Hear from GLC’s Susan Spence, VP of Portfolio Solutions, about how the performance shined for PSG managed asset allocation funds in Q1, 2018.
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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 to give you a quick way to stay up to date on how the asset allocation funds are performing.
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So, as promised, I’ve got Susan Spence with me in studio – Susan is 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: Thanks Christine. The first quarter was quite an interesting one, with the movements in the capital markets certainly capturing investors’ attention. So, I’m happy to be here today to give you an update on the PSG-managed asset allocation funds and to let you know how our funds fared in that environment.
Christine: You’re right –2017 was like a cake walk in terms of low levels of volatility, and then whack, markets dropped on inflation fears (among other things). The S&P 500 lost over 4% in one day - February 5th. And markets have been bouncing around ever since.
That brings me to the very first thing I want to talk about – you and I have talked a lot about how PSG’s approach helps to ‘smooth the ride’ for investors. Right now, in volatile markets, it’s exactly when I would expect PSG’s portfolio management approach to shine. Susan, not to put you on the hot seat, but I’m expecting big things from you! How did the PSG managed funds perform?
Susan: Well, Christine, the funds we manage did very well this quarter.
<Christine (interjecting): You outperformed? Beat the benchmark?
Susan: We did outperform, and we were also able to deliver pretty solid absolute returns. Nearly all of our target risk funds delivered positive gross returns, despite the benchmarks for the funds experiencing negative results.
<Christine (interjecting): So, despite people seeing headlines about the S&P500 or TSX having negative results, if you held a target risk fund managed by PSG, you were likely to have had positive returns in the quarter.
Susan: An in terms of beating the benchmark, every one of our target risk funds outperformed its benchmark on a gross basis in Q1, with excess returns ranging from 42 to 179 basis points.
Christine (interjecting): that’s actually quite a bit - like around half a percent to just under 2% - for a three month period.
Susan: It is, and you are absolutely right to say this is when our funds are expected to deliver strong relative performance. Our approach to constructing and managing the asset allocation funds is, as you said, intended to give investors a smoother ride throughout a market cycle. Not surprisingly, this tends to resonate best with people when the result is downside protection, which our funds delivered on during Q1.
Christine: Right – downside protection…it’s not talked about as much as absolute returns, but people forget that age old principle: it’s not just what you make, it’s what you keep. That’s what’s going to bring you to that financial goal line.
So how do you do it? What funds were the real difference makers in the construction of the portfolios that drove the outperformance?
Susan: It was the diversification by asset class and by region that made the real difference this quarter.
Christine (interjecting): and that’s really step one in your portfolio construction process, right?
Susan: Right. And it really came down to two of our non-benchmark calls being the primary drivers of outperformance for most funds: real estate and international bonds.
<Christine (interjecting): …um…non-benchmark calls – you mean, …something like a specialized or alternative asset type fund?
Susan: That’s right – funds whose holdings don’t directly align with the benchmark components our funds are measured against or with a subset of one of those benchmark components. As a reminder, the benchmark components I’m referring to are the broad Canadian bond, Canadian equity and broad world equity indices.
Christine (interjecting): Okay – so you mentioned real estate and international bonds.
Susan: Yes. After being an anchor for many quarters when equity markets achieved strong gains, the diversification benefit of our real estate allocations was very evident this quarter – real estate achieved modest positive returns in the context of a 4.5% decline in domestic equities.
In addition, our allocations to international bond funds within most fixed income exposures added value due to their currency exposures in a period when the CAD weakened.
Christine: On that note, holding non-benchmark relative and/or alternative asset classes like real estate – we can’t say it enough - this is a very specific and notable competitive advange that the PSG managed funds have. You are constructing more sophisticated portfolios designed to weather market volatility better in part because of these components. We’re talking customized portfolios that are designed for better risk adjusted returns.
Christine: So what about the benchmark-aligned exposures? Any of them contribute to outperformance?
Susan: Another driver of outperformance worth mentioning is that as a whole the Canadian equity managers we use did a good job at outperforming the S&P/TSX Composite Index through active management of their funds in a down market.
Christine: So when looking at active versus passive management for your underlying funds – this is really highlighting that choice to go with active managers.
Susan: Yes, it’s a good example of the value add that active managers bring to the performance of the PSG-managed funds.
Christine: Speaking of active management – we just heard that it made a difference in the underlying funds in the first quarter of 2018, but you make active management calls at the top portfolio level too. For example you hold a Real Return Bond fund managed by the Portico investment team in some of your funds, that is an active management call on your part – one of those ‘non-benchmark relative’ calls. In other words, investors wouldn’t always expect to see the Real Return Bond fund in portfolios but this was a call you had made last year based on your forward looking views. A good call on your part?
Susan: Yes, over the last year or so we have incorporated a real return bond allocation into the fixed income portions of some of the asset allocation funds – in our more conservative funds, where we know inflation protection is a primary concern for investors.
During the first quarter, we did see inflation expectations jump and, of course, real return bonds benefited from this and therefore contributed positively to performance in those funds where we have an allocation. This wasn’t as material a driver as those I mentioned previously, but it all adds up and directionally it certainly was a positive and it’s another example of a building block within our asset allocation funds delivering on expectations in a certain environment.
Christine: So now going forward, how are you positioned now, and what things are you watching for that might cause you to adjust your positioning.
Susan: Right now we are taking a balanced approach within our portfolios, both from a fixed income / equity perspective and from a foreign and domestic equity perspective – staying essentially neutral versus our benchmarks. This means excluding real estate from the calculation, we are targeting and moving toward a split of 60% foreign and 40% domestic within our equity allocations. And the fixed income / equity mix of course varies fund by fund, depending on the risk profile.
From the fixed income / equity perspective we are weighing the headwind of rising rates on bonds against generally stretched valuations within equities and issues that may impact global growth as we get later in the market cycle. And our positioning within equities reflects our view that the risk-adjusted opportunities for domestic and foreign equities look pretty balanced right now - we are weighing relative valuations against risks across the various regions.
Christine: And what about those non-benchmark relative holdings and specific sector positioning – last year you started to pull back on high yield bonds, are you sticking with that call?
Susan: Last year we did trim 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 and to reflect what we saw as a less attractive risk/reward opportunity going forward. Our view on high yield bonds has not changed. We continue to have some exposure in select funds, but the bulk of this is through the use of an unconstrained fixed income fund that has the discretion to tactically vary its exposure to high yield bonds by also holding other assets and focuses on delivering positive absolute returns.
One other thing we have generally been doing is reducing our exposure to the U.S. market somewhat within the context of our foreign equity allocations, from a previously overweight position – this is in keeping with taking an overall more balanced approach to the funds.
Christine: Any comments to wrap up and summarize the quarter?
Susan: What I’d like to end with is another reminder that our target risk funds outperformed their benchmarks at a time when it really matters to investors – when markets are volatile and investors are looking for some capital preservation and a smoother ride.
Strong long-term risk-adjusted returns – that’s the value proposition of the asset allocation funds we manage, and that’s exactly what investors are getting.
Christine: Thank you Susan – I can’t think of a better point to end our discussion on, and kudos to you and your team for all the insight and expertise that go into the portfolio construction, active management, and continuous oversight of PSGs asset allocation funds to deliver those results.
Christine: 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 and fund breakdown is right there for you.
Christine: Will you come back next quarter to talk to us again about the AAFs you manage?
Christine: I look forward to it. Thank you.
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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.