A tactical portfolio rebalancing can cut your risks in troubling times

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Martin Pelletier: Choosing the wrong benchmark can lead to performance chasing, poor results and excessive risk taking

Traders work on the floor of the New York Stock Exchange. Photo by Spencer Platt/Getty Images files “There is only one cause of unhappiness: the false beliefs you have in your head, beliefs so widespread, so commonly held, that it never occurs to you to question them.” — Anthony De Mello

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We are in full-blown correction mode with few places this time around to hide besides cash, which really isn’t much of an option these days considering current inflation levels.

The worst-performing markets and sectors are those most sensitive to rising interest rates and central bank tightening, which so happen to have been the hottest sectors to own over the past decade. 

This is because many of these segments, especially technology, are highly dependent on ultra-low rates and readily available capital to substantiate their record-setting valuations and to fund their operations, given that many have negative free-cash flow and earnings.

For example, the Nasdaq index is down 12.5 per cent so far this year, closely followed by the tech-heavy S&P 500, which is down 8.5 per cent. The MSCI EAFE index, meanwhile, is down 6.3 per cent and, closer to home, the S&P/TSX composite is down just 0.6 per cent as oil has once again come to the rescue, since it’s the only sector in positive territory.

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Even bonds, normally a safe haven, are getting whacked, with the FTSE Canada All Government Bond Index down nearly four per cent this year. South of the border, the iShares U.S. Treasury Bond ETF is down 2.5 per cent. So much for the traditional 60/40 portfolio saving the day.

Not surprisingly, we’ve seen the usual statements by market pundits urging investors to stay the course. History has shown that previous geopolitical events such as the ongoing Russian and Ukraine conflict have proven to be temporary and will blow over, they say. Worries about inflation or rising rates, well, we’re also told that those, too, are transitory.

However, if this is truly the case and times like these don’t warrant a tactical rebalancing, then why not buy the S&P 500 index itself, which has worked so well — until now. This little secret has worked especially well for those Canadian mutual fund managers overweight the U.S. as evident by their huge inflow in assets under management.

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More On This Topic How investors can protect themselves from geopolitical, fiscal and monetary risks Excessive risk-taking shows it’s time to raise rates and let the revolution begin A little portfolio protection just in case Russia ever does invade Ukraine Such a strategy works when quantitative easing and free money keep flowing, at least until the day the taps are turned off. What happens if there is a permanent step change in the market, not unlike what transpired prior to the collapse of the tech bubble in 2000 or even the financial crisis in 2008?

This leads to important discussions around benchmarking and risk management. Choosing the wrong benchmark can lead to performance chasing, poor results and excessive risk taking.

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Article content For example, the S&P 500 has had a stellar run with its valuation premium to other global markets currently at a three-standard-deviation event, but many forget this wasn’t always the case. In the decade following the collapse of the 2000 tech bubble, commodity heavy markets such as Canada outperformed.

This is why it’s important to take a step back, stop looking to the past and start looking ahead. There is a reason why portfolio and fund managers have an obligation to disclose that past performance is not indicative of future performance.

A great first step is to set a target return that factors in one’s financial goals and objectives as well the conditions of the broader global market, including both equity and fixed income, and then adjust asset allocations to try to meet that target while taking as little risk as possible. This means being market agnostic and not being influenced by ingrained beliefs, or what others are doing.

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._____________________________________________________________  For more stories like this one, sign up for the FP Investor newsletter.

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