dollar boat in the bad weather illustration economic instability

Following the 2008-2009 financial crisis, I decided I could no longer manage money the same way. It has become a regular mantra in my articles and discussions with clients.

I transitioned to ETFs after previously using primarily managed money and mutual funds. Managed investment solutions failed me during a time of crisis. I was paying managers to outperform the broad market for my clients, when most did not.

If you have been following my articles, you will know how I build my ETF portfolios and the type of ETFs I use: mostly plain vanilla broad indexes and rules-based construction.

This current crisis has been an opportunity to test my investment strategy, and I’m happy to report that my conviction in my portfolio management strategy has not wavered. That said, I’ll share some important observations about the equity markets (the issues affecting the bond market merit an article of their own).

Market timing still doesn’t work. If you do not have high conviction for a particular market or sector, then stick with a broad-based, low-cost ETF for general market exposure (e.g., something like VUN or SPY for the U.S. market, and XIC or ZCN for Canada). Throughout this incredibly volatile bear market, broad market indexes took a hit, but they also participated on the good days — and history has shown repeatedly that you don’t want to miss the good days. With markets moving sometimes close to double digits in one day, it was extremely perilous to attempt any kind of market timing.

Further, although some market sectors like technology and healthcare have performed better than the broad market throughout this pandemic, others, like energy and financials, have not. As a rule, I do not overweight during a bear market unless I have a strong conviction, especially with markets moving so fast. For example, I have been a strong believer in the technology sector since I built my portfolios and use XLK and XLC. I have also held health care (via IXJ) for some time. I held these positions despite some observations that the tech sector was getting too expensive, which paid off.

ETFs can work in a downturn — if you hold. My ETF strategy did not let me down during the unprecedented volatility of the markets in March. I attribute that to managing my portfolios based on a consensus, research-based view of the markets. Further, you can use best-in-class ETFs to build a portfolio, but nothing trumps asset allocation. I did not try to trade in and out of the markets during this pandemic; I just stuck with my views of risk-on versus risk-off and rebalanced portfolio positions when they either fell below or rose above their portfolio allocations. I made small adjustments to my asset allocation strategy, never deviating far from my benchmark weightings. As the markets plunged in March, I increased my broad U.S. market position (VUN).  My research indicated that the steep pullback was overdone and that stocks were likely oversold.

Currencies matter. I do not usually use currency hedging to generate additional return, but the devaluation of the Canadian dollar against the U.S. dollar since the beginning of the year made a compelling case to hedge some of my U.S. positions to Canadian dollar.  Having an ETF strategy made it particularly easy to modify my hedging strategy when the dollar fell below US$0.70 —  I only hedge with large, broad-based ETFs (e.g., from Vanguard, iShares and BMO) that usually have hedging costs of 20 bps or less.

Classic risk management still works. I had started de-risking my portfolios in the later part of 2019, following the surge in equity markets worldwide. For the first time ever, I added a gold position, GLDM, and a market-neutral ETF, DANC. I was looking for something uncorrelated to equity that had the potential of offering a positive return even in a market downturn. It took me quite some time to sift through the offerings of market-neutral ETFs, and I finally settled on DANC because I could understand its trading strategy. Further, the aim of generating a 4% return in up and down markets seemed unpretentious and achievable. In the case of gold, with interest rates so low and equity markets so high (at the time), I felt that there was not a huge opportunity cost to reducing some of my fixed-income and equity exposure to invest in gold. These investments did their job through plunging markets, posting positive returns throughout.

Emotions can derail the process. My motivation for using an ETF strategy in my portfolio management hinges on my belief that we have to extract as much emotion as possible from the investment process. This pandemic certainly drove home the fact that emotions can derail not only the investor, but also the portfolio manager. When doing large trades in my portfolios, I always double-check my methodology before proceeding. I also ensure that we have two pairs of eyes (myself and my trading assistant) throughout the process and that we are mentally grounded.

I attribute the performance of my portfolios over time to asset allocation, my ETF strategy and personal discipline. This crisis was a test for all of those tools I’ve put in place personally to keep my emotions in check and stick to my investment strategy — and fortunately, they passed.