Market Commentary
They say there are old pilots, and there are bold pilots, but there are no old, bold pilots. If we use that as an analogy for investing, I think I’m safe to say that most investors prioritize long-term investment returns versus short-term wins and thus prefer to be in the “old pilot” category. That’s certainly our position. Given the stock market’s incredible return to near-record highs after selling off about 20% in early April, we believe having too much exposure to stocks at current valuations is a bold investment choice indeed.
Of course, we are happy that stocks have rallied and that the worst of the trade war has been avoided, for now. The question remains, where do we go from here? Tariffs are substantially higher than they were a few months ago and global trade is being redrawn as we speak with inevitable economic disruptions. Perhaps we end up in a better place when the dust settles – one step back and eventually two forward. Or perhaps, near record-high valuations for stocks (see figure 1) are not warranted given the realities of deteriorating economic fundamentals and extreme uncertainty. As far back as the data goes, when you pay current valuations for stocks (defined by the price to earnings ration), the 10-year forward returns from stocks are dismal. That’s not a market timing mechanism, but it is a good indicator that investors should be looking to balance out their portfolios with other, more fairly-valued assets.
For decades, the most sophisticated and wealthiest investors in the world have benefited from exposure to private assets. In many cases, the best investments are not publicly traded. This may include equity in the fastest growing companies, unique loan structures with higher yields and better capital protection, the best pieces of real estate or interest in complex infrastructure projects. If nothing else, these investors had a much bigger pond to fish in, most companies with over $100 million in revenue are privately held (i.e. don’t trade on stock markets), see figure 2.
Arguably the most significant development in my career has been the “democratization” of private assets. In the past few years, we have seen private asset managers accelerate their offerings to individual investors through portfolio managers like ourselves. Increasingly, we are gaining access to the most respected private asset managers in the world that offer our portfolios enhanced diversification, higher yield, lower volatility, better downside protection and improved long-term return potential. These benefits were on full display in recent months as President Trumps trade war roiled stock and bond markets, while our private asset portfolio provided stable returns. Our capabilities and opportunities from the highest-quality private asset managers are now enhanced on our new platform at Wellington Altus. It’s not just about what we gain from what we add, but what we gain from what we remove – exposure to one of the most volatile assets out there, publicly traded stocks. The stock market is increasingly defined by its high concentration, high valuations and massive daily moves driven by computerized trading systems that can buy and sell millions of shares in fractions of a second. If we can own a bit less of that, while improving long-term returns, we believe it’s a very good thing. Figure 3 highlights the disparity in alternative asset ownership between Canada’s own pension funds, global family offices that manage money for the ultra-wealthy and the average Canadian’s portfolio. Our strategies have progressed alongside the private asset industry, as the quality and breadth of strategies available to us has expanded, so has the allocation in portfolios. We now target around 25% for clients with appropriate objectives. I can’t overstate the return and risk management benefits we believe this brings to client portfolios.
Portfolio Strategy
Debt
Liquid Fixed Income
- Once again, traditional bond strategies with large allocations to government debt and high sensitivity to interest rates failed to deliver during the market sell-off in April.
- Our strategy focusing on better yield/income with less sensitivity to interest rates has proven effective at delivering better returns in the long-term but also avoided much of the volatility caused by interest rate fluctuations.
Private Credit
- Despite modest softness in credit markets, private credit has continued to deliver portfolios healthy cash flow/yield, offsetting some of the volatility in stocks.
- The credit quality of the portfolios we own is excellent, the leverage is low and this continues to be one of our most constructive risk/reward segments of portfolios.
Equity
Public Equity (stocks)
- Our move into international stocks near the depths of the selloff in April has provided excellent returns and also sets up portfolios with additional diversification. We are pleased, we will continue to monitor the geographic exposure of the stock allocation as global trade and alliances are reshaped.
- As alluded to above, we are once again concerned about equity valuations. Portfolios are already substantially underweight stocks, to the extent we can allocate to other investments with better risk/reward expectations, we will continue to do so. The probability of excellent returns from stocks at these valuations is low.
Private Equity
- We are amongst a select few wealth managers in Canada that have been investing in private equity for several years. As the opportunity set expands and improves, we are in an excellent position to identify and implement the best strategies into portfolios. This is a competitive advantage clients are benefiting from and we believe still in the early stages.
Real Assets
Real Estate
- Certain segments should continue to experience growth, however several factors could weigh on returns more broadly (i.e. building costs, modernization of old buildings, higher financing costs). We have reduced exposure over time in favour of more attractive sectors.
Infrastructure
- Infrastructure tends to offer inflation protection, steady cash flow backed by real assets that are difficult to replicate, have rising demand and investors can earn modest capital appreciation as the replacement costs rise.
- Infrastructure has multiple tailwinds right now (pent up demand, shifting definition of infrastructure to include things like data centers, increased energy demand, lack of public funding to finance projects). The opportunity set in infrastructure has finally opened up to individuals and we intend to capitalize.