First come rising interest rates; then comes market volatility.
Beste Alpargun says she’s positioned to take on the cyclical nature of the market.
How? Through a low volatility pooled fund, which she says takes market activity into consideration so clients aren’t negatively affected (see “Cumulative total returns,” this page).
“Over the past 50 years, three of the four most volatile periods occurred in the last decade,” says the portfolio manager at SEAMARK Asset Management in Halifax. “The traditional response is to reduce equities in favour of fixed income. But with rates at historic lows, fixed income offers little yield support and suggests a volatility surprise when rates reverse.”
Also, as interest rates rise, investors relying on bonds could be in trouble. Alpargun advises them to set clear goals that include their capital preservation, income and growth requirements.
“Bonds are still going to have a place in many portfolios, but the term and selection might be different [than when] rates were falling.”
For instance, if an investor’s time horizon is five years and she has mostly short-term bonds, she should carry them until maturity to preserve capital. Once that happens, though, she should reinvest the proceeds because she’d benefit from the increasing rates.
Alpargun outlines her strategy for what’s coming next.
What’s your investment process?
As economic growth’s slowed in recent years, we’ve emphasized sustainable dividend growth. Coincidentally, we believe dividend payout ratios are set to rise from historically low levels.
We focus on investing in multinational corporations with geographically diversified earnings. This approach allows the portfolio to indirectly benefit from growth in emerging economies without taking on the high risk inherent in direct investment.
We employ a total equity platform. This means we’ll look at what’s good in Canada, and then increase diversification and return potential by adding attractive companies from the U.S. We complete the portfolio by including international names, like Nestlé, that are able to trade on the U.S. exchange. Tight portfolios allow us to be absolute-return oriented, rather than benchmark-centric.
We examine 10,000 stocks and then bring that number down to 350. We keep these companies in a master list, and know them inside out. Our portfolio managers and three investment analysts do the research. We also have access to brokerage research from large firms in North America.
When analyzing companies, we’ll look at management and their track records. Management should have an existing strategy that is well-crafted and aligned with the company’s core competitiveness. Balance sheets should be capable of weathering economic downturns, but also have financial strength and flexibility to benefit during periods of economic expansion.
For example, selling small-ticket items makes the company’s income stream less volatile. If you follow that logic, some consumer staple companies are suitable because they have resilient revenue growth, even during downturns.
When it comes time to buy stock, we’ll keep the two-year target price in mind, but we’re more concerned about the four-year price. This is because we’re not interested in the short-term—we look at the quarterly breakdown but it doesn’t affect our decision.
For a company to be successful, it needs time to realize real returns. We pick companies based on quality. Volatility is a problem in the market right now, so to avoid that we look at longer time horizons.
And what’s your long-term outlook?
We focus on the North American market. Energy is one of the major trends. The U.S. is becoming more self-sufficient in its energy needs and natural gas availability. Thus prices are playing with dynamics, suggesting volatility. We pick well-positioned energy companies that will sustain growth and profitability decades from now.
What’s catching your eye?
We look at popular, blue chip companies. Although valuations are high, they still tend to be less volatile. Also, we like large-cap players because they pay a certain level of dividends, and there’s potential for them to increase those dividends.
How do you manage risk?
Through low volatility, which is part of our mandate. In volatile times you’re more worried about capital preservation. Having low volatility reduces this fear by protecting capital and preserving yield for returns (see “Change in value per $100,” this page).
Would you ever go all cash?
No, that would be aggressive. If stocks are expensive and we didn’t see value in purchasing at the time, we still wouldn’t think it was wise to go all cash because there’s still a cost for keeping money. But if I had to ballpark a cash limit, I’d estimate 20%.
Suzanne Sharma is associate editor of Advisor Group.