Don’t miss the forest for the trees

Strategies to reposition your portfolio

Stock investors are currently witnessing one of the most powerful stock price advances in history. In just six short months, the Canadian stock market has rallied a full 50 per cent off the lows seen in March of this year. Although not back to pre-crash levels, equity prices have staged a remarkable comeback, despite the backdrop of a contracting economy, decreasing exports and growing unemployment. The unprecedented and enormous global stimulus programs, record-low interest rates and the perception that the financial system has avoided a broad collapse have all been fodder for this tremendous rally.

Now that the dust has seemingly settled and many investors’ portfolios have rebounded to more palatable levels, it would seem an appropriate time to reflect on last year’s market meltdown and look at new strategies. Investors now have the opportunity to reposition their portfolios to survive and thrive through heightened volatility, increased correlation between investments and the potential for another global shock to the system.

For the majority of stock investors (both individual and institutional), investment decisions have been guided predominately by the tenants of the two major investment styles: “value” and “growth”.

Value investors focus on finding undervalued stocks, which have been temporarily shunned by investors, and patiently wait for the market to realize what they had so diligently discovered—the stock’s intrinsic value. Growth investors, on the other hand, focus on the stocks of companies whose business is rapidly expanding, have earnings growth momentum and perceived above-average future earnings prospects.

As one can see, both of these investment styles focus on the minutia. The investment decisions for both are focused on the individual stocks; of less importance is the big picture, the macroeconomic flows. Portfolio protection, in either case, is predominately found through diversification into different sectors of the economy and/or through investing abroad in international markets. These approaches have provided good protection when markets behave, meaning when markets act independently and historical correlations remain intact.

Unfortunately, traditional trends seem to be changing. We live in a far more global economy than at any other time in history. Information, capital and risk have never been able to flow across borders with such speed. This realization presents new and formidable challenges for today’s investors. Through this present downturn, many investors witnessed these traditional diversification techniques provide little of the protection that was supposed to be built-in.

Having investments in different sectors, market caps or countries didn’t help as international markets were highly correlated and the failure of a single sector (financials) concentrated in a variety of global institutions threatened the viability of businesses everywhere. The events of 2008 and 2009 illustrated just how large and potentially damaging market risk is to a portfolio with a high weighting to stocks.

If the solution was simply to reduce the weighting of stocks and “de-risk” your portfolio, this may be the end of the discussion. Unfortunately, there are countless risks carried by all asset classes and the macro forces that trigger these risks are dynamic and in constant flux.

The current efforts of central banks in keeping interest rates at generational lows are just one example. Portfolios with a high weighting towards cash, although perceived to be safe, can in fact lose their purchasing power due to the effects of inflation. So, although they may be safe in nominal terms, the longer they remain in cash—providing virtually no return—the less purchasing power they will ultimately have. As another example, it is these same low interest rates that have made bond investing the winning trade over the past couple of years. Recent bond performance is tenuous and probably fleeting as governments must eventually reverse course and begin winding down their support for the market by raising interest rates, causing lower bond prices. Couple these dynamics with new worries—many of which are byproducts of the massive interventions on behalf of central banks and governments to combat this downturn—and it becomes very difficult to name a static policy that doesn’t face future risks.

What we are approaching, here, is an argument for needing a more macroeconomic outlook and a more flexible, dynamic approach to the allocation of capital to the three main asset classes: stocks, bonds and short-term investments. Although this approach goes directly against the buy-and-hold adage, there are strong arguments that it can provide investors with the tools necessary to reduce risk and protect capital in difficult environments, as well as provide growth during rising markets. Beyond the intuitive opportunities that are apparent, a comparison of Canadian tactical allocation funds and static balanced funds over the past three years has shown the former to have a higher annualized return and lower standard deviation, which is the common risk measurement metric.

For investors, there are a few options available to implement this type of approach. The first would be for the individual investor to attempt to manage these strategic changes themselves. This is clearly the riskier approach and requires the individual to gain the necessary insight and actively manage his or her own account. The second approach would be to invest in an actively managed balanced mutual fund. There has been recent growth in this segment and a cursory search turned up in excess of 20 different options for Canadian investors. Balanced mutual funds that use an active approach like this are typically labeled as “tactical asset allocation” funds. The final option for investors is to invest through an investment counsel firm that subscribes to a “top-down” or active investment philosophy. These firms typically have larger investor minimums due to the regulatory restrictions of investing in pooled or discretionary accounts, however, their fee structures are usually much lower than traditional retail mutual funds. The latter two options both put the portfolio decision in the hands of a portfolio management team with broad resources to monitor the markets on an ongoing basis.

Although stock picking philosophies have their place as a means of selecting individual stocks to include in the equity portion of a portfolio, there are clear risks when these approaches are coupled to a static management approach. These dangers appear to be intensifying due to the growing linkages in our global capital markets. With the tremendous equity market rally that has somewhat resuscitated the value of investor’s portfolios, this reprieve may offer investors a window of opportunity to re-evaluate their own portfolio approach. Too often, investing discourse is focused on the merits of individual stocks; the events of 2008, however, have shown us the dangers in missing the forest for the trees.

Sean Weaser is a principal and analyst at Integra Capital Corporation ( and can be reached at