Asset Allocation and the building/re-balancing of Turner Tomenson client portfolios.
A significant number of academic studies have focused on Asset Allocation and the performance of
portfolios over time. We have adopted, and continue to utilize, Modern Portfolio Theory to find
strategic advantages to building client portfolios through Asset Allocation for predictable risk adjusted
returns over time.
Through the economic cycle, from trough (recession) to peak (expansive GDP growth) and back to
trough (recession), different asset classes will perform at different levels.
In times of slowing economic growth, central banks will lower interest rates and provide monetary
stimulus to soften the negative impact. Usually through this period more growth-oriented assets will
underperform (such as small companies or developing economies), while interest rate-sensitive assets
(fixed income, like bonds or preferred shares) will outperform.
As investors perceive an economy is close to bottoming (with interest rates at their lows), they start
looking to growth assets for increased returns, anticipating the next period of growth in the cycle.
Unfortunately timing this change is fraught with danger and volatility tends to rise during this period of
As can be seen in this chart of the S&P500, from the end of the recession in 2009, the market has had a
number of significant surges and corrections, although the direction has continued to be up (with higher
highs and higher lows). Achieving portfolio growth and not giving it back during times when markets are
difficult is always the greatest challenge. Through consistency in our Asset Allocation strategy (staying the course with our target weightings) despite some holdings that may under-perform at times, we are able to capture growth when it occurs.
If we look at the 3 year history of our 60% equity/40% fixed income model through the very slow economic recovery since 2009, it is quite clear that all asset classes have performed at certain times, making
a contribution to the total portfolio
However, there have been assets that have, during the low interest rate environment, been
considerably better performers (such as preferred shares). However, this does not mean that they will always out-perform. In fact, as interest rates begin to rise, these assets will likely be under-performers (as will government bonds and some high-grade corporate bonds). Some might question why hold these at all? There’s too much uncertainty and potential volatility in the world, and these provide stability and income should the unexpected occur. The same holds true for assets that at times provide a high degree of growth to the portfolio, but lag during other periods. Specifically the small companies indexes (Canada: XCS, US: IWR, IWC, Intl: SCZ) or emerging markets indexes (XEM, FXI, EWZ and INDY) have been in this category lately.
So, a common question has arisen through the under-performance of some of our high growth assets:
Why is my TFSA not performing? Garth and I have adopted a strategy for tax efficiency that prescribes
using different accounts within the total portfolio for sheltering assets from tax. For highly taxable, interest paying investments, we prefer, when we can, to shelter them in the RRSPs. This would help RRSPs perform better, through difficult markets, but under-perform in times of growing equity markets.
For TFSAs we have more aggressive growth investments sheltered from the potential for large capital
gains. However, through difficult markets, these assets have underperformed. As history has proven,
this is likely a short-term phenomenon and in time, these assets will once again outperform, and TFSAs
along with them.
We try to hold the most tax-advantaged assets (which pay tax-efficient dividends) in non-registered
Different assets in the total portfolio will perform (and under-perform) throughout the economic cycle.
The balance and diversification of your total portfolio is crucial to capturing the growth in good markets
and limiting the downside in difficult markets (regardless of the account in which they are held).
Predictions for 2013:
Underperforming assets (small companies and emerging markets) will likely out-pace assets that have
performed well over the last few years (REITs, Preferred Shares). However, a balanced portfolio should
still have those asset classes, because it is never certain what our volatile world will throw at us next.
We are always aware our main obligation to you is to preserve your capital. We pursue growth within
this mandate. We are pleased to report the model portfolio described above has achieved a return of
10.71% in 2012, with the three-year average return being 8.28%. More importantly, $100,000 fully
invested in our model on Jan. 1, 2010 has grown to $126,225.93, a 3 year compound annual return of
Thank you for the privilege of working with you, and we look forward to many years of success
Despite rising interest rates, market volatility, European debt woes, slow economic growth, the US housing disaster and all the pundits and doom-sayers, 2010 has been a profitable year for Turner Tomenson clients. Our 60-40 model, upon which we base most of our client portfolios (that’s 60% equity-40% fixed income) is at point of writing up by approximately 14% since the beginning of 2010.
Of this, 56% is held in the Materials and Energy sectors. While it makes up only 3% of our model, it is important that we have exposure to this particular asset class. Because we cannot necessarily pick which asset class will out-perform in any given time period, we want to have exposure to asset classes that have the potential to move higher and add to our model’s ability to achieve growth. This is part of what makes this diverse model so attractive. As you know, our goals are (a) preservation of capital and (b) making it grow. With the potential for growth in this Small Cap Fund, however, is a greater risk (and potential for volatility) so we want to ensure we keep its weighting light, relative to the rest of the portfolio.
Our (boring) theme continues to be balance and diversity.
Some of the other asset classes that have performed well this year:
The iShares Russell Microcap® Index Fund The iShares Russell 2000 Index Fund The iShares Russell Midcap Index Fund The iShares S&P/TSX Capped REIT Index Fund The iShares S&P India Nifty 50 Index SPDR® Gold Trust
Will these out-perform in 2011? Likely not, in fact we’re currently not buying them (and in some cases re-balancing client positions to take profits) because they have become too expensive for our liking. This is exactly what we mean by active management.
It’s also why we preach the discipline of balance and diversity: in all likelihood, one of this year’s underperformers will be next year’s outperformer:
Horizons AlphaPro Gartman ETF (“HAG”) The iShares MSCI EAFE Index Fund (CAD-Hedged) The iShares FTSE China 25 Index Fund
As well, we have the Fixed Income stabilizers in the portfolio that focus on interest income and dividends and perform as our model’s anchors when markets become volatile. And we certainly expect more of that in 2011.
Late this year, Equity markets have become stronger as the US Fed has chosen to inflate assets with quantitative easing, but there are perils and uncertainties that can turn the euphoria into fright with one nasty economic or political shock and investors must always guard against complacency.
A large increase in volatility can and may be just around the corner.
Having balance and diversity in a portfolio is the key to limiting the impact of this potential volatility.
We wish you a happy, healthy, prosperous and Balanced New Year.
It’s a boring story: Balance and Diversity (and Yield) If you are looking for an exciting ride from your investments:
STOP READING NOW!
This year saw the Volatility Index (VIX) return to the highest levels since the 2008-09 Financial Crisis amid the calls for a double dip recession (May).
The S&P 500 fell 17% from its April highs in April to its lows at the beginning of July. Certainly not the stomach churning ride of over 50% from the crisis, but certainly enough to drive the already anxious, ready – to – retire folks (who had not already bailed) scurrying into the arms of bonds with 3% returns.
If you could have timed it right and bought from those in a panic, the S&P 500 rallied back to the April levels in the glow of the US Federal Reserve’s renewed stimulus effort (commonly known as QE2, technically referred to as Quantitative Easing) close to 22%.
If you chose to stay invested from the beginning of the year until today you would have secured a meager 5.5% return for all this roller-coastering (and emotional navel-gazing). Better than a 3% (bond yield) perhaps, but also a sleepless night or two.
The 60% (globally diversified) Equity and 40% Fixed Income model portfolio that we follow has produced a total return year to date of near 10.5%. We do not anticipate such good fortune regularly, but we are content with something in the vicinity of 7-8%.
This year's diverse asset classes driving the model?
REIT’s with returns in the vicinity of 20%.
Small Canadian companies with similar returns.
Small US companies.
Assorted Income Trusts.
High Yield corporate bonds.
Fixed-rate perpetual Preferred Shares.
Next year? Not sure, but the model will not catch the highs nor will it catch the lows like the S&P 500 (or TSX for that matter). Over time, different asset classes perform differently at different times bringing balance and diversity to a portfolio and smoothing out potential volatility.
In light of recent market events, we’d like to update you on our perception of current market conditions.
Also remember that our methodology is based on developing a strategy and patiently (and cautiously) building portfolios that will minimize the impact of volatility over the long-term, allowing for more continuous growth.
In some cases this may require a longer period of building while we try to maximize the value of the individual holdings, utilizing short-term volatility in the markets to get the best possible prices. As we have explained before, but wish to emphasize: our strategy is to put purchase orders (for our clients) in below the current market prices so that in the event that market volatility allows a move to lower prices, our orders are executed, providing better value.
We believe that statistically, prices will eventually revert back to the mean and we use the 200 day moving average (for each security) as our guide. Currently, most (if not all) of our securities (that we buy for clients) are trading well above their 200 day moving averages. This is in fact a rare occurrence (anomaly) in the markets.
Bond prices continue to move higher (yields lower) and at the same time equity prices are moving higher (as well as commodity prices, especially gold). Bond prices are moving higher as the demographic (retiring baby boomers) seek to capture more secure yield (income) for their investment strategy.
At the same time, central banks in the developed economies that are facing economic stagnation, (Europe, US, Japan) have pledged to buy bonds to continue the monetary stimulus that they believe is necessary to keep the economies from deflating.
While bond yields move lower, this makes dividend yields (from common and preferred shares) more attractive and investors are pulled towards equity markets to take advantage of the better yields. Hence the recent rise in equity prices.
We do not expect this situation to last, however the timing of the next move is uncertain. We had anticipated the economic uncertainty to give way to more volatile markets in September and October, but so far, with the central banks providing comfort for the markets, this has not developed.
And as the famous economist, John Maynard Keynes once espoused: “markets can remain illogical far longer than you or I can remain solvent”!
Again, our methodology for building portfolios is based on patience to get the best possible value for our clients. To discuss your portfolio in detail and the implications for your current situation, we are available at your convenience, so please call Matt Watson or Taryn Ashby (1-800-438-3319) or by email firstname.lastname@example.org , email@example.com and set up a time to come in or chat with us by phone and we will happily take the time for a review.
Earlier this week, the National Bureau of Economic Research (the official arbiter of recession dates) declared that the recession that began in December 2007 (Chart of the Day declared that the recession was 'underway' back in early January 2008), ended in June 2009 (Back in June 2009, Chart of the Day stated that the recession would ultimately be declared to have ended in June 2009 -- plus or minus one month). For some perspective on the recession just past (a.k.a. the Great Recession), today's chart illustrates the duration of all US recessions since 1900. There are a couple points of interest... Of the 22 recessions that occurred over the past 110 years, the most recent recession is tied for fifth in terms of duration. It is also worth noting that the recession just passed was above average in duration and the longest since the Great Depression.
Quote of the Day"It's a recession when your neighbor loses his job. It's a depression when you lose your own." - Harry S. Truman
"Some of the world’s leading investors are becoming more worried about deflation and are re-shaping their portfolios to prepare for a possible period of falling prices. Bond-fund heavyweight Bill Gross, investment manager Jeremy Grantham and hedge fund managers David Tepper and Alan Fournier are among the best known investors who are bracing for deflation, a development that could cripple global economies and world stock markets. The investors cite weak economic figures and a mounting consensus that global policy makers are reluctant, or unable, to take further steps to boost economic growth as reasons for their market positions."
"...preliminary signs of deflation are spurring Mr Gross and the others to take on huge positions of interest-bearing investments such as bonds and dividend-paying stocks..."
Gregory Zuckerman, From: The Wall Street Journal, August 02, 2010 11:30AM
Uncertainty is the rule at the moment and uncertainty tends to drive investors to safer investments. However as the pundits do, so do the investing public and emotion tends to drive investor psychology.
Most of the recent negativity entered the market in late April when volatility (created by the uncertainty) spiked and equity markets dropped between 15-20%. In other words, the sentiment was quickly built into the market. The media are usually the last to the party and only after the big hedge funds have positioned themselves accordingly do they start talking in hopes that the general public will get motivated to follow their course and provide instant profitability to their (the hedge funds/portfolio managers) new positions.
We build our portfolios to, as best as possible, immunize our clients from this volatility: diverse, balanced portfolios. We use asset allocation strategy : for example, in a 60% Equity (a large portion of which are dividend paying) and 40% Fixed Income, this model retracted less than 5% during the late April to early July period and while equity markets remain in negative territory on the year, that portfolio has returned approx. +6% on the year (to date).
Late last year we moved our retired, more cash flow oriented clients to more income driven portfolios with 60-70% fixed income (adding preferred shares with approx 6% dividend yield) thinking that over the next couple of years equity markets may move sideways at best.
With our younger, still working, families who do not require income from their portfolios for the next couple of years (at least) we remained 60-40 (Eq/FI). We still want to have a growth component, but we have actually been focusing on Asia and the emerging economies more for future growth.
In Bill Gross' piece, he focuses more on the developed (G8) countries, mostly on the demographic issues of slowing population growth. We see the global economic engine of growth shifting towards emerging economies where there is significant wealth being created and demand for more developed goods and services as well as above average population growth. The battle among G8 countries now is who can provide these goods services and who will have the cheapest currency with which to be more competitive. Canada and Australia have the resources, so we focus a little more on those economies as well, but trying to maintain an international bias.
I will not ever discount the intellect of the great economic minds as they ponder the economic future, but I do question their timing and covert intentions when they engage the media.
I think we have taken the long-term approach to reduce volatility and taxes as best as is possible : you should ensure that you have TFSA's set up and maxed: $10,000 (each) now and $5,000 (each per year going forward).
While we think equity markets will move sideways (in a range) for the next little while, we also are not going to be able to time the next growth leg accurately so that any change in asset allocation should be considered with long-term implications based on future cash flow needs.
That being the case I am happy to discuss your cash flow needs, the benefits of perpetual preferred shares and any other asset allocation issues whenever you have the time.
We are in a new era of heightened volatility caused by the many uncertainties currently permeating the global economy:
1) Fiscal Issues in Europe 2) Moderating economic growth in China and the US. 3) Rising interest rates and a declining housing market in Canada 4) Consumers more interested in saving 5) Record levels of corporate cash, sitting idle.
On April 29th I asked you if you were prepared for that volatility. If you were our clients you were.
The ETF SPY (S%P 500) dropped 17.19% from its high on April 26 to its low on July 1st.
Over this same time period our diverse and well-balanced model (60% Equity, 40% Bonds and Preferred shares) fell approximately 7.41%.
In fact, 2010 to date, the SPY is down 4.29%, the XIU (TSX 60) is down 1.92% and our model is up 2.16%.
Keeping volatility low in a portfolio is the key to capturing long term growth. The key to keeping volatility low is to have balance and diversity in a portfolio: Across asset classes, geographical economic zones, economic sectors and company size.
Keeping correlations between these different investments as low as possible, so that they do not necessarily move in concert with each other.
In his most recent Global Economic Monthly Review, Neil Soss, well-known economist at Credit Suisse suggests that the era of rare, brief and mild recessions experienced from the early 80’s to the mid 2000’s is over:
“expect …more frequent slowdown and speed-up scares” and “expect the slowdown scares to be scarier.”
In other words volatility is here to stay, so “buckle-up” and immunize your portfolio as best as is possible.
This is where our expertise lies: minimizing the impact of volatility, so that growth can be achievable.
We also look closely at the impact of taxes on a portfolio, maximizing the opportunity to reduce them and add value to the after-tax growth.
Make sure that you are maximizing all the opportunities available to you to get the growth that you need. We can help.
J. Scott Tomenson began his career in 1980 after receiving a BA (Economics) from the University of Western Ontario. Throughout the ‘80s and ‘90s, Scott specialized in risk management and the trading of fixed income products as Vice President at a number of investment dealers and banks, both in Toronto and New York.
Using his experience in understanding and managing risk, Scott began a wealth management practice in 1999, working with affluent families in the GTA. This practice evolved to specifically focus on private business owners and their families. J.S. Tomenson and Associates Family Wealth Management provided expertise in key areas of investment counsel and advanced planning.
In early 2010 Scott joined forces with Garth Turner to form Turner Tomenson Wealth Management Group. With their combined years of experience and expertise they offer a clients an unparalleled level of financial advice.
Scott lives in Toronto with his wife Mary and he is active in the community. His free time is spent fundraising for Cancer and Alzheimer’s support and research as well as coaching and playing hockey.