MASTERCLASS: Investment Strategies in Market Volatility - April 2020

MASTERCLASS: Investment Strategies in Market Volatility - April 2020

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Jenna Dagenhart: Welcome to Asset TV. This is your investment strategies in market volatility masterclass. Coronavirus cases continue to climb globally, and the healthcare crisis has also led to a lot of panic in the markets. Joining us today to help investors navigate these historic times are three expert panelists: Kim Inglis, Financial Adviser and Associate Portfolio Manager at Raymond James, David Picton, President, CEO and Portfolio Manager, Canadian Equities at Picton Mahoney Asset Management, and Mike Greenberg, Vice President, Portfolio Manager, Multi-Asset Solutions at Franklin Templeton Investments.

Jenna Dagenhart: Circuit breakers have been triggered multiple times. The TSX and the New York Stock Exchange have temporarily halted trading for 15 minutes, of course, to give investors some time to digest, absorb information. During all this turmoil, some people have called for even shutting down equity markets, but David, you say this would be the worst thing you could possibly do. Why?

David Picton: I think when you get into a crisis situation, liquidity is everything that is searched for by the individual investors, major institutions. And any time you remove or you impair that liquidity, you actually I think exacerbate the problem. The circuit breakers function amazingly well in terms of causing that little pause that everybody required, but to actually shut down a market when there are people who are now potentially being thrown out of work and require access to some of their funds, to me, would just exacerbate the problem, make it much worse.

Jenna Dagenhart: You think 15 minutes is plenty of time?

David Picton: I think it is enough time. Like you said, some of those 15 minutes, we are actually impatiently waiting for it to start. Of course, it would be nice to just take a complete break from everything for a day or two, but I don't think that would be the right thing to do.

Jenna Dagenhart:Kim, how are you handling the market volatility with your clients? I mean, how would you describe investor psychology, and is now the time for investors to maybe reframe their thinking?

Kim Inglis: Yeah. So, in my situation as an adviser, I'm definitely taking a longer term view of things because the vast majority of my clients have a multi-decade time horizon. They're either mid-career or they've just retired, and with longevity, people living longer or in some cases, I've got assets where clients are wanting me managing it for their grandchildren's retirement. So, with that, it's dealing a lot with investor emotions over the short term and managing that for my clients.

Kim Inglis: Definitely, it involves a bit of a reframing of your mindset. I use a few examples as analogies. Let's say you go to the grocery store and your favorite soup is on sale. Well, usually, people are taking that opportunity to buy a few extra cans. If you, say, are driving your car and you go pass a gas station and gas prices have dropped, you might fill up your tank.

Kim Inglis: Another thing that people need to think along the lines of is, say, their real estate. If they're in their principal residence, and they're planning on living there for quite some time, which is the case with most people, if their house price has dropped 10%-20% in value, would they sell it tomorrow? Probably not.

Kim Inglis: It's interesting because in the stock market, people act the exact opposite, where what they really should be doing, if they're longterm investors, and they're buying solid good quality stock, then they should be looking at market corrections or crashes, any drawdown experience as an opportunity as the market is going on sale, the equivalent of your soup going on sale or that sort of thing. So, it's definitely that reframing of the mindset.

Jenna Dagenhart: Mike, which factors do you think are behind the wild swings and the record speed of selling that we've seen?

Michael Greenberg: Yeah. I mean, some of it was just market positioning. When you look at the volatility event that we had in March, you had a lot of players that were levered up and levered in one direction. We had the risk parity funds, the vol control funds, et cetera. It really became, for sellers, into a declining market both in stocks and bonds. That just really perpetuated the trend that we saw going down. Of course, the macroeconomic backdrop went from gray to very, very dark skies very quickly as well.

Michael Greenberg: Then on the other side, you had an extremely aggressive reaction from central banks, and then eventually from governments as far as monetary and fiscal quality. So, you have these dual pressures pushing on the market up and down and, of course, that's just caused some really wild volatility that we haven't seen in many, many years.

David Picton: That deleveraging is a major contributor to what was going on. There's some stats that I've seen from some of the US foreign brokerages suggesting, for instance, things called CTAs that look at different, say, asset classes, and then use leverage to play the momentum of those asset classes. There's a statistics that went out that they may have sold $250 billion in equities in one month alone. US market and mutual funds may have liquidated 15% of their longs and their shorts or five-day period of time.

David Picton: So, you have an economic event, but then you have, as Mike suggested, the leverage of these massive organizations that also piled onto it. I think that was a real contributor to what we saw go on through the initial stages of that downturn.

Michael Greenberg: Yeah, and I guess the only good news is, I think, some of that leverage is moved on. So, you've almost moved from the technical part of this drawdown to one that's probably going to be a bit more fundamentally focused now as we look more towards what's the economic impact of stay-at-home and whatnot.

Jenna Dagenhart: David, tell us your hypothesis on how we fell so far so quickly, and if you have a longer time horizon, is this just a blip?

David Picton: Well, there are certain things that have changed forever, but what normally happens when you get into a recessionary phase, there's been an attempt to take a liquidity array to raise interest rates. Then you start the bear market decline, and over, say, a 20-day period of time, there's a debate, "Are we going to have a soft landing? Are we going to have a recession? The market is selling off 5%-6%."

David Picton: In this case, there was no debate. There was a mandated recession by governments. It took place very quickly, very swiftly. So, instead of having the 30% drawdown over a multi-month period of time, you had it over a 20-day plus period of time.

David Picton: So, to me, that was the determining factor that this wasn't going to be a debate. This was a clear significant economic shot that we are going to have to deal with, and then on top of that, when you threw all of the leverage numbers in place, it happened hard and fast.

David Picton: I think it presented an amazing opportunity because when you get into a recessionary environment, and when you see that fear in the marketplace, you have to lean into it at some point in time. There is usually a silver lining that emerges through some period of time in the future, and I think we are given one of those opportunities in this drawdown phase.

Jenna Dagenhart: Yeah. David, I know we touched on liquidity briefly when it comes to markets and why you say it's important for them to remain open, but taking a closer look at liquidity again here, I mean, how are credit spreads being affected by the sudden decline?

David Picton: It was fairly dramatic. In fact, it was not even so much the spreads that were interesting in blowing up, but rather the fact that you couldn't trade anything. I think the Federal Reserve did an amazing job of recognizing that much sooner than a lot of people. They did an emergency rate cut. They did further rate cuts to get rates to basically zero, but then they went after each of the most important areas of the credit market where they sensed that there was not just a value issue, but rather a liquidity, and threw the kitchen sink at it.

David Picton: Just to put it in perspective, when we had the quantitative easing programs back five years ago, the Fed was buying approximately $60 billion or so of government bonds per month. There are a couple of days where they were buying $75 billion per day of different fixed income securities to make sure that that market functioned.

David Picton: Now, it wasn't perfect, and they weren't trying to save the day and make everything healthy, they're just trying to make sure that if you needed to move money in and out, you were able to do it in a reasonable type of fashion. I think they are to be commended for the job they did this time around.

Jenna Dagenhart: Mike, also looking at credit here, I mean, any thoughts on high yield versus investment grade?

Michael Greenberg: Yeah. I mean, just to echo David, his points, I mean, credit was definitely bashed up pretty good, and a lot of that was technical and just being unable to sell and whatnot. We definitely have a lot of investors that need yield, and there's not a lot of yield to be had in government bonds. We're starting to get some nice yields in equities, but the dividends, it's unsure how safe some of those dividends are.

Michael Greenberg: So, we're definitely looking at credit. We've been nibbling away a little bit. Now, if you think it's going to be a V-shape recovery and a very, very quick rebound to normalcy, you probably want to take a little bit more risk in credit. You want to be dipping into the high yield, the really risky stuff in the hopes that it bounces back.

Michael Greenberg: We're thinking of it more of the balance between return on your money versus return of your money. There's definitely default risk in some of those riskier credit, especially in things like energy, airlines, et cetera.

Michael Greenberg: So, we've been nibbling away a little bit more within IG, a little bit higher quality credit as, again, we're getting a pretty good opportunity to get some decent yield here, and with some of the companies that our underlying managers are selecting, we think pretty good chance that we'll get our money back on top of, of course, the yield that we're going to get. So, that's how we're looking at it.

Michael Greenberg: I would say, though, in Canada, we're still a little bit more cautious. So, to David's point on some of the measures that came out from the Fed and even the government, we've definitely had pretty strong reactions from the Bank of Canada as well. Although they haven't quite focused on the credit market to the same extent.

Michael Greenberg: So, we're still seeing a little bit of a gumming up of the system in Canada as far as trying to create, trade some of the credits. So, at this point, we're still a little bit more focused on US investment grade, but definitely being a little bit more selective.

Michael Greenberg: I would say, too, within portfolios that we manage, we use ETFs, we use active funds. We're definitely preferring more active managers in the fixed income space at this point because, again, you definitely have seen some babies getting thrown out with a bath water, in a sense, with some of these names. We like the fact that there's someone picking and choosing where they want to take credit risk for us for our portfolios.

David Picton: Just to follow up on Mike's point there, I think a couple of great things I'd like to add on, too. First of all, in the very worst of the storm, you saw an area where you had spreads blow out in almost all available products. High yield spreads blew out. Investment grade spreads blew out. Commercial paper spreads blew up. Risk arbitrage spreads blew out. Market neutral factor risk premium like long short momentum or long short value or quality, those all blew out at the same time.

David Picton: When that occurs, that is usually an amazing environment. Absolutely, some industries are going to be changed. So, you get this opportunity to taking advantage of, an incredible dislocation of the market, and then as Mike said, if you can add in an active component to it so you differentiate between those industries that are maybe changed and impaired for either ever or for a long period of time between those that are not, which have been thrown out, as he said, the baby with the bath water, it makes for a really good setup for adding risk in portfolios.

Jenna Dagenhart: Are either of you looking at the concentration of BBB at all when it comes to investment grade? I mean, Mike, is that of concern at all for you?

Michael Greenberg: Well, I mean, it is. At the same time, there's a lot of leverage some of these companies can pull as far as trying to protect that rating or deal with ratings such as cutting dividends. So, maybe not super shareholder friendly, but okay for the bonds. The other thing I would mention, too, is many people think the minute it's downgraded, that means there's going to be this massive selling pressure, but a lot of these bonds are held by active managers that have that flexibility to hold those names throughout.

Michael Greenberg: The other thing I would highlight, too, is when you look at BBBs and you look at the fallen angels, a lot of the pain happens before the angel falls. A lot of the price hit happens before the actual rating agency comes out and tells you that it's now no longer an investment grade bond.

Michael Greenberg: So, it is a concern because it's a very large portion of the market, much bigger than it's been in the past. It's the reason why I would say we're not going two feet into the pool here as far as credit risk. Again, being a little bit more picky and choosy about what we buy. It is an overhang, absolutely, but I think it's something that the market can deal with.

Jenna Dagenhart: Now, which economic indicators are you monitoring most closely right now, Mike?

Michael Greenberg: Yeah. I would always separate the economy from the stock market because if you were just watching economic indicators, things were still looking pretty good as far as the numbers that were being printed on Bloomberg, as far as some of the economic data points because they are very, in some cases, quite lagging.

Michael Greenberg: So, in a way, a lot of the traditional leading economic indicators are probably going to turn well after the stock market already has its rebound. So, we're focusing on two things. One is the virus, so virus-related. Really, it's really that second derivative rate of change. It's when things are still bad but getting less bad is the point that we want to focus on.

Michael Greenberg: So, things like the growth rate of new cases, death rates, things like that, we don't necessarily want to wait till we see those numbers getting better. We want to look for those numbers to start getting less bad. I'd say the same thing as it relates to containment measures. Obviously, the containment measures have been very severe and have had massive economic consequences and for a good reason, but we want to also try to understand when those containment measures start to let off a little bit.

Michael Greenberg: There's alternative data sources that we can look at for that. There's some things that we look at that monitor traffic patterns. So, obviously, we saw a massive decline in congestion and traffic patterns in places like London, and Tokyo, and New York, et cetera.

Michael Greenberg: Once we start to see those bottoming and actually starting to come back, that would be something to look at that things are not necessarily returning to normal because I agree with David. There's going to be some somewhat permanent change in certain sectors and in certain behaviors, but once we start to see that recovering and getting a little bit better, and some of the higher frequency consumer sentiment monitors that we look I think is another thing to look at because once this consumer sentiments stops bottoming out and gets a little bit less bad, once we see traffic congestion start to come back a little bit, it's giving a sense that the worst of the containment measures are probably behind us, and that we are going to see a slow recovery in economy, which, of course, would help support risky assets.

David Picton: I've got a different take on that. What we did is we went back to the great financial crisis to try and build a playbook as for how this crisis might play out. I guess an important starting point for all of this is that the markets don't bottom when the war is won. Markets bottom when you start fighting back properly. So, we began the fight back.

David Picton: So, the first thing we did is we had to recognize there's a massive problem. It may have taken, say, the United States a little while to do that, but they finally did, and they started the containment measures, et cetera.

David Picton: Then you have to make sure that markets remain liquid. Obviously, we talked about the Federal Reserve and some of the steps that they did to make sure the bond market was functioning, and they are targeting very specific spreads that they thought were critical, investment grade spreads, mortgage-backed securities spreads, commercial paper spreads. So, you could say: Check, problem recognize. Check, fed providing liquidity.

David Picton: The third step in the GFC playbook is you need a fiscal stimulus. It took a couple of months to do that back in 2008. This time, it took them a couple of weeks to put it together, and they doubled the size of the stimulus program to two plus trillion, and they committed that there'll be more, if necessary. Another check.

David Picton: This time around, the banks are part of the solution as opposed to part of the problem back in '08. So, now, they are extending terms and forgiving credits in the short term. Another very positive.

David Picton: So, you've got a number of steps in the GFC playbook outline already and they've already been successfully implemented. Now, to what Mike was saying, you need a peak in virus numbers, and you need to see that coming out of Italy, and out of Europe, and then you need to see that eventually out of the US.

David Picton: Then I think the important step that's missing is you need to put a playbook to remove uncertainty as to when this economy starts. So, if you wait for the data to get better, it would be way too late, but if I think there's a credible playbook that says, "Through use of massive testing either for antibodies or to see if you have the virus, to make it safe for the people that are not going to be at health risk to go back to work, and to continue to isolate those that are, to implement measures when you go in to the office as to what we're going to do, when we get to that point, and you start to remove that other level of uncertainty, I think the market will be on very strong footing.

Jenna Dagenhart: I like what you said about the bottom two. That's really interesting, David. Kim, going off of that, how do you help investors through the bottoming process?

Kim Inglis: Yeah. So, with my situation, again, a lot of my role is not just portfolio management, but it's very much a coaching role. It's very much making sure that clients are staying educated on not just the markets, but educated on investor psychology, really. There's a couple of components to that. One would be recognizing investor psychology as it relates to the markets, and then also recognizing investor psychology and how my clients might react to things.

Kim Inglis: So, with regards to where they're at in the markets, you can go to the classic investor psychology textbook and it will have the chart that you'll see with essentially the emotional roller coaster that clients will go through when they go through a market cycle. You'll see that the markets are going up, and clients are excited, and optimistic, and what have you. You hit the top of the market, there's euphoria; it's going to go on forever mindset.

Kim Inglis: The markets start to turn like they did earlier this year. You go through a little bit of a denial like, "Oh, it's just going to stay in China. It will be contained." You go further down, obviously, which what we've gone through is panic selling. Eventually, you get to capitulation, a bottoming process, and then if something happens that will bring the markets back up, clients will go through more of that hope, seeing a light at the end of the tunnel, glimmering optimism there. So, we'll go through that again.

Kim Inglis: The reason that it's important to make sure that clients understand where they're at in that market cycle is because often, investor sentiment is a contrarian indicator of things. So, if you can recognize how people are feeling in the market, and how people are reacting, and essentially do the opposite, that's often the better idea.

Kim Inglis: You use the Warren Buffett famous quote of, "Be fearful when others are greedy, and greedy when others are fearful" idea. It's making sure that clients understand that, and get that.

Kim Inglis: The other side of it is, obviously, the more psychological side of it of cognitive biases, and making sure that you as an investor and you for your clients recognize what limitations there are that are being brought upon.

Kim Inglis: So, to use as an example, say, loss aversion, for instance, is a classic cognitive bias that investors will have, and the basic promise there is that when the markets are bad, people feel it twice as much as when the markets are going up. So, when the markets are going down, it really sucks for investors. They really take it hard.

Kim Inglis: So, what people will do is they'll start to get into habits that are really not good, and it's having them recognize that. So, with loss aversion, what you'll see is you'll see clients will start to check their accounts everyday, sometimes multiple times a day. Sometimes they're wanting to know performance constantly, but that's the absolute worst that they can be doing.

Kim Inglis: When you look at the basic numbers, we all know that markets over time go up, but that process of going up is not a straight line. It's got bumps along the way. If you're a client that's looking at performance every single day, there's an almost 50% chance that when you look at the portfolio and you're looking at it every single day, it's going to be in a drawdown period. That's going to make you feel really bad. That's going to make you make bad decisions.

Kim Inglis: So, as a part of that bottoming process and, really, as a part of that part whether you're at the bottom or at the top or anywhere, it's educating clients and making sure that they are recognizing things that can get them off track, and not doing those things.

Jenna Dagenhart: Yeah. Going back to your Warren Buffett comment, I've also heard, "When the VIX is high, it's time to buy, when the VIX is low, it's time to go," a similar phrase. Mike, what do you think the recovery will look like, and how would we be able to tell when we've reached the bottom?

Michael Greenberg: Yeah. I mean, I like David's GFC playbook analogy, and totally agree. I mean, the stock market will obviously bottom well before the economy, and we'll only really know that with hindsight. I'd say that one difference, though, when you look at the GFC, it really was the system that failed. We were having a massive banking crisis, which then caused an economic recession. Whereas this time, it really was a planned economic recession that caused the system to fail.

Michael Greenberg: So, luckily, we had that playbook in place from 2008 on fixing the system with the alphabet soup of programs that the Fed had and to David's point did, I think, a very good job at getting ahead of it and making sure that we didn't have that system failure.

Michael Greenberg: Our view is it's going to take a little bit longer to get that economy back in place. Some of the things that we're looking at is what is that playbook that David mentioned as well. What is that playbook to get the economy back to "normal", whatever that looks like? It's probably going to be in stages. Not everyone will go back to work at the same time. If the government told me I could go back to work tomorrow, I probably wouldn't. I would probably stay home and work for another couple of weeks.

Michael Greenberg: So, there's going to be, in our view, a bit of a slow removal of some of the measures that are in place for containment. You probably see, obviously, certain workers go back earlier than others. Schools opened at some point. Mass gatherings start to be allowed, but when you look at the longer term consequences, I think this is pushed forward. A lot of trends that were already in place as far as working virtually, a meeting like this that we're having today, in the past would have been at a conference in front of a live audience. Now, we're doing it via technology.

Michael Greenberg: So, there's definitely going to be some sectors, I think, that won't come back all the way. I can guarantee our firm business travel will be down. Meeting with clients will be done virtually more so than face-to-face. Of course, we'll still do some of that, but the trend has been pushed in that way. More people will work from home. There'll be less real estate needs from certain companies because they can save a whole lot of money, and probably have less of an environmental footprint by allowing workers to work remotely rather than forcing people to commute and come in.

Michael Greenberg: So, we're a little bit cautious on the economic recovery side. We don't think it's going to be many people who will try to use a letter to describe it. We don't think it's going to be a V. It's probably more of a W or one of those sign waves things where we'll see a bit of a letting up of some of the containment measures. We'll see some growth come back, but it won't be necessarily extremely vigorous. That's just going to probably create a fairly volatile environment for us going forward. So, that's how we're thinking about it.

Jenna Dagenhart: Yeah. Maybe a letter doesn't exist for this kind of recovery. We'll see.

Michael Greenberg: Well, I've heard the Nike swoosh maybe would be a good one because we obviously had a heck of a drawdown, so there's going to, of course, just from mathematical standpoint, a year from now, the numbers are obviously going to look a lot better than they did over the next little while, but maybe not back quite so quickly to the previous levels.

David Picton: I think there'll be a real differentiation among industries, and Mike touched on that. Certain industries are now going to be secularly challenged, perhaps. Others are going to be challenged like the airlines, but eventually, I think there'll be some return to normalcy. It might just take longer.

David Picton: I need a haircut. I believe that the day we go back,  my hairdresser is going to be the busiest she's ever been in her life. So, that's going to be looking like a V. So, it's almost like you're going to apply these letters across different kinds of industries, and then one other thing that we don't really talk too much about, I don't hear a lot of people like in the financial press much talk about it, is what if we have a breakthrough?

David Picton: We basically have harnessed the entire world scientific and medical community to focus on this one unique problem. They have torn down all kinds of barriers. The FDA is acting faster than ever it has. They're sharing information regardless of who gets the credit. What if all of a sudden we get an antibody test that is quick and reliable that says, "You have had this. You are safe. You can go back to work immediately," or what if we actually get a vaccine that comes out of this? We give it to everybody. Everybody goes back simultaneously.

David Picton: So, this shape in recovery has got a whole bunch of uncertainty attached to it, and it's not all negative uncertainty. It could also be very positive uncertainty if you get one of these breakthroughs on the left field.

Michael Greenberg: That's a great point, David, and to some of the stuff Kim was talking about around clients is that their focus tends to be on those negative tail events, but to David's point, absolutely, there's those upside events as well. To Kim's point, I mean, that's where someone like herself comes into place to keep people invested.

Michael Greenberg: People that probably called her up that wanted to cash out on March 18th or March 19th, whenever that low point was a couple of weeks ago were probably well done by to not necessarily get out at that point. We'll see. We'll see where things end, but that's an important point that the losing out as well can be very detrimental to portfolios after you've seen some of these big drawdowns. Many times, just staying invested and having a plan and sticking to plan is really key to get through some of the stuff.

Jenna Dagenhart: I know there are a lot of uncertainties as you mentioned, but do you think that before things do start to return to normal, do you think that we could get not just recession but potentially a depression, David?

David Picton: Well, we have a recession, and the data will look like the absolute worst you've ever seen. We're going to take basically a recessionary unemployment cycle that takes place over two years, and we're going to do it within two weeks to a month, and that's unprecedented. It will look, as I said, as the trailing data comes out, it will look absolutely monstrously bad.

David Picton: Again, it can also reverse just as quickly, maybe not all of it, as soon as we get a clear plan as to how we get people back to work and how we get industries functioning again. So, recession, depression, the recession is clear, depression requires a whole bunch of other bad things to happen. When we're contained for an extremely long period of time and it becomes life over the economy, I don't believe that's going to be the case, but I think the data will look absolutely monstrously bad, and not to really pay too much attention to that short-term data, anyway.

Michael Greenberg: Yeah, and you have to remember, too, in the depression, that was really a 10-year, almost a 10-year event. You had governments not providing fiscal stimulus. In fact, they were cutting back. You had a lot of potential policy errors made at that point in time, and just a very difficult environment. Never say never, but, obviously, the reaction that we've had from fiscal and monetary has been enormous.

Michael Greenberg: This too shall likely pass. Now, will we get another virus at some point that hits us and causes some dislocations? Quite potentially, but to David's point, there's a lot of very smart medical people working at this. Once testing rolls out, et cetera, we'd probably start to move back to a bit of normalcy.

Michael Greenberg: So, I think every time there's a crisis, we tend to look back for an old word to describe it, depression. We had the great financial crisis, et cetera. Maybe this will be the lockdown crisis. We'll come up with a cool name for this at some point later, but I think the depression name is maybe a little bit given what was going on back then versus what's happening now.

Jenna Dagenhart: Yeah. As you say, central banks, governments are being very perhaps not just reactive, but proactive in their approach with all of these measures to control the damage and stimulate the economy, slashing interest rates practically to zero. What do you think the impact has been, will be on equity markets? David?

David Picton: Well, I think you have an amazing opportunity, as I said. You basically discounted a recession a three-week period of time. As painful as that is, you usually have to lean in to that, especially if there's a coherent plan as to how we return to normalcy. We've got a lot of the points and a plan in place.

David Picton: So, I am constructive on the equity market. We've both discussed with Michael already how some of these sectors may not be the same as they were. Others will be almost exactly the same as they were, and where the ones that were exactly the same that got put on sale, you have to take advantage of that.

David Picton: I'm not saying it's going to be an easy route either. When we come through this, whatever it is, there's going to be some unintended consequences. We just put a massive amount of new debt in place. We just put a massive amount of new quantitative easing and liquidity in place. What happens post this? What happens to when we go and finance all of these new initiatives? How does that play out? Do we actually get maybe a change in interest rates? Does the yield curve steepen? Do people's love affair with utilities and some of these yield plays get challenged when their valuation starts to shrink even if they play good yields? So, the longer term ramifications are not easy to start out, but the opportunity in the middle of the worst of it to add to equity was a fairly fat pitch for investors to hit.

Jenna Dagenhart: Yeah. Kim, how do, as David said, how do you help people lean in? How do you help clients lean in when they want to lean out given loss aversion and other factors at play?

Kim Inglis: It really ends up coming back to communication. That's so, so, so very important right now, and it's having people stay focused on the right things. One of the best ways as an adviser to make sure that your clients are staying focused on what's important is to make sure that everybody has a financial plan.

Kim Inglis: It's often something that's almost an afterthought. People think of the portfolio first, but the importance of a financial plan really drives a lot of your portfolio returns. Yes, portfolio returns might be in part attributed to how XYZ company has appreciated in value, but there's a lot of things that come out of your financial planning process that help drive your returns as well like tax efficiency, the asset allocation, the rebalancing, and cash flow management. All of those sorts of things ultimately also drive the bus in that regard.

Kim Inglis: So, it's really making sure that people are going back to their financial plans and making sure that everything is on the right track with that, and if they're focusing on that, then they're focusing on the right things. They're focusing on the long term. They're focusing on their goals as opposed to what noise they're hearing in other areas of the market.

Kim Inglis: The other thing that the financial plan will do and that's especially helpful in these times is really nailing down an individual's risk tolerance, which is the other thing that is so, so, so important, and ultimately in your portfolio management because with each client, it's very, very different in that regard.

Kim Inglis: So, not every portfolio is going to look the same because it's got to be tailored to that risk tolerance. If you can spend the time with the client through the financial planning process and really nail down, target down what the risk tolerance is, what they can actually, from a dollar perspective even, what they can afford to withstand when markets are volatile, but also what, from a psychological standpoint, what they can emotionally withstand because those are very much related. Then you can build out the portfolio from there, and then, again, that entire process keeps clients focused on the right things, and not getting distracted along the way.

Jenna Dagenhart: One final question here on fiscal and monetary stimulus. Mike, give the bond buying plans in place that we've discussed, how should investors be thinking about fixed income, and what's the impact on passive bond ETFs? I know you said you're more of an active person.

Michael Greenberg: Yeah. I mean, fixed income is going to be a tough space to manage over the next number of years. I mean, historically, government bonds have been a great pillar of a balanced portfolio to give you that, A, negative correlation to equity risk, so it gives you that diversification, but it also gave you some pretty decent returns as we've seen yields really decline for the last 25 years.

Michael Greenberg: We're now getting to levels where a lot of the juice is out of that lemon. There's just not a lot left in government bonds to give you that return. Now, that being said, yields in the US and Canada are not zero. There's still room for them to go down. We expect once we get through this we'll see a recovery. We'll probably see yields rise. With the supply of bonds, they're going to hit the market, but with the front end, probably being fairly anchored at zero or close to it.

Michael Greenberg: We do probably expect a little bit of yield curve steepening. So, some of that yield cushion will get built back into bonds. So, we would be a little bit less exposed to longer duration government bonds. We're not super aggressive at taking them down just yet because we do think there's going to be some volatility. So, we're taking our moments to reduce duration and reduce government bonds.

Michael Greenberg: I think over the medium term, that's probably a place you want to be a little bit less exposed until we do get a bit of a higher yield. So, with us, within fixed income, it's still staying true to fixed income and still being a little bit more conservative within fixed income. When we do take a little bit of extra risk, it's more an IG as I mentioned, and not quite too aggressive and high yield at this point.

Michael Greenberg: Then again, ETFs are a great tool. We love ETFs as far as a tool to build well-diversified portfolios with, but you have to know what you're getting within that ETF. ETFs provide you daily, if not, minute-by-minute liquidity, but the underlyings of some of those ETFs do not have a very liquid profile.

Michael Greenberg: So, we've really avoided and reduced, if not, actually completely eliminated things like high yield ETFs, bank loan ETFs, and some of the riskier, less liquid credit ETFs in the portfolios just because we didn't want to be a foreseller of those at the absolute wrong time.

Michael Greenberg: You saw in the recent volatility environment a very wide bit of spreads, but also big discounts to NAV on some of these ETFs. Meaning, if you were forced to sell these things, some of the IG ETFs are trading at a 10% discount to NAV. So, you are basically giving away 10% because you were forced to sell. Generally, asset managers like ourselves are more liquidity providers. So, we would be more taking advantage of that. So, we were actually adding to IG through some of the active ETFs that we have exposure to because we were able to basically buy some of these things at a discount to NAV.

Michael Greenberg: So, I think you need to think about fixed income in a few ways. What is it there for? It's really there generally to offset equity risk in a portfolio. It may not be as efficient as doing that going forward just given the level of yields, but we still think that that correlation will be there to benefit you in "risk-free" government bonds. We'll see how risk-free they are going to afford, but then definitely, there's opportunities in credit as well, but again, we are preferring, in many cases, even when we do use an ETF, we're preferring active ETFs or active managers to, again, pick and choose a little bit the spots that are offering a bit more opportunity.

David Picton: I have a good analogy to add on to what Mike was saying there. My son actually provided this. He found it on Twitter, I think. It says, "How to be a great investor? A, be very calm under pressure. B, invest your portfolio during a 40-year downturn in interest rates." So, we've done that.

David Picton: So, I don't believe we have another 40-year downturn in interest rates ahead of us. So, portfolio construction is going to be an absolutely critical force within a portfolio. How do I replace some of that income that I'm not going to generate from my bond portfolio, and how do I promptly diversify for an environment that might be completely different than what people are used to over the last number of years?

David Picton: Some of those diversification angles, whether they're commodities, would have had no real benefit to you other than some brief spurts here and there. Maybe in the new world, post this COVID crisis as we calm down and we start thinking in the ramifications of using more and more debt to solve debt-related situations, maybe the diversification angle starts to change, and that will be critical for I think people to adapt to as we go forward.

Michael Greenberg: Yeah. It's a good point. I think the loss of yield on government bonds is, of course, a concern for those investors that are relying on that yield for return. As a portfolio construction person myself, it's almost that risk, that asset class is not going to be there for you the next time that you see an equity drawdown take place. It's almost more concerning.

Michael Greenberg: To follow on with what David is saying, I mean, you have to really look at what other asset classes are out there that maybe could provide some of that shelter going forward, especially from a Canadian's perspective. Currencies are one area. The US dollar, the yen have very risk-off properties. Gold, not a perfect record by any means, but is another tool that you can use if you're worried about the debt issuance, debasement of the US dollar, those really dark places that you could go going forward given all of this QE and fiscal spending. Gold would potentially be that store value for you in those cases. Certain alternatives and certain investment strategies that are more market neutral are other ways to do that.

Michael Greenberg: So, I wouldn't want to completely abandon the thought that government bonds are still not a good diversifier because we still think they are. I think you just have to adjust a little bit your return expectation for them, but definitely, to David's point, looking for other ways to diversify what is the biggest risk in most people's portfolio, which is equity risk is going to be really important going forward.

Kim Inglis: I just wanted to add to that in terms of the yield side of things because I think that moving forward, portfolio construction is going to be more important than ever because you're looking at different investments where people need the income from their portfolio, so they need to be finding these areas, but seeing individual investors where they're going and they're saying, "Oh, well, look at XYZ energy company, that's suddenly at a 20% yield. Let's buy that," without actually looking at how sustainable that is. Are there going to be dividend cuts? Likely, there's going to be a lot of dividend cuts coming down the pipes. It's making sure that people are doing their homework and picking the right investments, and not just seeking out yield to seek out yield, but they're actually looking for sustainable yield there.

Michael Greenberg: Yeah. It's a good point. I mean, many people equate yield with total return. Of course, it's not at all. Yeah.

Jenna Dagenhart: Yeah, and you can invest in companies and sectors not only that you think are going to do well, but that you think will not do well. Going off of that, I mean, David, how does the ability to go long and short help you manage volatility?

David Picton: It's critical when you're running a strategy where everything correlates to one in the broad market like we've seen through this crisis. There's really only a couple of things that are really uncorrelated. Bonds, to a certain extent, even though on some days they got challenged, but having the opposite exposure in the market, for instance, instead of being long the market, you're short the market or at least certain securities is absolutely a diversifier. Maybe adding a volatility exposure can be a diversifier.

David Picton: So, yeah, being able to construct a portfolio that takes away either stock market risk or bond market risk or presumably better to take them both away and focus on stock selection risk is an absolute necessary tool I think in portfolios going forward.

Kim Inglis: That's where a lot of alternatives have been really shining through right now is because they've been able to do that, and they've been able to actually had job at risk. So, I've definitely seen that on my side of things, anyway.

Jenna Dagenhart: Kim, how do you help clients with different time horizons, and how does financial planning drive the bus in terms of investing strategies?

Kim Inglis: Well, again, really, the financial planning, it really, again, that goes back to keeping them focused and focused on the long term. What it can also do not just on some of the things that we've talked about previously with regards to asset allocation, to tax efficiency and stuff like that, but whether it can also help in, as going back to that discussion on cognitive biases. That's another way of helping people recognize and avoid that thing.

Kim Inglis: One of the best ones that it helps with I find is actually market timing, something that Mike was talking about a little bit earlier, is it can help with, for instance, overconfidence bias, which is essentially 80% of drivers out there think that they're better drivers than everyone else. Well, you just have to drive out in the streets of Toronto to know that that's definitely not the case.

Kim Inglis: It's the same thing with investors, whether that's your individual retail investor or even professional investors often succumb to this overconfidence bias. They think that they are better investors than they are, and they forethink that they can time the markets, that they're going to be good at that, but, obviously, that's something that is not the case for most people.

Kim Inglis: I always think of the study that William Sharpe did, Nobel Prize winning economist. He found that for someone to be actually good at market timing, they have to be right 74% of the time, which just doesn't tend to happen in the investment world. So, what financial planning can do is help people avoid that market timing. It helps them recognize that, for instance, you might get it right on the way out, but then trying to get it right getting back in is the other side of the coin. Just as markets don't go up in a straight line, they also don't go down in a straight line. They'll go down. They'll have a dead cap balance along the way. They'll go down some more. They'll balance around for a while before eventually recovering.

Kim Inglis: So, saving people from trying to time that, which finding that bottom is typically more of a rear-view mirror type analysis. Saving people from doing that, in part, is done through the financial planning process, and, again, really driving forward towards that long term goal, whatever it is for the client, which tends to be sneaky to my clients multi-decades down the road. So, that's what that really helps with.

Jenna Dagenhart: Mike, as correlations like investors feel like they have nowhere to hide, what are you recommending?

Michael Greenberg: Yeah. I mean, you don't want to manage for 5% of the time. You want to manage portfolios for 95% of the time. There's definitely periods where you see correlations spike. It goes back to what we started off the call with. You had just massive liquidation from markets because of risk parity funds, and other levered players. There's been a few other instances of this in the past as well, but once that happens, you do get back to a bit of normalcy.

Michael Greenberg: So, we're definitely not throwing in a towel on good old-fashioned diversification by asset class, by region, by investment style. You want to look at the factor exposure within portfolios. The correlations amongst factors tends to be a little bit more stable. So, really understanding how diversified you really are. If you own a lot of equities, a lot of high yield bonds, a lot of emerging market debt, and a lot of Canadian dollars, it's all tied to risk on. That's all the same bet.

Michael Greenberg: So, you need to really be able to look under the hood to make sure you do have through your diversification. Then going back, the typical portfolio, even if it's a 60/40 portfolio, 60% equity, 40% fixed income, probably 80% to 90% of your risk is actually coming from equities.

Michael Greenberg: So, it's then again, what is the most efficient way to add something to the portfolio that gives you that diversification to equities? Government bonds were great because not only did you get diversification, you got paid to do that. You can go and buy put options. That gives you great diversification to equity, but it's extremely expensive to do that more systematically.

Michael Greenberg: So, it's a little bit like a value investor who's just looking for what's the best deal right now that I can buy that's going to add diversification to my portfolio. At times, it's going to be rates, government bonds. At times, it's going to be certain currencies. At times, it's going to be certain alternative investment strategies, et cetera.

Michael Greenberg: So, I think it's really important just to keep that in mind that for Kim's investor base and for many people who are not necessarily day traders and should not be day traders, they should be decade traders, good old-fashioned diversification we think continues to work, but you want to be smart about it. You want to have someone behind the scenes like a camera or someone like ourselves who's there looking at what's the most efficient way to get through diversification in your portfolio to make sure you're not over your skis in any one part of the market that can come back to really bite you.

Kim Inglis: Yeah. They say don't be a short-term trader with long term capital.

Jenna Dagenhart: Yeah, making sure that your portfolio is what you think it is. David, are advisers finding any unintended exposures or correlations in their portfolios?

David Picton: I do believe there are some, for sure. Mike alluded to a point where you could look like you have different kinds of assets. They go into different kinds of buckets, but if all act exactly the same, that's usually when you get to trouble.

David Picton: Now, there's another important point here. In this environment where we saw that massive liquidation process take place, all typically diversifying assets acted the same, with the exception of a bit of help from the bottom market, and then maybe a little bit of volatility exposure, the puts, et cetera.

David Picton: It is not often when all of your diversifying strategies and assets act exactly the same. Usually, that occurs in a really penultimate amount of fear grips the entire investment process. That is usually the time where you have to do a couple of very simple things. You have to rebalance away. You have to take some of that bond exposure up right away to get it across the other asset classes, and to Mike's point, you have to take a little bit of, "What is the best risk reward play that gives me some diversification here?"

David Picton: Those once in a decade opportunities when everything acts exactly the same tend to be at the bottom before things start to act more normally and your portfolio starts to perform really well again.

David Picton: So, it's really a matter of making sure you're not all the same, but sometimes even if you're property built and you get all the same, you have to take advantage of the rebalance process.

Michael Greenberg: Yeah. I think many times we're not going to predict these events, but we can control how we react to them, and then that's really what Kim is getting at earlier I think as well is very few people are going to predict a 2008 or a 2020, et cetera, but what we can be is try to put our emotional biases aside, which even we as professional investors are going to have. Hopefully, our investment process helps deal with those a little bit, and react to these types of events because you may have not been as defensive as you may have wanted to have been had you known what was going to happen, but what you can do is rebalance your portfolio, put some money into risk assets for those clients that can afford to take a little bit more risk because you just got a nice reset, which obviously make forward-looking returns a lot more attractive over a medium to long term horizon.

David Picton:  We are probably in an environment over time of lower returns just because our starting base and, say, interest rates and fixed income are so low. So, if you add that 40% of your portfolio to the other 60, the overall portfolio is going to generally be more prone to less returns than it had over the last number of years. So, unfortunately, when you do get the reset, as Mike called it, you have to lean into that if you're going to have any kind of chance of meeting the longer term goals.

Jenna Dagenhart: Yeah. Mike, going off of what David said about looking at risk return and, of course, keeping an eye on sharp ratios, et cetera, when do you think a good time is to add risk?

Michael Greenberg: Yeah. I mean, now, I can tell you that in a few months, for sure, but I think you should have been chipping away already at risk a little bit in your portfolio. It depends also on your own situation. So, that's why working with a financial adviser is so important because everyone's different. So, it's hard to make a blanket statement.

Michael Greenberg: I can talk about our own portfolios. I mean, we definitely had a little bit of dry powder, a little bit of government bonds that we were more than happy to sell at these rates to rebalance into equity. So, I think, not to pick the necessary day that you go in, but I think to start chipping away at risk assets I think you had that opportunity in the last week or two, and I think that continues.

Michael Greenberg: I don't think it's going to be a straight line up or down. So, I think whereas I'd say going into the year, it was more of maybe take some profits on strength because valuations were maybe a little bit more stretched. Before the virus, we already saw economic growth decelerating a little bit. There was a lot of political uncertainty, of course.

Michael Greenberg: So, for us, that's when you leaned against equities a little bit, and maybe took a little bit of profit. We're probably now on the other side of that where it's more taking some opportunities to add to equities, add just tied to a little bit of credit risk. So, we would be starting to do that already now.

Jenna Dagenhart: Kim, would you recommend a staggering investment strategy or a dollar cost averaging strategy?

Kim Inglis: Yeah. So, it's interesting right because as both David and Mike alluded to, there's so many opportunities out there right now if you're a long term investor, especially if you're a long term investor. I mean, you look, for instance, the other day I was looking at the Berkshire top holdings, and Warren Buffett, arguably the best investor in history, is down peak to trough over at 35%. Does that mean he suddenly became stupid overnight? No. Well, obviously, that experience that he's had within his portfolio, for lack of a better wording. It's something that happens when there's been panic selling, indiscriminate selling that causes just mayhem across the board, but what that does is that opens up opportunities for investors.

Kim Inglis: So, for the individual investor, probably the easiest and least stressful way of dealing with that is someone doing dollar cost averaging. They're adding set amounts on a regular, automated basis to their portfolio. It takes some of that guesswork out. Anyone who's got cash right now is obviously in a great position to be buying some of these good quality investments, but what you don't want to be doing is taking that entire chunk of cash and investing it right away. You definitely want to be spreading it out in conscious so that you're hedging out some of that risk that you guys are saying before. You're never going to get the bottom exactly perfect. So, you buy a little now, buy a little a few weeks from now, that idea so that you're minimizing that chance that you're just going to keep buying lower.

Jenna Dagenhart: David, are there green shoots of growth emerging from this?

David Picton: Not many green shoots of growth yet. There's green shoots of health emerging. Virus counts are or whatever they are, and I don't trust the virus count numbers. Unfortunately, you have to look at the death toll numbers, and as sad as that is, there are some signs that things are peaking out. That's very critical.

David Picton: Then I think the next signs of a green shoot will be when companies and working with governments outline a plan as to how we get people back to work. That will be the biggest possible green shoot. The sooner it happens, obviously, the more constructive it will be as long as safety is being measured and taken into account. That's the key green shoot; come up with a plan, post the crisis to get people back as soon as possible to get the economy moving again.

Jenna Dagenhart: Yeah. You say you don't necessarily trust the numbers, and there's so much information out there. Kim, how do you help clients tune out some of the noise and stay focused on the long term being decade traders as Mike said?

Kim Inglis: Yeah. So, I mean, again, that goes back to that reframing the mindset. In some circumstances, it means remembering what's happened in history. Obviously, it's not going to necessarily say that's exactly how it's going to go in the future kind of thing, but it can give you a general idea. If you look back at history, you look back literally every single year in the market, there has been something major or it's really the last major to cause market volatility. I mean, even if you look at the last decade, we've had phenomenal numbers over the last decade, but yet we've had European debt crisis. We've had Brexit. We've had Fukushima. We've had any number of things that have caused volatility along the way, but the market has still improved.

Kim Inglis: Even looking back further than that, obviously, the markets have seen world wars, terrorist attacks, natural disasters, you name it. Over time, even wars have been given the right time context, nothing more than noise over the long term. So, it's important to keep that in mind. Then also from just the human elements, I bet, just to keep in mind that people are very resilient in general, and this is what's kept the markets going for so long is that people eventually adapt, businesses adapt. Things eventually move on, and then you can grow again. It's without a doubt that that will happen at some point here. So, keeping that focus for longterm investors, just remembering that part of it.

Jenna Dagenhart: So, David, knowing what we know now, how do you manage a portfolio and what does the portfolio of the future look like?

David Picton: Well, the portfolio the last 40 years, all it needed was stocks and bonds, and that portfolio would have done a tremendous job at meeting everyone's objectives and more. Given our starting port on interest rates, I think we have to incorporate new tools into the mix. Those could be alternative investments like a long short fund or a merger arb fund that aren't really related to the stock market or the bond market.

David Picton: In other words, extra strategies on top of it. We probably want to incorporate some other assets that maybe we haven't thought about in the past. Maybe we have direct exposure to commodities, for instance, whether it's gold or even copper in the mix. So, that's the portfolio side of the equation.

David Picton: As individual investors in our own particular sleeve within that portfolio, in my case, Canadian equities, you stick with your knitting. Mike alluded to this already. At Picton Mahoney, we have a process that focuses on quantitative inputs and fundamental inputs. We keep trying to evolve each of those separate inputs, make our teams better and stronger, and then we look for the overlaps between them. Having a discipline to stick to is absolutely critical if you're going to meet the objectives that people have you in their portfolio for.

Jenna Dagenhart: Yeah. You make a good point about stocks and bonds in the past, but looking forward, Mike, what does the 60/40 portfolio look like? Is that dead? What's next?

Michael Greenberg:Yeah. I think we got to be careful not being too dramatic about calling the death of the 60/40 portfolio. I think it's definitely an evolution more than a concrete burn it down and build it back up again. I think bonds, yields will probably rise at some point. As yields rise, there is a negative return probably coming or at least a very, very low return coming from that government bond portion, but we've also had a nice reset in stocks and credits. So, you're probably going to make it up a little bit on that side as well.

Michael Greenberg:As yields rise, that's building a cushion for the next drawdown for yields to fall again and give you that negative diversification. Now, that being said, absolutely. With yields as low as they are compared to where they were 10, 20, 30 years ago, the cushion is not as cushiony, I guess, as it was in the past.

Michael Greenberg:So, I think absolutely evolving traditional 60/40 portfolios to look at different asset classes or different strategies to help enhance that diversification is something that I'm sure we all are doing, and we're definitely doing at our firm and looking at how to do that.

Michael Greenberg: So, I think the main thing, though, and probably this is more something that Kim has to deal with is when you're sitting down with a client who's had that experience of the 60/40 portfolio in the past, it's resetting some of those expectations on what can be achieved out of that portfolio going forward.

Michael Greenberg:If they have a very specific return target that they need to meet for their financial goals, that's where working with an adviser, the person may need to look at taking a little bit more equity risk or changing some saving habits or some spending habits to meet that goal.

Michael Greenberg: So, I think the portfolio itself is still strong. I think 60/40 is still the way to go or an 80/20 or a 20/80 or whatever the mix is. It's still I think the way to go for the vast majority of clients assuming that the person that's looking after that portfolio is trying to evolve that portfolio for what's to come, but I think the biggest challenge will be then somewhat at an investor level trying to reset some of those expectations on what they've achieved in something like that in the past versus probably what's more reasonable out of that portfolio going forward, and that's obviously a tougher conversation to have with people sometimes than when things are looking better from a long term return perspective.

Jenna Dagenhart: Kim, any final thoughts on your end from the adviser perspective?

Kim Inglis: Well, at the end of the day, I would say that, ultimately, it doesn't matter what caused this crash. It doesn't matter what caused previous crashes. It doesn't matter what's going to cause future crashes. They all follow a very similar pattern. They said that history doesn't repeat itself, but it rhymes. Ultimately, humans are very hardwired to fear and grief. So, the same kind of patterns that you see in a market cycle will repeat themselves moving forward.

Kim Inglis: So, it's keeping that in mind. It's having, as Dave said, the different processes, and as Mike was referring to, having the right plan in place to take advantage of that, and ultimately sticking to those processes, sticking to that plan, going back to your financial plan, making any adjustments that you might need to along the way, but staying focused on that. That's ultimately what I would go back to.

Jenna Dagenhart: Well, thank you so much for your time, and really great to have you, everyone.

Kim Inglis: Thanks for having me.

David Picton: Thank you.

Michael Greenberg:      Thank you so much.

Jenna Dagenhart: And thank you for watching this Investment Strategies in Market Volatility Masterclass. I was joined by Kim Inglis, Financial Adviser and Associate Portfolio Manager at Raymond James, David Picton, President, CEO and Portfolio Manager, Canadian Equities at Picton Mahoney Asset Management, and Mike Greenberg, Vice President, Portfolio Manager, Multi-Asset Solutions at Franklin Templeton Investments. I'm Jenna Dagenhart with Asset TV.