Asset Allocation Limiting Volatility

Asset Allocation Limiting Volatility in the Portfolios                                                                       April 24, 2013

By Robert Luft, Portfolio Manager, DWM Securities Inc.


With the first quarter of 2013 now behind us, let us look into the rear view mirror briefly:  the first 90 days helped The Dow and S&P500 reach all time highs as of the time of writing:  as of April 11th, the S&P500 was up 10.3% year to date.  Over the same time period Gold is down 9%, oil is basically flat, and natural gas is up 20%.   The TSX is off 1.4% from the start of 2013.     • Source: MarketQ

Q1 began with concerns over the US Sequester (tax cuts) and continued concerns in the Euro zone, withCyprussparking fears that even deposits in banks may not be safe from the thirst that sovereign nations have for additional tax revenue. Japanhas sparked international interest with its strategy to “follow the fed” and, taking a page from theUS, embark upon a systematic strategy of quantitative easing to bolster domestic inflation.  This has caused the Nikkei to skyrocket over 32% year to date.

Now we look towards Q2 and the beginning of earnings “season”. 

We also enter a seasonal period of volatility… the old “sell in May and go away” theories abound.

A quick search will reveal many studies both for and against the effects of seasonality on the markets.  There is no clear indication or data to suggest either or bullish or bearish case for markets during this time of the year.  So where does that leave us?

As somewhat of a student of human nature, I am more apt to believe that behavioral economics will come into play in the upcoming quarters as people start to feel the economy is improving.

The housing market in theUScontinues to improve (or at least not drop).  This will potentially have a wealth effect on theUSconsumer:  when one’s house finally stops dropping in value, one will tend to feel less impoverished.  This may lead to increases in consumer spending (“Hey I can afford that vacation/car/widget now…”), and have a corresponding effect on GDP growth. 

GDP = consumption + investment + (government spending) + (exportsimports)


A spending consumer will hopefully lead to increased business confidence, and capital expenditure.  At some point this will lead the fed to stop printing as the jobless numbers fall.  We may then see rising fed fund rates and inflation.  How do we prepare your portfolios for this?  In a simple word: BALANCE.

I continue to believe the Canadian consumer is overleveraged, and specifically over leveraged to residential housing.  When and if the scenario for GDP growth above plays out, and interest rates rise, we will see consumption inCanadadecrease with the exact opposite wealth effect I outlined above.

Due to this, Canadian equities were reduced across our models in January and again in March. 

We have increased our exposure to small and mid sized US equities, international equities, and emerging markets.  Overall equity exposure is lower than I would expect long term, but I do expect a near term pullback in the overall markets (think 3-5%).

Due to this we have kept some “powder in the gun” (ie: cash/conservative holdings) for if and when this happens.

My expectations for a balanced portfolio this year are not high:

For a portfolio equally balanced between equity and income oriented securities a return of expectation of between 4 and 6% is not unreasonable.  (3% of the return coming from the diversified equity portion and 2-3% from the income oriented securities).

Through active rebalancing we hope to be able to add to some of the sectors that we expect to outperform over the foreseeable future, specifically US and International equities.  We continue to strive to deliver above average returns while reducing portfolio volatility.

When you stand with your two feet on the ground, you will always keep your balance.

~ Tao Te Ching