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The Evolution of Investments

The investment world is changing and constantly evolving. In order to create a sustainable financial plan it’s important to understand these changes and how they impact you.

The traditional theory of diversification was that diversifying your portfolio was as simple as having a portfolio of both stocks and bonds. A general rule of thumb under this approach was to take 100 less your age and that’s how much equities you should hold in your portfolio. Therefore, if you were 60 years old an ideal portfolio allocation would be 40% equities and 60% bonds.

As history progressed, the theory of diversification also progressed. Rather than just having a portfolio of stocks and bonds, it was generally thought to diversify within those categories with different types of bonds and stocks in different sectors and/or countries. While this worked for a period of time as global markets become more integrated with on another this diversification theory becomes increasingly correlated. This can be illustrated with the below graph where two recent market crashes are shown. The blue line is an undiversified portfolio and the purple is a highly diversified portfolio across various sectors and countries. A clear conclusion is that although the two portfolios vary significantly they general move in the same direction. This is because the global markets are becoming more correlated. Twenty years ago when something happened in China, we didn’t hear about it for some time in Canada. In today’s world, when something happens in China we hear it about within minutes.

Therefore, we are left with the challenge of how to combat the issue of correlation in our portfolios. A good resource to look at is how the large pension funds, endowments, or other large institutions are managing their money. A good example of this is the Canada Pension Plan (CPP). CPP has similar needs to a retiree, they both have annual cash flow obligations, they need to protect capital, and they need to minimize volatility in their portfolio.  The CPP Investment Board publishes an annual report on how they invest each year. The 2017 annual report goes into explanation on the evolution of alternatives in the private markets. In addition to stocks and fixed income bonds, the addition of alternative asset classes such as real estate, private equity, mortgages, private debt and absolute return strategies are the new normal. The report goes on to note that “over the long term, many private markets are expected to provide better net returns than the nearest public equivalents. Also, these investments carry a higher return to compensate for their illiquidity…” Since 1999, CPP has progressed from a portfolio holding zero alternative asset classes, to 41.6% alternative asset classes in their portfolio in 2017.

With Avail’s strategic partner in WealthCo we are able to assist our clients tap into this alternative market within their portfolio in addition to the traditional stock and bond markets. This alternative market aims to minimize the overall volatility and correlation within the client’s portfolio. The goal is not to achieve the highest rate of return in the market but rather achieve a reasonable and sustainable rate of return that allows the client to stick to their financial plan that we create while also providing enough flexibility for any changes that may arise during the year.

Talk to me today about your wealth planning goals and how we can create a plan that’s right for you.

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