TAKING SOME RISKS IS FINE, BUT YOU STILL NEED TO PROTECT YOUR PORTFOLIO.

‘No question that liquidity is sacrosanct’

The longer the bull cycle, the greater the confidence and speculative activity as investors get more courageous about venturing outside their comfort zone, and this latest great run in global equity and bond markets has certainly rewarded such risk-taking.

Unfortunately, there are plenty of commission- based advisers in Canada that still get paid quite handsomely to feed into this speculation and, as a result, there is often no one to help protect an investor from making a bad decision. This is because there still isn’t a legal fiduciary requirement for Canadian investment advisers to act in the client’s best interest unless they are operating as registered discretionary portfolio managers.

There are plenty of examples of this dynamic, which, depending on the timing, didn’t turn out well for many.

For instance, a plethora of junior oilsands deals were sold to retail investors during the bull run in energy from the mid- 2000s through to 2014. Peak oil supply was the narrative and yet there were plenty of risks on the horizon, including a co- ordinated effort by environmentalists to constrain Canadian export capacity and, more so, the explosive growth of shale in the United States that resulted in an oversupplied market.

Those investments, and most if not all those junior oilsands companies, all came crashing down along with oil prices in July 2014.

Canadian brokers were quick to adapt though, shifting their focus to the launch of the cannabis sector. Shell companies were snapped up promising big returns in a few months’ time upon listing. However, there was little substance to many of these micro-companies other than a bit of land, maybe one or two facilities and one heck of a story to tell about how it was going to profit by getting a slice of a grossly overestimated market.

We wonder what happened to those micro- companies considering the carnage among the sector’s largest participants, with share prices more than halved and class- action lawsuits flying around.

Even more recently, the explosive growth in Canada’s shadow banking market has many looking to profit from the residential housing boom in Vancouver, Montreal and Toronto. Mortgages are being bundled up and sold to investors with the promise of high returns and lower risk levels.

There are some good managers out there operating in the sector, but also many bad ones, leaving it up to investors to undertake a thorough due diligence on the portfolio of mortgages being held and the quality of the managers overseeing them.

The other problem with excessive risk-taking, the resulting lack of liquidity, is an important one.

“If you don’t have ample liquidity, and it’s not durable, in times of stress, as you’re looking for liquidity, you’re forced to sell assets at declining prices, which then eats into your capital position, so it becomes this very, very negative cycle,” Ruth Porat, Alphabet Inc.’s chief financial officer, has said. “There’s no question that liquidity is sacrosanct.”

Risk and return go hand in hand and the more you sacrifice liquidity, the greater the risk. Although advisers may make it easy to get into a position, always remember to ask yourself if it will be as easy to get out of that position when conditions begin to deteriorate.

There is nothing wrong with a bit of speculation within one’s portfolio, but be cognizant of the amount of work involved, since it is ultimately up to you to weigh the returns against the risk potential. In the event you make a mistake, having some liquidity will go a long way to limiting the damage of that mistake.

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.