Alfred Lee: 2023 Outlook & Strategy: 50 / 30 / 20

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[00:00:00] Pierre Daillie: Hello, and welcome to Insight is Capital. I’m Pierre Daillie, Managing Editor at Joining me today is Alfred Lee, Director. Portfolio Manager, and Investment Strategist at BMO Global Asset Management. 2022 was a challenging time in markets, which had investors riding on ways of uncertainty. As we begin the new year, we’ll discuss if inflation and interest rates are trending in the right direction.

[00:00:23] We’ll discuss portfolio strategy and fixed income strategy. We’ll explore the 2023 market outlook, central banks, gold, key risks, and portfolio construction across various asset classes.

[00:00:37] Disclaimer / Announcement: This is the Insight is Capital Podcast.

[00:00:42] The views and opinions expressed in this broadcast are those of the individual guests and do not necessarily reflect the official policy or position of or of our guests. This broadcast is meant to be for informational purposes only. Nothing discussed in this broadcast is intended to be considered as advice.

[00:00:56] Pierre Daillie: Alfred, welcome. It’s great to have you. Happy New Year.

[00:00:59] Alfred Lee: Good to see you. Happy New Year.

[00:01:01] Pierre Daillie: 2022 was one of those rare moments in markets, in market history where both bonds and equities nominally suffered, as much as double digit losses or more. we’ll call 2022, the terrible twos. There’s been a lot of buzz, about the traditional 60/40 portfolio being broken for some time, and that was true in 2020. Those, one of those rare, brutal moments, and definitely it was true last year in 2022, only now the difference between 2020 and 2022 is that we actually have more time now than we did in 2020 to make meaningful changes. We’ve seen investors to the sh- move or shift to the short end of the yield curve now to take a break from risk and take advantage of also short-term yields, which we didn’t have for a very long time, was that the right move or is that simply what investors did in reaction to rising rates and volatility?

[00:02:01] Alfred Lee: I think in 2022, it was definitely the right move. when you look at the majority of the year last year, the yield curve was essentially flat for the majority of the year. obviously we got the inversion of the yield curve heading into the fourth quarter of last year. But, as I mentioned, for the majority of 2022, because we had y- a flat yield curve, a lot of investors weren’t really compensated for taking on term risks.

[00:02:26] So usually when you look at advisors, their books are usually hugging the short end anyway, just because they think, from an advisor’s perspective, they don’t like volatility on the fixed income side of the portfolio.

[00:02:38] the short end, the curve naturally is the, I would say the comfort zone for where advisors like to park money. So it was definitely the right place to be in 2022 as we head into 2023. And as we’re there now, you get the inversion of the yield curve. What we’ve been recommending is maybe taking some of that allocation, just parking, some of that in the long end for now

[00:03:01] So basically just taking a barbell approach, so maybe, 75% into, something like short-term credit, which you can get through an ETF, and then the other 25% in something like long-term US Treasury or a long-term Canadian federal, ETF. And I think that’s a good way to play fixed income at this point.

[00:03:20] Yeah,

[00:03:20] now that we’ve seen, we’ve seen some softening up on the inflation print this week, with, the, inflation data coming in softer, as ex- as expected and I think as hoped for, [laughs], what are, your thoughts on the probability and the timing that the Fed will pause on hikes?

[00:03:44] And I want to get back to the, 75, 25, discussion, but I’m just curious to know what your thoughts are before we get to that on, on, on what the chan- what the, what’s, first of all, what’s the probability of the Fed pausing and, tied to that obviously is

[00:04:04] when.

[00:04:05] Sure. we were saying at the, end of last year, around Q3 of last year, we did a roadshow around Canada, which is our, annual economic forum. At that time obviously, inflation was very top of mind. I was saying at that point we’re probably going to get the pause on interest rates by both the Fed and the Bank of Canada, sometime in early 2023.

[00:04:32] I’m gonna, I’m gonna stick by that call. I just think, when you look at, when you look at, inflation, it seems to be trending in the right direction. with the CPI print, as you referenced just now, definitely trending in the right direction. We get a six and a half percent print in the year over year number and a negative for the month over month, number yesterday.

[00:04:54] Yeah.

[00:04:54] I think we’re definitely trending in the right direction. the last couple inflation prints outta Canada a little bit more stubborn, but I think we’re trending it in the right direction. When you look at a lot of the leading indicators, shipping cargo containers or the cots of shipping a cargo container, they often reference that one, which is back to pre COVID levels.

[00:05:12] this is, to me this has always been a supply side issue, right? Where, when COVID hit in 2020, everything just came to a standstill. Manufacturing came to a standstill. and, a lot of people did ramp up demand, but a lot of those were one time purchases. So things like refrigerators and whatnot, those are one time purchases.

[00:05:31] You’re not gonna buy another refrigerator right now- if you already did. so I think demand is gonna come down just because interest rates have gone up as well. we’re starting to see a lot of companies kind of report, supplies are building up. So Lululemon’s a good example of this. Nike’s a good example. even if you talk to your local, local bike store, for example, they have a ton of supplying bikes right now, which is very different than 2020.

[00:05:55] But what’s gonna happen is eventually I think they’re gonna start slashing prices, so that’s gonna be deflationary. but just going back to your central bank question, I think a pause is prudent. I think we’re gonna get that in early 2023, so probably, potentially as early as not this meeting, but the meeting after that.

[00:06:13] So the second meeting in 2023, there’s a lot of inflation data that comes up between now and then. but if it continues to trend in the right direction, we could get it as early as then. I think it is the right, I think it is the prudent move to do. usually when you get interest rate hikes, it takes 18 to 24 months for those rate hikes to take in effect. So we don’t even know the effects of the, initial rate hikes at this point.

[00:06:39] But, as I mentioned, a lot of the leading indicators are treading in the right direction.

[00:06:44] Pierre Daillie: Yeah. we, yeah, as far as the rate hikes are concerned, that only began in May. And, of course, the market was telegraphing it ahead. And, once again, now the market is telegraphing, the, outlook for yields to drop as well for this year. And, so when we saw some of that yesterday, and, it was interesting also you mentioned Lululemon and, inventories, concern over inventories.

[00:07:13] There was also, the route in, Aritzia for example, which, reported, gangbuster profits and revenue, but then had this, scary number on their inventory. which again leads to what your, point about, prices falling.

[00:07:30] Yeah.

[00:07:31] Because, of, demand destruction.

[00:07:33] Yeah.

[00:07:34] and in the, in the context of huge inventories, we saw Amazon also have that problem last year as well, right?

[00:07:40] Yeah.

[00:07:40] Where they had, yeah.

[00:07:41] Sorry.

[00:07:42] I don’t want to get into the weeds, but, sorry,

[00:07:44] Alfred Lee: go ahead. You were gonna say-

[00:07:44] No, I was just saying, where, it’s been a little bit more resilient is the service side, obviously, right? I, think there’s some stickiness there.

[00:07:53] Yeah.

[00:07:53] I think there’s, when it comes to mortgages, for example, if you bought m- a house for, a million dollars, a couple years ago, and now you have to refinance, not at a 2% rate, but a 5% rate, you know that cost-

[00:08:06] Yeah.

[00:08:06] … of that mortgage is gonna go up, right? on the servicing side, it’s a little bit more resilient, o- obviously, when it comes to hospitality and, restaurants and whatnot. we haven’t gone out in the last two years, right? there’s a lot of people that are just trying to make up for lost time.

[00:08:20] Yeah.

[00:08:20] So I know, I know, my wife has been booking, two, three vacations at a time, and I think a lot of people out there are just-

[00:08:27] [laughs].

[00:08:27] … to make up for lost time, Yeah. I think eventually maybe in six to eight months when people are concerned about, employment and whatnot, and I think they’re gonna be a little bit more, prudent in their, spending on the services side, so that eventually will come down as well.

[00:08:44] yeah, and I think to put

[00:08:45] Pierre Daillie: the, mortgage point in question. to bring some light to the mortgage point or provide some context, when you, if you stop and think for a moment, to go from a 2% rate to a 5% rate is a one and a half times increase in total cost.

[00:09:01] It’s 1.5

[00:09:03] times more. a $5,000 payment now is 12,500.

[00:09:10] Alfred Lee: Absolutely.

[00:09:11] And yeah. and that’s some of the, the, I think the, when you look at the CPI calculation, I think that’s where, it’s, not a, it’s not a perfect calculation. however, if you look at things like, real estate listings, for example, I look at it from time to time just to see where housing prices are, what I’m noticing now is that over the last couple of months, houses are, just sitting there and then they get re-listed at a lower price and sitting there still and get- and getting re-listed at even a lower price. that to me is more of a reflective, indicator in terms of what’s going on in real estate market.

[00:09:52] Yeah.

[00:09:53] I think eventually when that gets repriced and new kind of transactions happen there, then you start seeing the mortgage, the mortgage service as costs start going down at that point.

[00:10:05] I think

[00:10:05] Pierre Daillie: it’s pretty scary to be a central banker these days. [laughs]. when you have, Powell for example, chairman Powell, keeping at, keeping it, [laughs], what’s, he’s, keeping at it like Paul Volcker, right?

[00:10:21] Yeah.

[00:10:22] they, commentators have, harped on the idea that, he’s really, he fancies himself or wants to fancy himself as, as similar to Paul Volcker in his fortitude and, his, credibility, as a credibility seeking exercise. I think it’s interesting, when you look at, what’s actually happening on the ground, such as with mortgage rates that we’ve just, talked about, it’s, hard to imagine that, that, behind the curtain, they’re, they don’t wanna be early and they don’t want to be too late, right?

[00:11:02] Yeah.

[00:11:02] there’s been talk of Goldilocks.

[00:11:05] Yeah.

[00:11:06] when, is the just right moment.

[00:11:08] Exactly.

[00:11:08] It was it’s nice that there was a pause in January from policy meetings.

[00:11:12] Yeah.

[00:11:12] Because that gives the Fed more time to reflect on what’s actually happening and, changes in sentiment.

[00:11:17] Yeah.

[00:11:17] But, the big story this year looks like it’s fixed income, right? It’s hard, it’s really hard to put a finger on exactly what will happen with earnings on the equity side and, other factors that are affecting, discounted cash flows, duration, arguments about, duration and what, the current risk-free rates are that, valuations are based on, but with fixed income, it’s a little more concrete. Right?

[00:11:54] we have a, an environment where, fixed income is, looking at, the prospect of falling yields. And because we have yields today that we didn’t have at least for 15 years, there’s a really big opportunity there. And, I, think, a lot gets lost in the discussion about, for example, on credit, a lot of investors, a lot of advisors, are averse to investing in credit.

[00:12:28] Because, it has so many moving parts, at least that the, that’s what the imagination informs investors with is, that it’s a complicated area. Maybe let’s get back to… Sorry, I’m just, babbling now. Let’s get back to what you said about, the allocations that, that you’re, modeling in portfolios for fixed income right now, given the environment that we’re in, where yields have come up to this historically, significant level, both on the credit side and on the government bond side.

[00:13:08] maybe explain the 75, 25, split that you’re recommending, or that you’re suggesting.

[00:13:14] Alfred Lee: Yeah. when you look at, the yield curve right now, it’s no longer a flat yield curve as we saw in 2022. the long end of the curve is starting to come down, which, I think is a good sign that, the market believes that inflation will eventually, get under control because, if the market believed that inflation was still running rampant, there’d be no transactions occurring at the yield levels where they are in the long end of the curve at this point.

[00:13:44] So the good thing is that, the long end of the curve is coming down, from an inflationary standpoint. The bad news, however, is that in an inverted yield curve tends to indicate, recessionary environment tends to be a pretty reliable indicator as well.

[00:13:58] So we still like the majority of the allocation and fixed income being on the short end of the curve just because-

[00:14:05] Let’s say if inflation starts ramping up again, China opening up is, the major elephant in the room, I would say, just because, when economy opens up, and this is one thing that we mentioned before, North America opened up last year. We said inflation was going to, get worse before it gets better.

[00:14:23] And the reason why is because you could always buy something before you, can make something, or you could, buy something faster than you can make something. So-

[00:14:32] For that reason, demand tends to come back online faster than supply. so that’s why, we, think the shorten the curve still makes more sense just in terms of being overweight.

[00:14:43] if inflation does start to pop again, the long end will underperform. but at the same time, I think at this point, we have enough indication that we are relatively confident that inflation is being tamed by both the Federal Reserve and the Bank of Canada. So I think it makes sense to have some allocation on the short end or on the long- end of the curve. but at the same time, because, w- we, believe, because there are, growing recessionary forces out there, you potentially want to have some allocation on the long end of the curve to offset, equity market risk as well. And I know a lot of people will say, in the last, year equities and the long end of the curve, so long, long federals and long treasuries have been highly correlated. Yes.

[00:15:32] but I think as the Fed starts to tame down, their monetary tightening, that correlation, that positive correlation between long bonds and equities will eventually break at some point this year. That’s very

[00:15:45] Pierre Daillie: interesting. Are there any other aspects of fixed income that, that you observed that you found interesting?

[00:15:52] Alfred Lee: No, the, main thing is I think, fixed income, we’ve been saying, I think this potentially could be the golden era for fixed income,

[00:15:59] Yeah.

[00:16:00] … as you mentioned. I think, when you look at, your yield to maturity on, investment grade credit, for example, it, it’s, still levels that we haven’t seen in a very, long time. So let’s say for example, once we get to the terminal value, the yield maturity on US investment grade, for example, is, six, six and a half percent at that point.

[00:16:23] when we model kind of long-term annualized return assumptions for equities, we generally use between, seven to 9%. So a lot of people could be seeing the yield and maturity from fixed income, which is a lot more of a certainty than equity market returns. And they could say, I’m getting a little bit less returns, but it’s gonna come with a lot more certainty, so why don’t I just shift some of my risk over to-

[00:16:47] fixed income.” so I think that I, I think over the next year, maybe year and a half fixed income is gonna outcompete, fixed income is gonna outcompete equities at that point. but I do believe that, there are certain pockets within the equity market that can perform very well.

[00:17:04] Yeah.

[00:17:04] I just think it’s gonna be a very different environment than, what we’ve been accustomed to over the last 10 years, because in the last 10 years, it’s been a very different environment where, risk assets have been driven by zero interest rate policies and quantitative easing.

[00:17:20] We’re reversing all that down where we have actual, interest rates and we have quantitative tightening, which is the opposite. one thing that we’ve been noting is that, everybody’s saying that we are moving into a new regime, which I 100% agree with, but people are saying this is a new regime, but in fact, we’re moving into the old regime, which-

[00:17:39] Yeah. [laughs].

[00:17:40] … more seasoned investors are accustomed to, right? Where-

[00:17:43] Absolutely.

[00:17:43] … the last 10 years has been outside the norm, I would say.

[00:17:47] Yeah.

[00:17:48] Pierre Daillie: Something that favors more fundamental, more active, styles of investing.

[00:17:53] Alfred Lee: Yeah. I think, even inequity factors, I think, repositioning, some of your broad beta equities into things like, more defensive growth, for example-

[00:18:02] Yeah.

[00:18:03] … things like, low volatility and things like quality, I think, or certain factors that could perform very well in this environment.

[00:18:10] So you

[00:18:10] Pierre Daillie: actually have, underweight equities a little bit and overweight fixed think income in your models. Yeah.

[00:18:19] And, so on the equity side, let’s, shift gears and talk about equities now. On the equity side, what are your, core holdings? What are your, what are some of your sector choices?

[00:18:32] Sure.

[00:18:32] And then speaking of factors, what are also some of the factor overlays that you would include in that equity allocation?

[00:18:40] Yeah. So

[00:18:40] Alfred Lee: we’re actually using factors as the core of our models at this point.

[00:18:44] Okay, great.

[00:18:45] So low volatility and, quality, I think are, the two core positions that we’ve been running with, the model for quite some time, at least the last five to six years.

[00:18:55] but we continue, you, we continue to believe these are factors that will perform well in this environment. so when you look at low volatility, I think, as I mentioned, I think, I’m, very constructive of equities this year. I just don’t think we’re going to get that, 2008, 2020 where we’re coming off the market bottom really saw the markets take off. I don’t think we’re gonna see that this year.

[00:19:19] and, just the reason being that 2008, 2020 we’re really driven by QE. We’re not, we don’t have QE, we don’t have the same level of stimulus. stimulus is going to be, decreasing rather than increasing. And, equity markets are forward-looking as well.

[00:19:37] so I, I don’t think we’re gonna get that acceleration off the market bottom. so I think, more defensive growth areas are gonna perform well. so I think low volatility will be well positioned because of that. quality I like, just because when you screen for quality, you’re looking at companies that have, high, return on inequity, low earnings variability, and, low financial leverage as well.

[00:20:02] So you’re looking for those companies that have strong balance sheets, don’t have a lot of debt burden. So as in, in, in- interest rates remain high.

[00:20:10] a lot of those companies that have to service their debt and kind of, refinance, it’s not gonna be an impact to them. and at the same time, when you look at, the last 10 years, the kind of, equities that have done well are those higher growth ones, the ones that can access cheap debt and kind of just, grow their companies using, low cost debt, and I think it’s gonna be a disadvantage for them going forward.

[00:20:38] so that’s why I think I like, quality as, a factor and really low-

[00:20:42] Yeah.

[00:20:42] … volatility as those, foundations to your portfolio at this point.

[00:20:46] Pierre Daillie: Yeah. So you’re cutting by, going with low vol and, quality, you’re cutting a lot of that duration risk that was in the market last year from rising rates, right?

[00:20:55] Yeah, exactly.

[00:20:56] Company, companies with lower carrying costs or, in some cases, no carrying costs for, debt are not gonna be susceptible to, interest rates remaining higher for longer, for example. like we, we’re, I think in, the discussion, and one of the things that, that possibly gets lost is that the Fed pauses, but then they don’t cut. That’s also a possibility that they don’t cut for a while. They, may just pause and say, okay, we’re gonna leave rates at where they are right now and see what happens, and watch the data, watch, watch the, since they’re data driven, we’re gonna watch what’s happening and only when we start to see… so anyway-

[00:21:41] I actually think

[00:21:43] Alfred Lee: that’s a, very possible outcome, though. I mean-

[00:21:44] Yeah.

[00:21:45] … our, base case right now is that they are going to pause in interest rates and then keep them there. unless, things really start to hit the fan and then they really need to cut rates. them holding rates really is, really just saving the, bullets in the chamber if they need-

[00:22:06] Yeah.

[00:22:07] … in order to fight a recession going forward. part of the reason why they use QE is because, the grinded interest rates basically to zero and had nothing left to stimulate the economy and, had to resort to QE. So I think having learned those lessons, they’re not gonna fire those bullets until they actually need them.

[00:22:27] Yeah. So we could, we, I,

[00:22:29] Pierre Daillie: feel like just listening to the daily comment feed that comes through that, that there’s some assumption somewhere in there that, if the Fed pauses, the Fed will cut, but I’ve only heard a few voices actually saying, there’s a very strong possibility the Fed will, pause and then stay.

[00:22:48] Alfred Lee: Yeah. And there’s also-

[00:22:50] Right?

[00:22:50] … other ways in which they could stimulate the economy as well. there’s also quantitative tightening. they could slow down the, pace of quantitative tightening as well, without moving to overnight rate. also I think, when you look at currency, for example, when you look at where the Fed is right now, last year I would say the Bank of Canada was the one central bank that was ahead of them in terms of, taming inflation. At this point, I think the Fed is number one or just, ahead of everybody else in terms of taming inflation, just, by looking at how their CPI is moved.

[00:23:22] So I think because of that, if anybody’s going to pause first, it’s likely the Fed. And then when you look at, other jurisdictions, Europe, for example, they’re much further behind, so they’re gonna be hiking-

[00:23:34] Yeah.

[00:23:34] … rates as the Fed is going to remain, stable. So as a result of that, the US dollar is gonna come down. so that’s another way to stimulate their economy as well.

[00:23:45] Pierre Daillie: So you have factors as the core low-vol quality. Now, are there any sectors that you

[00:23:53] Alfred Lee: prefer?

[00:23:54] Yeah, so the one sector that we really is, Canadian banks. And the reason why is because when you look at, the valuation of p- of banks right now trading on P ratios that are, very attractive versus the, not just the overall market, but where they have been historically as well. when you look at, just the P ratio versus, the TSX, I think it’s trading at something like a 25 to 30% discount to the market.

[00:24:21] When you look at Canadian banks, I’d say arguably some of the best businesses in the world where, it’s basically, a oligopoly where there’s limited-

[00:24:30] Yeah.

[00:24:30] … competition, but at the same time they’re involved with every part of the economy as well. so I think, Canadian banks are well positioned. I think they’ve underperformed because there’s an expectation that, interest rates are higher, interest rates is gonna have an impact in terms of their earnings and their loan qualities, which, you know, as a result of that, the banks have been writing up their loan loss provisions.

[00:24:54] But when you look at non-performing loans as a percentage of their total portfolio really hasn’t increased in the last, 12 months.

[00:25:02] and still on an absolute level, I think they’re, it’s around, 40 basis points of 70 basis points depending on which bank you’re looking at. so a lot of that bad news has already been at least partially baked in. so we, like Canadian banks dividend, yields are still, very attractive at, as well. typically when, the dividend yield is above 4%, now they’re at, 4.5 or 4.6%.

[00:25:27] That’s usually a very good buying signal, historically. I think, Canadian banks is one of the sectors that we like. another area that we like is also energy. So when you look at energy, I think they’re going through this transition, obviously, governments obviously want them to move to more renewable energy.

[00:25:48] So if you’re looking at this as a fossil fuel company and you’re, you’re obviously making pretty good margins at this point because the demand for energy. but you also don’t want to reinvest in infrastructure because you don’t know, or that over the next 10 years they’re going to move, to more renewable sources of energy.

[00:26:11] So you don’t wanna spend, billions of dollar bringing new infrastructure online, which usually takes five, five years to build-

[00:26:18] Yeah.

[00:26:19] … and then another five years on top of that there to break even. so when you look at, a lot of the Canadian energy companies, for example, you look at the cash, positions they’ve been accruing-

[00:26:30] Yeah.

[00:26:30] … and there’s nothing to do with them other than payout dividends or increased share buyback. So that’s another sector we like. so those are two sectors that we hold in our, model portfolios. one thing that we have on the radar interestingly, is gold.

[00:26:45] And I think it just goes back to, you know what I was saying about central banks, when you look at where the Fed is, compared to other central banks in terms of the request of taming inflation, I would say they’re further ahead. So the US dollar I think is gonna weaken as a result of that. And what really held back the, gold and gold miners over the last year has been the strength of the US dollar. So as the-

[00:27:10] US dollar starts to fade here, I think that’s gonna be a huge catalyst for a gold going forward.

[00:27:16] And that,

[00:27:16] Pierre Daillie: that similarly would, hold true also for commodities which are priced in US dollars as

[00:27:20] Alfred Lee: well, right?

[00:27:21] Yeah. Yeah.

[00:27:22] and also with China opening up, you know-

[00:27:24] Yeah.

[00:27:24] … who knows the impact on, commodities as well usually tends to be positive.

[00:27:29] it’s weird,

[00:27:30] Pierre Daillie: isn’t it though, when, [laughs], you know that during a year when inflation spiked that gold, took a back seat and, but as you said, it’s because of the rising dollar. but it’s interesting also, I think what you said, and may correct me if I’m wrong, but you said that, higher gold prices will lead to a, lower dollar or, and a lower, dollar will lead to a higher gold price. I know there’s a relationship there.

[00:27:56] Yeah.

[00:27:56] but, is there any sort of cyclicality to that in terms of how, how gold is being favored and the dollar is falling?

[00:28:06] Alfred Lee: yeah, right now-

[00:28:08] are

[00:28:08] Pierre Daillie: they, mutually, are they, exclusive to each other or is it just,

[00:28:14] Alfred Lee: do they go hand in hand?

[00:28:15] Not always. they tend to be inversely correlated.

[00:28:17] Yeah.

[00:28:17] you definitely, bring up a good point there. there are times when, they are positively correlated, however-

[00:28:25] Yeah.

[00:28:25] I think the major driving, factors for gold, you tends to be, you buy gold as, a hedge for three reasons, a weak US dollar, which we’re seeing right now.

[00:28:36] inflation and, geopolitical or macroeconomic risk. so those are the three reasons you buy gold. typically when you have, macroeconomic risk increasing, you usually have US dollar increasing as well. And that’s when you, where you typically have a strong correlation between gold and, the US dollar.

[00:28:58] But now obviously with, the concerns, geopolitical risk of already baked into risk assets, unless we get, tensions rise in Russia, Ukraine, or we get-

[00:29:10] China invading Taiwan. geopolitical risk right now is already priced in, I think. So the main concern is really just, the US dollar, losing kind of momentum at this point, which should be favorable for gold.

[00:29:23] Awesome.

[00:29:24] Pierre Daillie: Now last but not least, I want to ask you, because your, model portfolio follows a 50, 30, 20 split between equities, bonds, and alternatives. Is that the correct order? It is, right? Yeah.

[00:29:35] Yep.

[00:29:36] What are the alternatives that, that you are favoring?

[00:29:39] Alfred Lee: right now we have, preferred shares in there. Okay.

[00:29:42] So that’s, that’s been in there for a long time just because as a portfolio construction building block, it tends to have, non-correlated returns with both equities and bonds. So that’s why we’ve, had that position over the last, I would say, 10 years even.

[00:29:59] Yeah.

[00:30:00] so it’s always been a static position, but, as the ETF industry you know-

[00:30:05] Yeah.

[00:30:05] … evolves and provides exposure to, a lot of this, alternative exposures and with the changes in 81-102, that’s gonna allow the ETF industry to provide exposure into-

[00:30:17] deeper, exposures into alternatives. long short, you mentioned, I think that’s gonna be very interesting because I, maybe long short’s gonna underperform this year, but I think the importance of long short was really made in 2022 when, you had bonds and equities falling, but long, short, if it’s designed appropriately, is going to give you positive returns in, that kind of environment.

[00:30:44] And the challenge, however, with, when you have certain positions that are considered alternative, in areas like, or years like 2022, when you get this de-leveraging in the market, or when you get the market sell off, all of a sudden the correlation rises in, as an alternative that diversification doesn’t really, favor your portfolio-

[00:31:03] Yeah.

[00:31:04] … when it really matters. Long, short, however, that negative correlation still holds up in 2022. long short is something we’ve been considering. other things like, gold bullion, I think that is another consideration as well. but those are, some of the alternatives that have definitely, considering that alternatives bucket of a balanced portfolio.

[00:31:27] Yeah.

[00:31:28] Pierre Daillie: Interesting, Alfred, I, I, I hadn’t even the, new sort of the new liquid alternatives that have come into the market, really only came on stream in the last three years, and probably most of them in the last two.

[00:31:43] So they’re, still very new in terms of, adoption-

[00:31:48] and, but I hadn’t considered, I know preferred shares have been a favored position, in your models-

[00:31:55] as an alternative asset. I hadn’t considered that, the preferred share strategy in, as an alternative allocation predates, 81-102 changes to-

[00:32:06] Yeah.

[00:32:06] … allowing liquid alternatives to be made available to investors.

[00:32:11] Yeah.

[00:32:11] in the last three years… And of course, we had, up until the end of last year, investors had really very little incentive to, look at alternatives other than as a forward looking exercise and-

[00:32:27] that’s something that, that’s really hard to, because of biases really hard to get investors into alternatives when, the 60, 40 was doing so right up to the end of last year.

[00:32:37] Yeah.

[00:32:38] it’s only like when, a crisis happens, or like this pullback we had in 2022, that people start to look at their options. It’s unfortunate that, something bad has to happen before you start looking at-

[00:32:50] Yeah.

[00:32:50] … something that, that, that’s a forward-looking allocation.

[00:32:53] Yeah.

[00:32:54] that a lot of, you know, that a lot of well-heeled or professional investors would’ve done in advance of the end of last year, given where valuations were and, Zirp and-

[00:33:06] all that stuff, re- retail investors are not apt to-

[00:33:10] to load up on diversifiers when they don’t know there’s a need to.

[00:33:14] Yeah.

[00:33:15] So something bad has to happen-

[00:33:17] Yeah.

[00:33:18] … in order, in order for the, for that, impetus to arise-

[00:33:22] For

[00:33:22] sure.

[00:33:22] … to, make that change. But Alfred, thank you so much. That was a really comprehensive discussion and, you just have such a great way of, elaborating and explaining, how things fit together. thank you so much for your incredibly valuable

[00:33:40] Alfred Lee: time.

[00:33:41] Always a pleasure to have these conversations with you.

[00:33:43] Pierre Daillie: Yeah. Love catching up with you, Alfred.

[00:33:45] Yeah.

[00:33:46] Alfred Lee: Thank you so much.

Listen on The Move

In this podcast episode, Pierre Daillie, Managing Editor at, interviews Alfred Lee, Director, Portfolio Manager, and Investment Strategist at BMO Global Asset Management. They discuss the challenges faced by investors in 2022, with both bonds and equities suffering double-digit losses. They also touch on the traditional 60/40 portfolio being broken, and the shift towards short-term yields due to rising rates and volatility. Lee recommends a barbell approach, with 75% in short-term credit and 25% in long-term US Treasury or Canadian Federal ETFs. They also discuss the current state of fixed income investments, the yield curve, and the outlook on the equity markets. Lee suggests diversifying portfolios with alternative investments and emphasizes the importance of forward-thinking allocation strategies.

As always, thanks for tuning in.


Short-term yields vs. long-term risks [00:01:01] Discussion on the shift to short-term yields in 2022 and whether it was the right move, and recommendations for a barbell approach in fixed income for 2023.

Probability of Fed pausing on hikes [00:03:20] Discussion on the probability and timing of the Fed pausing on hikes, with reference to inflation data and leading indicators.

Trending in the right direction [00:04:54] Further discussion on inflation trends and leading indicators, and the possibility of a pause in interest rates in early 2023.

Rate hikes and inventories [00:06:44] Discussion on the market telegraphing outlook for yields to drop, concerns over inventories, and demand destruction.

Resilience of services side [00:07:44] Services side being more resilient, stickiness in mortgages, and potential decrease in spending on services in the future.

Mortgage rates and real estate market [00:08:43] Increase in mortgage rates and its impact on total cost, reflection on the real estate market, and potential decrease in mortgage service costs.

Challenges for central bankers [00:10:05] Discussion on the challenges faced by central bankers, the pause in policy meetings, and the search for the "just right" moment.

Fixed income opportunities [00:11:02] The big story of the year being fixed income, the prospect of falling yields, and the opportunity it presents.

Allocations for fixed income [00:12:04] Discussion on the 75-25 split recommended for fixed income allocations in portfolios.

Fixed Income Outlook [00:13:14] Discussion on the yield curve, inflation, and allocation strategies for fixed income.

Golden Age for Fixed Income [00:15:52] Fixed income as a more certain investment option compared to equities, with potential for outperformance in the next year or so.

Equity Allocation and Factors [00:18:10] Core holdings and sector choices for equity allocation, with a focus on low volatility and quality as key factors.

Low Volatility and Quality [00:19:34] Discussion on why low volatility and quality are good investment factors in the current market.

Possibility of Fed Pausing Interest Rates [00:20:45] Exploration of the possibility of the Fed pausing interest rates without cutting them.

Stimulating the Economy [00:22:27] Discussion on other ways the Fed could stimulate the economy, such as quantitative tightening and currency.

Canadian Banks [00:23:54] Explanation of why Canadian banks are a preferred sector due to attractive valuations and strong businesses.

Energy and Gold [00:25:35] Discussion on the potential of energy and gold as investment opportunities, including factors such as government policies, cash positions, and central bank actions.

Alternatives [00:29:39] Explanation of the 50-30-20 split between equities, bonds, and alternatives in the model portfolio, with a focus on preferred shares and the potential of long-short strategies and gold bullion as alternative investments.

Investing in Alternatives [00:32:26] Investors' reluctance to invest in alternatives due to biases and the need for a crisis to happen before considering diversifiers.

Conclusion [00:33:14] Thanking Alfred for his comprehensive discussion and valuable time.


Where to find Alfred and his team:

BMO ETFs Dashboard
BMO ETFs Trade Ideas and Podcasts
Alfred lee on LinkedIn

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