Advisors reassess risk tolerance and rejig portfolios amid market swings

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Advisors are re-evaluating their clients’ risk tolerance amid the recent market volatility and also re-balancing strategies to produce income and growth in portfolios.

According to a recent Natixis Investment Managers survey, 80 per cent of advisors responsible for fund selection and portfolio construction in North America say investors may be taking on too much risk in their portfolios because of the prolonged low-interest-rate environment that has “distorted stock values and decimated bond yields.”

In turn, advisors are repositioning client portfolios to prepare for more market volatility driven by the expectation of rising interest rates, increased inflation, ongoing supply chain disruptions, and geopolitical tensions.

The survey, which included 166 investment professionals who manage US$3.9-trillion in assets collectively, shows more than two-thirds (68 per cent) believe more frequent rebalancing will be important as markets churn.

“When things are going to change, it’s always an opportune time to go back and re-evaluate,” says Dave Goodsell, executive director of the Natixis Center for Investor Insight.

The survey also highlighted that 84 per cent of advisors are expanding their model portfolio offering, which includes streamlining the investing process, providing clients with a more consistent investment experience, and enhancing their potential to beat market benchmarks.

Jay Smith, portfolio manager and investment advisor at CIBC Wood Gundy in Toronto, says investors may be in a riskier position because volatility has been historically low, until recently.

“However, to the extent that investors hold great companies and have a decent time horizon, I don’t think they have much to worry about,” he says.

Mr. Smith says he thinks the shift to value from growth stocks has contributed to increased market volatility.

“One way to decrease risk in this environment is to shift more funds to value companies from growth companies; this dampens volatility and, certainly, that has increased returns this year,” he says, citing the example of Canadian banks hitting new highs and technology companies taking a hit in recent weeks.

The environment of rising interest rates impacts growth companies negatively because, at higher interest rates, their discounted future cash flow is worth less in today’s dollars, Mr. Smith adds. His strategy is to have a balanced portfolio of both growth and value companies.

He says investors can also carry more cash for the short term – whether that’s three months or a year – whatever they deem appropriate for their own circumstances “to avoid ever having to sell securities at an inappropriate time.”

Advisors should also reassess whether the investor’s portfolio is appropriate for the changing environment, he adds.

“Bonds are great in a falling interest rate environment, but since bond prices move inversely to interest rates, they’re not so safe in a rising interest rate environment,” he says. “It might make sense to shorten maturities.”

At the same time, growth stocks may undergo a different valuation when rates are considerably higher.

“It’s up to an advisor to point out and discuss the relevant issues with investors, to make sure they’re aware of the changing reality, and the different risks associated with a new and different macro environment,” he says. “If necessary, take appropriate action to align portfolios with a new and different assessment of risk.”

Not as much ‘risk-taking’ as six months ago

Laura Barclay, senior portfolio manager at TD Wealth Private Investment Counsel Inc. in Markham, Ont., says her firm does “tactical rebalancing,” often quarterly, to ensure clients’ asset allocations are in line with their investment plans.

“It’s the concept of sell high, buy low – and that’s to respect the boundaries of where the client risk profile lives,” she says.

In today’s low-rate environment, that’s in the higher portion of the range of about 55 to 75 per cent in equities, depending on the client.

Ms. Barclay says the risk varies depending on the investor’s age and the purpose of the money, whether it’s for retirement, health care costs, or to build generational wealth.

“If you take more risk, you’re supposed to make more money,” she says.

Yet, investors appear to be a bit more cautious as interest rates are poised to rise and government stimulus is being pulled back. “I’m not seeing the kind of risk-taking I saw six months ago,” Ms. Barclay says.

To help cushion the greater proportion of equities in a portfolio, Ms. Barclay says she focuses on buying and holding higher-quality companies with strong cash flow and strong management teams.

“Quality of holdings will cushion the downside,” she says. “Quality businesses survive recessions; they still get beat up with pricing because everything gets sold off ... but sometimes there are incredible buying opportunities.”

Risk tolerance changes over time

Simon Tanner, principal financial advisor with Dynamic Planning Partners at iA Investia Financial Services Inc. in Vancouver, says risk tolerance is something advisors are trying to gauge with clients continuously – especially as markets roil.

Sometimes, what clients report about their risk tolerance on a know-your-client questionnaire will be different than when they experience a market drop.

“Even if someone has an established risk tolerance, time heals all wounds, and they forget what 2008 was like or late 2018, or March 2020, and they start to take on more risk,” he says.

When markets are volatile, it’s a chance for advisors to check in with clients on how much they can stomach and verify their risk profiles.

Mr. Tanner says advisors should connect with clients directly – either over the phone, video call, or in-person – to find out how they’re feeling about the market swings that are expected to continue in the coming months.

“The real role of an advisor is to sit down and talk to your clients and say, ‘Hey, your portfolio is down. Here’s why. How do you feel? Are you comfortable with this level of volatility?’” he says.

“We need to get back to understanding what the ultimate goal of the portfolio is – whether it’s long-term growth, income, or a mix,” Mr. Tanner adds.

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