Notice: This newsletter is intended as a general financial market outlook, and should not be relied on as investment advice.
With the year over the halfway point, it makes sense to look at the performance of the various asset classes, to see whether any obvious out or under performance by an individual asset suggests possible rebalancing within an investment portfolio. Of course, an investor, whether using a traditional pension plan such as a defined contribution scheme, or using a Personal Pension Plan (PPP) or an Individual Pension Plan, would be entitled to expect their investment manager to be monitoring the assets in the plan, and taking appropriate actions.
Being aware that, for example, US equities as represented by the S&P 500 Index, have delivered a return of 18.7% so far this year and world equities, represented by the MSCI World Index have returned 18.8% against a return of only 2% from the S&P/TSX60 might suggest that the advisor would be examining the weightings between the US and Canada in the equity section of the portfolio. When looked at over a longer period, one discovers that the TSX60 has lost 2% p.a. while the S&P 500 has risen 6.2% p.a. so that the out performance by the US market has been going on for half a decade and that therefore, it is likely that the weighting of Canadian equities in a balanced pension plan is probably somewhat lower than was the case when the plan was set up 5 years ago. If this is a situation that the investment manager is comfortable with, then there may be no need to make changes, but it emphasizes the need for the manager of an investment portfolio to continuously monitor the performance of the assets it contains, to make sure that the asset allocation created when the portfolio was established is still reflected today.
Likewise, given the very strong performance of investment grade bonds since the financial crisis of 2008-09, with the DEX Long Term Bond Index being up 2.7% p.a. over the last five years, despite falling very sharply by 6.3% so far this year, it is probable that the bond/equity allocation will have changed so that bonds are now a somewhat larger percentage of the portfolio than when it was established. With bonds which have risen by almost 15% and Canadian equities having fallen by over 10% over the last five years, most Canadian balanced portfolios with a 60/40 equity bond split will now be nearer a 50/50 weight, if they have not been rebalanced, even though the non-Canadian equity portion will have compensated for some of the lacklustre performance by the TSX60 Index.
Of course, it is likely that the vast majority of investment managers will have been actively monitoring the changes in weightings that have occurred over this exceptionally volatile period, but it is always difficult to sell down a winning position to invest in a falling position, which is what rebalancing requires. Nonetheless, this is the single most important discipline that investors can expect their managers to deliver, and is a good starting point for discussion with the manager.
Assuming that rebalancing has been taking place on a regular basis, it will have added to the overall return from the portfolio as will the periodic investment of contributions, preferably on a regular basis, Dollar cost averaging, or investing the same amount of money into the plan every month or two weeks, means that the investor is buying fewer shares when prices are higher, and more when prices are lower, as their money goes further when prices have fallen. This is the classic investment maxim of “Buy Low, Sell High” being put into practice, except that there is no need for the investments to be sold to realize profits. The average cost of the holdings will however be reduced if the prices fall from the initial investment, while they will only rise gradually when prices are rising. A combination of rebalancing and dollar cost averaging are the two basic tools which will help the performance of the underlying assets regardless of whether they are bonds, equities or other unquoted investments that can be held in IPPs or PPPs.
Source: Bloomberg.com current as of July 18th, 2013