In typical fashion, markets have reflected opposing sentiments – uncertainty and optimism. On the one hand, the worry associated with the pandemic and on the other, optimism fueled by a resurgence in activity and strong government support. Our portfolio management and asset allocation teams have been busy, first and foremost, protecting capital during the market decline and then shifting positioning to benefit from the recovery. As we look forward here are some areas of opportunity we see as we manage client capital through a challenging time. 

Revisiting equity exposure for a changing environment

Some investors might conclude that mega-cap stocks in Canada and US are the only place to be. Companies like Shopify, Facebook, Amazon, Microsoft, Apple and Google had very strong returns and our portfolios benefited from owning them. However, the recovery in stocks has broadened beyond these names. For example, in late 2020 we saw a resurgence in companies that were hurt most from lockdowns. With new vaccines these companies got a new lease on life. Throughout the year our teams took profits by selling some of the mega-cap stocks and buying companies likely to benefit from a post-vaccine world. This includes buying leaders in the travel and leisure industry. This may be hard to imagine at this point of COVID fatigue, but remember markets are always looking forward.

Late last year investors also began to favour areas that are more cyclical like value stocks, small-cap and emerging markets. These areas of the market were laggards earlier last year and have now risen above the pack. We were positioned for this shift in leadership by having a strategic allocation to value stocks and tactically buying small-cap and emerging earlier in the year. Today we are overweight equities in client portfolios with a bias to global small-cap companies. We believe we will benefit from a strong earnings recovery as more businesses reopen and stimulus remains a strong tailwind. We have also continued to increase our weight in emerging markets companies and recently launched a frontier equities strategy. As we look longer-term we believe these asset classes will be important sources of return in portfolios. 

Bond investing in the wake of a pandemic

Our positioning in bond portfolios also reflects that the worst appears to be over. Yet we are not in the clear and safety is important in a bond portfolio. The challenge, however, is that the tradeoff for safety is low yields. Current yields remain lower than they were before the pandemic and central banks are inclined to keep them low. Our bond portfolios are positioned to improve yield by investing in high quality corporate and provincial bonds. We also believe that government stimulus will result in rising inflation expectations. This has led us to own real return bonds which will benefit from this trend. Finally, we have positioned the portfolio to benefit if the recovery stalls and bond yields fall. This is a prudent offset to other positioning and helps protect capital should the economic recovery falter. 

As we look to strike a balance between safety and income, we have also been adding to high yield bonds that carry a much higher yield. The focus here is on strong credit research to avoid companies that may not be resilient if economic recovery stalls. 

Fertile ground for alternatives

Private market alternatives have been an attractive addition to portfolios for some time. These assets can be generally characterized as having strong returns, coming mostly from income and relatively low volatility. This combined with added diversification makes private market alternatives appealing on a long-term basis. The tradeoff for accessing these characteristics is reduced liquidity and the time it takes to deploy capital into new assets. Recently, however, we have been able to put more client assets to work in these strategies. Within our infrastructure portfolio we completed the purchase of four operating wind assets and one construction-stage solar project in the US. These assets have strong expected returns and benefit from fixed price contracts for the energy produced. Not to mention this now brings our renewable power generation to 1.4 gigawatts, enough energy to power more than 320,000 homes.  

Within our direct real estate portfolio we have completed our first purchase in the residential apartment sector. Historically residential has generated more stable returns and income compared to other property types like retail and office. We expect our allocation to this property type will increase.

Our positioning

The bumpy road to long-term performance

Building wealth for the future requires discipline, thorough research and a process for managing risk. The opportunities that are most attractive today are assets that can benefit the most from the economic recovery. Yet we also need to recognize that the road to recovery from here will be bumpier than what we’ve experienced so far. To manage this risk we continue to be broadly diversified while tactically tilting the portfolio to the areas of the market with the greatest opportunity. 

This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.

Markets reached new highs in 2020 in the face of a global pandemic. This leaves some asking if this is sustainable.  Continued growth depends on improvements in the economy, company earnings and government support. The good news is that we have seen advances on these fronts over the last several months. However, markets have high expectations for 2021 and any shortfall may result in a setback. Here are three areas we are looking to see progress on in 2021:

1. Markets and the economy become more connected

The global economy had a terrible 2020 but equity markets delivered strong returns. This disconnect is quite normal when a cycle comes to an end and a new one emerges. The reason is that the economic data provides an assessment of where we were, while the market is focused on a brighter future. Looking forward we need to see continued improvements in the economy and believe market returns may be more modest- reflecting a more normal outlook as opposed to a strong recovery. Of course, these improvements don’t happen in a straight line and fluctuation in the economic recovery will cause volatility in markets.

2. Earnings will need to move above pre-pandemic levels

As economic activity increases in 2021, overall business earnings should continue to recover. Globally, earnings are expected to rise and surpass pre-pandemic levels in late 2021. This isn’t good for equity markets- it’s a requirement!  This is because the current market level already reflects this earnings recovery in the form of higher valuations. If this outlook falters, it may lead to a temporary decline in markets. 

3. Government support is a necessity

The recovery we have experienced has been largely the result of unprecedented government spending, zero percent interest rates and bond-buying by central banks to heal credit markets. Going forward, government spending will be the dominant tool for managing the recovery. We are looking for a continued willingness of policymakers to run sustained supportive policy until there can be a transition to private-sector spending and investment.

What does this mean for your portfolio?

An improved outlook for the economy combined with uncertainty argues for portfolio diversification. At CC&L Private Capital, we have built diversity within our asset class strategies and across our investment platform. Diversification across traditional and alternative asset classes will be even more important as we look ahead. In 2020 we increased investments in private market assets like infrastructure. We also began to offer frontier market investments to our clients and increased exposure to emerging markets. This broadens portfolio diversification and positions our clients well for the future.

Often after discussing our market outlook, a client will ask, what should I be doing? For long-term investors, sticking to your existing strategy (while we manage the rest) is almost always the best advice.  This year we would add to this sage wisdom and say now is a really good time to revisit your asset allocation to ensure that you are balancing risks while achieving the long-term return necessary to meet your financial objectives.

This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.

The biggest investment challenge today is that bond yields are near all-time lows. This means lower bond returns in the future. Equities will continue to be a source of long-term return but developed market valuations are above average. Further, the integrated global supply chain means developed market equities are more interconnected today and don’t always provide the desired level of diversification. This is where the search for alternative sources of return and increased diversification begins.

Evolution of our investment platform

Part of our job is to find sources of differentiated return and evolve our investment platform to include new strategies when appropriate. This happens when the opportunity is significant and we can find the right talent. Two years ago, we found just such an opportunity and brought on an experienced team to manage frontier equity investments. We are now making this strategy available in client portfolios.

The opportunity in frontier markets

Let’s start with a definition. Frontier markets are made up of some of the fastest growing countries in the world that are not yet considered emerging markets. These countries are located in Southeast Asia, the Middle East and Africa and are largely overlooked by global investors. We focus on buying companies in countries with large populations and rising incomes. As incomes rise, large segments of the population move out of poverty and begin to increase their spending significantly on goods and services that weren’t affordable before. Our investment team finds companies that benefit from this growth in consumption.  The companies we choose to own are very different to businesses in the developed world because they are meeting local consumption demand rather than being another supplier to global markets.

We also invest in companies that are exposed to other long-term trends exhibited by countries experiencing significant economic change. These include the benefits from urbanization, improvements in technology and access to healthcare, to name a few. These trends present investors with long-term growth opportunities. Along the way, investors are also providing much needed capital to companies that are under invested, which also has an impact on the development of these countries.

What about risk?

Managing risk in our portfolio is as much about what we don’t own as what we do own. For example, our investment universe has 8,000 companies of which we only expect to own 20-40. We start by avoiding higher risk industries and buy those companies with strong growth trends. We also focus on industries and companies with favorable environmental, social and governance (ESG) characteristics. This is an important part of our risk management process. We reward companies with strong ESG factors and engage those companies who need to improve. Once we have screened out the industries and types of companies we don’t want to own, we identify high quality companies with strong brands in large markets. Finally, we only invest in companies with experienced leadership teams and companies that we see as underappreciated by the market. Together, this helps us screen out risk in our portfolio and focus on the investments with the highest probability of success. 

The nature of investing in frontier markets is that these are developing countries which often lack a truly democratic process and strong regulations. This can’t be ignored and our research process identifies these risk exposures and adjusts our targets and ultimately the exposure to the companies in that country. For some countries, the risk is too high and we avoid them altogether. 

Adding frontier markets to a portfolio

Adding frontier markets will increase portfolio expected return and diversification. The added diversification is important because it means we can add a modest allocation to this volatile asset class without meaningfully increasing risk. This is possible because frontier markets experience volatility for different reasons and often at different times. In the chart below we show the degree to which frontier markets and other asset class returns move in relation to global equities. The lower the asset class is on the chart, the more different the returns are and the greater the benefit of diversification. 

Diversification benefit of frontier

Despite frontier markets’ low correlation to other parts of a portfolio, we recommend a modest allocation that varies depending on the portfolios’ mix of stocks and bonds. At modest allocation levels, investors can increase expected portfolio return and improve the relationship between the portfolio return and the risk required to generate that return.

Is adding frontier markets right for you?

As a firm we want to provide our clients with differentiated sources of return that will benefit their portfolios as long-term market outlooks change and new opportunities become compelling. We believe adding a modest allocation of frontier markets to a portfolio is a good option for many investors. However, the decision to change the portfolio asset mix should be made in conjunction with a fulsome discussion about the risk and return tradeoffs. We are here to help clients navigate a more challenging market environment and position their portfolio to meet their objectives while considering any unique circumstances. We can help you determine if adding frontier markets is right for you.

This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time. 

You’ve saved and invested for your dream retirement, and without jeopardizing that goal you’d like to help your children with a deposit for their first home, or put some money to use for philanthropic purposes, or otherwise spend a portion of your savings before retirement. Understanding how much you can spend now and still afford to fund your golden years can be difficult—but knowing what we call your core and excess capital can help you

What is core and excess capital?

In a nutshell, core capital is the wealth an investor needs to retain to support his or her retirement, while excess capital is the amount that can be spent today without affecting those plans.

For example, imagine an Ontario couple, both aged 65 and taking full CCP and OAS benefits. With $5 million saved up and invested, they plan to spend $175,000 each year of their retirement (linked to inflation and after tax). Knowing this, along with the composition and tax treatment of their investment portfolio1, it’s possible to work out how much money the couple is likely to need today in order to meet their retirement-spending aspirations. Happily for our imaginary pair, after crunching the numbers it’s around $3.9 million, less than their $5 million invested wealth. The $3.9 million is their core capital, and the remaining $1.1 million is their excess capital, namely what they can afford to spend today and still support their retirement as intended. 

* Core Capital is the assets necessary to have a 90% level of confidence that you will be able to meet your spending over your time horizon. Based on estimates of the range of returns for the applicable capital markets. Core capital relies on all other incomes assumed on the Essential Facts page of this analysis such as CPP, OAS, pensions, etc. Data does not represent past performance and is not a promise of actual or range of future results.

Confidence to determine strategy

Core and excess capital values are based on calculations and forecasts of future investment performance that can never be 100% certain. However, at CC&L Private Capital, we believe we can estimate clients’ core and excess capital with a high level of confidence, such that the core capital amount will be able to sustain clients’ planned spending even if financial markets perform poorly. We simulate 1,000 potential investment return scenarios, looking for a core capital amount that provides adequate resources in at least 900 of them. This is called the 90th percentile (90%) level of confidence and many of our clients feel this is an appropriately conservative approach. Of course, if you want more certainty we can plan for that, but it will require a higher level of core capital.

Knowing your core and excess capital can also help in determining the right investment strategy for you. Take an investor, saving for retirement, who has a portfolio that reflects their moderate risk appetite. Finding out that they  have excess capital above and beyond what they need to fund their retirement may result in a reevaluation of their investment allocations. Their core capital, the amount needed for their  retirement, could remain invested in line with their moderate-risk preference, while they could decide to treat their excess capital differently, depending on their  circumstances. In short, understanding your excess and core capital may help you to make better-informed investment decisions.

1. Our calculation is based on a portfolio with a 45% allocation to fixed income investments and a 55% allocation to equities. The couple is assumed to have $4 million of taxable assets and $1 million of assets in RRSPs.
2. Core capital is the assets necessary to have a 90% level of confidence that an investor will be able to meet his or her spending over a specified time horizon, based on estimates of the range of returns for the applicable capital markets. Data do not represent past performance and is not a promise of actual or range of future results.
This post is for information only and is not intended as investment advice. The views expressed are those of the author at the time of publication and are subject to change at any time.