Fine-tune your portfolio
One of the principles in which I strongly believe is the need to fine-tune your mutual funds portfolio in line with changing economic and financial conditions. This does not mean dramatic strategy shifts – I would rarely advise that. Rather it means adjusting asset weightings with a view to minimizing risk and maximizing return potential.
Last spring I predicted that trends in place at the time would lead to higher rising interest rates which would gradually improve yields on money market funds. I felt that the bull market in equities would run out of steam and that bond funds would stay under pressure. Much of that has happened as predicted, although bonds managed to rally during the summer.
As I look ahead to 2005, I see a continuation of these trends but with some subtle differences. Among the new realities I feel should be taken into account are these:
A stronger loonie. Our dollar has been edging higher recently, fuelled by a number of forces including a strong trade surplus, high commodity prices, a balanced budget (or better) in Ottawa, and a huge U.S. deficit. Some experts now predict the loonie could climb to US85c next yea and perhaps higher. If this happens, it will have the effect of reducing returns on U.S.-dollar-denominated securities, as we saw in 2003. We are unlikely to see anything like the kind of advance we experienced in that year but even a 5% to 10% rise in the value of our currency will have an impact on U.S. equity returns and would likely wipe out any gains on income and cash investments. As a result, you may wish to reduce your weightings for U.S. money market funds and U.S. equity funds, unless you have a special need for U.S.-dollar funds.
The presidential election. History tells us that U.S. stock markets fare badly in the years following a presidential election. If the incumbent loses, the effect is magnified. With the election looming and the race apparently tight, this is all the more reason to cut back on U.S. equity funds.
Softness in Europe. There are conflicting signals from Europe. We’ve been seeing weakness reflected in the performance of European equity funds which as a group declined 4.8% on average in the three months to Aug. 31. Since European stocks are the primary holding for most international equity funds, I suggest reducing your position in that sector.
Strength in income trusts. The income trusts market suffered a sharp correction on interest rate fears in the spring. But it rebounded well after it became clear that rate increases would be moderate and gradual. Strong oil prices have further helped by pushing up the value of energy trusts.
Good prospects for Canada. I believe the outlook for the Canadian stock market in 2005 is positive. I expect commodity prices will continue to be strong, at least in the first half of the year, and that the TSX will outperform the major U.S. indexes. Any currency gains would be a bonus.
Here is my new Model Balanced Portfolio, which takes account of these developments. The “Model” column is the neutral position while the “Current” column is the mix I advise at this time. I never vary by more than five percentage points on either side of the model.
Aggressive investors should add to the equity weightings shown here, reducing bond funds and money market funds accordingly. Conservative investors should do the opposite.
|MODEL BALANCED PORTFOLIO|
|Type of Security||Model||Current|
|Canadian Money Market Funds
U.S. Money Market Funds
Canadian Bond Funds
U.S. or Foreign Bond Funds
Income Trust Funds
Canadian Equity Funds (value)
Canadian Equity Funds (growth)
U.S. Equity Funds (value)
U.S. Equity Funds (growth)
International Equity Funds (value)
International Equity Funds (growth)
Note: I recommend that at least one-third of your bond fund holdings be in lower-risk short-term bond funds and mortgage funds. Conservative investors may wish to increase that to at least half their fixed-income assets.