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Focus on these areas to help protect your portfolio from fall volatility


So far 2018 is looking to be much more of a bumpy ride for investors after being spoiled with smooth sailing for the two years prior. This ongoing lull combined with the dog days of summer could provide an excellent opportunity to review one’s portfolio holdings to ensure they are well-positioned heading into the fall, which history has shown tends to be a more volatile period.

The problem is that investors often allow emotion to work its way into portfolio design, implementation and maintenance. For example, this means instead of rebalancing, investors end up buying more of those positions that have strong near-term performance and selling those with weaker near-term performance, resulting in a highly concentrated portfolio. This is fine as long as markets continue to deliver favourable results, but not so good during corrections.

That said, we’re not saying that a correction is imminent, but it costs nothing to ensure one’s portfolio is properly diversified and thereby protected in the event of a sudden and sharp turn in the markets. This doesn’t mean an extreme shift to a defensive position, but more so maintaining the right balance within the investor’s portfolio to match their ability and willingness to take on risk.

In this regards, there are three main areas of diversification to be considered during such a review.

Asset class diversification

This is the level of ownership between equities, fixed income and cash. Given the poor performance of bond markets many have taken their fixed income allocations to ultra-low levels;  therefore, their previous 60/40 portfolio is more likely 70/30 now. This is evident by the July AAII Asset Allocation Survey showing that equity allocations are at 68.3 per cent — well above the historical average of 61 per cent.

In addition, investors have shifted towards short duration bonds on concerns over the risk from rising interest rates. All of sudden you have a scenario in which there is a much lower bond position, one that is shorter duration in nature paired with a higher equity position.

To make our point, let’s compare two portfolios: one that is 70 per cent in the S&P 500 and 30 per cent short-term Treasuries against one that is 60 per cent in the S&P 500, 20 per cent 10-year Treasuries and 20 per cent long-term Treasuries.

Surprisingly, since January 2000 the 70/30 portfolio generated an annual return of only 5.4 per cent, which is less than the 60/40 portfolio’s annual return of only 6.7 per cent. This is because of substantially lower drawdowns in 2008 with the 70/30 losing 23.9 per cent that year versus the 12.8 per cent loss in the 60/40.

Manager strategy diversification

The key in the aforementioned results is having low-correlated strategies in one’s portfolio. The same can be said about strategy diversification. This means holding a variety of managers undertaking different investment processes such as quality and value, low volatility, risk-parity, tactical asset allocation, option and derivatives, private equity and debt, and alternatives such as market neutral and long/short funds.

It is important that each is benchmarked independently as well as accepting that each will deliver a set of results that will differ from one another, but when combined will smooth out the return and risk profile.

Market and sector diversification

Finally, there has been a lot of herding into the U.S. equity market and we can’t blame investors given just how strong a performer it has been. However, we are seeing some great value opportunities in other markets such as EAFE (Europe, Australia and the Far East) and emerging markets with a steepening discount multiple to the U.S.

When looking closer to home and digging deeper within our own market, for example, there has actually been outperformance in Canada’s telecommunications and banking sectors when compared to their U.S. peers.

In conclusion, stepping away from the crowd and expanding your time horizon when evaluating your portfolio are two great ways to ensure proper portfolio diversification is being undertaken. It also certainly helps not having an adviser selling funds based on recent performance but rather working with you to ensure a maximixation of the return-versus-risk profile of your portfolio through regular and consistent rebalancing.

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.



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