Blogs & Comment

Investment diversification does work

For investors with well-balanced portfolios, 2011 wasn't such a terrible year after all.

(Photo: Jack Hollingsworth)

With the S&P/TSX Composite Index down 12.6% so far this year and only a scant few more trading days left in 2011, it would be easy to label this as a bad year for Canadian investors. International equities will be down by slightly more, and U.S. stocks will have to rally well to escape closing out 2011 in the red.

Perhaps, though, it would be better to say it was a bad year for equities, because as I look at the returns on the various asset classes, it doesn’t seem to have been too bad of a year for anything other than equities. Let’s take a look.

Cash: Cash rates started out 2011 at intergenerational lows, and there were no changes in administered rates, such as the target overnight bank rate, to give them any kind of a boost, so they remained low throughout. Rates on one-year GICs, for example, started the year at 1.63% and finished it at 1.67%, while the five-year tranche dropped from 3.10% to 2.70%. Shorter-term cash rates remained dismally meager as well: a 30-day term deposit went from paying 0.90% to start the year to 1.00% at the end of it.

While low right now, one thing we can always say about cash is that it always has a positive return. And any capital allocated to cash was capital that was not potentially allocated to equities, and in a year like 2011, that was a good thing.

Fixed income: International debt risk was the big investing influence this past year, and Canadian debt shone relatively as a result. My regular activity includes monitoring some 60 Canadian debt issues. Here are some of the total returns these bonds have generated to this point in 2011:

Among Canadian federal government issues, short-term bonds (up to three years in remaining maturity) had an average total return of 3.0%; medium-term bonds (three to five years), 5.6%; and long-term bonds up to the 2041 maturity, 14%. Total return included interest income plus or minus price change. Among corporate issues, the bank bonds I monitor total returned an average of 4.6% this year; utility bonds, 4.2%; and other corporate bonds, 4.4%.

Preferred shares had vastly different returns this year depending on their type. Straight preferreds had an average total return of 3.1%, while floating rate issues returned -15.3%. Clearly it mattered this year which type one chose; last year both types lost money.

Income trusts/income stocks: Of the six categories among these selected issues, all six had positive total returns. Among them, power generation issues had a total return of 23.1%; pipelines, 34%; business trusts, 3.2%; REITs, 24.6%; oil and gas royalty companies, 12.0%; and funds of trusts, 3.9%. Here total return excludes any distribution or dividend increases that may have occurred throughout the year.

The main income trust index rose 17.7% and the energy trust index, 15.1% in 2011, so money was generally made this year in this asset class.

Common shares: Of the five categories of blue-chip Canadian equities that I continually monitor, only one, financials, had a negative total return this year at -6.5%. Performance therefore depended on how the various sectors were weighted.

The point: Virtually everyone understands the theory of diversification. Just for fun, I’ve included a numerical example here using 2011 year-to-date numbers for a money market fund, a bond ETF and three equity ETFs representing Canadian, U.S. and international stocks. A typical balanced portfolio allocation is shown, but you can easily adjust that to your own liking. The point is that diversification among asset classes really helped ameliorate the return an equity-only investor would have suffered this year: a loss of 2.7% is better than a loss of greater than 10%.

It was not so bad of a year after all!

Portfolio

Security

Allocation

Security Return YTD

Allocation return YTD

Cash

Fund

10%

0.70%

0.07%

Canadian bonds

XBB

40%

5.59%

2.24%

Canadian equities

XIU

25%

-13.01%

-3.25%

U.S. equities*

XSP

15%

-1.11%

-0.17%

International equities*

XIN

10%

-15.90%

-1.59%

* Canadian-dollar hedged

100%

-2.70%