Global economies are still grappling with the COVID-19 pandemic and its variants, which has led to production disruptions, supply chain bottlenecks and rampant inflation, starting what is anticipated to be a turbulent 2022.
Growing global political and economic tensions, including between the United States and China – the two largest economic powerhouses – further complicate the landscape for family office and other investors.
Mike Stritch, chief investment officer of the BMO Family Office in Chicago, says high-net-worth individuals should have a geographically diversified portfolio, which usually consists of investments in equities or debt, and private partnerships, as well as some real estate. They might also want to consider investments in private U.S. companies, provided they can access those investments in an efficient manner, and are careful about managing the tax implications.
About stocks, which have had a long run that has driven up values, Stritch says, “We’ve gotten a little more defensive versus earlier in the [past] year, and we have favoured some income producing assets or real estate as a way to head off sustained inflationary pressures.”
He adds, “Investors need to ask themselves, ‘For 2022, where do I think value versus baseline allocation emerges?’ And we’re pretty heavily favouring North America at this point, with the U.S. higher than Canada.”
Another concern, he says, is that the Chinese economic slowdown might represent a real risk that has so far been underpriced in the market. For example, Chinese real estate strains could drag down China’s economic growth more than expected, which could, in turn, have an ancillary impact primarily to Europe, Japan, and emerging economies that sell into China.
“The U.S. and North America are more insulated from that, so that’s why we’ve been overweight in that direction,” Stritch elaborates. “We had this view before this emergence of the latest COVID-19 virus strain in Omicron,” he adds.
Diversified investing in terms of both investments, and geography, is necessary to maximize investment opportunities, says David Wong, managing director and head of portfolio solutions and investment management research at CIBC in Toronto.
Wong, who is also part of a coordinated team at CIBC to offer family office services to clients, draws an analogy between a jazz band requiring complementary instruments to succeed, and a properly diversified international portfolio of investments.
The return profile for fixed-income investments such as global government bonds, and investment-grade corporate bonds in developed country markets is comparable to those available domestically. But geographic diversification provides an opportunity for investing in different segments of the market that are not available in Canada, such as much deeper high-yield (below investment grade) corporate markets, floating rate loans, and deeper securitized markets, such as for mortgage backed securities, collateralized loan obligations and asset backed securities, Wong explains.
The Canadian equity market is heavily concentrated in the financial and resource sectors, which, combined, represent more than 50 per cent of the S&P/TSX Capped Composite index benchmark. To properly diversify to other key sectors, such as technology and healthcare, which are dominant in U.S. markets, or consumer discretionary, which is represented by global brands in Japan and Europe, it is necessary to invest outside Canada, says Wong.
Some emerging economies might face more challenges in the first half of 2022 because their populations have low vaccination rates and they do not have the same access to therapeutics as other countries at a time when “the virus will probably continue to be a headwind throughout the world,” says Christine Tan, portfolio manager, multi-asset solutions with SLGI Asset Management Inc., a subsidiary of Sun Life Financial Inc. in Toronto.
“In ’22, you want to focus on countries where the vaccination rate is above average,” she advises investors.
“I’m a firm believer in investing outside of North America, and maybe now is a better time than ever to do it,” says Dan Riverso, chief investment officer with Jesselton Capital Management Inc. in Toronto.
Riverso notes that, although the U.S. market has had a large run-up, several emerging market countries have faster rates of growth.
He gave an example of a high-net-worth client who wants to have 40 per cent of their portfolio in fixed-income instruments and 60 per cent in equities. They then need to select their preferred regional allocation, such as domestic or foreign developed markets, or emerging markets, and hire managers with expertise in those regions to make more specific investing decisions.
Assuming a family office investor with a home bias wanted to have a 60:40 split in their portfolio, they might choose to base their fixed-income instruments exclusively in Canada, with the equities split one-third in each of Canada, the U.S. and the rest in Europe and Asia, suggests Riverso. They might also opt to add a 5-per-cent weighting in emerging markets by substituting 2.5 per cent out of each of the U.S. and international portfolios, he elaborates.
The fixed-income portion of the portfolio could also be diversified outside of Canada if there are higher yields to be gained. “The question then becomes, ‘Do you hedge the currency exposure back to Canadian dollars?’ That depends on the risk tolerance, income needs, etc. of the investor,” says Riverso.
Those ratios could be modified depending on the return objectives and risk tolerance, and other preferences of the investor, he adds.
For global investors, it is generally advantageous to invest in international markets through a funds structure because there are about 50 countries – representing both developed and emerging markets – that could potentially be attractive venues for various instruments, says Wong.
But family office investors sometimes prefer to have direct ownership of stocks for a variety of reasons, including taxation advantages, and the ability to have more control over assets. Given these and other complexities involved, family offices also require expertise in tax, financial planning, and on-demand advice, he notes.
Most family offices are not equipped to be able to choose investing in one country over another. “So it’s probably best just to hire an active manager with experience in analyzing these different countries, and being able to choose where the best opportunities are,” says Riverso.
If an investor is reluctant to invest outside of Canada unless absolutely necessary, the United States would be a good option because it has a higher concentration of industries – in particular growth-oriented industries such as technology and healthcare, than Canada, says Stritch.
Wong warns that if an investor is reluctant to invest outside Canada and maintains too high of a domestic concentration, they run the risk of experiencing more severe downturns – if, for example, they are holding equities and the financial or resource sectors enter a downturn.
An investor that relied exclusively on the Canadian stock market over the past 10 years would have experienced an average annualized 8.8 per cent return, when using the S&P/TSX Capped Composite as an indicator of performance, says Wong.
But if they had split one-third in each of the S&P/TSX Capped Composite index for Canada; Russell 1000 for the U.S., and MSCI EAFE for Europe, Australasia and Far East markets, the return profile would have gone up to 12.8 per cent over that time, he says.
The corresponding standard deviation statistics would be 11.4 per cent for Canada, and 9.99 per cent for the blended portfolio. “This means the blended portfolio has higher return and lower risk, which is the main point of diversification – to get more efficiency, no matter what outcome is desired,” Wong explains.
“That’s what happens when you go outside of your borders. The math just overwhelms any of the concerns you might have had about investing in any individual market,” he stresses.
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