large discrepancy with data going back to 1950.
Here in Canada, many blue-chip dividend paying companies have been hit hard over fears of multiple rate hikes by the Bank of Canada. Consequently, there are some great companies in the banking, insurance, telecommunications and utilities sectors paying sustainable dividends between 25 and 100 per cent greater than 3 their 10-year averages. Exploring low-correlated alternatives
This may also be a great time to explore alternative strategies in the event that both bond and stock markets continue to disappoint. For example, these could include long/short managers in both the fixed income and equity space or even a touch of private equity.
However, it is imperative to do one’s homework to ensure risk management processes are in place before pulling the trigger. This can be a difficult task especially when it comes to separating out those in the right place at the right time or worse, those using leverage to boost their returns.
That said, we’ve identified more than a few managers out there that have demonstrated an ability to add value in troubled markets thanks to a rigid and proven risk-managed investment process.
Markets like this one are the reason why you are paying someone to manage your wealth — and a good time to ask what you are getting for your money.
Martin Pelletier, CFA is a portfolio manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.