Veritable Wealth Update - 2021 Q1
Riding the Roller Coaster
As we push into the second year of the COVID-19 pandemic, it feels frustrating we do not know when it ends. We want the pandemic roller coaster to pull into the station and allow us to resume previous lives, or something close to them. Vaccine approval peaks gave way to messy vaccine distribution valleys. Highs from reopened shops and restaurants were erased by the quick spread of a dangerous variant. An exhausting ride.
Exhaustion comes from constantly changing expectations on how our world will unfold. We go from a belief there is no end in sight to one where the end is near, and then back again, and back again. We make plans, cancel, and remake them. These past weeks, I cannot figure out if my daughter’s school is open or closed. Uncertainty is hard on the soul. We want answers. We look to the media and experts for help and learn, once again, no one knows what is going to happen.
Financial markets are no different. They spent the beginning of this year struggling between excitement of a multi-year economic recovery and fears of seemingly high asset prices and hangover effects from massive government support programs. For equity markets, excitement had the edge over fear. World equity markets returned 4% during the first three months of the year. Re-opening excitement overly benefited Canada’s TSX which has larger exposure to Financials and Energy sectors as compared to global markets. It returned 8%. Fixed income markets are tougher to read as expectations of a stronger economy, a positive, and expectations of high inflation, a negative, both result in higher interest rates. With bond prices inversely related to rates, global bond markets fell over 4% and Canadian bond markets fell over 5%.
For the first quarter of the year, Veritable Funds continued to produce the type of stable returns we expect. The equity-focused Pillar Fund returned 2.7%. The income-focused Foundation fund returned 1.0%, avoiding the downdraft created by rising interest rates. To make our discussion easier, I refer to the Fund as a combination of Pillar and Foundation, which is how they are mostly used. When specificity matters, I will refer to Pillar or Foundation individually. See your account statements and talk with your advisor to understand your family’s personal returns.
Given the balance the Fund maintains across asset classes and geographies, over any time period there will be some markets that return more than the Fund and other markets that return less. We do not chase the highs to avoid the lows. Chasing returns requires making significant bets on a specific outcome of an uncertain future. Dazed by the speed and intensity of the pandemic, its easy for people and markets to forget that clarity about the future has always been an illusion.
Uncertainty Solution #1 - Process
The world may be uncertain but decisions on spending, on savings, and on where to invest those savings are not optional. Successfully managing through an uncertain world requires making quality decisions. The outcome of a single decision may be good or bad, but a quality decision-making process tilts the playing field in your favour. With repeated use of that process the tilt is enough to guide you to your goals. In his recent memoir, former U.S. President Barack Obama discusses the importance of a sound decision making process.
My emphasis on process was born of necessity. What I was quickly discovering about the Presidency was that no problem that landed on my desk, foreign or domestic, had a clean 100% solution. If it had, someone else down the chain of command would have solved it already. Instead, I was constantly dealing with probabilities. A 70% chance, say, that a decision to do nothing would end in disaster. A 55% chance that this approach versus that one might solve the problem, with a 0% chance that it will work out exactly as intended, a 30% chance whatever we chose would not work at all, along with a 15% chance that it would make the problem worse.
In such circumstances, chasing after the perfect solution led to paralysis. On the other hand, going with your gut too often meant letting preconceived notions or the path of least political resistance guide a decision, with cherry picked facts used to justify it.
But with a sound process, one in which I was able to empty out my ego and really listen, following the facts and the logic as best as I could, and considering them along side my goals and my principles, I realized I could make tough decisions and still sleep easy at night, knowing at a minimum that no one in my position given the same information could have made the decision any better. – from ‘A Promised Land’
How we invest your capital will not land on the desk of the President or Prime Minister. It is still of critical importance. If world leaders can sleep easy at night, you should be able to as well.
Inside Veritable, we are building fact-based and probability aware investment processes. This removes personal biases and hopes. We lay out long term returns for asset classes and study how often they have done well and how often they have not. We map the economic forces that drive returns and question how those forces may change. We test combinations of asset classes and review how likely their returns move together, move in opposite directions, or have no relationship whatsoever. And when we hire investment managers, we seek those who have proven their capital allocation processes to be effective and repeatable within their markets of expertise.
Uncertainty Solution #2 - Diversification
An honest investment process prevents overconfidence. It reveals that behind carefully calculated averages lie a wide range of results, with some assets having wider ranges than others. Seeking to construct quality portfolios, our investment process reveals its most important result: an uncertain world requires diversification.
By investing in many asset classes in many geographies, the Fund is exposed to many economic forces. Through investment partners with global reach, Veritable portfolios own equity in companies, those that trade on public stock exchanges and those that are private enterprises; they make loans to companies, buying bonds on public exchanges and making loans directly to private companies; and they own hard assets like real estate and infrastructure. When some economic turbulence cause one of the asset classes, strategies or countries to struggle, we expect the unrelated parts of the portfolio to continue untroubled, creating stability.
The stability of returns within our Veritable funds’ return profile can be measured by their volatility. Volatility considers the ranges of returns around their average value. Since their inception, a combination of our Foundation and Pillar funds has half the volatility of a global 60% equity and 40% bond portfolio. Given Canada’s exposure to cyclical financial and energy sectors, our funds have one third of the volatility of a Canadian focused 60% equity and 40% bond portfolio.
Volatility matters. Lower volatility investments are more likely to generate their expected returns, increasing the likelihood of success of a financial plan. Higher volatility investments are more likely to see significant drawdowns, which put a financial plan at risk. Following a large loss, a rebound of a high volatility investment may not occur before the capital is required. Importantly for volatility, the whole is less than the sum of its parts and return is not wholly sacrificed in a drive for stability.
Critical and Required Assets
Consider the inflation concerns plaguing traditional bond returns. Inflation is bad for fixed-rate bonds. Rates rise and prices fall. To mitigate this risk, the Fund owns bonds short in maturity or with adjustable rates. More important than lowering the impact of inflation on the portfolio’s bonds is the inclusion of assets in the portfolio not fragile to inflation. The Funds owns assets that do well during inflationary times. Many of these are hard assets like real estate and infrastructure. These are land, buildings, and systems critical to the way people live and required for a nation to function.
A significant portion of the Fund’s real estate is Canadian apartment buildings. Through investment partners, the Fund owns a portion of 440 apartment buildings housing 21,000 families and students. The buildings are in 41 cities and towns spanning from Victoria to Dartmouth. They range from multi-hundred-unit buildings near urban centers like Edmonton, Montreal, and Toronto to 25-unit buildings in rural areas like Brighton ON, Brooks AB, and Prince Albert SK.
As inflation increases, rents increase. The increased rental revenue supports returns generated by the apartment buildings. Considering rents rise each year and the fixed-rate mortgage on the property resets every fifth year, real returns may even increase. Canadian rental apartment buildings are particularly attractive. Canadian rental markets benefit from strong demographic forces, an increasingly unaffordable housing market, and limited supply growth.
Similarly, infrastructure assets are essential services where price increases are passed on to customers. These assets have regulated long-term contracts to keep our communities functioning by generating electricity, treating water, or transmitting data. The Fund owns 12 solar energy farms across the U.S. generating 770 megawatts. It owns a regulated U.K. water company providing wastewater treatment for 14 million people around London. In Spain, the fund owns over 500 kilometers of fibreoptic cable linking the Balearic Islands with the mainland. The revenue these services generate are linked to GDP, energy costs, or directly to inflation measures. As revenue increases with inflation, real returns remain stable.
Preparedness and Continued Optimism
By bringing all these different assets together, the portfolios become robust against all economic environments. As the uncertain future rolls through to the certain past, we update our data, learn as much as possible, and follow our investment processes to continually improve. We have a great responsibility to deliver your family to its financial goals, regardless of the roller coaster we are on today or any economic ride that lies ahead.
The optimism I spoke about in my last letter for COVID vaccines continues. It has become a frustrated optimism due to their lack of availability. But the data is clear, they make a big difference. Today’s experiences are intense. Soon enough they will get lumped into yesterday’s memory pile. Please accept today’s pain of the lock down and do not discount the value of getting to tomorrow in the best health possible.
Best safe, be well,
Chief Investment Officer
Aligned Capital Partners Inc. is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). Advertised performance is net of all fees associated with the fund. The indicated rates of return are the historical monthly returns including changes in unit value and reinvestment of all distributions, as of December 31, 2020. The Fund’s past performance is not necessarily an indication of how the Fund will perform in the future. For current performance information, please contact Aligned Capital Partners Inc. Important information about the Fund is contained in the offering memorandum which should be read carefully before investing. Performance numbers are unaudited and based on information we believe to be accurate; Aligned Capital Partners Inc. makes no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained in this publication. All investments involve risk, including loss of principal. Content is for informational and reference purposes only and shall not be construed to constitute any form of investment advice. Content does not take into consideration the investment objectives, financial situation, or specific needs of any particular person. Any information is not to be relied upon in substitution for the exercise of independent judgment. Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. Nothing herein shall constitute an offer or solicitation to anyone in any jurisdiction where such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such a solicitation. Content may not be reproduced or copied by any means without the prior consent of the author and Aligned Capital Partners Inc. Content is subject to change without notice.