Higher Volatility…Not Entirely Unexpected

Investors stepped into 2016 to significantly higher levels of volatility. Since the beginning of this year, markets across most regions have witnessed sharp declines, with several markets and sectors tipping into bear market territory. 

The concerns inflicting the markets are no longer a shock to investors. Here’s a quick summary: 

• Oil prices have continued to plunge, with the WTI currently trading under US$30/per barrel. 
• In tandem with the fall in oil prices, the Canadian dollar continued to slide relative to the U.S. dollar. The loonie is currently trading at around 68.86 cents – a level last seen in 2003. 
• Growth in China – the world’s second largest economy - has continued to slow, and is now being reflected, rather dramatically, in its equity markets. Economic growth is likewise slow across the globe, in part due to China’s slowdown. 
• The U.S. Federal Reserve has begun to increase interest rates, leading to concerns that central banks elsewhere will start to follow - signaling an end to a prolonged period of supportive monetary growth policies. 

The knock-on effect of all these concerns on businesses and consumers is a valid one. On the one hand, companies are increasingly more risk averse. On the other, companies will have to compete more aggressively to attract new financing as interest rates rise while companies with poor business models will find it much more difficult to attract capital. This could lead to a rise in default rates - even outside of the resource sector – a prospect that should not come as a surprise to investors. On the consumer front, particularly in the U.S., the uncertainty in the global economy is leading to an increase in savings. Although the U.S. has started to raise interest rates, it is unlikely to initiate another increase until sentiment improves. 

Keep Calm and Ride Out the Storm 

It is easy for investors to lose sight of their investment goals or objectives when the markets are shaken like they’ve been over the recent weeks. In times like this, investors rarely maintain a rational position, flipping from high levels of optimism and greed when equity prices are on the rise to fear, skepticism and pessimism as prices fall. Notably, each type of reaction tends to happen in unison, and the swing from one to the other often goes far beyond what reason might call for. I believe we are in this environment today. 

Naturally we should always be cautious about the types and degree of risks we take on in our portfolios and I believe our investment specialists have been prudent in their positioning strategies. In addition, over the last several years we have taken the necessary steps to bolster our portfolios to ride out the current market environment in a manner that preserves capital for our investors by including mandates such as the Global Trend Strategy to select portfolios. This strategy helps improve downside protection and minimize the impact of the downturn on returns. 

The investment managers that we’ve appointed to manage the respective mandates in your portfolio are guided by a disciplined process and philosophy. In general, our managers are being cautious in the current environment, investing in companies that have sound business fundamentals and ones that are able to withstand some effects of the volatility. Our value equity manager, Sionna Investment Managers, for instance, is uncovering attractive opportunities in good companies that others are unwilling to own in this environment. Most of our managers are also generally defensive, switching into capital preservation mode as needed. 

Overlay Portfolio Management for Added Oversight 

From an Overlay Portfolio Management perspective, we were active over the last quarter and took advantage of opportunities to harvest tax losses across all mandates. We focused on opportunities in sectors such as Financials (e.g. AGF Management Ltd., Home Capital Group), Materials (e.g. Goldcorp Inc., Potash Corporation of Saskatchewan Inc.) and Energy (Calfrac Well Services, Pulse Seismic Inc.) to strategically book some losses. By selectively realizing losses when markets are down, we provide you with an opportunity to offset taxable capital gains in your portfolio. Given the on-going weakness in the markets, we will continue to actively look for tax loss opportunities. 

We are currently we are in the process of re-positioning the asset allocation for select portfolios to slightly decrease the exposure to Canadian equities, in favour of international equity markets which are expected to have better risk-adjusted performance. In tandem, we are increasing exposure to the Global Trend Strategy mandate to provide investors with greater downside protection. We also decreased the portfolios’ allocation to small cap equities. These changes are expected to benefit the portfolios and cushion them against the effects of further market volatility. 

In an environment of uncertainty and increased volatility, it is best for investors to remain calm. Knee-jerk reactions can often have devastating consequences on overall portfolios. We recommend speaking to your Advisor to address any specific planning concerns you may have or discuss changes to your plan. Along with our investment specialists, we will continue to monitor the market environment, the inherent risks and adjust, or rebalance the structure of our portfolios should the outlook change. 

Sincerely, 

Corrado Tiralongo 
Portfolio Manager 


VIEWS FROM OUR INVESTMENT SPECIALISTS: 

The following are a few comments from our investment specialists: 

We remain defensive on the energy sector over the short-term, in the continued belief that we are in a ‘lower for longer’ environment in both natural gas and crude pricing. 

On oil, we continue to believe that the 1985/86 example remains the most relevant roadmap to follow to help navigate today’s environment. Our work suggests that while fundamentals appear weaker in the near-term, it is likely that the crude oil market will be in balance by the end of 2016. This should allow crude prices to drift up from their cash cost to their marginal cost of production (estimated at $60/bbl). As such, we anticipate our position turning more positive through the next quarter. 

Based on our review of crude fundamentals and equity valuations, we believe that the market continues to be positioned for a more optimistic outcome in the short term, especially as it pertains to high cost production. Our order of preference amongst the sub-sectors of the energy space is as follows: refiners, integrateds, oil producers, oil services, gas producers and, finally, heavy oil producers. We have begun adding opportunistically to oil producers that benefit the most from the shift towards $60/bbl without requiring even higher prices than that to deal with their expanding debt loads. 

Picton Mahoney Asset Management 
Sub-advisor: Canadian growth equities 


Markets are inherently uncertain. When the market is rising, it’s important to be vigilant about signs of overconfidence; and when markets are down for non-fundamental reasons, it’s time to take advantage of opportunities to upgrade portfolios. This philosophy is consistent with Warren Buffett’s timeless adage to “be fearful when others are greedy and greedy when others are fearful”. 

Throughout the year (2015), we were reminded about the importance of “sticking to our knitting”. Despite the depressed energy sector and the meteoric rise in Valeant Pharmaceuticals earlier in 2015, both of which hurt performance, we remained steadfast in our investment philosophy and process. We maintained our position that both trends would reverse course in due time and that clients would benefit as a result. We have already seen the Valeant trend reverse course; the stock more than doubled earlier this year before falling dramatically to erase all of those gains – ending the year down 15.5%. While a reversal has not yet occurred in the energy sector, we believe the price of oil will inevitably rebound to marginal cost levels. 

Sionna is patient and focused on the long term. We ignore the noise in the market and take advantage of down markets. These are hallmarks of successful investing. It is what enables us to confidently remain overweight the energy sector, while anchoring the portfolio with stable and high-quality companies. This philosophy has served us well and will do so again. There’s no doubt that our portfolios will emerge from this downturn stronger and that this investment approach will continue to serve our clients well in the years ahead. 

Sionna Investment Managers 
Sub-advisor: Canadian value equities 
IPC Private Wealth: Canadian Value & North American Value equities 


Despite certain challenges to global growth, we do not foresee an impending global recession. We believe improving economic circumstances in the developed world will lift profitability in industries not directly competing with the developing world and not heavily dependent upon labor input. Inflation, for much of the world, remains dormant. 

Given we believe global growth will remain “lower for longer,” we find the best earnings growth opportunities exist in companies that are innovative and poised to show revenue growth contribution from market share gains, rather than dependence on the macroeconomic environment. We think that for the next couple years, the market will reward market share-driven secular organic growth through stock price outperformance. In particular, companies making use of technology to develop innovative new ways of conducting business or create revolutionary new products or services should deliver strong performance. 

In a slow global growth environment, these stocks should outperform as investors seek out secular growth companies that can grow their revenues. These companies have strong financial balance sheets, address large global and secular growth markets, and possess large scale that provides competitive moats versus legacy competition. Our investments emphasize companies with management teams focused on building growth companies that will not just survive but thrive over the long-term, and can increase capital investments in their businesses. 

Marsico Capital Management, LLC 
Sub-advisor: U.S. Growth equities 


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