'Don’t take on more risk by sticking with last year’s winners'

CIO says cautious optimism feels right for 2020 but that there are more questions than answers in the market

'Don’t take on more risk by sticking with last year’s winners'

Cautious optimism for 2020 feels appropriate but one CIO has warned investors not be caught taking on more risk by sticking with last year’s winners.

Greg Taylor, of Purpose Investments, said 2019 was a year when almost everything worked. He cited the massive rally by global equities and long bonds enjoying double-digit returns as yields fell across the world. Even commodities rallied, he added, with oil, copper and gold all up more than 10%.

Taylor believes there are positive signs for continued gains this year but said investors should be on the alert given we’re in the later stages of the market cycle and on the verge of a closely watched presidential election.

He said: “I know, it feels good to have big gainers like Apple and Amazon on your books, but the winners are often crowded trades, which carry some risk. Paring back a bit is wise. With RRSP season around the corner, now is the time to tweak portfolios.”

He added that equities are starting the year with optimism that earnings growth will return but that investors shouldn’t expect another double-digit increase in multiples to drive markets higher.

“What we may see is a change in leadership, either the long-awaited rotation from growth and momentum stocks to value,” he added. “If global growth does emerge, a more significant theme could see capital flow away from the over-owned American markets to others.

“An important indicator to watch will be the US dollar. A strong dollar weighs on earnings growth for most companies. As global growth picks up and money flows to other spheres of risk assets, the dollar should fade, providing some boost to earnings.

“The prediction that feels the most certain is the expectation that volatility will return to most markets. US politics have come to dominate investing globally. Heading into a very contentious presidential election should make for many market-moving events.”

From a bond perspective, Taylor said that most market watchers are calling for a much quieter year ahead, with central banks broadly signalling no changes in rates. He believes that barring a flare-up in trade tensions or an event that would cause yields to collapse, the curve should remain steep and bonds should “go back to acting as the base in portfolios, not a source of capital gains, and overall duration should be shortened”.

Taylor added: “If there’s one thing to say about the current environment, it’s that there seem to be more questions than answers. Things have been positive for the last year, but uncertainty continues to linger.”

With that in mind, the CIO said that many investors, including professional advisors, are asking Purpose about how to position their portfolios for success.

Here’s a sample of what he’s been hearing and his thoughts on what to do:

Is it time to add alternatives to provide returns that are less tied to traditional markets?

“Yes! We think alternative asset classes are tools that all investors should consider including in their portfolios. Broadly speaking, alternatives offer lower correlation to traditional markets and provide diversified, additional return streams. We especially like alternatives as a way to gain income in a world of suppressed yields. Yes, rates have rebounded from the lows of last year, but they remain low. Bonds likely won’t be providing the income foundation that their reputation suggests they should. Options-writing strategies are a favourite of ours for adding income while reducing overall portfolio risk.”

If volatility returns how can we earn a stable return?

“It can be easier than you think. The aforementioned options-writing strategy is a simple way to add a more stabilized source of return in the form of consistent, diversifying income. Another choice would be through the use of structured products, which can provide strong downside protection while churning out a consistent yield. Structured notes can be complex and time-consuming, so it may be easier and more convenient to access them through a portfolio which replicates the outcome. Lastly, a tactical asset allocation fund can also help provide more stable returns through periods of volatility, especially if it’s rules-based and can move quickly in response to the shifting market environment.”

How do we position our fixed income portfolios if yields have finally begun to recover?

“With a recovery in yields, it’s especially important to take an active approach to your fixed-income allocations. Passive bond indices do not capture a large enough portion of the fixed-income universe to be truly diversifying. Nor do they have the ability to shift stances with respect to the market. Investors are unlikely to get paid enough to take long duration credit and rate risks, and should stick to shorter duration and a more defensive credit position. If tax efficiency is a primary concern, consider the advantages of a corporate class structure for your core bond position.”