Getting your investment risk right – Morningstar.ca
A goldilocks approach to investment risk, where your portfolio is neither too hot nor too cold, becomes more important the closer you get to retirement.
Take too much risk, and you could blow up your portfolio and experience lean years rather than golden years in retirement.
Conversely, by avoiding risk you may fail to generate the wherewithal to sustain your lifestyle during your later years.
“You can lock in a term deposit or fixed income investments, but if you’re a retiree with 25 years to live, if you go too conservative, you’re not going to get a nice outcome,” says Fidelity International’s Richard Dinham.
And the current market environment, where interest rates are at historic lows and real investment returns – when factoring in inflation – are hovering below 1 per cent. Inflation is now running at around 1.6 per cent and annual GDP growth is below 1.4 per cent.
There’s also rising speculation that central banks could cut rates again in 2020.
With interest rates falling, the return from cash-based investments alone could be expected to also be lower. People can be locking in negative or very low real rates of return if relying too heavily on cash, says Dinham.
“You need a diversified form of risk – including equity risk and credit risk – to smooth your outcomes. Equities inevitably dominates here, but it’s taking the right amount of risk is vital.”
Back to basics
A large part of the problem for those nearing retirement, or already retired, is the concept of sequencing risk. Dinham refers to this as a core concept, “a 101 of financial planning” for retirees.
This refers to the risk that market volatility will erode an individual’s superannuation balance, particularly around retirement when these amounts are at their highest.
Compounding is a key element here – again, something that is generally well understood when we think about earning income and investing, but not so much in the context of retirement.
For example, let’s say you invest $100 in shares, and the share market declines by 10 per cent in the first year, and then increases by 10 per cent in the second year.
After the first year, the investment of $100 is only worth $90. At the end of the second year, that $90 in turn only grows to $99 – an overall loss of 1 per cent, or 0.5 per cent a year.
For the total amount to return to $100 again, the portfolio must return 11 per cent in the second year, not 10 per cent. The size of the returns must be large enough to offset the earlier losses.
Recovering after market losses
Source: Fidelity International
Though markets will generally recover at some point, the losses may be permanent for investors who don’t have the benefit of time to wait for this.
“It’s about finding a way of minimising the impact of markets while still remaining invested in them.”
A bucket approach to asset allocation is one commonly used method. The premise is that assets needed to fund near-term living expenses should remain in cash, as explained by Morningstar’s Christine Benz.
Assets that won’t be needed for several years or more can be parked in a diversified pool of long-term holdings, with the cash buffer enabling you to ride out periodic downturns in the long-term portfolio.
Benz recommends cash allocations should be tailored depending on your life-stage. In general, people still earning an income require less cash than those who are retired and drawing from their portfolio.
The right amount of cash also depends on your investment approach. If you’re an opportunistic investor, you may want more cash on hand to put into the market during a dip.
It’s also worth shopping around for the most attractive term deposit or other cash vehicle.
GM, POSCO Future M to boost investment at battery materials plant in Canada – The Globe and Mail
General Motors Co GM-N and South Korea’s POSCO Future M said on Friday they will invest more to boost production at their chemical battery materials facility in Canada, taking their estimated total investment in the plant to over $1-billion.
The companies said the new investment includes an additional CAM and a precursor facility for local on-site processing of critical minerals.
The development comes a few days after the Canada’s federal government and the Quebec province each provided about C$150-million ($112-million) for the facility.
The companies last year established Ultium CAM joint venture, which is majority owned by POSCO Future M, and had initially invested about $327-million, according to media reports.
Their battery facility in Becancour, Quebec, will produce cathode active material (CAM) for electric vehicle (EV) batteries.
Canadian pension fund CDPQ puts brakes on China investment, Financial Times reports – Reuters
June 1 (Reuters) – Canada’s second-largest pension fund Caisse de dépôt et placement du Québec (CDPQ) has stopped making private deals in China and will close its Shanghai office this year, the Financial Times reported on Thursday, citing people familiar with the matter.
The news follows a May 8 parliamentary hearing in which several Canadian pensions, including CDPQ, were asked about their relationship with China as bilateral political tensions have intensified.
CDPQ is leading its regional investment efforts from Singapore, the report said, noting that it still has business interests in China.
“We paused private investments for some time already — and have focused on liquid markets, which is the majority of our two per cent total portfolio exposure to China. We expect this trend to continue,” the newspaper quoted CDPQ as saying in a statement.
CDPQ confirmed the Shanghai office closure later this year, but declined to comment further.
The Financial Times in February reported that Singapore’s sovereign wealth fund GIC has reduced private investments in China.
During the May hearing, Michel Leduc, a senior manager at the Canada Pension Plan Investment Board (CPPIB), said China was an “important source” for its portfolio.
“We recognize that any investment in China needs to be handled with care, sophistication, and an acute understanding of the current political and geopolitical environment,” Leduc said.
A CPPIB spokesperson declined to comment further on Thursday.
In May, Canada’s C$211.1 billion ($157.87 billion) British Columbia Investment Management Corporation (BCI) said it had reduced exposure in China and Hong Kong by about 15% over two years and paused direct investments in China.
“Our current exposure in China is less than 5% of the overall BCI portfolio, the majority of which is through public markets and via indexed funds,” the asset manager said.
In April Canada’s third largest pension fund, Ontario Teachers’ Pension Plan (OTPP), also closed its China public equity investment team based in Hong Kong.
At the start of the year, OTPP said it was pausing future direct investments in private assets in China, citing geopolitical risk as a factor.
OTPP expects to name a new head of Asia-Pacific Private Capital Direct in the coming months to replace Raju Ruparelia who has left to pursue other opportunities, a spokesperson said by email.
($1 = 1.3372 Canadian dollars)
Our Standards: The Thomson Reuters Trust Principles.
Why Canada would benefit from 'direct index' investing – The Globe and Mail
Traditionally reserved for institutions and ultra-high net worth individuals, direct indexing is a hot topic for investors as technology advances and downward pressure on retail trading commissions have done much to democratize its access. In the United States, direct indexing strategies are expected to outpace the growth of both ETFs and mutual funds. In response, U.S.-based providers are scrambling to build, buy or partner to acquire the required capabilities to get in on the action, driving down the costs and required account minimums for investors. For Canadians, it’s worth getting a better understanding on what Direct Indexing is, and what we can expect for the future of these strategies north of the border.
As a brief overview, direct indexing amounts to personalization at scale. Similar to a traditional investment fund, direct indexing gives individual investors a way to get exposure to a broad segment of the investment market, such as an equity index. Unlike traditional funds, however, direct indexing involves individuals investing directly in the underlying securities (stocks or bonds that make up a larger index), instead of simply buying units of a fund. Investing in this way offers multiple benefits. First, there are a variety of tax strategies (most notably tax loss harvesting) made available by directly holding the individual securities, which can add a potential 1-3% after-tax return on an annual basis. Second, the investor would have near-full autonomy to incorporate their personal preferences for the purpose of excluding securities that do not align with their values or investment objectives. Consider an index that is made up of the 500 largest companies listed in the United States, when investing in this product the investor does not have the choice of what companies make up this portfolio, meaning they may be required to invest in companies that do not align with their values or investment objectives. However, by holding the underlying securities, these non-aligned stocks can be excluded from the investor’s portfolio. While traditional thematic ETFs and mutual funds provide generic options for investor choice, the opportunities for hyper-personalization inherent in direct indexing strategies are almost endless.
As a concept, direct indexing is not new. Sophisticated investors, such as institutions and wealthy investors, have long held the requisite buying power and influence to overlay all manners of unique constraints on their investment portfolios. However, technology advances that could handle significant scale coupled with reduced trading costs brought this concept into the hands of individual investors – the former made it possible for investment managers to offer direct indexing while the latter made it affordable for the retail market.
The seismic nature of this shift cannot be undersold. Consider an investment advisor seeking to satisfy the individual needs of their clients across 10,000 individual investment portfolios. They’d need to manually ingest a mountain of client-level information, go about buying into hundreds of thousands of individual securities and monitor all accounts to identify portfolios that require rebalancing when they drift out of alignment. Prior to the advances described above, this would be cost- and time-prohibitive. Direct indexing offers this high degree of personalization in an automated fashion that is feasible for the investment manager, while better serving individual client needs.
When compared to the U.S., Canada has been slower to internalize the required pre-conditions to support direct indexing, but the outlook is increasingly positive. Leading direct indexing technology-solution providers in the U.S. are expressing interest in Canada as an expansion target. Additionally, Canadian broker-dealers are exploring ways to enable zero commission trading at scale. Fractional shares, at one time considered more of a marketing gimmick, is also slowly finding its footing as firms are tapping into lower account balance investors that are seeking alternatives to traditional funds.
Beyond these structural considerations, it’s worth examining whether demand among Canadian investors will be sufficient to justify bringing direct indexing to the Canadian market. For instance, the main driver for adoption of direct indexing in the U.S. is the opportunity to capture additional after-tax returns through direct indexing’s optimization capabilities. However, given tax code differences in Canada related to the treatment of capital gains, the benefit provided from tax optimization strategies deployed on Canadian portfolios will likely be less than those experienced by our counterparts south of the border. That said, believers in the concept remain steadfast that the increase in personalization for Canadian investors will be enough to drive demand for direct indexing.
Direct indexing likely still has a place in the Canadian investment landscape, despite the differences between Canada and the U.S.. The first ‘Canadianized’ direct indexing solution made available to the mass-market will have to navigate Canada’s structural nuances; if done successfully, investors aim to significantly benefit by accessing institutional investment capabilities at a cost likely competitive with most Canadian mutual funds.
Michael Thomson is director, and Jeffrey Joynt a consultant, with Alpha Financial Markets Consulting
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