The Quality of Returns Matter

Brandon Snow's picture

It’s been a few months since my last portfolio update and I wanted to provide some context to the market with a few items that came across my desk in the last few days.

First on the portfolios, our cash levels are now higher than they have been in some time. The difficulty we are having finding attractive risk-reward and growth concerns surrounding China are keeping us more patient towards adding new ideas to the portfolios. The equity funds I manage are about 20% cash and our asset allocation fund is up to 40% cash (from 30%). The incremental cash is coming from equities. Our core names continue to do what is expected and remain in the portfolios. The non-core side is driven by specific themes: improvements in Europe, North American transportation tightness and a strong outlook for natural gas prices.

Two pieces caught my eye this week, first is this article from the Wall Street Journal:

Based on the most recent data, investors are putting the highest percentage of their 401(k) into stocks since 2008 (67%).  The Fed’s reduction of government bond rates has reduced potential returns across fixed income assets, leaving equities as the only option for many investors to achieve their retirement goals. Of course equities have higher risk than most bonds, but most people cannot retire comfortably on government bond returns so they are taking on more risk. I think a better idea would be to reduce return expectations and avoid that risk, especially five years into the longest bull market in history. And as we all know, in aggregate, individual investors have been poor at timing the market historically.

This leads into the second piece, which is the Dalbar report from Quantitative Analysis of Investor Behavior (QAIB). This is an annual report that quantifies the impact of mutual fund investor decisions timing to buy or sell. They have been producing this report for 20 years and have data going back 30 years. The report can be found here:

The conclusion is that investor timing, both from a market perspective and the type of funds they buy (chasing what is working) significantly reduces returns in both equities and fixed income. Over a 20 year period the SPX had returned 9.2% annually while the average equity fund investor had achieved only 5%. Over the same time period the Barclays Aggregate Bond Index returned 5.7% per year while the average fixed income investor returned just 0.7%.  While fees on your average fund reduces returns, the biggest detractor is attempting market timing which often results in buying at the top and selling at the bottom.  Interestingly, the majority of the damage is done selling at the bottom.

We continually discuss capital preservation being key to our philosophy (because we aren’t that smart and can’t know everything, we need to focus on what can go wrong) and I believe we have proven this philosophy in practice over the last three years. Something we don’t discuss, but is important to keep in mind is the quality of returns: a less volatile fund (especially on the downside) will help prevent this adverse investor behaviour.  Here are some performance and risk metrics on our flagship Cambridge Canadian Equity fund:

While the market isn’t offering the opportunities it was a year or two ago, our team is working hard to find the best risk-reward opportunities for all of our mandates. Going forward, if the market becomes speculative and we see multiple expansion drive returns, we won’t keep up and that is fine. We will stick to our philosophy and process to deliver the best and highest quality returns possible for our clients. After all, we are clients ourselves and we are committed for the long-run.

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