Mike Philbrick's Market Outlook
Mike Philbrick, president of ReSolve Asset Management
At ReSolve, portfolios are constructed to employ a number of different layers of diversification.
First, we allocate to a diverse universe of asset classes that thrive in different economic and inflationary regimes. Second, these asset classes are also diversified from a geographic standpoint, so that we can harvest growth (and positive returns) from all corners of the globe. Finally, we deploy capital towards different, uncorrelated investments strategies, to maximize the chance that we have a positive return stream at all times.
True diversification will become particularly important, given that today’s traditional and popular areas of investment offer potentially extended valuations and very low starting yields due to years of quantitative easing and central bank intervention.
For example, the S&P 500 saw historically low volatility in 2017. In fact, it was the second-least volatile year in the last 84 years (second only to 1964). Further, the S&P 500 also achieved the fourth highest Sharpe ratio (3.03) over the same time. Keep in mind the average Sharpe ratio for the S&P is about 0.50. So investors have become accustomed to receiving very high returns for the risk they’re experiencing, but after nearly a decade of carefully managed quantitative easing and artificially low interest rates, inflation and volatility seem to be returning to developed economies and this has the potential to “upset the apple-cart” for investors. Staying in harmony with the changing economic regime and inflationary paradigm is likely to require different core asset classes and approaches in the coming years.
So far in 2018, we’ve seen inflationary pressures mounting via increased consumer demand, full employment and what appears to be synchronized global growth. Combine that with the potential for a reduction in central bank accommodation and the development of increasing trade protectionism globally and you have the potential for a very different regime and resulting asset class risks and returns in 2018 and beyond.
This makes diversification of paramount importance. Make sure your portfolio contains or considers for allocation asset classes that have the potential to thrive in this changing and potentially inflationary environment. Unfortunately the average Canadian investor is quite under-diversified, with 59 per cent of their equity allocation in the country even though it only represents 3.3 per cent of the global market capitalization for stocks. This is known as the home country bias and is a form of extreme overconfidence and under-diversification. Given how other large Canadian investors with local pension liabilities approach this, it’s unlikely the retail investors here are optimal in their allocation.
ISHARES MSCI CHINA A ETF (CNYA.N)
China’s domestic “A” share stock market is the second-largest stock market in the world by market capitalization and the Chinese economy is the second-largest economy in the world. Yet, China’s “A” share market represents only 0.73 per cent of the MSCI Emerging Markets Index. The index is scheduled to begin increasing their allocation this month for the next 10 years to an anticipated 16.9 per cent by 2028. Basically, every global portfolio and portfolio manager in the world could be chasing China’s domestic stock market for the next 20 years. Finally, this stock market has an exceptionally low correlation to North American stocks, providing significant diversification.
ISHARES MSCI SAUDI ARABIA ETF (KSA.N)
The story here is very similar to the story with China. Saudi Arabia is the largest economy in the Middle East and the seventh-largest emerging market stock exchange. The FTSE indexes have already approved Saudi Arabia’s inclusion, and MSCI is expected to make announcements in this regard within the month. This has the potential to attract billions in additional global asset flows for Saudi Arabia’s stock market. Like the China “A” market, this stock market has an exceptionally low correlation to North American stocks, providing significant diversification.
HORIZONS GLOBAL RISK PARITY ETF (HRA.TO)
A global ETF portfolio covering over 95 per cent of investible assets, including regional equity indexes, government bonds, commodities, real estate and inflation-protected securities. The benefits of diversification are best realized when assets that derive returns from differing economic forces are held in a “risk-balanced” way. This leads to enhanced stability during changes in economic and inflationary regimes and is known as risk parity – a better global balanced fund. Risk parity (and diversification) is about preparation, not prediction.
RESOLVE ADAPTIVE ASSET ALLOCATION GROWTH COMPOSITE
Performance as of April 30, 2018
- 1 Month: 0.12% fund, 0.26% index
- 1 Year: 9.37% fund, 6.63% index
- 3 Year: 7.36% fund, 6.61% index
* Index: Benchmark consists of the following investable universe of low-cost ETFs in Canadian dollars: 45% Vanguard Total World Stock Market, 20% Vanguard Total Bond Market, 20% SPDR Barclays International Treasury Bond, 2% PowerShares DB Commodity Index, 2% SPDR Gold Shares, 3% iShares iBoxx $ High Yield Corporate Bond, 1.5% iShares International Inflation-Linked Bond, 5% SPDR Dow Jones Global Real Estate, 1.5% iShares TIPS Bond.
* Returns are after fees. Both index and composite include dividends.
TOP 5 HOLDINGS AND WEIGHTINGS
- SPDR Dow Jones Interntnl Real Estate ETF (RWX.US)
- PowerShares DB Commodity Index Treckng Fund ETF (DBC.US)
- SPDR Gold Trust (GLD.US)
- Vanguard FTSE Europe ETF (VGK.US)
- iShares 7-10 Year Treasury Bond ETF (IEF.US)