MBA, CIMTM, Fin. Pl.
Investment Specialist, Products Knowledge
A sharp rebound
The fields of investment and gastronomy have several things in common.
For example, there’s no single recipe for success… financial or culinary!
To each his own style
Each investor and each portfolio manager try to get the most out of the financial markets by using a variety of strategies.
- Some prefer more passive management, while others are highly active traders.
- Some favour a value approach, while others opt for growth style, or even momentum investing.
In all cases, the objective remains the same: to construct a portfolio that will outperform all the others.
A question of ingredients
If we return to our culinary analogy, in investment as in cooking, it all boils down to the choice of ingredients! To have the best portfolio, you must first know where the return comes from, so that you can take advantage of the components that generate maximum profitability.
Bailey, Richards and Tierney established in 2007 that the total return of a portfolio or of a fund is derived primarily from three components: static allocation, strategic allocation and tactical allocation.
1 – Static allocation
This term simply refers to the movements of the markets themselves. The total return of a portfolio will be highly dependent on its exposure to different markets such as, for example, the Canadian stock market, the U.S. stock market, the bond market, etc.
Add to this that a portfolio allocation of 50% stocks and 50% bonds will have a decisive influence on its performance and stability. In fact, according to the study by Bailey, Richards and Tierney, 80% of the total return could be due to the movements of the markets to which the portfolio is exposed, which brings to the fore the need to carefully determine the allocation of a portfolio.
Good news in this regard: our wealth management advisors have mastered the art of creating custom portfolios for our clients. The support of an experienced advisor is key at this stage, as pointed out in the study by the Centre interuniversitaire de recherche en analyse des organisations, known as CIRANO. This study shows that households that had chosen and retained a financial advisor accumulated, on average, 290% more assets over 15 years than households that did not have an advisor. A real boost for life projects or retirement!
2 – Strategic allocation
This term refers to the asset allocation policy of a portfolio. We already know that, to generate return, an investor must be exposed to certain markets. Strategic allocation establishes the basic percentage that will be invested in each asset class.
For example, it is at this stage that the percentage of Canadian and foreign stocks will be determined. The strategic underweighting or overweighting of certain market segments will account for 10% of the total return produced by the portfolio.
This allocation is always based on the investor’s profile and is usually established for several years, unless there are major changes in the investor’s situation. Another reason for the manager to change the allocation is if strong market trends emerge and seem to persist for a rather long period.
3 – Tactical allocation
Also known as tactical deviation, this type of allocation refers to the temporary moves that a manager makes in the basic strategic allocation.
Take the example of a portfolio composed of 50% fixed income, 25% Canadian equities and 25% global equities. If the manager has good reason to believe that the Canadian stock market will underperform foreign markets in the coming weeks or months, he could tactically deviate the composition of the portfolio: while keeping the allocation of 50% fixed income, the manager could slightly reduce the allocation of Canadian equities (20%) and slightly increase that of global equities (30%).
These portfolio moves are usually made on a temporary basis, according to macroeconomic forecasts and for a period that can be very short. Many investors sometimes place excessive importance on this type of move. However, tactical allocation accounts for only 10% of a portfolio’s total return. It should also be noted that tactical deviation is often used during difficult market periods, in order to stabilize the portfolio and limit declines.
A simple but effective recipe
You now know what makes up a portfolio that has the potential to generate returns that will outperform comparable funds:
- First, exposure to a wide range of financial markets to take advantage of all available opportunities (static allocation accounts for 80% of the return).
- Then, a good mix of asset classes according to your investor profile and your needs (strategic allocation accounts for 10% of the return).
- Lastly, an active manager who can temporarily adjust your portfolio, according to the financial and economic environment.
Properly combined, these three components produce an optimal result. As in the kitchen, the quality of the ingredients and the right amounts, as well as the talent and experience of the chef, will clearly tip the scales in favour of a tasty and satisfying dish. Our portfolio managers know something about that!
Have questions about your investment portfolio? Our advisors are available and ready to talk to you.
Stéphane Girard, MBA, CIMTM, Fin. Pl.
The information contained herein has been obtained from sources deemed reliable, but we do not guarantee the accuracy of this information, and it may be incomplete. The opinions expressed are based upon our analysis and interpretation of this information and are not to be construed as a recommendation. For any questions, don’t hesitate to contact your wealth management advisor or your tax specialist, accountant or legal advisor.