Market Volatility - Fight or Flight


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A comprehensive review/presentation for larger investors, how to cope with market volatility

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Market Volatility - Fight or Flight

  1. 1. The PFP Group Wealth Management Team Market Volatility Fight or Flight?
  2. 2. No one likes uncertainty Everyone predicted the right outcome – in hindsight
  3. 3. Presentation Agenda <ul><li>What is Volatility? </li></ul><ul><ul><li>Financial Definition and common beliefs </li></ul></ul><ul><ul><li>What’s wrong with volatility </li></ul></ul><ul><li>Historical Perspective </li></ul><ul><ul><li>The last 70 years </li></ul></ul><ul><ul><li>Volatility and return </li></ul></ul><ul><ul><li>The next few years </li></ul></ul><ul><ul><li>Strategies to deal with volatility </li></ul></ul><ul><li>What are we doing? </li></ul><ul><ul><li>Asset allocation </li></ul></ul><ul><ul><li>Income generation </li></ul></ul><ul><ul><li>Security selection </li></ul></ul><ul><ul><li>Effective use of derivatives </li></ul></ul><ul><ul><li>Tax-based investments </li></ul></ul><ul><li>Wealth Planning </li></ul><ul><ul><li>Wealth Management – a holistic approach </li></ul></ul><ul><ul><li>Retirement and Estate Planning using insurance solution </li></ul></ul><ul><ul><li>Investment Policy Statement and peace of mind </li></ul></ul>
  4. 4. What is volatility? <ul><li>Dictionary: instability, unpredictability, explosive nature </li></ul><ul><li>Common beliefs: Prices go lower, fear factor </li></ul><ul><li>Financial Definition: Uncertainty of returns provided by a security/asset </li></ul><ul><li>Statistical Definition: A measure of the probability distribution of the future returns of an asset </li></ul>Assume both Asset A &B have expected return of 15%,; S.D. of A is 5%, S.D. of B is 10%
  5. 5. TSX Composite vs. market volatility – last 5 years TSX: -5%; Volatility: +200% Annual dividend: approx 2%
  6. 6. TSX Composite vs. market volatility – last 10 years TSX: +50%; Volatility: +50% Annual dividend: approx 2%
  7. 7. TSX Composite vs. market volatility – last 20 years TSX: +250%; Volatility: +50% Annual dividend: approx 2%
  8. 10. What does that mean? <ul><li>Volatility is cyclical </li></ul><ul><li>Volatility tends to go up in down market – fear factor </li></ul><ul><li>Volatility has increased in general </li></ul><ul><ul><li>High frequency, low cost trading </li></ul></ul><ul><ul><li>Uncertain macro/global environment </li></ul></ul><ul><ul><li>Government/political risk premium </li></ul></ul><ul><ul><li>More financial players globally </li></ul></ul>
  9. 11. What’s wrong with volatility? <ul><li>Hurts investors’ confidence </li></ul><ul><li>Difficult to plan and anticipate return </li></ul><ul><li>Send wrong message to genuine investors </li></ul><ul><li>Cyclical market can bounce 20-50% anytime. Market entry after bounce is risky </li></ul><ul><li>Encourage investors to stockpile too much cash </li></ul><ul><ul><li>Opportunity cost and potential inflation risk </li></ul></ul><ul><ul><li>Inadequate return for retirement </li></ul></ul><ul><li>Misled investors risk/reward of public securities vs. other asset classes </li></ul>
  10. 12. Historical perspective <ul><li>Secular vs. Cyclical market trends </li></ul><ul><ul><li>Secular Bull Market (US): 1942-1966; 1982-2001 </li></ul></ul><ul><ul><li>Cyclical Markets (US): 1932-1942; 1966-1982; 2001-? </li></ul></ul><ul><li>Secular: fundamental trend: global growth, inflation, interest rates, technological advancement </li></ul><ul><li>Cyclical: greed vs. fear, monetary/fiscal policies, business cycles, inflation/deflation, bubbles, policy responses </li></ul>
  11. 13. Index Value: 11,231.94         25.61 (0.23% Search
  12. 14. The next few years? <ul><li>Change in leadership follows the bursting of a bubble? </li></ul><ul><ul><li>Energy/commodities, technology, financials, health care </li></ul></ul><ul><ul><li>And the winner is…….. </li></ul></ul><ul><ul><ul><li>Developed countries vs. emerging markets </li></ul></ul></ul><ul><ul><ul><li>Net debtor nations vs net savers countries </li></ul></ul></ul><ul><ul><li>Secular trend vs. cyclical trend vs. political headwinds </li></ul></ul><ul><li>How long is deleveraging process going to continue? </li></ul><ul><ul><li>Tell tale signs </li></ul></ul><ul><li>What about Europe, US and the BRICS countries? </li></ul><ul><li>How does Canada fit in? </li></ul><ul><ul><li>Fiscal and political stability </li></ul></ul><ul><ul><li>Is global demand for our resources going away? </li></ul></ul><ul><ul><li>Is currency level a good predictor of economic performance? </li></ul></ul><ul><ul><li>What about the continue in-migration of human and financial capital </li></ul></ul>
  13. 15. What are we doing? <ul><li>Being more cautious and adjusting our asset mix </li></ul><ul><li>Repositioning our portfolios </li></ul><ul><ul><li>Continue to focus on quality/income right across the board </li></ul></ul><ul><ul><li>Employ institutional hedging/volatility dampening strategies </li></ul></ul><ul><ul><li>Focus on tax effective strategies </li></ul></ul><ul><li>Continue using high yield/corporate bonds, preferred shares, fixed income ETF’s and International Funds to compliment our portfolios </li></ul><ul><li>Continuing to communicate with you to make sure we are aligned with your expectations, goals and comfort levels </li></ul>
  14. 16. What are we doing? <ul><li>Repositioning portfolios: </li></ul><ul><li>Continue to focus on quality income generating companies and securities </li></ul><ul><ul><li>Utilities, REIT’s and High dividend paying companies </li></ul></ul><ul><ul><li>S&P Income Trust Index is +12.1% as of 25Nov11 </li></ul></ul><ul><ul><li>S&P Utilities Index is -2.30% as of 25Nov11 </li></ul></ul><ul><ul><li>S&P TSX is -14.6% as of 25Nov11 </li></ul></ul>
  15. 17. Examples <ul><li>Inter Pipeline - LP with interests in crude pipelines and nat. gas extraction facilities in Western Canada. Great cash flow with moderate payout ratio of ~75% and has increased distribution 6 times since 2004 keeping steady in 2008/2009. Current yield ~5.8% </li></ul><ul><li>Rate Reset Preferred Shares – Issued by various companies with investment grade credit qualities. </li></ul><ul><li>Enbridge 6.3yr Reset Preferred Share at 4.00% with 237bps spread (interest equivalent of 5.36%) </li></ul>
  16. 18. Dividends vs. S&P/TSX Composite Index Dividend paying stocks outperform the market Canadian Annualized Portfolio Performance by Dividend Attribute
  17. 19. Dividends vs. S&P 500 Composite Index Dividend paying stocks outperform the market U.S. Annualized Portfolio Performance by Dividend Attribute
  18. 20. Dividends vs. S&P/TSX Composite Index An important part of total market returns Dividends have comprised between 25% and 45% of total returns over the last 20 years. Source: RBC GAM, data as of Dec. 31, 2010. An investment cannot be made directly into an index. Chart and table do not reflect transaction costs, investment management fees or taxes which would lower returns. Past performance is not a guarantee of future results. 75% 64% 55% Capital Gains 25% 36% 45% Dividend Returns 20 Year 10 Year 5 Year Returns as a percent of total  
  19. 21. What are we doing? <ul><li>Employ institutional volatility dampening strategies </li></ul><ul><ul><li>Puts/Calls (Portfolio insurance and income generation) </li></ul></ul><ul><ul><ul><li>Example: Covered call on Dollarama to generate additional income </li></ul></ul></ul><ul><ul><ul><li>Example: Puts on TSX and S&P 500 indices – insurance against portfolio </li></ul></ul></ul><ul><ul><li>Customized Structured notes (both Principal Protected and Principal at Risk) </li></ul></ul><ul><ul><ul><li>Example: Alerian MLP index note and USD S&P 500 Note </li></ul></ul></ul><ul><li>Alerian MLP Index has a 6.5% ROC income with a currency hedge </li></ul><ul><li>USD S&P 500 Note is a pure play on the index but with a twist….if index is above 1285 on Jan 12, 2012 investor gets 7% return </li></ul><ul><li>Upcoming Gold Note </li></ul>
  20. 22. Why High Yield/Corporate bonds? <ul><li>5 Reasons to own High Yield/Corporate bonds </li></ul><ul><li>1. Higher return potential than other fixed income investments </li></ul><ul><li>2. Higher current yields / higher coupons than investment grade debt and </li></ul><ul><li>dividend-paying equities </li></ul><ul><li>3. Defensive features relative to dividend-paying equities </li></ul><ul><li>• Secured and unsecured investments rank senior in the capital structure </li></ul><ul><li>• Tighter covenant protection afforded to investors against deteriorating credit </li></ul><ul><li>profile </li></ul><ul><li>4. Lower interest rate sensitivity </li></ul><ul><li>• Senior secured floating rate high yield bonds have no interest rate duration </li></ul><ul><li>• When interest rates rise, high yield bonds tend to have a negative </li></ul><ul><li>correlation to government bonds </li></ul><ul><li>5. Credit cycles give active managers an opportunity to add value </li></ul>
  21. 23. Why Invest In High Yield/Corporate Bonds? FIVE BEST/WORST YEARS: HIGH YIELD & INVESTMENT GRADE CORPORATE BONDS (1987 – 2010) 5 Worst Years 5 Best Years
  22. 24. WHY INVEST IN CORPORATE BONDS ATTRACTIVE RISK/RETURN PROFILE 5-YEAR RETURN ANALYSIS: CORPORATE BONDS AND OTHER MAJOR ASSET CLASSES *BofA Merrill Lynch US High Yield Master II Index. **BofA Merrill Lynch US Corporate Master Index. As of October 31, 2011 ANNUAL RETURN STANDARD DEVIATION SHARPE RATIO High Yield Bonds* 7.9% 14.1% 0.50 US Corporate Bonds** 6.7% 7.3% 0.72 BMO Small Cap Blended 3.8% 23.0% 0.20 S&P/TSX Composite 2.7% 17.2% 0.13 Russell 2000 0.7% 24.5% 0.09 S&P 500 0.25% 18.9% 0.03 MSCI World -0.5% 20.5% 0.01
  23. 25. Higher yields offer downside protection when rates are rising - Period 1994 – June 2011
  24. 26. Why Fixed Income ETF’s and Funds <ul><li>Better liquidity and higher yields </li></ul><ul><li>Diversification </li></ul><ul><li>Breadth and depth </li></ul><ul><li>Transparent </li></ul><ul><li>Efficient way to get immediate access to specific areas that would be difficult for us to get access to </li></ul><ul><li>Compliments our individual security strategy </li></ul>
  25. 27. Examples <ul><li>iShares XGB – All Government Bond Index 3.166% yield with 6.75yr Duration and 218 holdings. </li></ul><ul><li>RBC Global High Yield Fund – Mainly US/Emerging Market High Yield Bonds with 5.6yr Duration, hedged back to CAD and a running yield of ~5.00% </li></ul><ul><li>Mackenzie International fund Pairing – 50% Mac Cundill Value and 50% Mac Ivy Foreign Equity. Upside capture of 77% and downside capture of 61% with a very low 0.32 correlation to the MSCI Index over 10yrs . 55% US and rest scattered among UK, Japan, France, Netherlands, Switzerland, Canada, Italy. </li></ul>
  26. 28. Investor Emotions “ Be fearful when others are greedy and greedy when others are fearful” -Warren Buffet “ A bear market is a temporary interruption of a permanent uptrend -Nick Murray “ You’ve got to be careful if you don’t know where you are going because you might not get there” -Yogi Berra
  27. 29. The Cycle of Market Emotions Point of maximum financial opportunity Optimism Excitement Thrill Euphoria Anxiety Denial Fear Desperation Panic Capitulation Despondency Depression Hope Relief Optimism Point of maximum financial risk “ Wow, I feel great about this investment.” “ Maybe the markets just aren’t for me.” “ Temporary setback. I’m a long-term investor.”
  28. 30. Patience will be rewarded By staying invested you will not miss the best days Source: RBC Global Asset Management Inc. An investment cannot be made directly in an index. Graph does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results. Performance data as of December 31, 2010.
  29. 31. The need for a well defined plan
  30. 32. WEALTH MANAGEMENT : Our Holistic Approach Philanthropy (Charitable Giving) Trust Solutions Holding Company Services Cash Flow Analysis & Management Retirement Planning Transfer of Wealth: (Corporate & Personal) Insurance Analysis Estate Planning Tax Planning Investment Management Clasdfkhsdfientadafaf Client The PFP Group
  31. 33. Wealth Management Plan: Tools to reduce/manage Risk & Volatility <ul><li>Money has a different meaning to each client </li></ul><ul><ul><li>Retirement, Estate and Legacy management </li></ul></ul><ul><ul><li>Income and Capital requirement </li></ul></ul><ul><ul><li>Tax minimization & Liability reduction </li></ul></ul><ul><ul><li>Capital growth </li></ul></ul><ul><li>Determine your Appetite for Volatility </li></ul><ul><ul><li>Asset Allocation </li></ul></ul><ul><ul><li>Investment objectives </li></ul></ul><ul><ul><ul><li>Needs, wants, must haves </li></ul></ul></ul><ul><ul><li>Cash Flow requirements </li></ul></ul><ul><li>Develop your Road Map </li></ul>
  32. 34. Wealth Management Tools: Creating a Road Map <ul><li>Risk Questionnaire : </li></ul><ul><ul><li>Review existing or complete a new Risk Questionnaire. Better understand what Risk and Volatility means to you and your situation. </li></ul></ul><ul><li>Investment Policy Statement : </li></ul><ul><ul><li>Ensure your “Investment Policy Statement” is clear on the asset allocation and the type of securities that will be held within your portfolio. This will help you understand the quality of the securities that are held and the maximum or minimum exposure you will have to any volatile securities. </li></ul></ul><ul><li>Will & Estate Review : </li></ul><ul><ul><li>Update Wills & Power of Attorneys (Including Business Will if required) </li></ul></ul><ul><ul><li>Taxes upon death- Income tax (Deemed Disposition) & US Estate Tax (if applicable) </li></ul></ul><ul><ul><li>Probate Taxes- .5% on first $50,000, & 1.5% over $50,000. </li></ul></ul><ul><ul><li>Transferring your Estate: Trusts, Hold Co’s, Gifting, Joint Ownership, Beneficiaries, Insurance. </li></ul></ul>
  33. 35. Wealth Management Tools: Creating a Road Map <ul><li>Personal Financial Plan </li></ul><ul><ul><li>Begin the process of having your needs, wants and objectives built into a comprehensive financial plan that can be used to monitor and review on an annual basis. </li></ul></ul><ul><ul><ul><li>Goals and Objectives: Be clear and concise. </li></ul></ul></ul><ul><ul><ul><li>Your Current financial situation vs. Projected financial situation (Net Worth) </li></ul></ul></ul><ul><ul><ul><li>Cash Flow needs: determine most efficient way to receive income, i.e.: Hold Co, Insurance, RRSP, Pension Fund, Investment Portfolio. </li></ul></ul></ul><ul><ul><ul><li>Tax Planning: Income splitting, types of securities or investments held, transfer of wealth. </li></ul></ul></ul><ul><ul><ul><li>“ Asset Allocation”- Rate of return required. </li></ul></ul></ul><ul><ul><ul><li>Risk Management: Estate Shrinkage- do you have enough to meet your needs in the future. </li></ul></ul></ul>
  34. 36. Wealth Management Tools: Creating a Road Map <ul><li>Holistic Wealth Management Approach </li></ul><ul><ul><li>Combining a Wealth Management Plan as part of your Investment Solution creates a a clear and concise road map to address your needs and objectives as well as the path that is required to obtain them: </li></ul></ul><ul><li>Our experience has shown the following </li></ul><ul><ul><li>Clearer understanding on return requirement </li></ul></ul><ul><ul><li>Minor changes to “asset allocations” to better meet your comfort levels. </li></ul></ul><ul><ul><li>More efficient estate structure leading to more efficient after tax returns resulting in lower risk and volatility from investment portfolio. </li></ul></ul><ul><ul><li>Tax efficient and capital guaranteed solutions to reduce volatility and deal with future tax obligations. </li></ul></ul><ul><ul><li>Greater understanding of the Investment Process and the quality of investments held leading to less anxiety around volatility. </li></ul></ul><ul><ul><li>Sense of comfort knowing that all facets of Wealth Management have been addressed </li></ul></ul>
  35. 37. The outcome of a well defined plan.