Kevin Greenard: Strategically adjusting your asset mix in periods of uncertainty

Kevin Greenard

Many financial articles and commentary pieces in the media are highlighting the disparity between Wall Street and Main Street. This week the U.S. officially entered into a recession at the same time that the Nasdaq hit an all-time high. Typically, these two events would not occur simultaneously. Unemployment rates are skyrocketing, GDP is falling, and consumers are naturally spending less.

The stimulus provided by governments has altered the direction that markets would normally flow. When trillions of dollars are put into the economy, it alters the normal path of the stock market. As a portfolio manager, I have to factor in historical, current, and planned government announcements and how they may impact the stock market. The unknown is the level of future interference, bailouts, and stimulus that will continue to be provided in the near term in both Canada and the U.S.

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Despite stimulus and the economy beginning to reopen, Main Street has been materially impacted by events this year. In my opinion, the economic shutdown, and financial impact has not been accurately reflected in the majority of stock prices.

In years past, I have always told clients that it usually pays to stay invested when the government is providing stimulus. This stimulus helps the markets today but sets future generations even further behind as government debt is swept under the carpet, and will eventually have to be addressed in the future.

When I speak with my clients about the current environment, the conversation focuses on strategically adjusting the asset mix in the short term. The terms “asset mix” or “asset allocation” refer to the portion of your investments that are held in cash, fixed income, and equities.

The Investment Policy Statement (IPS) has the optimal asset mix documented based on past discussions. The discussions would be based on the preferred long-term percentages that you would like in cash, fixed income and equities. The IPS does provide a range, typically 20 per cent above and below the fixed income and equity optimal level. The range for cash within the IPS can range from 0 to 40 per cent.

In my opinion, it is wise to adjust asset mix in periods of uncertainty. In times of capitulation and panic, stocks are normally over sold and stepping in to temporarily overweight equities and underweight cash and fixed income may be prudent. On the flip side, if the markets are going through a period of irrational exuberance, then we feel it is prudent to do some rebalancing, which includes sometimes under weighting equities.

Small adjustments and rebalancing trades can make weathering future pullbacks much more manageable. In communicating with clients, we are currently taking the conservative stance of temporarily underweighting equities and overweighting both cash and fixed income until markets return to valuations that are more reflective of current conditions.

The key question that many people should be asking themselves today is the portion of their portfolios that should be in cash, fixed income and equities. We feel investors should strategically shift how they look at asset mixes based on the current environment and most likely outcome.

When we talk with clients one of the first questions we ask them is if they need any cash from their portfolio. In the majority of cases we are finding that our retired clients are accumulating cash because they are not spending as much these days when they are staying at home. The money that they typically would have spent on travel and entertainment is accumulating in the bank. Many retired clients have sent us cheques to put in their investment account as they are simply not spending it like they did in the past.

In other cases, our clients have lost income from a business or employment. In these cases the savings strategy, such as a monthly pre-authorized contribution, is cancelled. We will also want to know if we should factor in the need to send them money from their investments savings.

We also ask clients who are retired whether they have any income requirements from the portfolio, or smaller withdrawal requirements. Many of our retired clients will request that we send them monthly cash flow from their investments. We are finding some clients are recently spending more time at home and are requesting lump sum withdrawals to do home renovations and landscaping projects.

Obtaining a thorough understanding of our clients’ cash flow needs is critical for managing risk. If a client desires a set amount every month from their portfolio, then we would typically put aside 12 to 24 months of cash as a “wedge” earmarked for these smaller withdrawals. This is done to ensure that investments do not have to be sold at the wrong time in the market cycle. When markets appear over valued we would encourage our clients to set up the wedge, or increase the cash equivalent component for the wedge.

We also ask clients if they will require any significant withdrawals from their portfolio in the next three years. Examples of significant withdrawals would be funds to repair a home (such as a roof), do renovations, or purchase a new vehicle, recreational item (boat or motorhome, for example), or real estate. These amounts are also documented within an Investment Policy Statement and earmarked as part of the “wedge” to ensure the funds can be liquidated and sent when needed regardless of market conditions. This amount is typically held as cash equivalents or short-term fixed income (one to three years).

Our approach is to look at the next three years and ensure you have this money either in cash or short term fixed income. It is important, when we work with clients, to map out their cash flow needs and any significant withdrawals. It is also important to look at the current market conditions.

It is only after both of these are completed that an appropriate asset mix can be set up and the best decisions can be made on where to draw on those cash flow needs. It is absolutely appropriate — and recommended — to deviate from the long-term asset allocation in the short term, if unusual circumstances warrant it.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director, wealth management, with the Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timescolonist.com. Call 250-389-2138. greenardgroup.com

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