The security of asset allocation in times of turbulence
Based on the March 9, 2020 Investments Unplugged podcast, featuring Philip Petursson, Manulife Canada’s Chief Investment Strategist and Jamie Robertson, Head of Asset Allocation Canada, Manulife Investment Management
2020 may go down in history as the year of the Great Pause — a surreal time as the COVID-19 pandemic raced around the world, overwhelming healthcare systems and affecting millions. It may be looked back on as a time when phrases such as social distancing, planking the curve, and covidiot became part of our regular vocabulary, and a time when panic buying emptied store shelves, making it next to impossible to find basics such as toilet paper, flour, and hand sanitizer. Students will never forget how schools closed, and proms and graduation ceremonies were put on hold. Sports enthusiasts will recall how stadiums and arenas around the world stood quiet, affecting even the 2020 Olympics.
There would be major pivots in manufacturing, where clothing companies and even car makers would shift their focus to mass produce masks, gowns, and ventilators for hospitals in desperate need of supplies, and economies around the world would scramble to adjust as valuations and interest rates dropped in dramatic fashion, bringing a quick end to the robust and long-running bull market.
During the past 10 years, the euphoria of skyrocketing stock prices has been an irresistible siren song for many investors, but it has also created a tough situation with recent sharp market declines. We are now in a time where investment fundamentals have never been more important, especially when it comes to asset allocation. According to Manulife’s Chief Investment Strategist, Philip Petursson, it’s all about the math.
“If you use the mathematical applications of modern portfolio theory, the optimal portfolio from 1970 through 2010 is 60 per cent equities and 40 per cent fixed income,” says Petursson. “However, sometimes adjustments are needed to take advantage of opportunities. Given the historic decline in the global markets in such a short period of time, it’s only reasonable and rational that equity investors should be thinking in terms of risk and reward and responding appropriately.”
When a black swan event, such as the COVID-19 global pandemic, comes out of left field, investors are quick to ponder how they should react. Jamie Robertson, Head of Asset Allocation Canada with Manulife Investment Management, says while no one could have predicted what is currently happening, investing fundamentals are more relevant than ever.
“You had equity markets that were so historically above and beyond their longer-term trends, with indications that risks were rising,” says Robertson. “However, there would be nothing in any of these typical indicators that we track that could have tipped any of us to a brewing pandemic.”
While it’s next to impossible to predict exactly when something might happen to cause a market correction or a bear market, careful assessments by the Manulife Investment Management Asset Allocation team has helped to make sure that investments were already well positioned to weather this Q1 economic storm.
“All through this robust market, we have examined where the pockets of speculative excess are, where the misallocations of capital are, and what areas should we be deeply concerned about. There were signs that should have been noticed,” says Robertson. “As equity markets became very stressed, we adjusted to a more neutral position using our investing fundamentals. Heading into this market volatility created by a global pandemic, we were more neutral in terms of our equity exposures, with a more diversified portfolio that allowed us to be in a protective stance as markets began to wobble.” The diversity found within an asset allocation fund helps to cushion the blow, and a managed portfolio helps to ensure that the level of risk is controlled. “In the case of your typical balanced fund, you’re investing in a very high-quality equity manager as well as a high-quality fixed income manager, both with mandates to beat their benchmarks,” Robertson points out. “These two sides have interactions back and forth to ensure the fund has the right balance. During the past five years, most global balanced funds have had a stable weighting to the US market, which has been the most dominate market in the world, by far. That’s a strategy that has worked very well.”
The Manulife Investment Management Asset Allocation team also takes a more holistic approach when constructing portfolios. Robertson continues: “We are looking at the overall outcome. If it’s an aggressive portfolio, over time, we are wanting certain equity-like returns with smaller levels of volatility. And then, at the other end of the spectrum, on the conservative side, we are looking to generate above-average fixed-income returns with a similar level of volatility.”
The team looks for opportunities and stability across a wide swath of asset classes, various global regions, and certain sectors when allocating funds — ending up with optimized portfolios constructed using processes designed to generate returns based on a five-year time horizon, with a healthy mix of higher-risk adjusted returns.
“The Manulife Investment Management Asset Allocation team looks at fixed income from a couple of different perspectives,” Robertson explains. “When we go through our process, we are looking across the spectrum to include government bonds, bank loans, high yield, and emerging market debt — we are looking at those high-risk adjusted returns. Under normal circumstances, high yield and emerging markets offer attractive returns, as long as overall market conditions are favourable. But that’s not to say there isn’t a place for government bonds, even if they are only yielding one per cent. You just need to consider the performance of long treasuries over the past six months, which are up into double digits. And we add in a good mix of long duration assets such as treasury bonds, as they have proven time and again to stand up when the markets hit turbulence.”
With very specific mandates and objectives, in terms of performance against the benchmark, Manulife looks to make sure that all of the best tools are in the toolbox at any given time — striving to build a very comfortable, low-cost, and efficient house that is somewhat hurricane-proof.
“This has been a market that has been correction-free since 2009. This has all happened so quickly, giving the market a good punch in the nose, and it needs to regain its composure,” Robertson says. “From that perspective, it’s simply going to take time to see how COVID-19 affects economic activity. We will need patience; we won’t know the outcome of the health crisis for weeks and potentially months. But certainly, when we get to the point where valuations are becoming very compelling, that’s when we’ll look to sharpen our pencils and become more aggressive.”
Stay the course
Current market volatility can be quite concerning for the individual investor, but the message is clearer than ever: stay the course and focus on the long term.
“I think that 2020 is already turning out to be a little bit different than what we anticipated, but certainly in our case, Manulife has a time-tested and well-defined process that we will continue to follow with a high level of discipline. I think that’s really the way to navigate through these markets,” says Robertson.
The value of advice that comes with a strong working relationship between advisor and client is never more important than during times of market volatility. The Manulife Investment Management team is here to provide the support you need through this time of unprecedented upheaval.
Support materials on market volatility, the value of advice, and the importance of staying invested can be found in Viewpoints.
A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates.
Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.
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