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as quickly. MSCI’s Canadian index for real estate invest- ment trusts finished the year down double digits.
Precious metals and commodities
Precious metals such as gold and silver are seen as safe havens: their value rises when there’s fear in equity markets. They’re also a hedge against inflation and currency weakness. While holdings can’t replicate fixed income returns, the Purpose Investments white paper said that precious metals can help achieve some of a 60/40 portfolio’s goals because they’re traditionally uncorrelated to broader equity markets.
However, CIBC’s 2021 outlook report warned that correlations across asset classes are increasing: “In the current environment, gold is not necessarily a haven play as traditionally defined, and therefore is no longer an effective risk hedge from a diversifica- tion standpoint.”
The report still expected gold to perform well in the coming years, peaking at US$2,300/oz in 2021. But for investors looking to avoid downswings, the CIBC report said long U.S. dollar and long CBOE vola- tility index (VIX) strategies are better risk hedges.
Gordillo said maintaining gold, commodities and Treasury Inflation Protected Securities (TIPS) pro- tects against inflationary shocks, and Crowe said she likes to allocate about 5% of a portfolio to gold.
Other alternative strategies
Crowe also uses hedged credit strategies that can go long and short on bonds, essentially hedging the interest rate risk.
“It’s designed to protect against capital losses from rising interest rates,” she said.
When credit markets froze in March 2020, the strat- egies “got hit pretty significantly,” she said, but the funds she uses re-entered positive territory last year.
With the introduction of liquid alternatives in 2019, retail investors now have easier access to products offering different income streams. There are now more than 100 liquid alts in Canada.
The challenge, Gordillo said, is that the Canadian market is heavy on equity products that can’t neces- sarily replace bond holdings. He pointed to covered call products, where an investor sells call options on a stock.
“You would think covered call writing has all the characteristics of clipping a coupon, lowering vola- tility,” he said. “But when Covid happened you’re down 30%.”
The nascent liquid alternative market was shaped by a decade-long equity bull run, Gordillo said. Prod- ucts designed to offset losses or provide returns uncorrelated to equities were a hard sell when the S&P 500 was up almost 29% in 2019, when the first products were released.
After the pandemic, advisors will be looking for products that can go long and short, and that are nimble enough to profit from down markets, Gordillo said, while eking out a better yield than bonds in good times.
Mackenzie Investments’ 2021 outlook report forecast a basket of different 10-year government bonds would return
an average of roughly 1.5% in the coming decade. Over the last 40 years, the 60/40 portfolio generated an average annual return of 9.6%; that will drop to about 4% for the next 10 years, the report said.
“Covid will definitely launch a whole new class of liquid alternatives that is likely to fill that gap,” he said.
A January ETF report from National Bank Financial showed some products performed according to plan, avoiding the market collapse when the pandemic hit. “We found that the market neutral products were grinding higher through various market conditions,” the report said, “and the anti-beta strategy delivered posi- tive returns during the worst of the selloff early in the year (before mean-reverting toward the end of 2020).”
While liquid alt strategies vary widely, over- all 2020 performance was solid: the Scotiabank Alternative Mutual Fund index finished the year up 4.91%, compared to the S&P/TSX Composite index’s 2.17% return.
Picton Mahoney’s Mesman said he’s focused on long and short opportunities in developed-market BBB- to B-grade bonds.
The Federal Reserve’s corporate bond purchases created opportunities on the short side to both pro- tect the portfolio and provide alpha in cases “where the real economy’s impact on financial assets has yet to be felt,” he said.
A report from Richardson Wealth released early this year said long-short credit strategies are suited to the current environment, reducing the risk from rising rates. The higher yield comes with a trade-off, though, which is risk from using leverage.
Dividing it up
Crowe has clients who want no traditional fixed income. In those cases, she allocates the 40% to alternative assets classes: private debt, real estate, arbitrage or long-short strategies, and hedged credit. In most portfolios she maintains some traditional fixed income and puts 10% to 20% in alternatives.
Goode said balanced portfolios at National Bank can only go as low as 30% on the fixed income side for compliance reasons, so she may move 5% of the overall portfolio into equities and 5% into different alternatives, depending on the client.
“We don’t want to get too aggressive,” she said. “Most of our clients are retirees.”
For clients making RRIF payments, Goode
likes to keep enough cash on hand to last 12 to 18 months in case of a dramatic market event like at the start of the pandemic. This means 5% to 10% of a portfolio in cash. For younger clients, she encour- ages them to stay fully invested.
Moving away from the 60/40 portfolio requires frank conversations with clients to make sure they understand the risks. It’s easy to underestimate the role of bonds when they’re returning next to nothing, but uncorrelated assets are essential in a downturn.
“Diversification remains key, as does minimizing volatility to avoid behavioural pitfalls,” the Purpose Investment white paper said.
“When a portfolio exhibits less volatility, invest- ors are less likely to make snap decisions to sudden market moves.” AE
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