How the best advisors capture the potential of stocks while managing risk
The stock markets are on a historic bull run and likely have more room to roam – but not without dips, corrections, and even a short-lived appearance of a bear along the way.
This is largely the opinion of four advisors who made SHOOK Research and the Globe and Mail’s inaugural ranking of Canada’s best wealth advisers.
Yet if these advisers are optimistic, it is with caution.
Here’s a look at the strategies they use to capture the upside in stocks while managing their risk.
Todd Degelman, Founder, Vice President and Senior Investment Advisor at Degelman Pruden Group at Wellington-Altus Private Wealth Inc. in Saskatoon
Mr. Degelman employs a three-pronged strategy for clients that includes a retirement style allocation in a globally balanced portfolio similar to that of the Canada Pension Plan Investment Board. The second round is a yield portfolio that has structured notes and dividend strategies “to get a little more improved return” compared to fixed income securities “without taking much more risk”. And the third round is dedicated to the “alpha generation”.
This latter part of the strategy often involves allocating capital to equity-focused fund managers in disruptive technologies – including exchange-traded funds (ETFs) of Cathie Wood and her team at Ark Investment Management LLC – as well as ‘value style managers focused on the environment – equity capitalization.
Other alpha-based approaches include a dynamic slope, selecting stocks with the highest inflows.
Depending on clients’ risk appetite, money is allocated to all three or even just one of the rounds, as opposed to the traditional 60% equity / 40% fixed income framework. Slowdowns are expected, but Degelman argues that the low interest rate environment – aside from the hikes – offers investors few options.
Additionally, focusing on an appropriate allocation to the aforementioned innings, while ensuring that the sub-managers are performing, limits the negative impacts of the unexpected, he says.
“It’s up to managers to navigate these uncertain times.
Rob Tetrault, Senior Vice President and Portfolio Manager at Tetrault Wealth Advisory Group at Canaccord Genuity Wealth Management in Winnipeg
Mr. Tetrault is “a big supporter of equities,” noting that the secular bull market could last another 10 to 15 years. Still, he expects a “potential reset in the second half of next year” that could see public markets drop as much as 30%. “But you still can’t run out of this market.”
Its approach to managing equity and fixed income risk has been to allocate more capital to alternative assets. Indeed, private equity is often not correlated with the performance of public stocks, and private debt offers a higher return than traditional fixed income while being less affected, in general, by rising interest rates. .
Alternatives also include real estate, infrastructure and farmland. Of particular note is an allocation to a music royalty fund which generates constant income with capital appreciation.
“You can argue that it has an inverse correlation with the markets,” he says. “If there is a recession, people usually play more music at home.”
Shawn Jerusalim, Senior Vice President and Investment Advisor at Jerusalim Financial Group at CIBC Wood Gundy in Toronto
Jerusalim also believes stocks still have a long way to go, despite the risks in China and those associated with the COVID-19 pandemic. However, he says the biggest threat is inflation – although it affects fixed income more than stocks.
“You have to be careful because fixed income securities are what protect clients a little more when [equity] markets fluctuate downward, ”he says.
Due to low bond yields, Jerusalim is also allocating more capital to alternatives such as structured note positions which pay monthly income with downside protection.
When it comes to stocks, he often employs four active sub-managers for global exposure while surrounding their passive exchange-traded fund strategies for exposure to North America.
Constant throughout reassures clients that a diverse approach works best. “We create wealth by investing in a portfolio of companies over time,” he says.
Still, most portfolios have around 10% cash to buy in declining markets. “The markets are falling very quickly. And they often bounce back quickly too, he adds. “So if you don’t have the cash available, you often can’t take advantage of it. “
Nader Hamid, Portfolio Manager and Director, Private Client Group with Total Wealth Management Group at iA Private Wealth in Pointe-Claire, Quebec.
Stocks remain attractive given their performance relative to fixed income securities, he says.
“The premium you get for stocks is just as attractive as it was 10 years ago,” says Hamid. “The [return] the spread between stocks and bonds is always worth the risk.
He adds that the stock markets are in “a Goldilocks era” with strong economic growth and accommodating monetary and fiscal policy.
“It’s very rare to have a massive market correction in these booming economic times,” he says.
Mr Hamid is quick to note, however, that the stock markets could still fall between 5 and 20 percent.
“But there is so much money on the sidelines, that when we see withdrawals, they are often short-lived.”
Fixed income securities continue to be a “ballast” against falling stock prices. Yet Mr. Hamid allocates more capital to alternatives for better returns.
It relies on third-party sub-managers for fixed income and alternative assets, but stocks are managed internally, consisting of a portfolio of around 30 Canadian stocks and the same number of US stocks.
Only companies with a high return on equity, low debt, participating in growing industries, have consistent profit growth, and good management makes the cut.
In turn, the strategy often uncovers companies in long-term growth sectors such as cybersecurity, renewables and healthcare, Hamid said.
“So we’re less concerned with short term bumps. “