Is your balanced portfolio truly balanced?

Recently, we have seen a lot of so-called “balanced portfolios” from prospective investors with one of two concerns.  Either they have a typical 40%-50% weighting in bonds that earns meagre returns, or in search of higher returns, they have 70%-80% of the portfolio invested in equities. It’s rare to see a cash weighting above 5%. For different reasons, these strategies represent more risk than many people realize or are comfortable with.

These risk and return factors are why we think the industry standard model of a “balanced portfolio” of 60% equities/40% bonds is broken. You’re forced to choose between low returns or high risk and it’s a no-win solution for investors wanting a balanced approached.  Here’s why and what you can do about it:

Bonds – Too Much Risk for Too Little Return

We’ve written before in this blog about the risks of owning bonds at this point in the cycle. As interest rates rise, bond prices fall. In the portfolios we manage, we’ve taken a defensive stance for the past couple of years, reducing our allocation and holding bonds of short duration to preserve capital in client portfolios. We recently took this a step further and reduced our allocation to investment-grade bonds from about 12% to 8%, in a balanced portfolio.

In reaching this decision, our Investment Committee looked at the likelihood of interest rates rising (likely) and the absolute return we could get on bonds (minimal). We compared this to cash and other assets and decided there is little reason to be in bonds today other than a hedge on the economy, a source of near-term cash – or a lack of alternatives.

When you compare our 8% weighting to the typical 40% bond weighting for a balanced portfolio, it says a lot about our conviction – and the more attractive alternatives available to us. So what are these?

We’ve been deploying the bond proceeds into new opportunities in private real estate, private and public mortgages and private debt – in other words alternative assets that have different risk factors and enhance return. We are also earning higher yields and capital appreciation in preferred shares.

Profiting from Recovery in Preferred Shares 

We started buying preferred shares during the sell-off in the summer of 2015. We continued to buy as the market dipped further in early 2016. In hindsight, we were about three months early.  But the volatility allowed us to build a portfolio that generated a 5.5% cash yield and has risen in value since then. Preferred shares finished strongly in 2016 and are up appreciably year-to-date, in addition to generating a nice cash yield. We believe there is more upside as the market hasn’t fully recovered to previous levels.

Prepared for a Correction in Equities

As North American stock markets set record highs almost daily, many people have asked whether we are concerned about a correction. Our view is that we need a correction and would welcome one. We currently have an 18% cash weighting and a neutral allocation to equities. We are ready and waiting for the opportunity to deploy capital in a sell-off.  In short, we are hoping for the same opportunity in common shares that we enjoyed in preferreds.

These strategies underscore why we choose to manage money the way we do. Drawing on a broader investment universe gives us much more room to manoeuvre.  It helps us avoid areas we’re concerned about, like bonds, without being forced into an overweight position in equities. It allows us to enter areas of unrealized opportunity, like preferred shares currently and other alternatives.

If you are concerned about the asset mix in your portfolio, please feel free to get in touch. We would be happy to do an analysis and offer our independent perspective. Our services are suitable for individuals with $1 million or more to invest.