Five ways to fine-tune your portfolio
After being spoiled for most of the year, markets are starting to show some signs of weakness on economic concerns over an escalating trade war between the U.S. and China.
During the past month, oil prices have sold off 10.5 per cent while the MSCI Emerging Markets index is down 8.7 per cent. The S&P 500, MSCI EAFE and S&P TSX are down 3.5, 2.5 and 2.2 per cent, respectively.
It’s important to realize that near-term volatility is to be expected when investing but it must also be managed accordingly.
Unfortunately, many interpret this to mean trying to time the market or chasing returns in the segments that are outperforming, both of which can add further uncertainty into your portfolio design. Instead, there are things your adviser or portfolio manager can be doing to at least try to mitigate factors such as risk drag and an adverse pattern of returns, both of which are driven by shortterm portfolio volatility and can have a significant effect on your portfolio’s performance.
Here’s a look at five steps your adviser can take.
Ignore low yields and add bonds
Although interest rates and bond yields remain at record lows, having at least a small allocation to fixed-income securities can help manage your portfolio’s ups and downs. Looking back over the past 15 years, if one added in a small weighting (30 per cent) to bonds it only reduced the annual return by 50 basis points but, importantly, lowered the annual standard deviation by 4.6 per cent.
Take flight and look abroad
BlackRock did an informative piece this time last year showing that by adding in global equities (S&P 500, MSCI EAFE and emerging markets) into a Canadian portfolio, it boosted the annual return by nearly one per cent over the past 10 years while reducing the annual standard deviation by nearly 75 basis points. Over the longer-term (20 years), while the return benefit was lost, the annual standard deviation fell by nearly 1.85 per cent.
Don’t be afraid of going downmarket
Adding in some mid-caps, small-caps and micro-caps can also improve a portfolio’s risk-adjusted performance. Going back to 1972, we calculate that the rolling 15-year returns for an entire S&P 500 portfolio was as high as 18.7 per cent and as low as 4.1 per cent. However, by allocating half of the portfolio to mid-, smalland micro-caps, it boosted the range of returns to between 20.1 per cent and 6.5 per cent.
Green houses and red hotels
Adding some REITs into a broader portfolio can also be a great diversifier with most having a correlation as low as 0.5 to regional equity markets. For example, by adding a 10-percent REIT weighting into an all equity portfolio (S&P 500) we calculate it boosted the annual return (since 1994) by 20 basis points and reduced the annual standard deviation by nearly 40 basis points. We ran the same analysis (back to 2003 due to data limitations) on the S&P TSX and found similar results.
Add some boring into your portfolio
A 2012 Vanguard study showed those stocks that exhibited a lower volatility out of a composite of the largest 1,000 by market capitalization (December 1979 to September 2012) posted vastly superior relative returns to those with the highest volatility. This is counterintuitive as investors are often drawn to those companies that are gaining a lot of market attention. But that higher volatility can cause considerable damage to a portfolio during a market correction. While these approaches to managing risk are not rocket science, they are unfortunately not ubiquitous in the industry. It is worth checking to see if they are being employed in your portfolio.
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.