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Spring 2019: Improving and modernizing our portfolio strategy

Spring 2019: Improving and modernizing our portfolio strategy

Join Craig Maddock and Mark Fairbairn, VP and AVP or Investment Management and Strategy at MD as the discuss integrating meaningful diversification and modern investment choices into our already robust portfolio strategy. 




Craig [00:00:05] Hello, I'm Craig Maddock, Vice President and Senior Portfolio Manager with MD Financial Management. Today I'm joined by Mark Fairbairn, Assistant Vice President and Portfolio Manager, also with MD Financial Management. Today we're gonna be introducing MD's brand new Precision Portfolio Strategy. Maybe  to get us going Mark - what is MD Precision Portfolio Strategy, why do we have it and why is it needed?

Mark [00:00:26] Yeah. MD Precision Portfolio Strategy is our new strategic asset allocation framework. Why do we need it? As clients develop their financial plan, part of that is to go through and figure out, you know, what [are] their goals [and] objectives and then line that up against a portfolio that help them meet that objective. As part of that you need to understand one - what do you expect the long term returns on these various asset classes to be and what's the appropriate mix of that. That's effectively what the strategic asset allocation is.

Craig [00:00:49] Exactly and I think one of the key things for me when we've gone through the update of our portfolio strategies, it's been almost a decade since we've renewed the framework that we use to build a strategy, and we had a lot of discussions around what's the best way to look at the risk and return characteristics and construct these portfolios. And in that we had a really good, I guess, debate or discussion around do we want to create the most optimal portfolios of the most diversified portfolios and I think where we settle was actually very interesting Mark and maybe you can give a bit of [an] example as to how we actually got to where we ended up.

Mark [00:01:21] Sure, yea. So the starting point was what do we think each asset class is going to return over the long term, not short term, but free of biases over the next 10 plus years, what are these different asset classes expect to return from where we are now? From that you can determine what's the optimal allocation to this. So you put these different returns together and different combinations. Mathematically you get a portfolio with the best return per unit of risk. The challenge with that is, that it assumes those assumptions are perfect and they're not. We don't know exactly what the exact return on Canadian equities is versus U.S. equities versus emerging market or fixed income going to be over the next 10 to 15 years. We have what we think are reasonable, very good estimates of that, but we can't be certain of them and the optimal allocations are quite sensitive to exactly what those numbers are. So, I guess the only way to say it is, you know, you can only determine what the optimal portfolio is looking backwards. You can't really determine what it is going forward. So to balance that we looked at all the other approaches you just diversify risk as much as possible. So not necessarily the capital being diversified, but the actual amount of portfolio volatility if you will. What we did, is we iterated through the process such that you balanced the degree of optimality with a well distributed risk. What we did is, we looked to balance the risk across the portfolio. So we think you get a nice balance between a portfolio that's still quite efficient, very close from a return per unit of risk as the pure optimal portfolio, but very much more diversified across that basket of asset classes within the portfolio. So it's not sensitive to any one of those assumptions or any one of those asset classes performing exactly as we anticipate it would be.


Craig [00:02:58] And then to add on top of that, I know we solved for, I'm gonna call it various potential portfolio choices a client might have and I think this is an important evolution. So when we first designed our portfolio structure over a decade ago, there's been a lot of change in the industry; tax rules have changed for physicians in the way they actually show up in their portfolios, the amount of choices are available to people today. So even if we think about our continuum we sort of go from a passive investor, someone wants to use indices as their primary investment choice to being active to blending those two together. We've introduced alternatives and more recently we've introduced private alternatives - so real estate or private equity. All those have different return characteristics which I'm gonna call the naïve portfolio construction methods -  don't necessarily take into consideration. And I know within the precision portfolio strategy we've actually, using your combination of optimal and robust, as well as the unique characteristics of these underlying fulfilment choices, actually taken those into consideration to build, if you will, better portfolios for clients. That's probably what I think is the most interesting aspect of this new strategy. It allows for customization and choice by clients, but it also allows for intelligent understanding of the trade-offs between active, passive and the different considerations from a risk standpoint, to ultimately get better outcomes for each individual client and the way they might want to use their portfolios. And within that, as I mentioned, we are changing from an old strategy to a new strategy. Maybe Mark, what are some of the most notable things if someone has our existing portfolio and they moved to the new portfolio? What are they going to see as far as change right away?


Mark [00:04:24] Yeah. The most noticeable change that clients will see in their portfolio, is likely to be the reduction in the home bias. Home bias is preference for investors in [a] particular country to favour their home market. It has a myriad of reasons for that. U.S. investors will have a home bias preference to U.S.,Europeans to Europe, Canadians to Canada. We've always had a home bias, going forward we're still going to have all bias - it's just gonna be lower. And the reason is lowering is really a function of that robust portfolio construction framework that we've discussed. We're trying to get a more even distribution of risk in the portfolio. So trying to reduce the reliance of a portfolio outcome on Canadian equities by allocating some of that capital to U.S. International emerging market equities. I will note that it's important to consider that this is not a call on equity. This is not a significant reduction. Our expectations are Canadian. We're not lowering our allocation in the Canadian [market] on any short term view is really a rationalization of the overall portfolio risk in our portfolio. The other thing that clients are likely to see in their portfolio, for those that do have active management options in their portfolio, is an increase in the allocation of equities. That stems from our risk targeted framework, where we're solving for our portfolios based on a particular level of risk. Because we treat active strategies and passive strategies as two unique strategies with separate capital market assumptions, our active strategies tend to be conservative [and] tend to hold up better. So they have a lower volatility assumption than the passive strategies. As such, when we're targeting those portfolios very specific level risk the portfolio can accept a little bit more of that equity risk. Because of that portfolio with more allocation to active management, will see more equities than they had previously.


Craig [00:05:54] In addition, we'll probably see a few changes on the bond portfolios as well. So as we update, you mentioned that there will be number of portfolios that will increase their equity weight slightly as well, the composition of our bond portfolios are changing a little bit to better enable the use of duration in what we're viewing as potentially a more rising interest rate environment versus say the declining interest rate environment that we've seen over the last 30 years. So, put those together, I think slight changes that clients would see. On top of that, there's also an increased cost that comes with both the use of more foreign assets as well as even a slight increase in equity weights across portfolios. And to compensate clients for that, we are actually reducing fees across our portfolios, within certain aspects of the portfolios. Such that for clients, they will actually pay no additional cost to get the increased benefit of that slightly higher equity weight as well as the slightly higher foreign content weight than we would have held previously in Portfolios. Which I think is very important. So net of fees, net of the improvement that we expect to get from our risk adjusted return standpoint with the new portfolios. We do believe clients will be much better off. And what will allow us to reduce those fees as some changes we are going to be making to our fund line-up as well. So within our fund structure, we do use a variety of sub advisors, external sub advisors, and combine those in meaningful ways within the context of our pools or portfolios. So for a number of mandates we'll be rationalizing the strategies that we use. We'll be introducing some new sub advisors, moving ways with some previous sub advisors, and as well as introducing some related parties sub advisors of the new capability we have that comes with the recent acquisition of MD by Scotia. All those things together allow us to give this enhanced portfolio framework, as well as I mentioned, at a much lower cost to clients than we have had previously.


Mark [00:07:30] With all these new portfolio options and this increased flexibility of our new Precision Portfolio Strategy - it's probably a great time for you to come and make an appointment with your advisor. Make sure that you're taking the best advantage of these new opportunities that you have the best option for you to meet your financial goals. Thanks for listening.