Time to tweak asset allocation
YOUR MONEY, By Murray Becotte
The most important decision an investor makes is the asset allocation choice.
Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds and cash. The decision will depend largely on your investment time horizon and your tolerance for risk.
The idea is to balance the reward for taking on risk to achieve greater returns with the security that comes from preserving your original investment and still generating a sufficient return to meet your investment goals.
Once an asset allocation mix is determined it can be fine tuned as your personal situation changes or economic circumstances warrant.
The current economic environment is one of persistently low economic growth relative to previous recoveries.
However, within this context of slow growth, recent data in the U.S. and Europe has been encouraging, and it is likely that 2014 may be the first year since the financial crisis in which we witness synchronized growth among developed economies.
In particular, the U.S. is expected to benefit from better jobs growth, continued improvements in the housing market, rise in oil and natural gas production, a resilient consumer and less fiscal drag from the government.
These improvements have led to a change in the U.S. Federal Reserve’s (Fed) monetary policy characterized by continued low interest rates, but a slower pace of asset purchases.
However, from a global perspective, it appears that liquidity will remain abundant, with key support coming from the Fed as well as the Bank of Japan and the European Central Bank. In the big picture, it looks like an environment of improved growth and a liquidity backdrop that is supportive of asset prices.
In such an environment the risk/reward trade-off in fixed income is unattractive and a responsive asset mix should underweight fixed income, especially government bonds, and overweight position in equities.
With respect to equities, an acceleration in earnings is expected as the economy improves in 2014. Investors should favour companies that have the ability to increase their earnings in a low growth environment and thereby protect the real value of investors’ savings.
Geographically, North American equities, both U.S. and Canada continue to look good. The U.S. continues to have the broadest and deepest selection of quality companies globally.
In Canada, after a period of sustained underperformance versus U.S. equities, prospects for Canadian equities now seem more in line with those for U.S. equities.
The decline of the Canadian dollar will help improve the competitiveness, revenue and earnings of many Canadian firms. In addition, oil is poised for strong performance given low inventory levels, as well as limited excess capacity and a firmer energy sector should improve the relative performance of the S&P/TSX Composite Index. Investors should overweight U.S. and Canadian equities and maintain a neutral position in developed international and emerging market equities.
Within the fixed income allocation short-term rates are expected to stay low through 2014. The higher yield on investment-grade corporate bonds, relative to government bonds, lends support to preferring corporate bonds over government bonds.
Their incremental yield and shorter duration compared to government bonds, makes corporates less susceptible to the adverse impact of rising bond yields.
A board benchmark asset mix for balanced growth investor is typically 60 per cent equities and 40 per cent fixed income. Within the equity mix a typical split would be 60 per cent Canadian,
Twenty per cent U.S. and 20 per cent International. Under current economic conditions, a balanced growth investor may want to increase the equity percentage to about 67 per cent and reduce the fixed income component to 33 per cent.
Within the equity mix you may want to increase the U.S. portion to 22 per cent and reduce the International to 18 per cent.
(Murray Becotte is a chartered accountant and CFP working as an investment advisor with TD Waterhouse in Thunder Bay. Opinions expressed in this column are his. Your Money appears every Monday on the Business page.)