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You’ve probably heard countless times the fund industry mantra about how stocks outperform over the long run. But as Daniel Solomon, senior vice-president and chief investment officer of NEI Investments points out, that hasn’t been the reality for most investors, whose time horizons are much shorter than those of investment textbooks.
Solomon, who along with portfolio manager Christine Hughes is in the midst of a cross-Canada road show for financial advisors, says the challenges faced today by investors aren’t going away any time soon. Economic growth rates have slowed, and central bankers in Europe and elsewhere are grappling with a sovereign-debt crisis.
For individual investors, Solomon recommends an active approach to asset allocation, with some constraints. For instance, he says, 60 per cent of an investor’s portfolio could maintain a stable mix of asset classes. The remaining 40 per cent could then take a tactical approach, shifting between stocks, bonds and cash.
Challenging the conventional wisdom, Solomon argues that heightened volatility and low cumulative returns in the past 16 years have shattered some of what he calls traditional misconceptions about investing.
Consider the frequency of market catastrophes, often referred to as “black swan” events. Old-style thinking, according to Solomon, is that black swans are too rare to worry about. Not so, he says, citing the global financial crisis of 2008, and the Asian debt crisis 10 years earlier.
Solomon used the huge U.S. stock market to illustrate the market extremes of the more recent past. The S&P 500 index (excluding dividends) more than doubled from December 1996 to its bull-market peak in August 2000.
After that, it plunged 46 per cent by September 2002. Subsequently, it rose 90 per cent from that low by October 2007. Next came another plunge, this time by 53 per cent by the end of February 2009. Since then, the market has rebounded by 91 per cent as of the end of August of this year.
To help mitigate stock market cycles, Solomon emphasizes the importance of dividend-paying stocks, which give investors a “head start.” Dividend yields compare very favourably with government bond yields, he says, with much superior prospects for capital growth.
As for fixed income, Solomon says that high-quality bonds can’t be counted on these days to provide safe and relatively steady returns. If market yields were to rise by one full percentage point from today’s rock-bottom levels, returns would be dragged into the red, he says. (Bond prices and bond yields move in opposite directions.)
Under current market conditions, Solomon favours high-yield bonds, which are below investment grade in credit quality. The key to generating high-yield returns, he says, is avoiding defaults through active management.
Solomon favours managers who are “truly active,” meaning those whose portfolios have low correlations with their market benchmarks, and who have the flexibility to make decisive shifts in their holdings and build “high conviction” portfolios.
Reflecting his views is NEI’s hiring earlier this year of Hughes, the former AGF manager now running her own Toronto firm, OtterWood Capital Management Inc. Hughes took over in May as the portfolio manager of Ethical Balanced Fund, along with recent additions Northwest Macro Canadian Asset Allocation and Northwest Macro Canadian Equity.
With her tactical shifts in asset mix, and her use of protective puts, short selling, currency hedging and precious metals exposure , Hughes aims to produce positive returns, with or without the help of rising markets.