My adoption of ETFs for portfolio management came about following the global financial crisis of 2008-09. To this day, that was the worst financial crisis I had to deal with in my more than 30 years as a portfolio manager.
I did not immediately embrace ETFs in the aftermath of the financial crisis. Few investors were familiar with them at the time and the selection was limited. But, as more financial data became available, I decided to create discretionary portfolios using primarily ETFs after realizing that the majority of the managed products did not beat their benchmarks over time. For example, S&P Global Inc.’s SPIVA research shows that 75.3% of large-cap funds underperformed the S&P 500 composite index for the five years ended Dec. 31, 2020, and 98.6% of Canadian equity funds underperformed the S&P/TSX composite index over the same period.
I have published many articles explaining what attracted me to ETFs: their low cost, return potential and ease of risk management. So, what I would like to emphasize here is the conviction that I believe is required to make the most of an ETF model portfolio strategy.
Emotions and investing do not go well together. As Warren Buffett famously said, fear and greed are the investor’s worst enemy. Part of the attraction of ETFs for me was the fact that the plain-vanilla, passive market indexes eliminated the whims and emotions of active portfolio managers. I found the logic compelling. If doing better than the index is so difficult, then why not just buy the index?
But using ETFs for portfolio management is not a singular guarantee of success.
The portfolio construction process is critical to achieving solid results over time. The process begins with establishing a benchmark that is the foundation for selecting ETFs. The benchmark should hinge on an investment policy statement that outlines asset allocation parameters and risk profile. The statement also should speak to the portfolio manager’s investment style: top-down, bottom-up or contrarian.
ETFs will do their job by hugging index returns, but a portfolio manager who lacks conviction in their skills can easily lack the discipline to stick to their process over time, especially during a crisis or a bear market.
In tough times, the temptation can be great to ignore investment policy guidelines and second-guess investment decisions and management style, thus opening the door to transactions motivated by past performance or questions from insecure clients.
At times like this, keeping clients invested and focused on their long-term financial plan is critical. Rebalancing portfolios even as markets drop also is key: a recent actuarial valuation of the Quebec Pension Plan found that proper rebalancing could add up to 40 basis points of return, depending on the portfolio.
Talking to clients during volatility is extremely important. Clients who suspect that their portfolio manager questions his or her own decisions or does not fully understand portfolio performance attribution will look elsewhere.
Having an investment committee in place to discuss trading ideas within a portfolio can be helpful in maintaining conviction in a long-term investment strategy. I choose people from inside and outside my firm to discuss asset allocation decisions and ETF selection. I am not necessarily looking for people who endorse my investment decisions; rather, I am looking for an insightful exchange. Sometimes, these discussions will lead me to hold off on a transaction or discard it; but, in every case, the last call is mine.
Cultivating and sustaining conviction in an investment strategy means building and adhering to a solid portfolio-management process. But conviction will not get you far if it isn’t paired with discipline. Once you have a process in place, you need to stick to it. All kinds of temptations will come along to invest outside of your core investment thesis. Resist them. Discipline is about sticking to what you know and believe in — completely.
Once a disciplined process is in place, the final test of your conviction is to ask: “Do I invest in the same portfolio I’m telling my clients to invest in?” The answer should be:“Yes.”
Mary Hagerman, M.Sc., FCSI, CIM, Pl. Fin., is an award-winning investment advisor and portfolio manager in the Montreal office of Raymond James Ltd.