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2007 so far.


“There is always free cheese in a mousetrap.” – Arnold Wood.

With Canadian markets on a five year run, the pressure on a global investment manager to over-invest in Canada has increased.

Recall 1999. Canadian managers were under extreme pressure to own technology stocks. Some didn’t and were fired. Then, from August 2000 to September 2002, the Canadian market dropped 45%.

In the US, investment manager GMO avoided the technology and telecomm bubble but lost 1/3 of their assets to competitors. Former clients then watched the US market drop 42%.

Markets can and do correct.

“Look for extremes.” – Paul Balfour.

Global investment markets have performed well above average for five years. To average, markets must sometimes be below average. What’s likely to be next?

Interest rates and earnings drive markets. Note the rising interest rates and peaking corporate earnings in the background.

“Markets have a history of rewarding conservatism.” – Wilfred Hahn.

One of the benefits of being a globally diversified portfolio manager is that, because we are so diversified, we are always approximately right and never precisely wrong.

So far this year, short term bonds, higher than normal cash balances, Asian bonds and not holding corporate bonds, have all served us well. Gold and US cash, not so much. To capture now higher bond yields, however, we can (soon) reinvest cash balances.

The benefits of diversification are not just theoretical. Global markets are not always in sync. They follow different cycles. This allows diversification across asset classes, regions, currencies and sectors. Reducing or increasing exposures has delivered moderate, positive performance.

Increased does not mean 100% exposure. Reduced does not mean zero exposure. Adjusting exposures – within a range – ensures that a client remains exposed to longer term trends while reducing exposure to overvalued markets. The limits of the ranges make a client’s portfolio more predictable.

Not very exciting but prudent.

One of the best tools a portfolio manager has is the discipline of his investment processes. Critical in 1999. Critical now. With the noise level increasing, it is easy to sway from but critical to stick with the daily drudgery of the processes that have delivered a decade’s long track record of reasonable returns with little volatility.

Central to our discipline is the question of risk. Rather than bullish or bearish we simply focus on opportunities but not without considering the risks. This can mean being temporarily wrong.

One of the best tools an investor has is investment policy. When he crafts his policy he can then predict the range that returns are most likely to fall within. He also knows that markets can be volatile – both up and down. The unknown is his short-term appetite for risk. This is why the risk tolerance conversation is so critical – before, not after markets correct.

We would rather maintain a defensive posture for our client’s money and continue to deliver moderate, positive performance than have to explain participation in any market correction.

Originally published in the Business Thompson Okanagan news, August 2007.

Doug Cronk CFA is Manager, Investments for a Canadian Pension Fund.

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