Time for a portfolio rebalance?

Ruth Saldanha: Usually, at Morningstar, we recommend that when it comes to your portfolio, you invest according to a plan that focuses on your goals, time horizon and risk appetite and then stick to the plan. If you do this, you will have better outcomes. With recent volatility, investors have been worried about what to do and have been wondering if they should rebalance their portfolio in response to the market downturn. Scott Johnston, Head of Product for Vanguard Canada, is here to talk about asset allocation in these uncertain times.

Scott, thank you so much for being here today.

Scott Johnston: Hi, Ruth. Great to be here.

Saldanha: To start with, let's go with a basic question. Why should someone rebalance their portfolio?

Johnston: Yeah, that's a great question. So, really, most studies show us that strategic asset allocation is the most important decision you can make in your investments. So, typically, 90%-plus of your value comes from your strategic asset allocation. The reason for rebalancing is to stick with your strategic asset allocation. So, what we saw from the peak to the trough of the market over the last couple of months, so from the peak in mid-February to the trough in mid-March, is that if you had a regular 50-50 portfolio, 50% equities, 50% fixed income, it would have been closer to 40%-60% between mid-February to mid-March. What we've seen is that if you rebalance, you do two things – you improve your chance of return. So, we have various studies that show you leave money on the table if you don't rebalance – and you also improve the risk, you reduce the volatility of the portfolio and both an improved return and a reduced risk is such a rare thing in investing that makes rebalancing back to your strategic asset allocation really a very sensible thing to do.

Saldanha: Which then begs the question when should you rebalance.

Johnston: Yeah, there's no single answer really. So, it really comes down to two main factors – how close to your strategic allocation you want to stay and how costly it is for you to do that rebalancing. So, if you want to stay very close and you can do it in a very low-cost way, then you should rebalance frequently, maybe even up to daily if you are very professional. But if you are okay with slightly wider balance and if you have higher transaction costs, then you should be less frequent and a bit more cautious in how you do it. So, for professional investors or advisors who do this as their full-day, even they will find it difficult. For individual investors really the likelihood is that you won't have the ability to do it on a daily basis and the costs are likely to be higher. And so, in that case, there's a few things that we can see people doing. So, some people say I'm going to look at it quarterly, for example. That's good, but what that misses is major moves between the quarters. What we advocate is, it matters less what your strategy is and it matters more to set your strategy to when you are calm and you are not stressed by the markets, set your strategy, which for example, could be I'm going to look at it once a quarter or if markets move by more than 5%. And then, if you set your strategy, all you have to do is execute on it.

Saldanha: In this time because of low interest rates fixed income is not returning very much at all. So, in this kind of circumstance where should fixed income investors go to for yield and how should they play the fixed income space right now?

Johnston: Yeah, we face challenges. Interestingly, in this crisis, we face challenges on both the equity and the fixed income side. That said, fixed income has done what it's supposed to do which is act as the ballast in the portfolio. So, as equity has moved dramatically down and up, fixed income has moved as well but actually much more gently. So, if you have a balanced portfolio, the fixed income should have done what it is supposed to do which is act as a ballast.

More than that, fixed income products such as ETFs have actually helped the stressed bond markets. They've been a source of liquidity and price discovery. So, I think what I would say is, fixed income products have really stood up well. You're right, yield is reducing. And while we don't know what the future holds, it looks like that may stay that way for some time. I would say a couple of things here.

Firstly, I would say, keep fixed income as the ballast in your portfolio. Try to resist the temptation to go to higher-yielding fixed income, non-investment-grade, maybe deeper in the emerging markets. Because really our evidence shows that that is more of a replacement for the equity in your portfolio not fixed income. So, while you may be thinking that you are doing well and getting yield, what you are actually doing is increasing risk and should things turn sour or more sour, you may find that you lose out in your portfolio.

So, the biggest thing I would say is, stick with investment-grade as much as you can. Secondarily, because the yield on those investment-grade has reduced, think about returns as a potential return from your portfolio and not just income that comes from your fixed income or not just dividend from your equity. So, you are likely face lower dividends and lower income, but remember that capital returns are also part of your total return. So, if you seek income from your portfolio, for example, if you are in retirement and you are living off the income from your portfolio, look to both dividends and interest but also look to capital growth and being comfortable using that as a part of your total return.

Saldanha: Finally, should Canadian investors consider looking outside of Canada right now, and if so, where do you see any pockets of value?

Johnston: Absolutely. Now and always Canadian investors should look outside of Canada. So, we always say all key parts of your portfolio, Canadian equity, global equity, Canadian fixed income, global fixed income. So, the global side brings diversification and similar to rebalancing if you are just Canadian on your equity and fixed income and you add in global, the likelihood is, if you do that in a broad and balanced way, you'll improve the risk and return in your portfolio. So, always global, yes.

Saldanha: Thank you so much for being here today, Scott.

Johnston: Thanks, Ruth. Great to be here.

Saldanha: For Morningstar, I'm Ruth Saldanha.