If everything in your asset mix moves in the same direction most of the time, you will have greater exposure to market corrections
Monitors display stock market information on the floor of the New York Stock Exchange. Photo by Michael Nagle/Bloomberg files It has been quite a bumpy start to 2022 even for more conservative investors as large-cap equities lost 6.75 per cent, but the Bloomberg U.S. Aggregate bond index lost 2.1 per cent resulting in the Bloomberg 60/40 falling 5.4 per cent in January, its worst one-month correction since a 7.7 per cent drop in March 2020.
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Times like these show the merit of risk management and provide a good litmus test on how well-built your portfolio is with regards to protecting against corrections, especially since bonds are no longer filling that role. To assess this means drilling deeper into your portfolio design and composition, because it is how the positions act together that ultimately matters.
If everything in your asset mix moves in the same direction most of the time, you are not diversified and will have greater exposure to market corrections. This may not be an issue for more aggressive investors who are able to tolerate downside swings in order to fully capture upside moves, but it certainly would be for anyone with a lower willingness and ability to take on this greater risk.
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One can easily get caught trying to time the market or make every individual position a winner. We’ve found that this can lead to return chasing, excessive risk taking and, worst of all, not achieving one’s targets. This is where a discretionary manager can be of tremendous help.
A good manager will be able to map out the current market environment with regard to valuations and exposure to macro risks. In our view, this includes central-bank policy, which has recently been a primary driver of market returns, especially of those growthier segments with record-high valuations and excessive sensitivity to rising interest rates.
The next step would be to reduce, but not eliminate, those holdings with a higher sensitivity to these risks while adding to those that will protect against them.
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More On This Topic David Rosenberg: NFTs may be nifty, but not when it comes to investing in them How investors can protect themselves from geopolitical, fiscal and monetary risks FP Answers: Can I retire in 15 years even though I’m still paying off my mortgage? For example, we’ve been selling down our weighting to the tech-heavy S&P 500 while adding to more value-orientated segments over the past three months. We didn’t take the S&P 500 to zero, but reduced it by 30 to 40 per cent as we think it’s still important to have some exposure to the digital segments of the economy should rates not rise as fast as many, including us, expect.
Another area we trimmed was our Government of Canada bond exposure, because we don’t like the level of debt being accumulated by the federal government. There is also greater potential for policy error risk by the Bank of Canada and any subsequent negative impact on our economy and currency. We repositioned what we sold into American dollar-denominated floating and inflation-protected debt, but we didn’t do a complete swap out.
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Article content Our overall bond position is also at the lowest possible weighting within our investment policy statements due to our concerns over inflation and rising rates. We’ve been taking advantage of structured notes, which in our view is a hybrid of bonds and equities, moving our balanced portfolios outside the traditional 60/40 split.
Finally, we’ve been adding in a few market-neutral alternatives that we think will perform well in this current environment. If they do what they’re designed to do, they should have a low correlation to the broader market with downside protection provided by the short exposure within the fund.
Remember that balanced portfolios are called balanced for a reason since the more that absolute, binary positions are held, the greater the risk. In order to avoid this, we find it really helps to shift the target of a portfolio towards a goals-based approach and minimize the risk as much as possible to get there. This means owning a bit of everything, but tilting the overall portfolio around the current market conditions.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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