November 27, 2012

Back to Basics: Searching for Safety?

When there is uncertainty or volatility in the markets, the natural tendency is to try to protect your capital.  The pain of a bad equity market is much worse and lasts longer than the pleasure from a growing market.  Many investors still have strong memories of 2008 and do not want to re-live that.Market fatigue is common and the options for investors are confusing as concerns about the fiscal cliff in the U.S. and problems in Europe still dominate the news headlines.  It is no wonder some investors are thinking of moving to cash.  With interest rates at historically low levels, the outlook for bonds in the short term is weak at best.  Equities, on the other hand, are perceived as risky.  So why not sit on the sidelines for a little while?

Investor perception is not always representative of what is happening in the markets. What investors are reacting to is uncertainty and fear of global macroeconomic events. While these concerns are valid and the risks associated with them are real, we feel there are still opportunities in the equity markets for investors. Despite the seemingly continual flow of bad news in the media, equity markets have been positive in 2012.  Year to date ending November 16^th, the Canadian market, measured by the S&P/TSX Index, advanced by 1.9%. Foreign equity markets have fared better, with the U.S. market (measured by the S&P500 Index) growing by 8.8% in Canadian dollars and the International equity markets (measured by the MSCSI EAFE Index) advanced by 5.7% when measured in Canadian dollars.  Not all sectors have performed well, however.  Materials stocks, and gold mining companies in particular, have been hit hard in 2012 - despite a brief reprieve in the third quarter.

What should investors do with their portfolios now?  We recommend clients review their investment objectives during challenging markets before making any changes to their portfolios.  It is important to think of what is driving the desire to make a change and to keep in mind that timing the market is a difficult thing to do well and is often damaging to investor returns.  Retail investors have historically performed worse than the funds they invest in because they have moved in and out of the market in an attempt to preserve capital.  In other words, they would have been better off staying invested in the funds they held rather than selling and sitting in cash and waiting for things to improve before getting back into the market.

By reviewing their investment objectives, considering their investment time horizon and risk tolerance, investors are often able to re-focus on their goals and recognize the emotional need to make change may not be warranted.  If investing for the long-term, recognizing that you don’t need to draw income from the portfolio in the near term can often help you ride through market volatility.  Equities provide the growth for investments and are presently attractively valued.  If you are drawing income from your portfolio, you should not have all of your assets in aggressive, growth-oriented stocks.  Dividend paying stocks and high quality corporate bonds may be an option to consider including in your portfolio. But speak with your Investment Funds Advisor before making any changes to your portfolio.

Another strategy that allows investors to weather uncertainty in the markets is to think about price or valuation.  Logically, we understand we are better off if we buy things ‘on sale’ and sell things when they become expensive.  When we buy consumer products, we have no problem with this principle.  For some reason, this rationale reverses for many individuals when it comes to investing: people want to buy things that have been performing well (i.e. that are expensive) and sell things when they have declined in value (or are cheap).  Bonds have enjoyed several decades of good performance resulting from declining interest rates and are unlikely to deliver the same strong results they have over the last ten years.  Many bonds, especially government bonds, look expensive to us currently. 

The other alternative is cash.  Money market instruments or GICs currently pay very little as returns are based on current interest rates which are at historically low levels. These types of investments are suitable for investors who need to access their funds in the short term and/or who have very low risk tolerance. Growth is not the objective for these investors – safety of capital is.  But keep in mind, safety always comes at a price – in the current environment, buying what has performed well (i.e. bonds) or what will not experience volatility (i.e. cash) comes at a big price – limited potential return or even a negative return after considering fees, inflation and potential interest rate increases.  The challenge for all investors is balancing the desire for return with the potential for volatility or risk.

The key to investing during challenging times is to make sure your portfolio lines up with your objectives and to stay focused on the big picture rather than allowing emotions or market noise influence your investment decisions.  Having your investment strategy written down in an Investment Policy Statement helps keep you on track during uncertain times.

If you are concerned about how your portfolio is structured or about our funds, please call us.  Our team of Investment Funds Advisors is always available to help review your portfolio and answer any questions you may have.

This article is not intended to provide advice, recommendations or offers to buy or sell any product or service. The information provided is compiled from our own research that we believe to be reasonable and accurate at the time of writing, but is subject to change without notice.

Karey Irwin

Principal, Portfolio Manager - Private Clients & Foundations