The fourth quarter saw global markets reaccelerate higher, further extending 2019’s impressive gains. Positive developments with respect to the US-China negotiations on trade combined with the continuation of global central bank easing, led by the US Federal Reserve, which gave in to political pressure and reversed course mid-year, and the European Central Bank, which has done everything in its power to stimulate their economy with little success.
Global equity markets climbed yet another wall of worry in 2019, largely due to the resumption of easy central bank-led credit conditions. However, the majority of the increase in valuation for equity markets came from multiple expansion. With valuations for most assets stretched, fair to middling economic growth, trade and geopolitical issues, and now the coronavirus, caution is warranted. We are in the extra innings for this recovery and central banks keep extending the party – while we are not predicting an imminent recession (we actually don’t make predictions), we are reasonably confident that a repeat of the past year’s outsized gains is highly unlikely for 2020.
Prior to the second half of the year’s strong performance, our long-term expectations for global equity markets were for returns of around 5.50% with traditional bonds at 2.50%. We would likely fade the expectation for equities while keeping bond return expectations unchanged. Discipline (process) and diversification (portfolio construction) remain one’s best hedge in a market such as this, with intelligent diversification being one of investing’s only free lunches.
Our adaptive multi-asset portfolios are designed to provide durable returns and reduce risk, traits that our investors both value and need in a low return, richly priced, and fragile economic reality. As always, we remain attentive to changes and prepared for a range of outcomes.
Strong quarter for risk assets with underperforming sectors catching up considerably in Q4 – International equities, both developed and emerging, as well as commodities, partly driven by USD weakness. US Small Cap performance was very strong: +9.87% for the quarter, +25.4% YTD, yet flat from the end of Q3 2018, and remains very expensive with a Cyclically Adjusted Price Earnings Ratio (CAPE) of 53, placing it in the 92nd percentile historically per Research Affiliates.
North American Equity markets
Canada: TSX composite +3.16%, TSX 60 +2.40%, TSX Small Cap +6.72%
US: Total Market +8.95%, S&P 500 +8.98%, S&P 500 (C$) +6.78%, Russell 2000 +9.87%
International Equity markets
EAFE Developed: FTSE EAFE +8.33%, FTSE Europe +9.92%, FTSE Asia Pacific +6.95%
Emerging: FTSE +11.86%
Canada: Total Market -0.74% IG Credit -0.09%
US: Total Market +0.13%, Short Govt +0.42%, Medium Govt -1.43%, Long Govt -4.67%, IG Credit +1.45%, High Yield +2.54%
USD Index -2.25% CAD +2.19%, Yen -0.59%, Euro +2.65%
Broad Index +7.71%, Gold +2.90%
Global Equity Market Valuations – Price Earnings Ratios:
(Source – iShares US, Blackrock, Research Affiliates)
At Anchor Pacific, we employ a risk-based functional framework for capital allocation within the entire portfolio.
We make use of strategic/functional category and sub-category buckets that in-turn utilize underlying asset classes and strategies, with each functional category (sub-category) designed to achieve a certain outcome or goal and/or be exposed to a specific set of macroeconomic risk factors amongst the different strategy and asset class types. The sum of these parts equals our long-term core portfolio or Strategic Asset Allocation (SAA).
Because an optimal asset allocation evolves through time in response to changing economic circumstances and volatile market prices, Anchor Pacific also dynamically manages a tactical (or satellite) component to complement the core portfolio asset allocation. This tactical allocation bucket is for the most comprised part of an opportunistic theme and a risk-reduction or “risk offset” theme.
Beginning in Q4 2019, we officially introduced our Model Portfolios, which are designed to mirror the different respective components of each client portfolio and deconstruct the drivers of return for various portfolio components. This helps us to become more informed risk managers internally as well as helping us with our external communication to clients regarding portfolio performance – in other words, what worked well and perhaps less so, which then drives second-level analysis of why something occurred (was it expected, was it the result of something we missed, was it something that changed or was it a random outcome?).
While not every client will have the same holdings in the same percentages as the Models, and there is some level of uniqueness to each client portfolio, each client’s holdings within the “Global Public Beta” category should more or less track the performance and risk of its respective Model. It is our intention to maintain these Models internally as an index with a set of rules, features, and objectives, for maintaining, tracking and reporting on their performance in these quarterly commentaries. While many of the constituents of these Models have been used in client portfolios dating back to our inception in 2016, it is important to emphasize that the returns presented here are not the actual returns that any client received but what would be reasonably expected to be received by client maintaining an allocation to this Model (on a gross of advisor fee and transaction fee basis).
Here are the respective Model Portfolios we will be maintaining and tracking going forward:
The Capital Growth Portfolio consists of a spectrum of strategies and assets largely exposed to changes in global economic growth and corporate profitability.
The Global Public Beta Portfolio is a sub-set of the Capital Growth Portfolio, and consists exclusively of low cost passively managed investments seeking exposure to global public equities – the Portfolio is managed in both CAD and USD.
The Stable Portfolio consists of a spectrum of growth, income, and risk-managed strategies and assets that exhibit expected returns close to that of global public equities but experience lower levels of volatility.
The three sub-sets of the Stable Portfolio are the Risk Managed Equity Portfolio, the Absolute Return Portfolio, and the Managed Income Portfolio.
The Risk Managed Equity Portfolio employs strategies with the flexibility, expertise and structure to invest in strategies utilizing equities in some form of hedged or other manner designed to reduce or manage risk.
The Absolute Return Portfolio employs strategies with the flexibility, expertise and structure to invest in strategies utilizing asset classes other than equities, in some form of hedged or other manner designed to reduce or manage risk.
The Managed Income Portfolio employs various strategies designed to provide income with long directional exposure to various market risk factors that collectively are expected to experience lower levels of volatility than long-biased passively managed portfolios.
The Capital Preservation Portfolio consists of strategies and assets largely exposed to changes in interest rates and/or inflation and is meant to protect principal and provide stable returns during all phases of the market cycle.
The Tactical Risk Offset Portfolio, which was the subject of last quarter’s Portfolio Spotlight is structured to invest in the asset classes and strategies that are anticipated to perform well when returns from the equity market risk premium are negative for an extended period of time. This is because said strategies are exposed to either systematic or non-equity market-based risk premiums that have typically performed well during periods of market stress.
Model Portfolio Performance Summary:
Ringing in the New Year has a long tradition in Canada. Our country’s first recorded celebration of the New Year occurred on January 1, 1646 in Chateau St. Louis, Nova Scotia. In addition to celebrating the New Year and sharing good wishes, the occasion was also marked by a renewal of The Pledge of Allegiance to the Crown. Today we celebrate by forming New Year’s resolutions. The first month of the year marks a great time to start planning your finances and taking charge of your money.
We list six important financial steps you can take to begin 2020 – as you move to implement your New Year’s resolutions, this checklist will help you focus on some of the key financial matters to consider:
1. CONTRIBUTE TO YOUR TFSA
The Tax-Free Savings Account (TFSA) is one of the best vehicles we have in Canada for saving money. For 2020, the TFSA contribution room remains at $6,000. If you have been eligible to contribute to a TFSA since it was introduced in 2009, your total contribution room is now $69,500. A TFSA account is very flexible. You can use it to save for anything – wedding, home down payment, vacation, emergency fund, etc. You can withdraw your funds whenever you want and re-contribute the amount you withdrew in a future year. No taxes are due on earnings generated by your account unless you run afoul of the rules put in place by the government. The sooner you start contributing to your TFSA, the faster it will grow.
2. CONTRIBUTE TO YOUR RRSP (including Spousal contributions)
RRSP contributions are tax-deductible and will save you on taxes today while allowing you to grow your retirement pot. For 2020, your RRSP contribution limit is 18% of your earned income, up to a maximum amount of $27,230. If you have not yet maxed out your contributions for the 2019 tax year, you can still do so up until the end of the RRSP season, which is March 2, 2020. Contributions made until the deadline can be used to claim a tax deduction for the 2019 or 2020 tax years. It can also be carried forward to future years. If you are turning 71 in 2020, you can make your last RRSP contribution before December 31, 2020. By next year, you will be required to close your RRSP and do one or a combination of the following: withdraw cash, convert to an RRIF, or purchase an annuity. Your RRSP is not only for retirement. You can also withdraw funds tax-free to buy a house or go back to school.
3. CONTRIBUTE TO AN RESP (or start one)
College tuition keeps rising and a Registered Education Savings Plan (RESP) is one way to provide your children with an opportunity to obtain post-secondary education without the debt. Contributions you make to your children’s RESP qualify for matching government grants at 20 cents for every $1 of contribution, up to $500 in grant money per year (i.e. grant on $2,500 in annual contributions). You can place up to a lifetime maximum of $50,000 per child in an RESP account that qualifies for a maximum Canada Education Savings Grant of $7,200. Low-income families may qualify for additional grant money (a-CESG and Canada Learning Bond). As funds within an RESP are tax-free, it is advisable to start contributing to RESPs early so that compound interest and earnings can accumulate within the account on a tax-free basis over as long a period of time as possible.
4. PAY OFF DEBT
It is never too early to start thinking about paying off loans, particularly credit cards and other forms of high-interest debt. Create a budget that allows you to set aside specific amounts of money every month to settle your debt obligations. Consider paying off credit card debt before saving/investing in a TFSA or RRSP. This is because interest rates on credit cards can reach 20% or more, exceeding any realistic returns you can expect on your investments.
5. TAX FILING FOR 2020
The tax-filing season will soon be upon us. For most Canadians, the deadline for filing your 2019 taxes is April 30, 2020. For self-employed individuals, the filing deadline is June 15, 2020. Discuss a tax planning strategy with your financial advisor and your tax advisor. Make sure to utilize all the tax deductions you qualify for and don’t leave money on the table. There are many free options for filing your taxes in Canada and you should do so early so you can put your refund money to work right away!
6. AUDIT YOUR INVESTMENT PORTFOLIO
If you forgot to audit your investment portfolio at the end of last year, it’s time to get on it. Two important things to note:
Re-Balancing. If you are a DIY investor and invested in ETFs or index funds, you will need to re-balance your portfolio 1-2 times a year. This is to ensure that your asset holdings are still in line with your investment goals and risk tolerance.
Fees. Fees matter and can cut into your investment returns. However, not all fees reduce your long-term returns. Understanding and peeling back the layers of fees paid for investments is of extremely high importance. Advisor fees that provide financial and tax planning advice, and portfolio construction and risk management have been demonstrated to benefit individuals. At the implementation level, active managers who add value through quantifiable higher returns, diversification benefits, or access to otherwise inaccessible investment opportunities may justify the fees. Auditing your portfolio to understand and take advantage of these benefits is an essential annual task.
When you start the new year by charting your financial goals and how you aim to reach them, chances are that when you do your end-of-year financial review, you will have met most (if not all) of them.
Anchor Pacific Investment Management Corp. (“Anchor Pacific”) is a Vancouver, BC based portfolio management firm, which leverages process, technology, and infrastructure to democratize the process of managing endowment and pension style investment portfolios and deliver innovative, high-touch, and transparent investment programs across the full spectrum of asset owners and investment consumers.