Don’t stick your neck out…hedge

A former U.S. Federal Reserve official, Cathy Minehan, was recently quoted as saying, “We’re in a lousy middle, between the economy picking up on its own, and falling off a cliff.”

And no one likes falling off a cliff, especially when it comes to money. “This is no time to stick your neck out,” says John Hogarth, senior wealth advisor with ScotiaMcLeod in Toronto.

“Everyone keeps talking about the fiscal stimulus and the increased money supply, yet all the inflation numbers keep shrinking,” says Hogarth. “It is a very tough time to manage portfolios. You have to be hedged for the inevitable.”

The smart money is trimming its sails for every possible scenario — no matter whether its inflation, deflation or just low growth, the pros are to looking to preserve capital, reduce volatility in their portfolios, hedge for downside risks and maximize yield where they can — and of course — keep plenty of cash on hand.

“We think are in a low, low growth era,” says Neil Matheson, vice president of investment strategy at Standard Life. “If you’re approaching low growth with a somewhat deflationary or disinflationary tendency then equities don’t do all that well, so you definitely can’t stake everything on the stock market.”

To offset downside risks in equities and reduce volitility, Matheson likes fixed income instruments which have, as he puts it, “a strong negative correlation with the equity markets”.

“U.S. bonds are beautiful,” Matheson says. “If Canadian stocks go down, as they did in 2008, and has they have the last few months, then the U.S. bond prices go up and the U.S. dollar also tends to go up and you mitigate your losses in Canadian funds.”

“If Canadian stocks go up the bonds will go down — but you’ll have less volatility overall,” Matheson adds.

Over the last 20 years, investors achieved a lot of growth through rising stock prices, but the protein in a portfolio now comes from government and corporate bonds and blue chip stock dividends.

“The kinds of bonds we favor are in Standard Life’s high yield bond fund,” says Matheson. “We like things that are quasi-monopolies and things that are real stuff.”

“I am talking about TransCanada Pipelines, the airports, BC Ferries, NAV Canada, Highway 407,”says Matheson. “These are things you know are going to be around a long time.”

“They are also something that moves positively with the cycle, but are far less risky than equities,” says Matheson. “Corporate bonds have less than half the risk, in terms of the volatility of the equity market.”

“You have to look realistically to dividend income and interest income as an important part of the portfolio,” says ScotiaMcLeod’s Hogarth. “If you can achieve a return of 6% after fees, that’s a good return.”

Hogarth’s view is it doesn’t matter whether its inflation or deflation coming down the track — he likes the steady drip, drip, drip of “good old-fashioned, high quality, dividend paying blue chip stocks” in his asset mix. “If there’s inflation — then they’re a good hedge. Conversely if there’s deflation — cash is king. That means you want companies that are going to produce a lot of cash flow and those same companies are the safest place to be.”

And speaking of cash, Hogarth believes 20% of a portfolio should be cash.

Bay Street is a little bit bipolar on gold. If you’re Neil Matheson, who likes “real stuff” in his post-2008 munitions bag — you avoid it. Others like Hogarth believe “it has been an historical store of value throughout history”.

“You can’t deny that,” says Hogarth. “When traditional currencies are diluted, people flock to gold.”

“I not a gold bug,” adds Hogarth, “but 5% to 10% should be gold. If all this fiscal stimulus does turn into inflation gold will be a good hedge.”

(08/17/20)