Stocks and Bonds Could Both Fall?

How this manager is balancing both asset classes with what she sees ahead.

Michael Ryval 18 November, 2021 | 5:49AM
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From inflation to high equity valuations, balanced portfolios are in a challenging environment. But one manager still sees upside potential and levers left to pull.

Sarah Riopelle is at the helm of the 5-star silver-medalist $648.3 million RBC Global Growth & Income Fund F, and positioning the balanced fund for what's next following a rally in stocks since March 2020 and rising bond yields as conditions normalize. “That makes for a challenging situation: both stocks and bonds are fully valued at these levels,” says Riopelle, vice-president and senior portfolio manager at Toronto-based RBC Global Asset Management Inc., and a 25-year industry veteran who joined the firm in 2003 as a senior analyst within the Investment Strategy arm.

Bonds Still Work…For Now

Riopelle, who is a member of the RBC GAM Investment Strategy Committee which sets global strategy for the firm, believes there is some risk of a near-term downward movement in stocks and bonds at the same time. “But the keyword here is ‘near-term.’ It likely would not be a sustainable move in the same direction since historically stocks and bonds are negatively correlated. Bonds can provide stability in portfolios, in the face of equity market volatility. I would expect that relationship to hold for the next 12 months,” says Riopelle, who also heads the Portfolio Solutions team that oversees in total about $180 billion in assets.

Valuations by themselves do not cause market corrections, Riopelle adds. “As long as market fundamentals and investor optimism stay robust, there is room for stocks to run from here, despite the higher valuations.”

Riopelle and her committee colleagues are constantly monitoring global conditions that could cause problems. Among others, there are concerns about slowing growth in China, combined with problems in the Chinese property market, as witnessed by the issues around debt-plagued Evergrande Group, as well as the rapidly-evolving coronavirus situation especially in developing markets where vaccines are not readily available. There are also worries about supply-chain challenges that have prompted higher inflation rates as well as the eventual removal of monetary stimulus. “These risks are pretty well understood by the market. But the challenge is the possibility that reality may be different from expectations. We have to watch them very closely,” says Riopelle.

Too Good For Too Long?

But what worries Riopelle the most are unrealistic expectations of returns. “We have had a strong period of returns in the last decade and especially in the last 18 months. Investors expect this ‘new reality of strong returns’ and believe will be the base case going forward. But ultra-low bond yields are not sustainable and we expect them to move higher. Then we have elevated equity valuations. I’ve been telling investors that they need to moderate their return expectations going forward,” says Riopelle, adding that RBC GAM is looking at equity returns of 5-8% for the next 12 months, as well as benchmark U.S. ten-year treasury bonds that are forecast to return 1.75%, while Canadian 10-year government bonds might yield 1.5%.

Although Riopelle believes equities are fully valued, the team has been reluctant to reduce the equity exposure because they believe the economic cycle is in the early-to-mid stage and corporate profits have room to run. “That will provide support for equity markets. We also have to consider the relative return prospects for stocks versus bonds. If we are expecting 5-8% returns for stocks, and possibly negative returns from bonds, then our asset allocation is still weighted towards equities because of the relative returns—despite the fact that equity valuations are quite high.”

Currently, the asset mix for RBC Global Growth & Income Fund F is 64% equities and 36% bonds and cash. The neutral equity weighting is 60%.

The fund is a unique product because it is a fund-of-funds comprised of 10 RBC funds, such as RBC Global Dividend Growth Fund, RBC Global Equity Focus Fund and RBC Global Bond Fund, all of which are five-star funds. On a geographic basis, 31% of the equity portion is held in the U.S., followed by 22% in international equities, and 11% in emerging market equities.

Expensive American Equities

“Our models show us that U.S. large cap equities are the most fully-valued of the major regions that we track. As a result, we tend to have lower return expectations for U.S. equities, compared to other regions,” says Riopelle, noting that the RBC team has for some time tilted away from U.S. large-caps and towards international equities, “That said, all the indices we track are slightly above fair value.”

As the shape of the yield curve is often a harbinger of what’s to come Riopelle observes that the portion covering 10-year to 30-year bonds has been flattening. Yet she also notes that the shorter part of the curve, which encompasses the two to 10-year bonds, has been steepening. “It’s telling us that we’re likely to experience better prospects for the economy in the shorter term, but it will moderate over the longer term. It’s something we’re keeping our eyes on.”

Year-to-date (Nov. 8) the fund has returned 9.21%, versus 12.42% for the Global Equity Balanced category. However, over three- and five-year periods the fund has been a top quartile performer. It returned an annualized 13.09% and 10.83% for three and five years, compared to 10.26% and 8.24% for the category.

For her part, Riopelle acknowledges that for the year-to-date the fund has lagged the peer group because it has no Canadian exposure. “It’s hurt us relative to the peers because Canada has done well so far this year. Canadians already have so many of their assets invested at home. We think taking a globally diversified approach will benefit investors over the long term because the Canadian market is very concentrated in financials and energy, so they depend on what interest rates and commodity prices are doing,” argues Riopelle, adding that over the longer term that fund has benefitted from a diversified global exposure. “If you take a diversified approach you will have investments in multiple regions that will be going up and down at different times. You will get a smoother experience with a globally diversified approach.”

From a tactical viewpoint, Riopelle notes that over the summer her team reduced the bond weighting to 33.5% from 35%, and kept 2.5% in cash. “We were harvesting expensive valuations in bonds as yields had fallen, and therefore locked in the profits from those positions. We put the balance in cash as protection against volatility, especially on the equity side. We also wanted to have cash on hand for opportunities [in the equity market] that presented themselves.”

Big Team Looking for Small Changes

The RBC Investment Policy Committee, which encompasses a group of senior RBC managers, makes tactical asset allocation changes. “We look at everything,” says Riopelle, adding that they consult a 106-page reference book that is constantly updated with changes in trends. “Things won’t flash at you, and say, ‘Hey look at this.’ There are always subtle changes in metrics and signals that we have to monitor.”

Over the past few months, leading indicators of growth have been moderating, observes Riopelle, and economic surprises are more neutral in tone, compared to stronger signals over the summer. “We have earnings revisions for the third quarter and they are no longer positive. We are starting to see some earnings downgrades. And volatility has picked up. We were a little exuberant over the summer, and things are now starting to calm down. If I had to pick a term to describe the environment, I’d say, ‘We are cautiously optimistic.’”

At the moment, uncertainty in the equity market and opportunity cost in bonds appears to be mutually beneficial for the asset classes. “With the scarcity of asset classes that can generate a real return, you can justify higher valuations because clients are looking for something that can generate a return,” says Riopelle, “That will help support equity markets going forward.” Riopelle’s base case calls for economies continuing to grow, but at a slower pace, “We are looking for a modest rise in bond yields that will lead to low total returns for government bonds. And there is still room for upward movement for stocks from here.” 

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
RBC Global Bond Fund D11.23 CAD-0.01Rating
RBC Global Dividend Growth Fund D26.58 CAD-0.37Rating
RBC Global Equity Focus Fund D27.33 CAD-0.62Rating
RBC Global Growth & Income Fund F15.48 CAD-0.16Rating

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Michael Ryval  

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