Listen to Susan Spence, Vice-President of Portfolio Solutions Group discuss Q2 and long term performance of the PSG managed funds.
Christine: Hello. I’m Christine Wellenreiter, Vice-President of Marketing and Communications at GLC Asset Management Group, and you’re listening to the PSG update podcast – a quarterly discussion with GLC’s Portfolio Solutions Group, and a quick update on the performance of the asset allocation funds managed by PSG.
I’m here in studio with 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 – thanks, Christine.
Christine: Before we begin – a quick housekeeping note for listeners that if they haven’t already done so, subscribe to this podcast. Just search for GLC Asset Management in iTunes or Google Play. You’ll find us there and get new episodes automatically when they’re released. You can, of course, continue to get these podcasts on our website.
Susan, have you done that yet?
Susan: Yes I have! – and the nice thing is it allows me to access all the GLC podcasts, not just these PSG ones…
Christine: Perfect! Susan, I’m looking at the Q2 returns for PSG asset allocation funds. On an absolute basis, the returns look strong.
Susan: Yes, gross returns for our core target risk funds in Q2 were very solid.
Christine: So what are we talking about here?
Susan: Absolute gross returns range from around 1% for conservative or shorter-dated funds to near 4% for most funds at the aggressive or longer-dated end of the spectrum. The strength of developed equity markets was a key driving force in the quarter, so funds with more equity and less or no fixed income achieved the highest returns.
Christine: That is strong. And we’re just talking about a short 3-month period.
Christine: And what about the longer-term performance – how is that looking?
Susan: Good question – because these funds are really designed for investors looking for strong long-term investment results.
As you heard, the Q2 absolute returns were particularly robust – but when you look at, say, 5- or 10-year annualized returns you see a similar picture – absolute returns are strong.
Christine: Great! Maybe I should end the podcast there.
Susan: Well…you could, but then I wouldn’t get the chance to tell you about how we got there!
First you need to remember that we don’t look at returns in isolation – we aim to achieve strong long-term returns while taking on less volatility or risk than is experienced by the benchmarks the asset allocation funds we manage are measured against. And generally speaking we have delivered on that proposition over the longer term.
Christine: That’s a good point – okay – so now tell me how you got there. For our listeners to better understand how the asset allocation funds have been able to achieve those strong, longer-term risk-adjusted returns, would it help to dig into how the funds behave in different market environments? What can we expect when markets are up, like this past quarter? – and just as importantly, what can we expect when markets are down?
Susan: Sure – I think it’s interesting to think about it that way.
There’s definitely a pattern to up and down market behaviour over the long term as it relates to the performance of the PSG-managed asset allocation funds relative to their benchmarks. And it primarily has to do with our disciplined approach to portfolio construction and the strategic, and effective use of offsetting and diversifying building blocks within the funds.
In up markets the asset allocation funds tend to lag their benchmarks, as some of the diversifying elements that we use can be a drag on performance. We know and expect that. It’s really no surprise, because our funds aren’t made up of all the same type of fund – they are well diversified, so of course they won’t hold 100% of whatever happens to be working at the moment. However – and this is key – over the long term, the funds do achieve good upside capture results.
Christine: What’s upside capture?
Susan: Well as the name suggests, the upside capture ratio is a measure of how a fund performs relative to a benchmark in an up market. So, in the case of our funds – over the long term, in environments when markets are delivering positive returns, even though the funds underperform their benchmarks the majority of the time, they are able to capture roughly 85-90% of the upside of the markets – that’s what our funds have delivered in up markets, looking over a 5-year period.
Christine: Why is 85-90% upside capture good?
Susan: Well it’s good because it is it is pretty close to capturing 100% of the upside – for upside capture, a higher result is better – but it’s also important to consider it in combination with the funds’ performance on the downside.
Christine: Okay, so how does that look?
Susan: So, the effective diversification that PSG’s approach to portfolio construction achieves helps the asset allocation funds to preserve capital on the downside – and so, with just a few exceptions, the funds have proven to outperform the majority of the time in down markets and also tend to have good downside capture ratios over the long term, as low as around 70% for the most conservative funds – of course, on the downside a lower capture ratio is better.
Susan: At the end of the day, what all that means is that by losing less in down markets and almost keeping up with their benchmarks in up markets, the asset allocation funds have helped to protect capital and have delivered a less volatile return pattern for investors – which has led to the strong, long-term risk-adjusted results.
Christine: And that’s hard to see from just looking at the returns.
Susan: Right. The returns are what they are, but I think understanding the nuances about how they have been achieved and what the experience has been along the way in order to get to that point helps to set expectations for investors – and hopefully gives them comfort that our funds may be suitable to meet their investment objectives.
Christine: We should be talking about this more - this is exactly what investors are looking for when playing the long-game with their hard earned savings – back to that old saying of ‘it’s not what you earn it’s what you keep.
It’s how most investors will be looking at the success of their investment funds in meeting their goals.
Christine: But let’s get some more detail about how things played out for the PSG asset allocation funds this quarter – a quarter in which we saw volatility in equity markets, bond yields, and currency markets.
Susan: Well, as I mentioned earlier, equity markets were generally quite strong. The exception was emerging markets, which were negatively affected by the increased uncertainty stemming from trade disputes and heightened concerns over exposure to US dollar-denominated debt. At the other extreme was Canadian equities, where we saw a strong rebound from the negative return of the S&P/TSX Composite Index in Q1. Fixed income returns were positive, but not to the same degree as equities. So the more equity in the fund, the higher the absolute return.
In terms of relative performance, however, pretty much across the board gross returns for the asset allocation funds lagged benchmark returns – remember, as I said before, we don’t expect them to outperform in up markets, particularly in the high-flying markets, but in such an environment, the funds will still participate on the upside. So while the funds lagged, it was expected.
Christine: And did the weakness come from the components of the portfolio you expected?
Susan: My answer to the question is really “yes and no”. The weakness in relative performance this quarter was primarily due to real estate underperforming domestic equities, equity funds as a whole detracting value and negative returns from international bond allocations. We expect real estate to lag in strong equity markets, and given the moves in the currency markets over the quarter, it’s not surprising that international bonds lagged domestic bond returns when translated to CAD-based returns. What was less predictable is how the equity funds would do in the period.
Another thing to keep in mind is that although aggressive or longer-dated funds achieved better absolute performance, given differences in exposure to equities and real estate in particular, on a relative basis the more conservative and shorter-dated funds did better during the quarter – which is to say they lagged their benchmarks to a lesser extent.
Christine: It seems real estate often comes up as a driver of relative performance for the asset allocation funds – can you remind us again of the role it plays in the funds and why it was a drag on performance this quarter?
Susan: Of course. Allocations to the real estate funds do serve a specific purpose in the portfolios. Given low correlations with other underlying funds, real estate exposure provides good diversification and helps to reduce overall volatility. The real estate funds also tend to outperform equities when they are selling off, providing downside protection within the asset allocation funds -- sort of the inverse of what happened this past quarter – and remember, in the context of our funds, real estate exposures are benchmarked against the S&P/TSX Composite Index. In Q2, although the real estate funds delivered returns that were pretty solid, at over 2%, Canadian equities had a very strong upward move – the S&P/TSX Composite Index was up 6.8%. As I said, we don’t expect real estate to be able to keep up with equity returns like that…and we’re okay with this behaviour, knowing the benefits real estate brings to the asset allocation funds in weaker markets and from a volatility, or risk, aspect. Interestingly, on a year-to-date basis to the end of June the real estate allocations are adding value to our funds – so its impact really depends on the context and the time horizon.
Christine: Any other underlying funds that made a significant impact on Q2 performance?
Susan: Well on the fixed income side, I mentioned international bond allocations detracted value – and this was primarily due to the short-term impact of currency exposures in the international bond funds that we hold. An offset within some fixed income allocations was real return bonds.
On the equity side funds generally struggled to keep up with the strong markets, particularly in Canada where strength in energy stocks had such a big impact on the index’s return, but there were some bright spots – our allocations to a resource fund at the more aggressive end of the risk spectrum in most fund families had a positive impact, and some of the more growth-oriented foreign equity mandates also added value, particularly some of those focused on the US market.
Christine: Your mention of real return bonds caught my attention – we touched on them in our last podcast, didn’t we? Do you want to talk a bit more about this segment of the bond market and why you have an allocation to real return bonds in some funds?
Susan: Sure – I think it is interesting to highlight that this is the second quarter in a row that real return bonds have been a notable contributor in the portfolios that we hold them – in the more conservative or shorter-dated asset allocation funds where investors are very concerned about the impact of inflation on their assets.
Susan: As a reminder, our exposure to real return bonds is through allocations to a fund managed by GLC’s Portico investment division – and in Q2, Real Return Bond Fund (Portico) outperformed the FTSE TMX Canada Universe Bond Index by 1.4%, benefitting from rising inflation expectations at the shorter end of the bond market.
We are clearly in a rising rate environment, as key central banks globally have shifted into monetary tightening phases, and inflation has started to perk up this year. And it’s changing inflation expectations that drive the relative performance of real return bonds.
Christine: So let’s summarize what people need to know – the asset allocation funds managed by PSG have strong long-term performance, and they are delivering that with less volatility than the benchmark, and in Q2, 2018 the absolute returns were strong as well.
Susan: That’s right.
Christine: By design, you expect these funds to underperform their relative benchmarks in strong, risk-on markets like we just had and they did?
Christine: But over the long term, in up markets the funds don’t underperform by too much – which gives you the high upside capture result, which when married with the good downside market protection…that’s what delivers on that strong-long term performance.
Susan: That’s right, which includes a smoother, more comfortable investment experience with less volatility for investors – which we know, means they are more likely to stick with their investments and therefore are more likely to achieve their investment goals.
Christine: Right. And if people want to look into the specific holdings and mixes of the PSG funds – where can they find it?
Susan: They can find it on the GLC website – the target mix, benchmarks and fund breakdowns are right there for you.
Christine: Thank you Susan. Will you come back next quarter to talk to us again about the AAFs you manage?
Susan: I’d be happy to.
Christine: I look forward to it. Thank you.
Christine: This podcast was recorded on July 26th, 2018 in London, Ontario.
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