Volatility and politics might make some clients and advisors want to bow out, but discipline will lead to success
When the market moves dramatically down, the impulse among many investors and even some advisors is to move in accordance. Calls will grow to sell equities, move to cash, and pick up buying opportunities when the market hits bottom. It’s a thesis that sounds great in theory, but almost always fails in practice.
We know this approach is doomed because we are believers in the efficient market theory. That theory states that every piece of information known to the public and all of the probabilities that are unknown are already priced into the market and dollar weighted. When Trump makes an announcement that roils the market, that correction is a process of pricing in new information, or at least discounting certain probabilities in favour of others. Because its done by the collective wisdom of every investor, it is very difficult for a single investor to win. Confidence in outperforming the market on a day to day basis means believing you are smarter than the market, and none of us are.
On our team, we make adjustments based on our clients’ personal situations, but we never make adjustments based on market conditions.
What we do, though, is we rebalance. We take a disciplined approach to rebalancing portfolios in all conditions. When we see, as we did over the past two years, that our clients’ US equity allocations are taking up a greater per centage of the portfolio, we’ll bring them in line. What that does is it locks in the profits made during a bull run that would be lost when the market corrects. Holding onto those gains into the recent correction we’ve seen would see those percentages revert back to the model levels, but the overall portfolio would be smaller. Rebalancing, as we tell our clients, allows the portfolio to grow while retaining the correct levels of exposure.
That is not to say we don’t make adjustments with a view to long-term trends. In the last five or six years we have steadily increased US equity exposure, but only along the lines of US equities’ growth as a per centage of global equities. As the US has comprised more of the global equity market cap, it’s comprised more of our client portfolios. The only deviation we have from global allocations is a somewhat larger home bias to Canada.
Using objective measures to justify an allocation can also help when emotion gets involved. While the recent push to buy Canadian and cancel trips to the United States has not yet manifested in clients looking to divest from US allocations, we would caution them against such a move, noting the continued importance of the US as a global economic and market engine and citing its outsized place in world markets.
Fixed income is also helping us and our clients stay disciplined right now. By fixed income, too, I mean traditional bonds, not the mixture of preferred shares, high yield credit, and so-called fixed income products that functionally amount to cheating to maximized fixed income returns. Those advisors who cheated on their fixed income are now seeing those assets fall roughly in line with equities. They and their clients are paying the price.
When advisors and clients sit down and look at a volatile market, it can be easy to think, ‘time to make a big move.’ History and a respectful view of markets tells us not to do that. No individual is smarter than the rest of the world. And whenever you're making a call like that, what you're saying is the rest of the world is wrong, and I know more than everyone else altogether. And when you make a statement like that, generally speaking, you're going to be wrong.
