Volatility returned to the global markets in a meaningful way during the third quarter – we experienced the resurfacing of geopolitical issues highlighted by the threat of trade war between the US and China, a synchronized slowing of growth in the world’s major developed economies, a breathtaking rally in the yields of long-term US government bonds, as well as some temporary liquidity concerns in the overnight wholesale funding markets.
Bond yields fell across the global complex last quarter – The US yield curve (10 year – 2 year) flattened as the Federal Reserve lowered the key short-term interest rate twice in the quarter, with the policy range now set in the range of 1.75-2.00%. 10-year government bond yields are presently negative in Switzerland, Germany, Netherlands, Japan, and France.
Negative economic trends, inventory build-ups and geopolitical issues aside, monetary easing, led by the US and European central banks seem to be “Trumping” all other factors. We remain attentive to changes and prepared for various outcomes.
Despite the market’s barometer of volatility, the VIX index, reaching its 2019 high of 25 in early August, the quarter-over-quarter performance of most major asset markets were mixed and relatively muted given a strong reversion in September.
North American Equity markets Canada: TSX composite +2.56%, TSX 60 +2.79%, TSX Small Cap -1.31% US: Total Market +1.08%, S&P 500 +1.76%, Russell 2000 -2.33%
International Equity markets EAFE Developed: FTSE EAFE -0.85%, FTSE Europe -1.76%, FTSE Asia Pacific 0.35% Emerging: FTSE -4.13%
Bond markets Canada: Total Market +1.19% US: Total Market +2.34%, High Yield +1.29%, Short Govt +0.58%, Medium Govt
+2.76%, Long Govt +8.35%
USD Index +4.35%, CAD -0.88%, Yen -0.44%, Euro -4.35%
Broad Index -3.83%, Gold +4.26%
At Anchor Pacific, we employ a risk-based functional framework for capital allocation within the entire portfolio.
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 component to complement the core portfolio asset allocation. This tactical allocation bucket is comprised part of either risk-reduction or “risk offset” theme as well as opportunistic investments.
The tactically managed Risk Offset Portfolio (“ROP”) segment is the subject of this quarter’s Portfolio Spotlight.
The ROP 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.
The three asset classes that historically have provided non-correlated returns to equity markets and performed well during periods of amplified market stress are:
Long duration US government bonds
Japanese yen (versus the USD)
These distinct and liquid asset classes are non or negatively correlated to equities. They are also less correlated to one another, meaning that their co-movements are also distinct providing additional diversification and risk-reduction benefits to tactical inclusion within equity and balanced portfolios.
Correlation Matrix (monthly returns 3/07 – 9/19):
(Source – Portfolio Visualizer)
Long duration government bonds are typically most responsive to equity market stress due to global investors’ flight from risky assets to what is perceived as the highest quality asset (“flight to quality”) when the market becomes “risk-off”.
Physical gold tends to perform well during other periods of market disarray. Gold is often seen as a store of value when there is a crisis of confidence in the global “fiat currencies” where money printing and central bank intervention is perceived likely to increase purchasing power risk of these “fiat currencies”. Gold performed well during the 2008 crisis largely due to this fact. More recently, gold has performed well because the world is awash in low to negative bond yields – when interest rates are low, the opportunity cost of holding gold is lower as gold itself does not produce any cash flow or income for those that hold it.
The third “crisis alpha” asset is exposure to the Japanese yen. Due to persistent low-interest rates in Japan since the 1980s, the yen has long served as the world’s global funding currency – institutions have borrowed money in low-cost yen and invested in riskier assets denominated in other currencies, earning a risk premium and hence known as the “yen carry trade”. As market volatility leads to “risk-off”, these leveraged trades are unwound with investors being forced to buy back yen and thus creating a positive feedback loop for the yen and a negative feedback loop for investors that have funded with yen, meaning that the ultimate beneficiary of a mass unwinding of leverage in the global financial system will likely be the Japanese yen.
An equal-weighted portfolio of these three asset classes performed very well through the 2008 financial crisis and has recently begun to perform well relative to equities yet again. Performance over the longer-term suggests that there is a tactical element to the timing of entry and that valuation starting points do matter.
Annualized Returns (select periods):
(Source – Portfolio Visualizer)
Valuations at present suggest different degrees of risk from entering these trades now. We have substantially exited our long-term US government bonds given the significant decline in yields and rise in prices. We have a small allocation to medium-term bonds which will provide some benefit if yields continue to fall, yet will be less subject to price risk if they were to substantially back up, which is likely the next time markets definitively return to “risk-on”. Both gold and the yen appear to be a hold here – we view the longer-term outlook for gold as favourable while the yen appears to be a pretty low-risk insurance policy on global market financial stress.
Before December 24, 2019
1. Put tax-loss selling strategies to work
Harvest Capital Losses to offset realized gains in 2019 and three years previous. Examine spouse’s situation – advanced tax planning strategies can be used in certain situations.
Before December 31, 2019
1. Tax-Free Savings Account (TFSA):
Contribute to your TFSA. The TFSA limit for 2019 is $6,000.
Withdraw funds from your TFSA, rather than waiting until 2019, since a withdrawal in 2018 will be added back to your TFSA contribution room in 2019.
2. Registered Retirement Savings Plan (RRSP):
Consider withdrawing funds from your RRSP by year-end if you are in a low tax bracket for the 2019 tax year.
If you are age 71 this year, you must convert your RRSP to a RRIF by December 31 and begin taking minimum withdrawals next year. Consider the following:
Using your younger spouse’s age for minimum payment calculations.
Making an advance contribution to your RRSP by December 31 for earned income from this year, as you are still allowed to make a deductible contribution in the year you turn 71.
3. Make charitable donations
Donating qualifying securities instead of cash can increase your tax savings.
4. Contribute to your child’s or grandchildren’s Registered Education Savings Plan (RESP) or Registered Disability Savings Plan (RDSP)
5. Pay all tax-deductible expenses
E.g., investment management fees.
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 to deliver innovative, high-touch, and transparent investment programs across the full spectrum of asset owners and investment consumers.