This Week: iShares CDN S&P/TSX Cap REIT ( Ticker: XRE )

One of the pil­lars sup­port­ing mod­ern port­fo­lio man­age­ment is diver­si­fi­ca­tion. How­ever, with mar­kets around the world suf­fer­ing equally, you could be for­given for think­ing that the pil­lar has crum­bled and brought your port­fo­lio down with it.

But let’s not jump to such a hasty con­clu­sion. It could be that what looked like diver­si­fi­ca­tion in good times turned into con­cen­tra­tion in bad.

On the sur­face, many port­fo­lios look diver­si­fied. Obey­ing the dic­tum, “Don’t put all your eggs in one bas­ket”, many investors hold a good mix of Cana­dian, U.S. and inter­na­tional stocks. That helps improve returns in good times.

But global equity mar­kets have a bad habit of mov­ing in step with each other just when you would rather they marched to dif­fer­ent beats. In the lan­guage of Bay Street, cor­re­la­tions increase in bear mar­kets. This ten­dency under­mines diversification’s pro­tec­tive role.

The last six months are proof. The S&P 500 is down 15%, the S&P TSX 60 is down 20%, the MSCI EAFE, which includes devel­oped mar­kets out­side the United States, is down 23% and the MSCI Emerg­ing Mar­kets is down 30%.

It is clear that sim­ply invest­ing in broad mar­ket indices across many coun­tries does lit­tle to pro­tect against bad times. As all mar­kets become more glob­al­ized and inter­con­nected, as cor­po­ra­tions become more multi­na­tional, this ten­dency will strengthen.

Then where does that leave diver­si­fi­ca­tion and more impor­tantly, the future of your portfolio?

Iron­i­cally, it turns out that diver­si­fi­ca­tion may come from within. Rather than diver­sify across coun­tries, it may be more effec­tive to diver­sify across sec­tors, be they domes­tic or inter­na­tional. In fact, sec­tors within a mar­ket often have much lower cor­re­la­tion to each other than the broad mar­ket index does to its global counterparts.

The S&P TSX 60 has a cor­re­la­tion of +0.84 to the S&P 500, +0.80 to the MSCI EAFE and +0.85 to the MSCI Emerg­ing, with per­fect cor­re­la­tion being equal to +1.00.

How­ever, its cor­re­la­tion to its parts is lower, except­ing energy and finan­cials – no sur­prise given their dom­i­nance of the TSX.  The Cana­dian Energy sec­tor has a +0.90 cor­re­la­tion to the S&P TSX 60, Finan­cials are +0.75, Mate­ri­als are +0.68, REITs are +0.66, Util­i­ties are +0.50 and Tele­coms are +0.45.

Returns across sec­tors are just as var­ied. Over the last six months, Energy is down 25%, Banks down 15%, Mate­ri­als down 17%, REITs down 1%, Util­i­ties and Tele­coms both up about 3%.

REITs, util­i­ties and tele­coms are also less volatile and pay higher div­i­dends than sec­tors like energy, mate­ri­als and finan­cials. That makes them good can­di­dates for trou­bled times.

Last Decem­ber, we began reduc­ing the risk­i­ness or “beta” of our port­fo­lios. We reduced our allo­ca­tion to the iShares S&P TSX 60 ETF (XIU-TO) and cut the iShares S&P TSX Mate­ri­als (XMA-TO).

We added the iShares S&P TSX REITs ETF (XRE-TO) and the Clay­more S&P TSX Cana­dian Pre­ferred Shares ETF (CPD-TO) for their lower volatil­ity and high div­i­dends. Since then, both XRE and CPD both have helped improve the total portfolio’s returns.

The cur­rent div­i­dend yield on XRE is about 5.25% and about 4.90% on CPD and their total year-to-date return is 8.76% and 1.92%.We expect that with inter­est rates low and with lit­tle chance of an increase by the Bank of Canada in the near future, both ETFs will con­tinue to per­form well.

The other sec­tor to con­sider is util­i­ties. iShares recently added a S&P TSX Util­i­ties ETF (XUT-TO). It has returned about 3% in gains and div­i­dends since its launch in April. It may be another can­di­date for calm­ing a port­fo­lio, though its size is small at only $8 mil­lion in assets and it is con­cen­trated with only 11 firms in total and 65% of the allo­ca­tion in the top four companies.

Allo­cat­ing by sec­tor is not as sim­ple as allo­cat­ing by coun­try. Nor are there as many good choices avail­able in Canada, though the selec­tion is bet­ter in the United States.

But as glob­al­iza­tion causes equity mar­kets to move more and more in tan­dem, the sec­tor allo­ca­tion deci­sion will become more impor­tant. And the dic­tum may change to “Don’t put all eggs in your bas­ket, add bread and pota­toes too.”

Dis­claimer: We may hold posi­tions in any and all secu­ri­ties men­tioned in this report.

The archerETF Global Tac­ti­cal Portfolio

archerETF offers Global Tac­ti­cal Port­fo­lio Management.

Our out­look is Global: we invest across coun­tries, sec­tors, com­modi­ties and other asset classes to improve returns. Our man­age­ment is Tac­ti­cal: we strive to select the right oppor­tu­ni­ties at the right times in response to chang­ing mar­ket con­di­tions to man­age and min­i­mize port­fo­lio risk.

Please call us at TF 1–866-469‑7990 for more information.

Vikash Jain, Vice President, Portfolio Management, and regular guest on BNN, brings over 15 years of experience in investment management to archerETF, with the majority of his career devoted to portfolio management. Prior to founding archerETF in 2008, Vikash spent 6 years with Northwater Capital, an institutional manager, where he managed $5 billion in structured portfolios including a $1.5 billion fund of equity futures and swaps overlaid with hedge funds. Read more from the author/contributor here.

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