Market Commentary
It goes without saying that the first quarter was one of the most challenging markets that many of us have ever experienced, with March proving to be the most volatile month ever in the history of US equity markets.
This sell-off marked the swiftest on record and absent emergency rate cuts, central bank liquidity, and a massive stimulus plan – things would have been much worse in both equities and bonds. While April has brought greener pastures to the equity markets, this COVID-19 situation is unprecedented and the economic outcomes are highly uncertain with respect to timing and what things will look like after stabilization and the workforce returns.
Although it might seem the case, all investment portfolios are not built the same and a market such as the one we are presently encountering is certain to expose weaknesses and structural flaws which will likely prove costly if not properly addressed.
At Anchor Pacific, we have been cautious on equity markets, both public and private, which had been overvalued for some time. We have observed investors indiscriminately chasing return and income with little to no regard for risk. Lastly, we have observed what we would characterize as “a false comfort from diversification”, meaning that portfolios, while touted as diversified really, weren’t, especially under the severe market stress we experienced.
With this paradigm shift, risk management will matter once again and with market volatility likely to remain elevated, now and not later is the time to take a hard look at asset allocations, measure true liquidity within portfolios and critically assess existing private strategies such as real estate and private equity and lending.
The good news is that there is going to be a significant opportunity to achieve equity-like gains in many areas of the credit markets, especially in the structured markets where future distressed selling is likely to take place as more leverage gets unwound – we have significant experience with these sectors and are presently preparing to position client portfolios accordingly.
This is not our first financial crisis nor will it be our last – both Steve and Jon each have in excess of 25 years of protecting and preserving capital through multiple periods of financial stress. Disciplined risk management (framework, structure and process) and intelligent diversification (via portfolio construction) remain one’s best edge in a market such as this. Capable and competent leadership and a high level of technical expertise are of tantamount importance in successfully reaching the other side.
Our adaptive multi-asset portfolios are designed to provide durable returns and reduce risk – these traits buffered our investors and are more needed than ever in today’s new economic reality. As always, we remain attentive to changes and prepared for a range of outcomes.
Market Performance
There were very few bright spots in the quarter excepting US Treasuries, USD and duration/interest rates. The good news is that valuations are now much more attractive as all risk assets cheapened substantially. For the first time in recent years, most global equity markets are now cheap to their historical Cyclically Adjusted Price Earnings Ratios (CAPE) per Research Affiliates. The problem is the economic uncertainty as a result of COVID-19 and whether the “E” in earnings is actually relevant. Credit markets cheapened considerably relative to equities and there are many compelling opportunities to achieve equity-like gains given the margin of safety built into present valuations.
North American Equity Markets
Canada: TSX composite -21.10%, TSX 60 –18.62%, TSX Small Cap -37.94%
US: Total Market -20.84%, S&P 500 -19.43%, S&P 500 (C$) -13.11%, Russell 2000 -30.65%
International Equity Markets
EAFE Developed: FTSE EAFE -23.99%, FTSE Europe -25.66%, FTSE Asia Pacific -20.70%
Emerging: FTSE -24.41%
Bond markets
Canada: Total Market -0.24%, IG Credit -5.00%
US: Total Market +3.09%, Short Govt +2.72%, Medium Govt +10.50%, Long Govt +22.16%, IG Credit -2.97%, High Yield -12.75%
Currency Markets
USD Index +3.31%, CAD -7.68%, Yen +0.87%, Euro -1.88%
Commodity Markets
Broad Index -42.63%, Gold +3.6%
Global Equity Market Valuations – Valuations and Total Risk Returns:
(Source – iShares US, Blackrock, Research Affiliates)
Global Equity Market Valuations – Price Earnings Ratio:
(Source – iShares US, Blackrock, Research Affiliates)
Portfolio Spotlight
At Anchor Pacific, we employ a risk-based functional framework for capital allocation within the entire portfolio.
Beginning in Q4 2019, we officially introduced our Model Portfolios (or “Portfolio Groups”), which are designed to mirror the different respective components of each client portfolio and deconstruct the drivers of return for various functional risk category groups.
The 3 main Portfolio Groups that comprise the long-term core multi-asset portfolio are:
The AP-CIO Capital Growth Portfolio (the “Capital Growth Portfolio”)
The AP-CIO Stable Portfolio (the “Stable Portfolio”)
The AP-CIO Capital Preservation Portfolio (the “Capital Preservation Portfolio”)
Each of the Portfolio Groups is generically exposed to these risk factors to the following degree:
Weights to each Portfolio Group are specific to each particular client’s unique risk tolerance, time horizon, and liquidity needs, as well as the firm view of risk and return expectations for specific asset classes and strategies over the near, medium and long-term.
The AP-CIO 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 and is the subject of this quarter’s Portfolio Spotlight.
The Stable Portfolio is almost exclusively actively managed and is designed to target a long-term annualized full-cycle rate of return of CPI + 1.5-3.0% with an expected standard deviation of returns of 6-9%.
The three sub-sets of the Stable Portfolio are the AP-CIO Risk Managed Equity Portfolio (the “Risk Managed Equity Portfolio” or “RMEP”), the AP-CIO Absolute Return Portfolio (the “Absolute Return Portfolio” or “ARP”), and the AP-CIO Managed Income Portfolio (the “Managed Income Portfolio” or “MIP”).
The AP-CIO 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 AP-CIO 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 AP-CIO 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 MIP holds both “growth-oriented income” strategies as well as higher-yielding income dominant or “yield alternative” strategies.
The Stable Portfolio returned -9.76% during the first quarter, outperforming its Reference Portfolio (the “Reference Portfolio”) (-11.55%) by 1.79%. This was accomplished while undertaking less risk than the Reference Portfolio.
*Standard deviation of monthly returns and beta with respect to the S&P 500 Index (in USD) based on a three year backtest from April 1, 2017 to March 31, 2020.
1. The Stable Reference Portfolio is a blend of the following Exchange-Traded Funds: 35% iShares Core S&P/TSX Capped Composite Index ETF (XIC.TO), 35% iShares Canadian Corporate Bond Index (XCB.TO), and 30% Horizons Morningstar Hedge Fund Index ETF (HHF.TO)
We are pleased with the relative outperformance in what was without question the most challenging quarter we have ever experienced in our lengthy investment careers. Every holding in the Stable Portfolio has been strategically selected with intention and an overall portfolio purpose – the combination of risk-managed, low volatility, actively traded, and arbitrage strategies create a very strong equity market defensive position that is intended to prove resilient over time and enable the Stable Portfolio to act as a ballast in stormy waters. Client allocations to the Stable Portfolio are significant (40-45% of total) with additional money allocated in the second quarter at the expense of the Capital Growth Portfolio, as we foresee higher expected returns and more embedded protection versus the equity markets which we view as overpriced with considerable downside risk.
As of March 31, 2020, the Stable Portfolio consisted of 14 unique holdings across 10 differentiated sub-strategies. In the second quarter, we have subsequently adjusted our exposures by adding to Fixed Income Credit Relative Value, Global Macro, Arbitrage, and Equity Long Short while reducing within Short-Term Direct Lending, Canadian Equity, and Tactical strategies.
The firm’s model portfolios were established on October 1, 2019. The model portfolios are hypothetical investment portfolios used to showcase how we believe asset allocation may be used within the context of a client portfolio. The models also provide a basis with which to measure the quality of our advice and the effectiveness of our disciplined investment strategy. However, implementation assumptions (which may include but are not limited to the timing and diligence with which the portfolio is rebalanced, the execution price for securities transactions, and any trading and account-related costs, fees, or commissions) have been made when calculating the model returns that may be difficult or impossible for any investor to exactly replicate the model portfolios. For this reason, there is no expectation that the model returns will replicate the actual performance of any client following the same guided portfolio strategy. Performance figures are net of fund level expenses and fees but do not include any allowance for Anchor Pacific’s Investment Management Fees. Past performance is not indicative of future performance.
Model Portfolios
Beginning in Q4 2019, we officially introduced our Model Portfolios (or “Portfolio Groups”), which are designed to mirror the different respective components of each client portfolio and deconstruct the drivers of return for various functional risk category groups.
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 Equity” 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.
Here are the respective Model Portfolios we are maintaining and tracking going forward:
Additionally, we will be maintaining the AP-CIO Balanced Risk Portfolio, which represents an all-encompassing multi-asset client portfolio proxy for a typical client having a risk profile suggestive of a long-term asset allocation of 60% equities and 40% fixed income.
As of March 31, 2020, the AP-CIO Balanced Risked Profile held the following constituents:
AP-CIO Model Portfolio Performance Summary:
Returns for periods ended March 31, 2020
*Since inception return from October 1, 2019.
**Standard deviation of monthly returns and beta with respect to the S&P 500 Index (in USD) based on a three year back test from April 1, 2017 to March 31, 2020.
The firm’s model portfolios were established on October 1, 2019. The model portfolios are hypothetical investment portfolios used to showcase how we believe asset allocation may be used within the context of a client portfolio. The models also provide a basis with which to measure the quality of our advice and the effectiveness of our disciplined investment strategy. However, implementation assumptions (which may include but are not limited to the timing and diligence with which the portfolio is rebalanced, the execution price for securities transactions, and any trading and account-related costs, fees, or commissions) have been made when calculating the model returns that may be difficult or impossible for any investor to exactly replicate the model portfolios. For this reason, there is no expectation that the model returns will replicate the actual performance of any client following the same guided portfolio strategy. Performance figures are net of fund level expenses and fees but do not include any allowance for Anchor Pacific’s Investment Management Fees. Past performance is not indicative of future performance.
Portfolio Planning
CORONAVIRUS AND YOUR MONEY
The economy is in shock and governments around the world are taking unprecedented steps to limit the damage. However, there are beginning to be conversations around how the economy will come back online.
On March 18, 2020, the Canadian government pledged a whopping $82 billion in direct aid to shore up the economy. Since that date, not a week has gone by without another Federal Government announcement. We are seeing an unprecedented Fiscal and Monetary response by the Government.
We, also, should also take this time to think of our personal finances. Here are some of the things you should be thinking about now and for the future as we adapt to our “new” normal:
YOUR EMERGENCY FUND
These are the times that an Emergency Fund is designed for. It is recommended this fund be large enough to meet about 6 months worth of your expenses. When life and the economy return to normal, please make sure to re-establish this pool of money. It’s in precisely times like this that a cash hoard like this one comes in handy.
FILE YOUR TAXES AS SOON POSSIBLE
If you are expecting a refund, file ASAP. Don’t let the government hold your money any longer than necessary.
CUT YOUR EXPENSES
Do away with non-essential spending and look for ways to reduce your spending since nobody knows how long we are in this for.
Here are some money-saving ideas to get you started:
TAKE ADVANTAGE OF LOW-INTEREST RATES
Rates are trending down as the Bank of Canada continues to intervene by cutting the benchmark interest rate.
The Big Banks may soon be back to essentially offering 0.00% (or something close) on your savings account.
While rates are low:
1. It is cheaper to borrow. If you are looking to consolidate higher-interest credit card debt, this could be a great time to save money by using a low-interest personal loan to pay off your balance.
2. Refinance your mortgage at a lower rate if it makes sense after factoring in any penalties arising from breaking your mortgage contract.
WATCH OUT FOR FRAUD
The unscrupulous ones among us do not take a break, even in times of crisis. Scammers have been trying to exploit people’s fears during the coronavirus pandemic.
Here are some steps to take in order to keep scammers at bay:
1. Do not click on links in emails and texts from unknown sources.
2. Get your updates from reliable government sources.
3. Do not jump at offers to make a quick buck and generate high returns.
4. Avoid fake news and products that promise to detect, treat or cure the coronavirus.
5. Do not give anyone your SIN or credit card information unless you are confident they are legit.
6. Be wary of charity scams.
7. Watch out for deceptive adverts online.
CLOSING THOUGHTS
Whether you are an existing client or a prospective one, we are here to help you manage through this crisis by being a resource and strategic advisor partner in any way we can:
1. We will provide accurate information
2 Deliver unbiased advice
3. Act with accountability
4. Be your “one watchful eye”
5. Maintain discipline and keep to a well thought out plan
Now is the time to assess (or reassess) everything – your financial plan, your business plan, your capital structure, your succession plan, your portfolio, and to really evaluate your team of advisors (or consider having one).
Download the complete First Quarter 2020 Newsletter:
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.
To learn more about how Anchor Pacific can help you shelter, protect, and grow your money, contact us at 604-336-9080 or info@anchorpacificgroup.com
