Everyone Should Have a Tactical sleeve in Their Portfolio.

 

I decided to write this post because I have now had this conversation/written this email so many times I wanted to have my thoughts all in one place. This gives me the chance to clarify my thinking and put my rationale in writing. I am urging all of my clients (friends, family and prospects) to add a tactical sleeve to their portfolios, and here is why.

 

In the typical portfolio discussion, there are two asset classes that are considered:

1. Cash and Fixed Income for safety; and,

2. Equities for growth (and/or growth and income).

Most Canadian investors have some combination of these two asset classes in their portfolio based on their risk tolerance and cash-flow needs. One typical example is a 60/40 Balanced Portfolio. This means 60% of the portfolio is invested in stocks and 40% is invested in Bonds.

 

In my view, this approach is missing a key ingredient - a Tactical Sleeve. The reason I recommend adding a Tactical Sleeve is for diversification and a complementary approach to the Equity component of the portfolio.

 

The best way to explain the benefits of adding a Tactical sleeve is in the context of what you expect from your typical Equity investments. One of my dearly held beliefs is that – given time – Equity Markets move higher. History shows that they can fall significantly from time-to-time (1907, 1929, 1987, 2000, and 2008) and otherwise suffer long periods of underwhelming performance (much of 30’s and the late 60’s and 1970’s). On the other hand, history also shows Equity Markets are in a “bull market” ~75% of the time and (as recent market activity shows) have always rebounded from downturns to reach new, all-time highs. As a result, the best approach has been to “buy-and-hold” and actually add to stocks when they fall – to “buy on dips” when stocks are “on sale”.

 

It would seem an investor would be wise to “set it and forget it”, getting and staying invested no matter the ups and downs of the market. As we all know, this is easier said than done. Cast your mind back to how you felt in the year 2000 or 2009. I know from experience that investors felt terrible and some simply “threw in the towel”. Common refrain at the time was “why did nobody see this coming” and/or “why didn’t anyone do anything about it?” Folks were upset. Looking back from today, with markets near all-time highs it is easy to wonder what all the fuss was about. In hindsight, doing nothing was the right decision.

 

The cause for concern is there are no guarantees in this business. Even if you are able to stay invested during the next downturn, no one is promising the market will rebound again. Just because it has happened before, doesn’t mean it is definitely going to happen again the next time. On top of that, there is no telling how long it might take before the market reaches new highs. What if the market stays down longer than your cash and safety bucket can last?

This is where Tactical investments come in. They are designed to react in the exact opposite way. Whereas a downturn is seen as a “buying opportunity” to long-term investors, tactical investments are designed to protect against falling markets. Tactical investments treat falling prices as a sign to sell stocks, not buy!

 

As you can see, this is the exact opposite of the approach taken in the Equity component of portfolios. Adding a Tactical Sleeve on top of Cash and Fixed Income offers some further downside protection.

 

Even better, if a large drawdown does occur, tactical approaches flip, cautiously looking to add money back into the markets when the situation shows signs of reversing. These approaches get a sense of the direction of markets and look to get involved again as things start to “look up”. In the traditional Equity side of the account, you would have been buying all along as the prices were falling or at least holding on. The Tactical investor would have money in cash, ready to buy back into the market when the coast was clear.

 

The fact is that with enough time, markets have proven to turn around and in the end it is like it never even happened. If you have the patience, conviction and “intestinal fortitude” to ride out any downturn, then there is nothing you need to do. Most clients, though – and especially those at or near retirement - cannot afford to take the risk that the downturn lasts longer than their cash and Fixed Income. They need the money. Not only that, but these folks also have the relatively largest portfolios as they have been saving and growing their nest-egg for decades.

 

That is why I recommend a Tactical sleeve on top of Cash and Fixed Income to add another layer of protection to portfolios.

 

Please feel free to reach out to me directly should you have any comments, questions and/or want to dig deeper into the concept of tactical investments. I can be reached by phone: 416.231.6528, cell: 416.855.9512 or email: jeff.ker@rbc.com.