Podcast: PSG Q3 in review

This podcast features Susan Spence, Vice-President, Portfolio Solutions and head of GLC’s Portfolio Solutions Group division.

We'll speak with her about how GLC’s asset allocation funds fared during the third quarter of 2017.

Christine:  Hello, I’m Christine Wellenreiter, Vice-President of Marketing and Communications at GLC Asset Management Group and today we’re going to hear directly from the manager of GLC’s asset allocation funds about how those funds fared in the third quarter of 2017. – And that person calling the shots is Susan Spence – Vice-President, Portfolio Solutions and head of GLC’s Portfolio Solutions Group division - PSG for short. Hello Susan, welcome back and thank you for joining us again.

Susan:  Hi Christine.  Thanks for having me back this quarter.

Christine:  Susan, we’ve been sitting down together for a few quarters in a row now, and the topic of politics and world events has come up again and again, but this quarter – it didn’t seem like that drive the markets one way or another – would you agree?  

Susan:  I do agree, Christine. Markets exhibited very little volatility, even though there was geopolitical noise this quarter.

Christine: there was the heightening tensions with North Korea

Susan: Right…along with political noise and many headlines regarding the devastating impact of both hurricanes and earthquakes in certain regions.  But the markets seemed to generally shrug off any negative macro news and remain focused on the positive influences of the synchronized global economic growth we are experiencing.  One reason this is interesting for equities in particular is that for the past several years macro noise has been a big influence on market movements.

Christine: So what should we make of that?

Susan: Well it could be interpreted as an indication that markets are now focusing more on fundamentals – remember, a key outcome of the synchronized global growth story is the positive tailwind it provides for corporate earnings globally.

Christine: So what were the big drivers of market performance?

Susan:  Sure…let’s talk first about the bond market, and then we’ll move on to the stock markets. Bonds stood out in the third quarter due to their negative returns.  In Canada, this was particularly pronounced, as the Bank of Canada raised its key benchmark interest rate, the overnight rate, twice (in 25 basis point increments).  The first move was implemented in early Q3 but telegraphed prior to the announcement – so most of the impact from that was felt in Q2.  The second move, in early September and coming so close on the heels of the first hike, caught many investors by surprise – so we saw a real spike in yields at that time.  But it was not just short term rates that rose – yields were up across the board in the third quarter…with longer-dated and real return bonds experiencing the weakest returns.  There was also some monetary policy news in the US during the period – although that central bank held rates steady during the quarter, the Fed did detail its intentions regarding the unwinding of its balance sheet – this news had been expected and was easily absorbed by the markets.

Christine: Right –we need to watch the Fed because globally, yields often take their cues from the goings on in the US.   Okay, so how about equity markets – it sure was a slow summer for the Canadian market.

Susan:  Yes the Q3 chart for the S&P/TSX Composite Index looks a little different than those for other global indices. Most global markets experienced pretty steady gains throughout the period – but wasn’t the experience in Canada. After lackluster returns in July and August, things really turned…and domestic equities had a strong rebound in September.  In contrast to Q2, when we saw our largest sectors decline, in Q3 both financials and the resource sectors rallied.  Financials were boosted by the benefits that rising interest rates should bring to their results – think banks and insurance companies, while energy stocks stood out within resources as they rallied with the rising price of oil.  Oil passed the $50 mark, which is viewed as a key level for many energy companies to be able to improve their bottom line.

Christine: …and that turnaround from energy – that made a difference for other world markets as well didn’t it?

Susan: Well I think the turnaround from energy helped. But it was in combination with the growing evidence of synchronized global growth, and the positive indication that global leading economic indicators are giving with respect to that growth continuing that made a difference and had a positive impact.

Equity market returns were quite strong overall, with emerging markets leading developed markets.  This emerging markets' outperformance has been a trend for some time. Emerging markets ahead of developed markets on a one-year basis now.

Christine: But our Canadian dollar – that strengthened too over the quarter. That must have detracted from some of the international market returns for investors.  

Susan:  Yes, the Canadian dollar had quite a significant move during the quarter, up about 4% versus the US dollar.  The rate hikes taken by the Bank of Canada were, of course, a key driving factor.  And as you say, this did mute foreign equity returns for Canadians…but those returns were still positive in CAD terms. So overall they boosted the absolute returns of our asset allocation funds.

Christine: Susan, just before we get into the specifics of fund performance, I want to talk specifically to the real estate sector. We’ve heard from you many times about the important role that real estate plays in terms of optimizing the risk and return profile, but it’s such a unique asset class -- investors are unlikely to hear much about how it performed relative to stocks or bonds.  Can you give us some insight into that?

Susan:  Real estate achieved a positive return this quarter, but lagged the strong return of domestic equities.  So real estate outperformed bonds and boosted absolute returns in our asset allocation funds– but was a drag on the relative performance of our funds…as from a benchmarking perspective it is measured against the S&P/TSX Composite Index.

Now this short term performance doesn’t influence our strategic use of real estate in our asset allocations funds…over the long term real estate has added to the profile of the funds, both from a return and a risk management perspective.

Christine:  Well that’s a good segway into digging deeper on the performance of the AAFs. What were some of the other factors affecting performance?

Susan:  As I mentioned, emerging markets led returns.  Many of our global and international equity underlying fund holdings have EM exposure, but in addition to that, in the asset allocation funds with higher risk profiles

Christine: so…like the aggressive and advanced portfolio strategies

Susan: Yes…there we have an additional focused allocation to emerging markets which added value during the quarter.

Some other factors that were head- or tailwinds for certain holdings were investment style – for example, in the US market this quarter growth significantly outperformed value – and stock selection within fund holdings.

Christine:  How about specifically for the more conservative end of the spectrum where fixed income plays a bigger role. Can we go into more detail there?

Susan:  Sure….despite the overall negative absolute returns for bonds, fixed income allocations within our asset allocations funds added value relative to their benchmarks during the quarter.

Christine: in other words, provided better downside protection than just investing in the broad Cdn bond market as a whole?                                     

Susan: yes - which we like to see.  Specific holdings that were key contributors to relative performance were our shorter-duration positioned funds, including mortgages, and the Mackenzie unconstrained fixed income mandate (which was able to achieve a positive return despite the tough environment for bonds).  The asset allocation funds also benefited from our overall shorter duration positioning relative to benchmark.  The positive contribution to relative performance within fixed income this quarter illustrates well the value add that PSG endeavours to bring to the asset allocation funds through portfolio construction and our use of select off-benchmark allocations.   

Christine:  that is a really tangible example of investors getting the additive benefit of also having active management calls at overall portfolio level, in addition to the active management going on at the underlying fund level.

Susan:  That’s right.

Christine:  I want to move from looking back, to looking forward now. Susan, how do you see the economic and market backdrop today.

Susan:  As I mentioned at the beginning of this discussion, broad based economic strength continues.  To help put this in perspective, over 90% of the world’s economies are currently expanding.  

CW: that really is synchronized growth!

Susan: -- and this includes both developed and emerging economies.  And I also mentioned how this strength has been translating into robust corporate earnings results globally and that forward looking economic indicators suggest that the synchronized global growth will sustain momentum.  So this is all very encouraging, and, overall, recession risks remain low.

Christine:  So that sounds like a pretty rosy picture on the economic front, would you say we are in the ‘mature’ or later stages of the economic cycle?

Susan:  Yes, I definitely would, but what is more uncertain is how much longer this can go on for.  For now, the economic picture remains rosy, as you say, and the fact that low growth rates have driven this economic expansion supports this being a very extended cycle.  But that said, we are very cognizant of the risks out there –in particular, the geopolitical and political noise could still lead to trouble for the capital markets, there is the potential for central bank policy missteps as we progress through the unwinding of extreme monetary easing globally, and at some point fundamentals can’t be this strong forever.  For equities specifically we are all the more cognizant of the risks, as equity valuations, although they are supported by earnings growth and an attractive equity risk premium when you look at them versus fixed income, remain above average.  

Christine:  How is this view affecting the decisions you’re making on portfolio positioning?  

Susan: It is affecting us in that we continue to weigh the positives and negatives and take a balanced approach to our portfolio positioning, emphasizing offsets within the funds and good diversification.  Recently we have also trimmed some high yield bond exposure within our income-oriented asset allocation funds to lock in some of the gains realized in that part of the bond market.  Spreads have come in significantly over the past year, and we think the risk return proposition isn’t as compelling given where spreads are and where we are in the market cycle at this point.

Christine:  Thank you Susan. I really enjoy your insight into the management of the asset allocation fund managed by PSG. Today in particular there was such a clear and tangible example of the value investor get from a longer-term perspective on portfolio construction and position, without missing out on the benefits of portfolio management at the underlying fund level in which portfolio managers can take a nearer term view on the opportunities and risks within their given area of the market.   

Christine:  Susan, I can hardly believe it, but the next time we speak on a podcast about PSG’s asset allocations funds it will be in 2018!

Susan:  Time flies!

Christine:  A great time to look back at the year that was. Have a wonderful autumn and I look forward to speaking to you then.

Susan:  Thanks, Christine.  I look forward to speaking to you again in the New Year.

Copyright 2017 GLC. You may not reproduce, distribute, or otherwise use any of this article without the prior written consent of GLC Asset Management Group Ltd. (GLC).

This commentary represents GLC’s views at the date of publication, which are subject to change without notice. Furthermore, there can be no assurance that any trends described in this material will continue or that forecasts will occur; economic and market conditions change frequently. This commentary is intended as a general source of information and is not intended to be a solicitation to buy or sell specific investments, nor tax or legal advice. Before making any investment decision, prospective investors should carefully review the relevant offering documents and seek input from their advisor.