The significant increase in the Canadian equity market in the past three years has seen many Canadians benefit from strong capital gains. But now that the bad weather is settling in, some will look to adopt a more defensive strategy to protect against potential market shocks. Just in time, Russell Investments Canada Limited has released part two of a paper targeted at institutional investors—"What It Takes to Implement A Canadian Defensive Equity Strategy" – that provides a framework for how it is Canadian institutions can implement various new active and passive defensive strategies within their portfolio. Retail investors may be interested in some of the general ideas.
Authored by Adam Hornung, an institutional investment strategist at Russell Canada, the first part of the report was released in July and discussed the merits of employing a defensive mandate. Hornung describes the challenge facing many investors in Canada: Institutional funds need to be defensive, but have “encountered limited investable options…Few Canadian equity investment managers have actively managed products that are labeled as 'low-volatility' or 'defensive,' and while other providers maintain that their products are defensively tilted, the portfolio management team may not consistently look at defensive factors as part of their investment process,” says Hornung.
He goes on to suggest a framework for how it is these strategies can be achieved. The first step is to adopt a set of metrics to identify the extent to which current investment styles exhibit defensive characteristics. This requires a shift in focus to measuring portfolio risk in terms of “absolute objectives and desired outcomes rather than traditional measures of tracking error, or measuring benchmark-relative risk.”
The second step is to apply this new lens to the Canadian equity market to identify which stocks may be considered defensive. Hornung uses the Canada component within the Russell Global Defensive Index as an effective tool to identify defensive-oriented Canadian stocks, while benchmarking defensive-oriented Canadian equity investors.
The third step is to choose a vehicle and determine a strategy for defensive investing. For this step, Hornung describes a number of potential approaches to achieve, including “actively investing in value-oriented Canadian equities, which tend to have a defensive bias, utilizing passive ‘smart beta’ index-based investment approaches to reduce unwanted factor exposures such as low volatility and defensive indexes.”
As well, simply reducing Canadian equity exposure and thinking more globally in terms of asset allocation to reduce home-country bias is another option. According to Russell, these strategies will “serve to help reduce portfolio volatility, reduce risk and protect plan beneficiaries in the event of a Canadian equity market pullback.” Canadian institutions interested in “de-risking their portfolios” should shift their focus from evaluating managers relative to their benchmarks, to adopting measures that better align with the objectives of a lower risk portfolio overall. "With a little creativity and a subtle shift in mindset toward an outcome orientation and away from a benchmark orientation, Canadian asset owners can go a long way toward adopting a more defensive posture with their portfolios," says Hornung.
Get a full copy of the study here