Foresight - Summer 2022

The first half of 2022 has seen global equity markets correct and inflation return to levels we haven’t seen in decades. Covid lockdowns continue to disrupt the supply chain, especially in China. The Ukrainian conflict has disrupted energy supply as well as agricultural planting in one of Europe’s major bread baskets.

Growth stocks and the technology and biotechnology sectors have been particularly hard hit, falling as much as 35% off their recent highs. We have been using this significant correction in these sectors to add positions when a portfolio’s asset allocation plan calls for rebalancing across sectors or an outright buy of equities.

As always, not all equity markets and industry sectors are experiencing the same level of negative momentum since January 1, 2022 (includes currency):

All World Equity Index	US S&P 500	TSX60	BMO TSX Low Volatility	Japan
-12%	-14%	-2%	-0.4%	0%

While rising interest rates and the fear of increasing inflation have been a significant dampener to growth stocks, energy stocks have made an amazing resurgence, with the iShares TSX Energy ETF up 65% year-to-date. In the depths of the covid-driven bear market of March 2020, we were buying this ETF in the $3 to $4 range and at writing it is trading at $18. It has been a long time coming, as energy stocks have been underperforming for at least 5 years. The base metals area of the resource sector is also going against the negative momentum of the overall market, with the iShares Global Base Metals ETF up 9% and the iShares TSX Materials ETF up 7% year-to-date.

The recent increases in interest rates have had a significant impact on the long end of the bond market. The iShares US Treasury 1 to 20 Year Bond Ladder ETF is off 21% year-to-date and down 35% from its highs set in 2020. We continue to maintain a relatively short duration bond portfolio of 1-5 years. However, even the iShares 1-5 Year Bond Ladder has not been completely unscathed - down 4% year-to-date. To mitigate the negative effects of rising interest rates on bond prices, we continue to maintain significant positions in government floating rate bonds and inflation-hedged real rate of return bonds. Lastly, our bond portfolios maintain a weighting of approximately 10% in “Alternative Debt”, which is structured to add incremental returns while lowering market volatility.

All said, how have our portfolios fared in the first half of 2022? Although every portfolio is unique to the situation of each client family, at the time of writing, our portfolios by-and-large are down 3%-4% year-to-date. We never enjoy seeing portfolios decline in value. That said, given the double-witching in both bond and equity markets, we believe we are well structured to weather what ever economic environment comes at us in the coming months and years.

INNOV-ACTION

Our new paronomasia combines innovation and proactivity. Proactivity is about acting in advance of a future situation on your to-do list. Innovation is about adding new things to your to-do list. We are busy with both through the summer.

Education Accounts (RESPs)

RESPs can have three different phases...contributing (while your kids are young), withdrawing (when they are engaged in post-secondary education) and dormant (when they have grown up but are not pursuing post-secondary education). We always have been proactive in following up contributions and withdrawals. It is the dormant accounts that can fall by the wayside. Thus, our recent innovation: we ran a report of all of our RESP accounts and identified the “dormant” ones. For those accounts, we then analyzed the history of contributions, grants, investment earnings and withdrawals. Often, we discovered that the grants and earnings already have been withdrawn by the child and, thus, the remaining value of the account is only contributions, which can be withdrawn tax-free, thus closing the account. The final payout of tax-free funds can either be given to the child or returned to the contributor (usually the parent). The parent may have personal uses for the funds, or might pass them on to the child ...perhaps to seed a TFSA or start a house fund. Our innov-action here has led to such results. 

Matters of Estate

Bi-annually in June we conduct a review of estate planning designations across all investment accounts. These planning steps take the form of designated beneficiaries for RRSPs, RRIFs and TFSAs and joint tenancies for Trading accounts. Generally, these planning strategies lodged with your financial institution (NBIN) supersede provisions in your will. Typically, there are two significant benefits to these institutional designations: first, much greater time efficiency in passing the deceased’s assets to the heir(s) and; second, avoidance of provincial probate fees (1.4% in BC).

As we conduct this detailed review, we use our present knowledge of client circumstances to assess the appropriateness of these designations extant. We make a list of those that we are not sure about or those that clearly need to adjust for changed circumstances. The clients on this list will be contacted to discuss remedial action.

Dashboard

Our February Innovation was to consolidate the various metrics we use to manage each family portfolio onto one visual screen, rather than scanning several different worksheets for this important information. We beta-tested for three months to work out the kinks and will go Practice-wide over the summer across all accounts.

Call-to-Action index

We initiated this several years ago to identify how far off a portfolio is from your Asset Allocation Plan. The recent long Bull Market frequently was causing us to deliberately sit passively on new cash deposits...potentially welcoming a down-market buying opportunity (like March 2020). However, this deliberate strategy caused the Call-to-Action index to rise high. As a result, in January we re-programmed this index into two distinct components: one to track our deliberate holding of cash and the other to flag the original purpose of monitoring asset allocation rebalancing calls.

Speaking of Education…..

We are proud to report that Mike passed the first of three exams to earn the gold standard Chartered Financial Analyst (CFA) designation. This exam had a 36% pass rate.

WHAT’S NEW?

Our recent research has identified some interesting new investment vehicles, which we have added to our Master Portfolio template and have been adding to accounts where appropriate and timely.

Downstream, our Janus Diagnostic application will flag other accounts as circumstances develop 

Neuberger Berman Specialty Finance Income Fund (UAL810)

This private debt fund focuses on North American self-liquidating consumer and small business loans with short duration and steady cash-flow. It fits into our fixed income allocation as “alternative debt”, which constitutes approx. 10% of your bond allocation. It is comprised of thousands of underlying loans diversified across sectors, geographies and other factors. It has a target net return of 8-12%, with income distributed quarterly, and an average duration of approx. 1 1/2 years. Its short duration and amortization lead to low correlation to the overall fixed income markets.

Vanguard Small Cap Growth ETF (VBK)

This ETF provides exposure to a diversified group of approx. 750 small growth companies in the US. With a median market cap of $5.4 billion, it is largely comprised of companies in the technology (21.4%), healthcare (19.0%), industrials (17.7%), and consumer discretionary (15.6%) sectors. As of May 2022, its 10-year average annual return has been 11.24%; including a sharp drawdown of 30% since its all-time highs in November 2021.

iShares Biotechnology ETF (IBB)

This ETF provides exposure to approx. 370 US companies in the biotechnology industry. As with VBK discussed above, IBB has experienced a sharp drawdown of 35% since its all-time highs in September 2021. As of May 2022, its 10-year average annual return is 11.23%. It’s top five holdings are Amgen (9.8%), Gilead Sciences (8.4%), Regeneron Pharmaceuticals (7.14%), Vertex Pharmaceuticals (7.04%), and Moderna (5.23%).

VanEck Agribusiness ETF (MOO)

Like much of the global economy, the agricultural industry has been severely affected by the COVID-19 pandemic. But it has made an impressive recovery as commodity prices have soared in several categories and the war in Ukraine has further squeezed supply of products such as wheat and fertilizers. However, this industry is not immune to recession worries and has seen a sharp drawdown since April. MOO provides exposure to 55 global companies involved in agri-chemicals, animal health and fertilizers, seeds and traits, farm/irrigation equipment and farm machinery, aquaculture and fishing, livestock, cultivation and plantations, as well as trading of agricultural products. As mentioned above, even though MOO has experienced a recent drawdown of 20% since its all-time highs in April 2022, its 10-year average annual return has been 9.80%.

PERSPECTIVE                                                            

Lets look at thirty-six interesting months from March 2019 through March 2022. We have dug into clients who have a fiscal period Annual Report ending March 31st. The table below shows the simple annual return for each of those years, as well as the three-year, annual compound return.

—-——-———-—————-March 31——————————-

Client	3 year compound	2020	2021	2022	Allocation FI/E
A	7.56%	-5.30%	23.08%	6.77%	50/50
B	7.18%	-1.01%	19.6%	3.98%	35/65
C	7.19%	-1.35%	18.97%	4.93%	60/40
D	6.91%	-2.24%	19.44%	4.66%	50/50
E	6.77%	-3.16%	19.19%	5.59%	50/50

Each of these three twelve-month periods has a different story line. The 11 1/2 months to March 2020 continued a robust Bull market, but ended the year with the Covid collapse, in which equity markets fell 26-33%. Despite that ending, the 2020 annual portfolio returns were only modestly negative. At that juncture, and the unfamiliar territory of a global pandemic, there wasn’t a lot of optimism on the Street. However, the market recovery by August 2021 was remarkable in both size and speed. Rather than a financial debacle, portfolios produced staggering returns to March 31, 2021…19-23% in the chart. Rolling one-year portfolio returns after March 2021 remained in double-digits all the way through December 2021.

Each year, the portfolio return is, obviously, a composite of the individual returns across all securities owned. More generally, the overall portfolio return is a blend of the two major components in the asset allocation plan: fixed income and equities. It is a complicated and time-consuming exercise to dissect the overall return into its two components. In order to give us this perspective, three years ago we decided to establish the process for this and to execute it for one designated portfolio each month. By coincidence, the chosen portfolio for March year-ends is Portfolio A above. Lets drill deeper into its portfolio returns to see what the two components did on their own.

	Total return (above)	Fixed income return	Equity return	Allocation FI/E
2020	-5.30%	1.67%	-12.41%	50/50
2021	23.08%	2.63%	48.27%	55/45
2022	6.77%	-1.0%	13.3%	45/55

In the late March 2020 Covid crash, the modest fixed income return did manage to mitigate the 12.41% equity loss. The ongoing low fixed income returns in 2021 and 2022 were heavily compensated by the enormous 48.27% equity return, followed by a still-healthy13.3%. The low fixed income return “crossed the line” to NEGATIVE in the summer of 2021 through March 2022. Note in the chart above that the negative fixed income return was bolstered by the 13.3% equity return, to yield a satisfactory portfolio return of 6.77%. Our Annual Report analysis only extends to April 30th at the time of writing. Fixed income return continues to be negative. But the equity market has finally “corrected” over the last quarter, with the result that it presently does not “save the day” to produce a satisfactory overall portfolio return…. now approaching ZERO%. On the plus-side—as the Editorial wrote—we anticipate selective buying opportunities in this double-witching period.