Navigating uncertainty while positioning for the long term

Text transcript

Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Leslie Alba, head of portfolio solutions, total investment solutions, CIBC Asset Management 

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When we construct and adjust portfolios, a lot of what we do rests in three foundational principles: balance, quality and patience, which really are time-tested pillars that help investors manage risk, pursue sustainable capital growth, and perhaps, more importantly, avoid the pitfalls of emotional decision-making. 

Now, balance to us is more than a simple stock/bond split. It’s about thoughtfully diversifying across asset classes, sectors and regions, so that the portfolio can hold up under a range of different scenarios. And the aim is really to ensure that weakness in one area of the portfolio doesn’t derail overall portfolio outcomes if that happens. 

We emphasize a total portfolio approach, which really means treating the portfolio as a single, integrated entity that’s aligned to long-term objectives, rather than viewing the portfolio as a combination of siloed asset classes. We talk quite a bit about total portfolio approach. And, despite its rise in popularity, it’s important to acknowledge that it isn’t a prescribed strategy, but it’s more of a mindset of managing that portfolio holistically. That mindset keeps our focus on the true factors that underpin the risks and opportunities within the portfolio, which ultimately helps us avoid chasing arbitrary asset-class splits, or short-term trends. 

In practice, what that means is we keep equity risk in perspective of overall investment objectives and risk tolerance. We use fixed income for income and stability in the portfolio, and really size exposures so that no single theme or region dominates the outcomes. 

Another foundational principle is quality. And quality, for us, when constructing portfolios, is equally as important as balance. 

On the equity side, we prioritize businesses with durable cash flows, prudent capital allocation, and real competitive advantage. All of these are traits that tend to support stronger resilience in downturns, and also support more reliable recoveries. 

And then on the bond side, with spreads currently around the bottom of long-term ranges, we do favour higher-quality issuers and shorter-dated bonds so that we can capture attractive income while managing risk. 

In essence, quality is like our buffer against the unexpected, and really helps us deliver smoother capital appreciation or wealth accumulation over time. 

And finally, that last principle: patience. Patience may be the hardest principle to stick to, but it could also be the most rewarding. We know that markets are noisy and headlines can be unsettling, but long-term discipline, especially when managing portfolios, is essential. Having clear objectives and understanding risk tolerance and constraints helps provide an anchor to strategic asset allocation, and helps us resist the urge to react to short-term volatility, or the fear of missing out in markets. 

The evidence of having patience is pretty compelling. We’ve observed that over the last 30 years, missing just the best 10 days in the S&P 500 would have cut returns in half. And missing the 30 best days would have reduced returns by 83%. 

What’s interesting is that many of those best days actually occur during bear markets or early in recoveries, which tend to be when investors are most tempted to sell. So, it really is important to acknowledge that periodic drawdowns do happen, but that long-term returns continue to remain strong. 

All that said, strategic asset allocation is an excellent starting point, but not a finish line. And when we think about adjusting our managed solutions, we do believe that portfolios should evolve, but very thoughtfully, as risks and returns and correlations change. 

And the intention really isn’t to overreact to headlines or create an over-reaction in the asset mix, but rather to ensure that the portfolio continues to be positioned for those clear objectives that were determined at the onset. 

And so really, by focusing on those three foundational principles — balance, quality and patience — we believe that investors can navigate uncertainty more confidently and better stay positioned for those long-term objectives. 

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Our stance in equities is balanced across regions so that we can manage concentration risk, while capturing diverse sources of returns. In our managed solutions, U.S. equities remain an anchor, given the U.S.’s leadership in innovation and artificial intelligence, and also given that equity markets are supported by high profitability across sectors, deep and liquid capital markets to fund ventures, and resilient earnings that do tend to justify premium valuations over other regions. 

That said, we’re very mindful that a large degree of exceptionalism or outperformance may already be reflected in current valuations. 

And so, as a result, we generally hold U.S. equity allocation below its share of global market cap to help mitigate risks such as deglobalization, rising input costs, potential shifts in foreign demand for U.S. assets, and that persistent market concentration. 

So, to complement our U.S. equity exposure, and diversify our portfolios, we actively invest in emerging market equities. One area we’re watching quite closely is Chinese innovation. China’s rapid ascent in technology and production — which really does span electric vehicles, solar, AI infrastructure, and other areas — China’s ascent in those areas highlights the emergence of a changing competitive landscape. 

We do balance those opportunities in emerging markets against risks like geopolitics, state intervention, and potential structural inefficiencies by evaluating them within the broader context of policy and market sentiment, rather than really in isolation. 

Beyond the U.S. and China, we see constructive signs in Europe that could support improving corporate earnings as the economic recovery finds firmer footing. And then Japanese equities also seem to stand likely to benefit from ongoing corporate reform. And finally, Canadian equities play a very central role in our managed solutions because they offer differentiated economic exposures, attractive valuations, and steady dividend income. 

So, ultimately, our balanced equity positioning is about thoughtful diversification across geographies, sectors, and styles, which does reduce reliance on any single driver, and helps us keep portfolios resilient and well-positioned to capture growth, while managing risk along the way. 

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Today’s starting yields better allow fixed income to provide meaningful diversification and downside protection if equities sell off. In the post global financial crisis, low interest rate era, low coupons and elevated duration risk or sensitivity to interest rates really meant that even modest interest-rate hikes could produce outsized price declines. And that’s what happened. It was evident in 2022, when rising policy rates and inflation shock pushed both stocks and bonds down together. 

With yields now higher, fixed income can again act as a meaningful diversifier and shock absorber for three key reasons. 

First, is that coupons cushion drawdowns. Higher income helps offset price volatility, and reduces the depth of portfolio losses during equity stress. 

The second reason is that duration benefits, or that interest-rate sensitivity benefits can return when yields are higher. When equity markets sell off on growth concerns, market expectations often pivot towards policy easing. And in those environments, longer-dated government bonds tend to do well. Higher starting yields provide more room for interest rates to fall, which make the potential gain in bonds more meaningful than they were when interest rates were low. 

And then [the] third reason is that correlations tend to normalize when rates are higher. Outside of inflation-shock environments, historically, we’ve observed that high-quality bonds have exhibited low or negative correlation to equities, which helps diversify those risks. 

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As volatility and policy uncertainty evolve, the most compelling risk-adjusted opportunities, in our view, combine resilient fundamentals with very thoughtful diversification and discipline execution. So, in equities, we’re focusing on high-quality businesses with durable cash flows, very prudent capital allocation, and pricing power. 

Looking at Canada, our equity market offers attractive valuations compared to the rest of the world, and also very dependable dividends, which does create some stability in equity returns. 

When we look at the U.S., we’re looking for profitable growth at reasonable valuations, rather than extremely momentum-heavy concentration, which helps us reduce reliance on the most stretched AI-linked segments as leadership may broaden beyond the Mag Seven. 

In our managed solutions, where applicable, we also continue to hold low-volatility strategies. And those strategies are really there to complement our broader-market exposure positions, so kind of closer to those benchmark-like exposure positions. Those low-volatility holdings allow us to remain fully invested in the equity markets, and also allow us to benefit from equity-market participation, while managing volatility throughout the market cycle, throughout market turbulence. 

We’re also finding compelling risk-adjusted opportunities in the fixed-income space because, as mentioned, fixed income can again be a useful diversifier given where yields are today. In this asset class, our preference is for investment-grade credit over high yield, given the tightness of spreads and the macroeconomic backdrop. 

We’re also leaning towards shorter-dated bonds to capture the attractive coupon rate, while controlling rate risk, maintaining balanced duration across domestic and international markets. 

Where applicable in our managed solutions, we hold very rigorously selected private assets, which can further improve risk-adjusted outcomes in the portfolio. 

And finally, we do have some gold exposure. We express our gold views through disciplined equity stock selection in quality producers. So as volatility and policy uncertainty evolves, our playbook remains pretty straightforward. We remain invested, fully diversified and disciplined throughout time.

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