Pity the modern retail investor. Every weekday brings a deluge of new information — manufacturing shipments up, consumer sentiment down, the latest forecast for Canada’s housing market. Investors seem hungry for it all, poring over investment journals and business publications, blinking at Bloomberg, hoping to find that one fragment of information or insight that will catapult portfolios into the stratosphere. Or maybe they’re simply determined to never again get caught up in an asset bubble and watch their portfolio implode. Parsing all this information can lead to perplexity and paralysis, leaving one’s finger hovering hesitantly over the Enter button, wondering whether the next trade will bring financial security, penury or merely another $19.99 trading fee.
Which is a bad place to be, if you’re pondering where to invest your RRSP contributions this year. Canadian Business considers the cases for being bullish or bearish, and how one might select securities accordingly. And then we’ll explain why being agnostic on the twists and turns of the Dow is probably the more sensible approach.
George Vasic, equity strategist and chief economist for UBS Securities Canada Inc., has won several awards for accurate forecasting. His lengthy and successful career includes stints at Global Insight and PricewaterhouseCoopers, and he holds a master’s degree in economics. One might say he’s lived and breathed the markets for years.
Vasic expects the TSX composite index will end 2010 at 13,500, implying a banner year for Canadian stocks. Ever wonder what goes into a prediction like that? Vasic’s TSX target is backed by two key beliefs. The first is that central banks will not tighten interest rates prematurely. The second is that fiscal stimulus will continue flowing as broadly promised. That considered, Vasic believes the global economy will grow by 3.7% this year and next, or near the long-term average. Under such conditions, Vasic expects a “reasonable recovery.”
His suggestion, then, is straightforward. “If you want to follow the outlook, you would tilt your portfolio more toward stocks and away from bonds than would be your norm,” Vasic says. (Vasic suggests retail investors seek more sectoral diversification than is offered by the S&P/TSX composite index, which is heavily weighted toward financials and natural resources.) “Bonds are yielding less than 3.5%. Especially if they rise, you won’t even get 3%. And money markets are barely above zero. So the alternatives are not providing much return at all — they’re only providing protection.”
Protection might not sound so unappealing, if you subscribe to David Rosenberg’s newsletter. Every working day, as economist and chief strategist at Gluskin Sheff + Associates in Toronto, Rosenberg distils formidable quantities of incoming economic and market data for subscribers. Like Vasic, he’s been around long enough to have witnessed all kinds of markets. Many considered it a coup for Canada when Rosenberg left his post as Merrill Lynch’s chief North American economist in New York last year to join Gluskin Sheff. Rosenberg’s widely credited with prescience regarding the recent recession. He believes there’s more pain to come.
Rosenberg doesn’t talk about our recent economic troubles in the past tense. He sees the past few years as the opening act in an economic tragedy worthy of Aeschylus. “The depression is ongoing, even if the most recent recession has faded; the next one is not far away, especially now that the stimulus is soon to subside.” While he says he doesn’t know when our misfortunes will resume, he says it’s probably between two quarters and two years away.
Given this grim outlook, Rosenberg leans toward fixed-income securities, which typically weather downturns better than equities. He believes a permanent change in citizens’ portfolios is underway — they’re in the early stages of loading up on fixed income securities — anything providing a steady, reliable yield (even if that yield is barely above inflation). He recently suggested investors buy U.S. Treasuries. “Selloffs in Treasuries offer terrific buying opportunities,” he wrote, “especially since we are on the cusp of seeing deleveraging in the broad private sector about to swamp the massive balance sheet expansion in the public sector.”
As far as Rosenberg is concerned, equities have recovered far more strongly over the past year (the TSX is up nearly 55% since bottoming last March) than any sober assessment of economic fundamentals or corporate performance would warrant. “Considering the lofty valuations in many risk assets, we need to be extremely thoughtful about our asset-allocation decisions in the context of the likelihood that the primary trend is still one of deflation, both in consumer prices and asset values, especially in residential and commercial real estate.”
Two trained, pedigreed, credible strategists. Two plausible viewpoints, rooted partly in existing evidence and partly in informed conjecture. And their recommendations could hardly be more different.
It might seem as if every retail investor should decide whom to believe before executing another trade in their RRSPs. But if you are like the vast majority of Canadians, with neither the means nor the inclination to revisit your investment choices on a daily basis, your best bet might well be to ignore such suggestions entirely. To understand why, you could do worse than talk to Keith Matthews. He recalls one day back in the 1990s, when he was a young bond trader at Casgrain & Co., a Montreal firm with institutional clients. That day, a major U.S. brokerage suddenly reduced its recommended allocation for Canadian equities. A few months later, the same firm reversed course and started recommending that clients buy Canadian equities.
Matthews perceived no reason whatsoever for the flip-flop. Now a portfolio manager at Tulett, Matthews & Associates Investment Counsel in Kirkland, Que., he considers the incident a revelatory moment in his career. While many active investors find advice from strategists invaluable in tweaking their portfolios, Matthews scoffs at that approach. “There’s a ton of people in the brokerage industry geared around trying to forecast short-term events,” he says. “The brokerage world is all about giving snippets of information to get people to move things around. The stories and the theses behind their suggestions are very seductive and seem to make a lot of sense. But fast-forward six months, and their ability to forecast that short-term event was far from where you thought it would be.”
“Focusing on short-term noise,” he says, “is not a productive exercise.”
There’s no shortage of evidence to support the notion that most forecasters get it wrong. Start with the fact that each December, Mercer (the consulting, outsourcing and investment services giant) surveys investment managers about their expectations for capital markets in the following year. It publishes the results in its Fearless Forecast, which reveals the consensus. However lionhearted they may have been in January 2009, their forecasts on Canadian and global GDP, interest rates the Canadian dollar and oil prices were dead wrong last year. When guessing where stock markets were headed, their record was slightly better — the consensus failed to anticipate the strong recovery of Canadian and emerging equity markets, but was in the ballpark on U.S. and international equities.
The positive consensus forecast for 2008 missed entirely. The long-term record is equally uninspiring. But since the future has always had a way of surprising people, nobody should be shocked.
The fallibility of market-timing portfolio managers can be seen when comparing socalled “balanced” fund managers against their “tactical” counterparts. In theory, both types of funds are supposed to provide one-stop diversification for investors among stocks and bonds. The key distinction is that tactical managers have greater freedom to chase sectors or asset classes they believe will outperform. If a master tactician thinks financial services stocks seem pricey and mining stocks cheap, for example, she might shift accordingly. Or if stocks generally seem overpriced, she might move toward fixed-income products and wait patiently until all the suckers get taken to the cleaners, then buy back in. “Remember how they’re marketed,” Matthews says. “These are the smartest managers in the world. They work for the biggest firms with the most research. They’re able to gather all that short-term information…. They have complete freedom to move their portfolios, to go back and forth between stocks and bonds.”
If tactical managers’ instincts were right more often than wrong, you’d expect their funds to outperform their counterparts. But that’s not borne out by recent data. Over the past decade, the Globe Tactical Balanced Peer Index returned about 3.3% annually. The Globe Canadian Equity Balanced Peer Index soundly beat the tacticals with a 4.5% average annual return during the same period. When it comes to maximizing returns by flipping between asset classes, “it doesn’t appear that even the experts can do it,” Matthews concludes.
Equity analysts, whose job it is to scrutinize individual company stocks from every conceivable angle, fare even worse. The best of them have sophisticated, nuanced understandings of the companies they cover, enabling them to ask seemingly arcane questions of chief financial officers on conference calls. Yet the worst-kept secret about them is that they rarely advise clients to sell a security, regardless of changing economic or financial conditions, or even a company’s individual circumstances, for that matter.
Consider this: On June 18, 2008, the day the S&P/TSX composite index peaked, Bloomberg data reveal that just 4.5% of analysts’ recommendations told investors to sell the Canadian security covered. (Almost half were Buy ratings, the other 45.8% were Holds). In other words, analysts didn’t warn clients of the impending crash. When the TSX bottomed out last March, the Sells had fallen to 3.93%, but then so had the Buys (to 46%) — suggesting they didn’t foretell the recovery, either.
Further confusing matters, sometimes respected gurus say one thing and do another. George Soros, the billionaire hedge fund manager, told one reporter in late January that today’s prevailing low interest rates were creating asset bubbles, and “the ultimate asset bubble is gold.” One might have thought the sagely Soros was bearish on the yellow metal. Less than a month later, Bloomberg reported that his Soros Fund Management LLC aggressively bought a gold exchange-traded fund in the final quarter of last year.
All of this is to say that buying investments for your RRSP this spring based on the recommendations of the latest strategist report, TV interview or business magazine may not be the best approach.
If Matthews is correct that trying to respond to changing financial and market conditions is futile, what’s the alternative? “The good news is that there are investment strategies that can help improve the odds of a successful investment experience,” he says. He advocates something called asset-class investing, a concept that will be familiar to most readers. It involves selecting a mix of stocks, bonds and other instruments based on a plethora of factors that have nothing to do with where interest rates will be in two years’ time. The idea is to build a portfolio for all seasons and stick to it. Research reveals that this asset mix is crucial. It accounts for most of the variability of performance — more than 90%, according to studies performed in the late 1980s and early 1990s.
Before deciding the mix, Matthews says investors need to ask themselves all the usual questions: What’s their time horizon? How much risk can they actually stomach? How much money will they need in retirement? How much do they really know about markets? These are the very same questions you’ll find in virtually any mainstream book that discusses how to build a solid retirement portfolio.
Not surprisingly, diversification is one of Matthews’s favourite subjects. He points to the work of Harry Markowitz, whose research as a University of Chicago graduate student in the 1950s begat many of the concepts that underpin modern portfolio theory today. His chief insight was that by investing in various asset classes that often behave differently, one can achieve better returns while taking less risk. As a crude example, stocks and bonds often tend to move in different directions simultaneously, so owning a mix of them typically produces less volatile results than exclusively buying one or the other. “Very few things in the investment world are free for the taking,” Matthews tells clients. “The benefits of diversifying your asset classes, however, is one of them.”
But how to achieve it? When it comes to stocks, Matthews suggests considering not simply Canadian, American and international equities as discrete groups, but splitting each of those into subgroups of large companies, value stocks and small cap stocks, and adding emerging markets. As for fixed income, he divides that category into Canadian government and corporate bonds, and real-return bonds. And finally, he says investors should consider Canadian and global real estate investment trusts. For each category an investor decides to invest in, Matthews points to exchange traded funds that deliver pure exposure to those kinds of securities. He advises against actively managed mutual funds.
Matthews laid out his thinking on asset allocation in detail in his 2008 book, The Empowered Investor. Though it’s written in plain language and speaks to a Canadian audience, much of it is not particularly novel. Richard Ferri, a portfolio manager in Troy, Mich., discussed similar concepts in his 2005 book, All About Asset Allocation. Like Matthews, Ferri suggested building a portfolio “that is suitable for your needs and sticking with that allocation through all market conditions.” William Bernstein, a U.S. portfolio theorist, authored The Intelligent Asset Allocator — one of Matthews’s favourites.
As with any approach to investing, this approach to building portfolios isn’t for everyone. But even those who believe investors should pay attention to the outlook for markets and the economy often share much common ground with Matthews. While UBS’s Vasic prepares annual forecasts for the stock market, for example, he’s doesn’t think investors should load up on Canadian equities based on his latest predictions. On the contrary, in conversation with Canadian Business he emphasized many of the same concepts, including diversification and risk tolerance. “There’s all sorts of factors to consider,” Vasic says. “By the time you get to the economic outlook, you’re down to factor seven or eight on the list.”
A similar-looking portfolio, year in and year out, might not sound like much fun. Some advisers suggest investors “core and explore” — that is, maintain a sensible, conservative portfolio but allocate a small portion of it to more speculative or risky investments, or “alternative” vehicles like hedge funds. Ever the killjoy, Matthews advises against that, too. “The ‘explore’ just gets people into trouble,” he says. “Don’t bother doing it.” But if you’re looking for excitement, take up kite surfing or take your skateboard to the half-pipe. Your retirement savings are too important to indulge such impulses.