In Canada, we know that what happens in the U.S. has a profound impact on our country. Therefore, in today's environment, it is difficult to discuss the economy or the markets without considering U.S. politics and policies.
While policies matter, investing around politics is never a wise choice. Instead, we suggest considering the secular, profound trends that are already in place and that will continue to influence our investment approach for years to come, such as debt and demographics.
Signs Point to Slow Economic Growth
Since 2008, debt relative to GDP is higher in most nations than it was before the global financial crisis.1 It's not just government debt that has risen — household and corporate debt has been on the rise in many countries, as well.
In 2016, the first of 80 million baby boomers turned 70, and according to a recent survey, only 46% of boomers have saved more than $100,000 for retirement.2
Inadequate savings, combined with the current and expected market environment, require some new perspective on risk and return in order to best meet long-term objectives.
The biggest reason to revisit asset allocation is that bonds are currently offering very low interest rates. Historically, bonds have been the cornerstone of a diversified portfolio. They have provided a stable return profile, lowered volatility and acted as an offset to equities (and equity-like asset classes). However, it is likely that lower interest rates and returns become the new normal as a result of excess debt and an aging population. This means traditional asset allocation and investment strategies will be a part, but not the exclusive composition, of portfolios.
Even in a modestly rising interest rate environment, a portion of portfolios needs to preserve capital and provide a source of income and liquidity, while also providing potential appreciation in the event of a downturn in the equity markets. It seems unlikely that a traditional bond portfolio can meet these objectives entirely.
So what can investors do? We offer three strategies as a framework for building resilient portfolios.
A thorough understanding of risk is imperative in this environment. One of the most notable outcomes from the global financial crisis is what a complex and nuanced thing liquidity is. Managing expectations goes hand-in-hand with understanding risk — the more comprehensive our ability to measure, define and communicate risk, the more equipped we are to manage expectations of our investments and overall portfolio.
Focus on Long-Term Objectives
Long-term, strategic asset class mixes should be very thoughtful and objective driven. Focusing on the goals we want to achieve in the long run not only allows us to build a portfolio that's best suited for our individual needs, but it gives us the confidence to weather the ups and downs in the market.
Rethinking Fixed Income
On any given day in the current market environment, you may see a headline saying that it's time to sell bonds — in a rising rate environment they are a losing proposition. But because boomers are expected to live longer, they are investing in anything with income, including bonds, and putting off retirement. At a time when they would naturally be reducing their equity allocations, boomers are keeping a floor on bond prices.
To both manage risk and create return, we believe investors will need to rethink their approach to fixed income. Flexibility through active management will be critical and could incorporate increasing allocations to credit, including high yield, as well as alternative fixed income strategies — particularly those that can address interest rate risk.
A Resilient Portfolio Can Provide Long-Term Success
The old saying “may you live in interesting times" never seemed more apt. We know that uncertainty and bouts of volatility are likely ahead of us. With an objective-driven investment framework, a comprehensive understanding of risk and a portfolio built for resilience, investors will be well positioned for long-term success.
1 "Debt and (not much) deleveraging," McKinsey Global Institute, February 2015.
2 "Employee Financial Wellness Survey 2017 results," PwC, April 2017.