The coronavirus pandemic has been horrible on so many levels. It’s been horrible for the thousands of Canadians who have been infected, for the more than one million people who have lost their jobs and – like I need to tell you – it’s been horrible for your portfolio.
But here’s the good news: We’re constantly learning more about the virus, how to treat it and the most effective ways to contain its spread. These lessons will help us gradually re-open the economy and, ultimately, better prepare us for the next global pandemic.
What’s the connection with investing, you ask? Well, just as scientists and governments are learning important lessons, investors are getting a crash course in crisis portfolio management. In the spirit of taking something positive from a horrible situation, here are some key investing lessons we’ve learned.
Don’t sell into a panic
When the market is plunging, it can be tempting to sell your stocks to make the pain go away. But then what? After crystallizing your losses, you’ll be sitting on the sidelines wondering when it’s safe to get back in. By the time you work up the courage, you may have missed much of the recovery.
Investors who sold during the worst of the recent market meltdown are probably kicking themselves. From its Feb. 20 high to its March 23 low, the S&P/TSX Composite Index plummeted 6,7155.57 points, or 37.4 per cent. But by the end of April, the benchmark had recouped more than half of its point loss. As the economy re-opens and scientists find more treatments and possibly a vaccine for the virus, the market will likely continue to recover.
Instead of panic selling, a better strategy is to build a diversified portfolio of high-quality stocks and fixed-income investments and – as difficult as it may be – hold them through thick and thin.
Utilities are your friend
I’m a big fan of utilities and other companies with regulated or contracted cash flows, such as power producers, pipelines and infrastructure stocks. During a crisis, these stocks can provide much-needed stability.
Consider Fortis Inc., an electric and gas utility with operations in Canada, the United States and the Caribbean. The shares initially plunged with the rest of the market, but by the middle of this week they had clawed their way back to within 5 per cent of their pre-pandemic high. Other utilities stocks have also held up relatively well: Through April 30, the S&P/TSX Capped Utilities Index posted a year-to-date total return (including dividends) of negative 1.5 per cent, compared with a total return of negative 12.4 per cent for the S&P/TSX Composite Index.
“We expect the defensive attributes of the regulated utilities will cause them to hold up well even in a recession,” David Quezada, an analyst with Raymond James, said in a recent note. Another plus: Utilities, power, pipeline and infrastructure stocks offer well-covered dividends that rise over time. That’s why these companies account for roughly 40 per cent of my model Yield Hog Dividend Growth Portfolio (view it online at tgam.ca/dividendportfolio).
Don’t invest in things you don’t understand
“Has DFN suspended its dividend?” an anxious reader asked me recently. “I have owned it for many years and it is an important part of my income.” The reader was referring to Dividend 15 Split Corp. and, unfortunately, the class A shares – which had been yielding a risky-looking 13 per cent before the coronavirus hit – had indeed suspended distributions in March when the stock market collapsed.
Like many investors, this reader didn’t understand the risks of split shares. Such confusion is understandable, given that split share corporations offer two types of shares – split preferred shares and capital (or class A) shares – with vastly different characteristics. The split preferreds offer a modest payout and are relatively safe; they have first dibs on dividends spun off by an underlying portfolio of stocks and also get first claim on the capital of the underlying portfolio, up to a certain amount.
The class A shares, on the other hand, are more volatile. They are entitled to all of the value in the underlying portfolio over and above what the preferreds get. When times are good and the portfolio rises in value, the class A shares do well because they are, in effect, a leveraged play on the underlying stocks. But when stock prices plunge and the capital in the portfolio falls below a certain threshold, the class A shares are required to stop paying distributions (which are often funded by the sale of options on the underlying stocks). In such instances, the class A shares get crushed. Not only has DFN not paid a distribution for two consecutive months, but its share price as of April 30 was down about 44 per cent from its levels in late February. One way to avoid such nasty surprises is to stick with investments you understand.
Don’t forget fixed-income
When stock markets are surging, it’s easy to pooh-pooh fixed-income securities. Who wants to earn a measly 2 per cent annually when you can make many times that in stocks? It’s only when a bear market hits that investors wish they had more exposure to bonds or guaranteed investment certificates. Some investors can handle the volatility of an all-equity portfolio, but most are grateful for the stability that fixed-income provides. The lesson here is that you shouldn’t wait for a pandemic or other crisis to remind you that you have more equity exposure than you can stomach.
E-mail your questions to firstname.lastname@example.org. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
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