When it comes to analyzing the performance of one’s investment portfolio, timing is everything. The problem though is with the acceleration in trading and the rapid delivery of news, one’s time horizon is becoming shorter and shorter. We think this will only get worse as new technologies such as blockchain take settlement times from days down to seconds.
The risk in all of this is that investors will start reacting to news events instead of proactively analyzing it to separate what is important and what isn’t. Consequently, the fear of missing out will often take over, driving many to herd into those segments of the market that have recently been outperforming and away from those underperforming.
We’ve seen this in funds flow, especially here in Canada as those managers with a heavy weight towards U.S. equities have experienced a tremendous amount of new business given their strong returns since 2009. But this hasn’t always been the case as those managers with a concentration in resource-based markets such as Canadian equities were the shining stars in the period prior.
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For example, from January 2000 to January 2009 (excluding currency impact) the S&P TSX gained an annualized 5.8 per cent compared to the S&P 500 that was actually lost an annualized 1.0 per cent. Compare this to the period following from January 2009 to May 2018 where the S&P TSX has underperformed gaining an annualized 9.1 per cent versus the S&P 500 gain of 14.7 per cent.
Interestingly, over this entire 18 ½ year period the S&P TSX has beat the S&P 500 by nearly 1 per cent on an annualized basis although we doubt many investors have gone this far back in the analysis of their portfolio. While this excludes currency moves, it is also worth noting that the Canadian dollar is up only slightly over this period.
It’s not only Canadian equities investors are shying away from as many are also reducing their fixed-income positions given all of the negative reporting and worries over rising interest rates. However, instead of reacting to the recent poor performance in bond markets look at what happens when you extend your time horizon.
From January 2000 to May 2018, the aforementioned all-Canadian equity portfolio gained an annualized 6.2 per cent while the all-U.S. equity gained an annualized 5.3 per cent, assuming that one held their positions during the 45 to 50 per cent drawdowns experienced during the financial crisis.
Compare this to the 7.1 per cent annualized gain from a portfolio that held an offsetting U.S. Treasury position. Not only did it outperform on an absolute return basis but its worst year was a loss of 5.7 per cent versus 31 to 37 per cent for the all equity portfolios. This is reflected in the risk-measures with a 0.75 Sharpe Ratio compared to 0.32 to 0.39 for the all-equity portfolios.
Not surprisingly, there are those who will try to convince you otherwise that this time it’s different. We’ve heard it all from this being the end of the bull market in bonds to resource-based economies being left behind as the world rapidly transitions off of oil.
Making matters even worse is that advisers often end up giving in to what investors want and that is near-term performance. If they don’t, many face what is known as career risk meaning the loss of clients if their portfolios don’t keep up with the sweet spot in the market.
Instead, the job a good adviser or portfolio manager is to maintain diversification and a proper asset allocation mix that keeps risk in check. Risk can be managed a number of different ways beyond adding government bonds into the portfolio and could include other non-correlated assets as well as risk-managed strategies such as the use of options.
The bottom line is that if one is investing for the long-term then start thinking long-term in regards to portfolio design and implementation.
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.