February 2017

Positioning Going Forward

• Current Market View
• Risk Reduction
• Opportunistic Approach

Current Market

Everyone can agree that Donald Trump is a wildcard for the markets but so far has been astonishingly positive. However, all it takes is a late night tweet or a rush executive order to create significant uncertainty. As history tells us uncertainty will cause the market to sell down. In addition to Trump the risk surrounding Brexit, the elections upcoming in Europe and heightened corporate bond default risk in China are all creating a recipe for volatility.

Strangely so far the market volatility index (VIX) which tracks the riskiness of the equity market using option contracts is trading at extremely depressed risk values. The higher the VIX the more risk there is in the market. As of Friday the 27th it was at 10.58 which has only been breached 16 times in the last 10 years. 14 days in 2007 and 2 days in 2014. For reference the average VIX value in the last 10 years is 20.7 . It appears that investors are being very complacent with a lot of risk facing them. This generally doesn’t end well.

Fixed income traditionally has been used as the counter balance to equities but there has been an increasing correlation between bonds and equities that is troublesome. The diversification usefulness of bonds is not working quite as well as in the past. Traditional bonds are expected do ok in 2017 but are still vulnerable to rate rises and are likely to earn negative real returns after factoring in fees and inflation. To give our clients a stronger positive real return we have moved funds towards fixed income alternatives. We are also holding steady with the Pimco Monthly Income fund. Pimco has successfully executed their go anywhere to generate alpha strategy and was ranked the 4th best performing bond fund in its category for 2016 .

We now have positioned the portfolios in a defensive stance that is expected to both protect capital in the case of a market crash and participate fairly well to the upside. It will also allow us to be more opportunistic in a volatile market.

How we Approached Risk Reduction

1) Portfolios now have a full Alternatives allocation that is expected to retain full value in the event of a market downturn because returns from the alternatives generally come regardless of what the equity market or bond market does. We expect the return from these alternatives to fall between 6-7% based on historical data.

2) Equity picks made while not infallible are in companies with significant earnings, lower valuations and strong balance sheets. We are not investing in companies that are being valued on revenue growth in the absence of earnings and cash flow. If volatility picks up investors tend to sell speculative names and position themselves in companies with solid earnings.

3) Significant time was spent calculating how each portfolio component interacts with other selections in the portfolio so we could optimize an efficiently diversified portfolio.

How we Plan to be Opportunistic

1) Learning from several of the last pullbacks, if the S&P500 declines 10% in 2 weeks we will do an assessment and sell ½ of liquid alternatives held to buy equities. If S&P500 declines 20% in a month we will sell the other ½ of liquid alternatives to buy equities. Selling alternatives that retain 100% of their value during a downturn will allow us to buy low and sell high to generate alpha on volatile rebounds. Testing done on prior pullbacks shows this strategy would add significant value.

2) Currently we are unhedged to the US dollar in our equity investments. We will switch from unhedged to hedged versions of our investments as the dollar moves from the high end of our projected range of 0.76 (current value) to 0.70 CAD/USA. We believe the US Dollar should appreciate against that Canadian Dollar for 3 main reasons:

a. The US increasing its federal funds rate up to 3 more time for a total of 0.75% versus the Bank of Canada holding its rate steady. If the US treasury offers a higher rate of return demand for the US dollar increases because investors need to buy US dollars to purchase the higher yielding treasuries.
b. Real GDP growth rate in 2017 projected to be 2.3% in the US whereas Canada will be 1.9% . This creates demand for US dollars as investors buy local currency to invest in the country with higher projected growth.
c. Protectionist Trump policies are expected to increase the value of the USD according to several economists.

3) We completed a Monte Carlo simulation testing a ruleset that allows us to sell investments to maximize overall realized gains and cut investments that are not performing as expected. We are excited to continue using this ruleset to take emotion out of the equation in investments we hold.

After 7 months of diligent work we have finished cutting through several layers of compliance and regulations to implement what we feel is the best portfolio possible for you the client. We believe by year end our unique offering of alternatives and opportunistic strategies will deliver you the client a strong risk controlled return.

This newsletter was prepared solely by Bruce Morrison who is a registered representative of HollisWealth™ (a division of Scotia Capital Inc., a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada). The view and opinions, including any recommendations, expressed in newsletter are those of Bruce Morrison only and not those of HollisWealth. TM Trademark of The Bank of Nova Scotia, used under license. Morrison & Partners Wealth Strategies is a personal trade name of Bruce Morrison. >