October 2016

Defense Wins Championships

• Avoiding herd mentality
• Down market ratio
• How we’re working to add value

We’re getting back into football season and like in sports defense is instrumental to investment success. Also, like in football defense is not sexy and usually an afterthought, which is a huge mistake. It’s easy to get caught up in market sector bull runs and water cooler talk about large payouts from a lucky winning selection. Telling people you’re earning a stable annual return on a risk adjusted basis with a diversified portfolio is not exactly a story anyone wants to hear.

Falling into the trap of feeling like you’re missing out on returns or a trade can be emotionally hard. This is a major topic in behavioral finance known a herding and it been hardwired each and every one of us through evolution. This instinct can lead people to irrationally abandon well thought out long term strategies and pile money into the newest investment trend. These hot trends are often misunderstood and much higher risk than expected.

Herd-following investors are known for entering a trade to late and losing money once the smart money leaves. A well-known example of this is the “dotcoms” bubble that occurred in the late 1990s, investors allocated huge amounts of money into companies like without a sound financial business plan. They assume it’s a good trade since everyone is doing it. They are also known for selling out unfavorable strategies before they rebound and offer returns. This leads to a constant cycle of buy high and sell low that many people fall into.

When we talk about defensive portfolio there are several metrics we look at such as asset class and geographical diversification, asset correlations, volatility, valuation and portfolio turnover. The result of focusing on the above metrics is a favorable and down market ratio.

Down market ratio is the percent of participation to the downside in negative market return period. It is very important to follow because investment base erosion has a massive impact on future return. After losing 50% you need approximately 7.25 years of stable 10% returns just to break even. Definitely not a position anyone wants to be in!

Below I focused on how a $100k investment fund that participates in 85% of the upside of market but defends the portfolio with a down market ratio of 60% during negative periods in relation using the S&P500.

SP500 total return

A $100k investment in just the S&P500 over the last 15 years would have ended at $207,993. A defensive fund that gives up 15% of the upside to protect the investment base over the same period would be worth $242,434. This is a difference of $34,441 or 16.6%. On the initial $100k investment it’s a 34.4% difference of return.

By taking advantage of defense in our portfolios we are able to add value over the long term. We are executing this by:

• Thoroughly vetting investment fund managers and looking at how funds and other investments move in relation to each other in a variety of situations
• Holding a diverse group of investments and actively avoid the herding mentality even if it means holding good investments that are currently out of favor
• Continued stress testing of our portfolios using advanced 3rd party software to ensure efforts to give you strongest risk adjusted return are verified

While playing defense in your portfolio and earning boring steady returns may not be favorable with the short term herd followers, we believe that it can provide superior result over the long term. You also get the added bonus of having peace of mind in times of turbulence.

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. >