MARKET OUTLOOK FOR WEBSITE

1. RETIREMENT GOALS MET?
2. CURRENCY’S EFFECT ON YOUR PORTFOLIO
3. ALTERNATIVE AND MARKET UPDATE

1. RETIREMENT GOALS MET?
Concentrated Investing Versus Diversification

• Concentrated investing can offer larger returns but risks your investment goals
• Proper diversification achieves a steadier return with less risk of loss
• Explanation of “Diversification”

It is true that Bill Gates, Warren Buffet and almost everyone on the Forbes’ wealthiest list all ended up there by taking concentrated risks and were spectacularly rewarded for putting all their eggs in one or a few baskets. Similarly, around us we always hear fabled stories of the person that put everything into a marijuana stock, a gold penny stock or a couple junior oil and gas companies turning them into millionaires. It seems predictable and easy in hindsight.
However, before attempting to follow in these footsteps by betting on the next big thing or even a seemingly safe investment, don’t forget to check out the investor cemetery. When you do, you’ll see a massive graveyard full of unlucky people who, just like the very small population of life’s lottery winners, also put all their eggs in one basket and ended up with nothing.
Concentrating your bets works fine in theory if you know exactly what investments offer the best returns and put it all on whatever offers the best bang for your buck. In life unfortunately, there are no crystal balls. An investor needs to be humble, and not think they know more than they do. The average investor in a public company may know 5% of what is going on, myself as a portfolio manager with a team deeply researching an investment might know 15%, and even management itself may only know 40%. The remaining 60% depends on how their customers will act, ever-changing market dynamics and a seemly infinite amount of unpredictable variables.
Events rarely unfold in the manner that even the smartest investors, aided by sophisticated mathematics and ever-increasing computing power think they will. Sometimes the safest and best-looking investments turn out to be the riskiest due to investor herding and vice versa. Such randomness can cause serious damage to an investor’s life savings.
So how do we take the randomness or luck out of your investment goals? Through proper diversification. While return is seemingly random due to the lack of information all investors have, risk is difficult but much easier to define. While it’s not impossible to eliminate luck buying several different investments who’s return is based on unrelated factors will significantly weakens its influence.
In our process, we take into account how each type of investment generates return and the dependants of achieving that return. We also calculate the mathematical relationship of each investment based on its past return profile through a correlation matrix. This helps us understand portfolio risk to help ensure you meet your financial goals.
We created a model that simulated 25,000 years of returns to test 2 portfolios using the average 25 year return of the TSX. The first with a concentrated portfolio with a risk level 2x the TSX and a diversified portfolio with a risk level ½ the TSX. All else was held constant including return.

25 year test period starting 1992 2x Standard Deviation (1/2) Standard Deviation
Chance to Outperform the TSX 28.10% 75.30%
Chance to Double Initial Investment 44.40% 99.40%
Highest Return 25 Period Return. $ 48,239,868.98 $ 2,362,635.98

As you can see, the riskier portfolio has a much lower probability to meet a particular set of investment goals. When taking care of your financial future we prefer the boring low risk portfolio that does not risk our client’s financial future versus a concentrated moonshot. While $48.3 million looks attractive, this represents a 0.1% probability.
So the ultimate question, what type of investments and how many different investments should an investor hold? This is a large component of our value add as a portfolio manager.
The general magic number of investment held according to a well-known study and touted by Jim Cramer is 30 , anything above that is “diversification”. This, as is most general rule of thumb investment knowledge a good guide but simply not true.
The real answer is more complicated. Anytime you add an investment that lowers risk while maintaining or increasing expected return is worthwhile. This ignores margin and transactions costs because both are not part of our discretionary program.
“Diversification” does occur when an individual purchases several investments without knowing what the impact of each investment has on a portfolio as a whole. The most common case is an investor who buys several equities, mutual funds or ETF’s without understanding what the underlying holdings or the market exposures are. When all of these funds or ETF’s are aggregated it’s likely they have high concentrations to market risks without even knowing it. This can lead to significant and sometimes irreversible losses that destroy your end financial goals.
Going forward we will constantly complete the painstaking process of analyzing our portfolios and testing their expected return, riskiness and return correlations to ensure your future financial success.

2. CURRENCY’S EFFECT ON YOUR PORTFOLIO

Hedging Versus Not Hedging

The Canadian Dollar increase

We would like to address the Canadian dollar rise of 9.6% against the US dollar along with the surge against other major currencies. At a high-level, the sharp increase is due to:

1) The overwhelming consensus was the Bank of Canada was expected to hold interest rates steady for the foreseeable future. As of 5 weeks ago, they surprised the street with bullish rate rise talk and completed the interest rate rise on July 7th.
2) Stronger than expected Canadian economic data despite low oil prices, record consumer debt and increased taxation.
3) President Trump and the US are in a political mess. The healthcare failure, Russian scandal and all the other negative issues continue to plague the government’s ability to function. The administration is too busy putting out fires to focus on taxation, regulatory and all the other economic reforms that were expected to be good for the US economy.

Why leave a portion equities unhedged

At Morrison & Partners, we leave a portion of the equities held exposed to foreign currencies. There are several opinions on whether to hedge or not hedge fully. We have chosen to not hedge primarily because:

• In some cases, it is impractical to hedge. This is especially true with developed market, global and emerging market funds. These funds do not offer hedged versions. If we tried to overlay a hedge the cost would be astronomical and likely incorrect because positions in any one of the currencies held changes on a daily basis.
• There are hedging trade and contract costs that add up over time to significantly reduce returns.
• If held over the long run currency effects generally wash out and hedging causes you to lose a level of diversification.

A secondary reason is the general impact currency has on underlying equity investments. When the Canadian dollar rallies, it can cause Canadian companies to become less competitive reducing earnings. This creates negative impact on the share price of most Canadian equities. The opposite is true for US equities held. When the US dollar is weak, they become more competitive and earnings increase. This is a positive contributor to US equity share price. Gains and losses on equity help to wash out currency changes over the long run.

Quantifying effect on our Balanced Portfolio

Unfortunately, when the Canadian dollar has a steep rally it harms the short-term performance of our portfolio due to being unhedged.

For example in our balanced portfolio, we have total unhedged currency exposure on 39% of the portfolio. Other strategies have varying exposure depending on risk level. Of this 39% exposure:

• Approximately 21% is tied to the US dollar equities creating a negative headwind against our performance of 2.02%
• Approximately 10% is tied to the Euro equities which is has lost value of 3.0% creating a negative impact of 0.30%
• The remaining 8% is tied to Asian equities which for simplicity we will use a blend of 50% Japanese Yen and 50% Chinese Yuan. This blend lost value of 6.88% versus the Canadian dollar creating a headwind of 0.55%

In total, the strengthening Canadian dollar influenced our balanced portfolio by approximately -2.87% in the last 5 weeks. Despite this negative currency headwind, we continue to outperform the TSX and our benchmarks across every strategy we run. The equities we hold either individually or through funds continue to perform very well giving us strong returns based on investment selection.

Conclusion

It is our view that diversification of currencies is beneficial and short-term movements like the Canadian dollar strengthening should wash over the long term. Trying to time the currency market in our opinion is a fool’s game that leads to under-performance.

We will continue to focus on creating well-balanced diversified portfolios and our strong investment selection process. Our goal it to help you meet your financial goals over the long term despite a few bumps along the way. If you have any questions or want to discuss the currency impact, further please contact one of our portfolio managers.

3. ALTERNATIVE AND MARKET UPDATE

Alternatives Strategy Helps Outperform Broad Indexes

In the last nine months, we have fully deployed our enhanced diversification investment strategy utilizing an additional asset class of investments called alternatives.

Noble Prize winning research from Harry Markowitz was behind our reasoning to include this additional asset class. He is the architect of the Modern Portfolio Theory that proves you can minimize risk and maximize return by diversifying your investments. Armed with this research we are shaping your portfolios to push returns higher for a set amount of risk taken. As a trade-off, since nothing is free in the market a balanced portfolio will underperform a strong year in the equity market.

In the past diversification for retail investors was some sort of split between equities and bonds. The general rule of thumb is equities provide higher return and risk while bonds provide low return but are low risk. This thinking is outdated and many advisors and retail clients unfortunately still use this outdated method as discussed below.

Alternatives in Action

Not only did we do the theoretical research but we also used several real world examples to sway us towards this investment style. Here are two examples:

Yale
Led by David Swenson the Yale Endowment fund moved beyond the traditional equity and bond portfolio in 1985. At this time, public equity and bonds together accounted for 90% of holdings. By the end of 2016 under Swenson’s lead together, they only represent about 25%. Bonds were less than a 10% allocation!

A study showing what would happen if Yale used the traditional 60% public equity / 40% bond allocation instead of the enhanced alternative diversification strategy is shocking. If Yale had not gone to the alternative method endowment payouts to students would have been $28 billion LESS over the last 30 years. Not a small number considering the TOTAL endowment fund was valued at $25.4 billion at the end of 2016.

Canadian Pension Plan
In 2000 the Canadian Pension Plan was allocated to 95% fixed income and 5% equities. It was no secret changes were required to fully fund Canadians future obligations. The decision was made to follow the same type of path as the Yale endowment to increase return while keeping a low risk profile to protect all Canadian’s future.

By 2016, the allocation had changed to 15% traditional bonds and 31% in public equities. The remaining 54% allocation went to alternatives. The CPP has been growing steadily using this high allocation in alternatives. In 2016 income for CPP was $9.1 billion versus $5.2 billion in addition to contributions from all Canadians. In a press release directly from the CPP stated much of this banner year was attributed to private equity and real asset investments.

How has the market done?

Despite what you hear in the news about record stock prices real returns have been muted for Canadians. In the first 9 months the:

Canadian Universe Bond Index returned 0.07%
Toronto Stock Exchange (TSX) has returned 2.27%
S&P500 returned 14% in USD terms but in Canadian Dollar terms only 4.94%

Going forward we do believe the market is due for a pullback or pause for several reasons:

1) The bull market is old and it feels like we are in or near the last inning. Nothing says it cannot continue but we know it has to end.
2) Valuations are elevated based on all common valuation metrics such as price to earnings, price to free cash flow, price to book value and so on. Classic bubble readings historically.
3) Sentiment is extremely bullish as measured by the Fear and Greed index . History tells us irrational exuberance is a hallmark of a downturn.
4) Volatility (risk) metrics are at 23-year lows and in September alone overall volatility was the lowest on record . This tells me that investors are dangerously complacent.

Despite the fact we expect a pullback we are not attempting to time the market because there is significant danger in lost opportunity. Instead, we have positioned our enhanced diversification portfolios to capture most of the upside if this bull market continues. You can see this in our results so far this year. If a pullback does occur, we expect to outperform by protecting your hard-earned capital on the way down and then enjoy the returns subsequent as the market moves back using the same methodology as Yale and the CPP.

How are we doing?

Returns in 2017 have been strong despite low return of both bonds and equities. Across all mandates our portfolios return has been steady and greater than our performance benchmarks.

Out-performance in 2017 has been attributed to several alternatives that have worked exactly as expected to give clients steady bond like returns. We also decided to continue being overweight in US equities. Unfortunately, the sharp rise in the Canadian Dollar created some poor results late this summer, but overall for the year is has been a strong allocation choice since it is the best performing out of the three indices above even after the Canadian Dollar headwind.

Detracting from return was our choice to add Canadian energy equity exposure. Energy has lagged the market losing 14.02% in the first 9 months of the year. Despite headwinds in energy, we believe there is great value in the sector for the long term. This can be seen with our energy holding in Canoe Energy Income raising 8.36% alone in September. The other detractor has been our alternative selection of Fiera Long/Short -11.68% and Market Neutral -6.21% . Similar to picking equities you can do all the right due diligence but future expectations are not guaranteed. We are interviewing managers to find a replacement to maximize return to our clients.

Conclusion

We are excited about our new strategy and the performance it has brought so far this year against the broad market. Going forward we will continue to reassess and make enhancements as needed. We will do our best to provide you with more stable strong returns in the future.

This information has been prepared by Bruce Morrison who is a Portfolio Manager for HollisWealth® and does not necessarily reflect the opinion of HollisWealth. HollisWealth® is a division of Industrial Alliance Securities Inc., a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered. Morrison & Partners Wealth Strategies is a personal trade name of Bruce Morrison. For more information about HollisWealth, please consult the official website at www.holliswealth.com. >