With markets being as volatile as they have been this year – the S&P/TSX Composite Index is down 3.5 per cent year-to-date – investors are no doubt feeling queasy. It’s hard to blame them: low interest rates have caused many Canadians, who still want high returns, to take on much more risk.
Many investors, and especially boomers, still think that the 7 per cent annual returns they netted in the 1990s are the norm. Even those who have been invested in equities over the last few years have become accustomed to rising markets. But with bond yields still near all-time lows, equities becoming more expensive, and many baby boomers approaching retirement, ideas around risk and reward need to change.
“Those who haven’t reframed their return expectations likely have a portfolio that’s become much higher risk,” says Kristi Ashcroft, senior investment director of fixed income at Toronto’s Mackenzie Investments. “Two decades ago you could get a 7 per cent return in a low-risk bond portfolio. That’s not the case today.”
Investors, in general, have been buying riskier assets since the recession, with the hopes of generating higher returns, she says. More portfolios are invested in high-yield bonds, alternative assets such as real estate and private equity, and overall, people are owning more stocks than they used to.
“To get a 7 per cent return today, your portfolio likely has almost three times the risk than you would have had 25 years ago,” says Ms. Ashcroft.
People are focused on returns for good reason, she adds – they see that number when they get their statement, unlike risk, which only shows its face when the market falls.
Find the right balance
People don’t need to dramatically alter their expectations, but they do need to pay attention to the risk they’re taking to achieve those returns – or that queasy feeling could turn into full-blown nausea the next time the equity markets take a downturn.
Finding that risk-reward balance, where an investor can still earn what they need without feeling pangs of panic, is still possible, but requires a more sophisticated portfolio construction than before, and can be difficult to achieve on one’s own. Investors think a portfolio of 60 per cent equities and 40 per cent bonds is diversified, but stocks still account for a significant portion of that portfolio’s risk – even if the allocation seems balanced, says Ashcroft.
De-risk with diversification
One key to risk mitigation is, and always has been, diversification, but ideas around portfolio construction have changed over the years, along with greater access to technology that allows for more complex modelling of portfolio characteristics, says Ashcroft. Now, portfolio managers and advisors can take a much more precise approach to determine an ideal asset mix for a given risk and return target, and maximize the benefits of diversification.
For instance, when Mackenzie’s Asset Allocation team, led by portfolio manager Alain Bergeron, is constructing multi-asset portfolios – funds with various risk profiles that allow investors to zero in on the risk-reward balance that suits them best – it starts by looking at strategic asset allocation, or the long-term mix of exposures across different asset classes and geographies.
“They look at the correlations among different asset classes and the long-term risk and return characteristics,” says Ms. Ashcroft. “The goal is to assemble a mix of exposures that we believe offers the optimal return for risk trade off.”
The team also uses other aspects of active management to carefully choose where and how to take risk. It decides if it wants to make short-term tactical changes to its positioning based on current market conditions and opportunities, she says. For instance, if the team feels that there are more buys in Europe than Canada, then it might move some of its allocation from Canada overseas.
Finally, Mackenzie’s team relies on the expertise of portfolio managers who use rigorous bottom-up analysis to look for opportunities to invest in companies that will deliver an attractive return for reasonable risk.
“Picking good companies to invest in is really at the core of what we’ve always done at Mackenzie, and can be an important component of mitigating risk in a portfolio,” she says. “We can leverage that expertise and combine it with sophisticated portfolio construction to deliver superior results. When we take risk in the right way, we believe the performance will follow.”
Delivering better outcomes
Considering risk and return requires one to become more outcome- oriented with their investment objectives.
For instance, those who still want to achieve a 7 per cent return may be able to do that, if they understand the risk and the range of possible outcomes that portfolio may generate. But Mackenzie also has balanced portfolios that can achieve attractive returns, with more emphasis on protecting the downside for those investors, says Ms. Ashcroft.
As the markets continue to bounce around, investors will want to make sure they truly are in a balanced and diversified portfolio. Ashcroft says investors can benefit from working with an advisor to build portfolios that deliver good risk- adjusted returns.
“Investors have to remember that markets can fall,” she says. “Listen to your advisor and make sure you stay in an asset mix that’s appropriate for your risk tolerance not just your desired returns. Use products and strategies that will serve you well through any market environment.”
Advertising feature produced by Globe Content Studio. The Globe’s editorial department was not involved.