Strategy Dashboard:

A Phased Pandexit

Q3 2021

We continue to hold to the view that the major economies have entered the second phase of a global reflation cycle, though some like China have fallen back to a more normalized pace. As with any transition — a gear shift — some slippage occurs. Between gears sprockets, power is temporarily disengaged. Exactly that seems to be playing out globally at present. Also, post-Covid economic recoveries have been very uneven.

We also must acknowledge that many trends and developments at this time border on the surreal … at least that is the case for our investment policy committee with a collective 150-plus years of investment management experience. In some sectors, there exist high levels of speculation and certain assets are “bubbly.” But the surreal can last some time … in fact, especially so when policymakers may want these conditions to last in order to defer economic challenges down the road.

Asset managers are indeed dealing with new factors — new understandings. Yes, one must be very careful about claiming that “things are different this time”. However, new records do occur frequently, as we expect will be the case at the upcoming Summer Olympics in Japan. Weather records also occur often. As such, we are of the opinion that new thinking and new perspectives are needed presently.

Viewing the globe, we note a very unusual situation — most likely attributable to the post-Covid rebound. For the first time on record, developed nations have been growing faster than global GDP growth. And global growth is currently faster than that of emerging countries. This must resolve itself in one way or another. What will be the likely outcome?

Here we must consider the implications of longer-term developments and structural factors that we identify. We must anticipate that economic interventions and temporary boosts will find themselves out of runway for one reason or another — eventually. As always, we try to ground our portfolios to longer-term themes and developments. According to the Bank of International Settlements, the developed world has impaired long-term growth capacity.

Furthermore, we observe several ongoing debates that remain unresolved. The most critical of these is the question of future inflation trends. Expectations are widely divergent. Which will it be? This is one major reason why we choose to take a barbell approach. This allows us to better manage the risks.

All in all — considering the economic gearshifts, unanswered questions, and the surreal conditions — we have become moderately more cautionary. We continue to maintain that equity returns will outstrip that of fixed income over the interim to longer-term.

We next lay out our major strategies shifts for this new quarter.

CASH AND CURRENCIES

Adding to cash overweight

  • The primary theme of this quarter’s changes was to broaden diversification and hedge risk amidst a transitioning economic environment fraught with uncertainties.

  • Despite inflationary concerns, cash remains a critical buffer during such periods, in which financial markets tend to experience bouts of turbulence.

  • Net cash (and equivalents) exposure remains overweight in client portfolios and has been increased this quarter.

Unhedging foreign currency exposure

  • The Canadian dollar has been one of the world’s top performing currencies of late, as the pro-cyclical currency has been an outsized beneficiary from reflationary tailwinds.

  • At present levels, the loonie has reached or surpassed our assessment of fair value versus most major currencies worldwide.

  • Accordingly, we have fully removed hedges on US dollar and European currency exposures this quarter.

GLOBAL EQUITIES

Maintaining overweight equity exposure

  • Similar to last quarter, the Forstrong Investment Management team must reconcile medium-term economic optimism against shorter-term financial market vulnerabilities.

  • While valuations have become frothy in a number of market segments, we expect corporate earnings to be supported by continued economic recovery and accommodative monetary and fiscal conditions.
  • Overweight equity exposure represents the inflationary side of the barbell strategy we have employed and keeps client portfolios aligned with a fruitful operating environment for corporations.

Scaling back cyclicality

  • While net equity exposure remains overweight, the composition of equity holdings has been shifted away from some of the more vulnerable pockets of the market.

  • Sectors and regions with relatively high leverage to global growth have performed strongly during the reflationary surge; in many cases overshooting their underlying fundamentals.
  • Overweight exposures including Canadian equities (which have been propelled by a significant recovery in energy companies) and US industrials have been trimmed in client portfolios this quarter.

GLOBAL FIXED INCOME

Decreasing fixed income exposure

  • Historically, fixed income (particularly long-term developed market government bonds) would offer an attractive offset against equity risk during a period of heightened uncertainty.

  • However, with volatility emanating from investors’ fixation on the timing of Federal Reserve tapering and punitively low yields negatively skewing the risk/reward dynamic, we prefer to seek out other options.

  • Fixed income exposure remains underweight in client portfolios and has been further decreased this quarter.

Shifting emerging markets (EM) debt exposure

  • EM sovereign bonds continue to be one of the exceedingly rare fixed income asset classes which offer positive real yields and decent credit quality (the majority of issuers have an investment grade rating).

  • While EM currencies can be volatile in nature, many are heavily undervalued versus the Canadian dollar (limiting downside risk) and offer attractive diversification benefits.

  • We remain overweight EM sovereign bonds, but have modified the composition slightly this quarter; adding to local currency debt and trimming US dollar-denominated exposure in income-oriented mandates.

OPPORTUNITY INVESTMENT HIGHLIGHTS

Buying Chinese bonds and Japanese yen

  • To counter-balance the overweight equity exposure on one side of the barbell strategy, we sought out asset classes which would bolster diversification and perform well if inflation were to undershoot consensus expectations.

  • In addition to raising cash levels, two asset classes that we identified for the role were Chinese bonds (offering an attractive yield and policy diversification) and the Japanese yen (oversold and possessing safe haven attributes).

  • Positions in Chinese bonds and the Japanese yen were initiated this quarter.

Selling mortgage REITs and Chilean equities

  • Mortgage REITs have recovered impressively since March 2020, as low funding costs, Federal Reserve MBS purchases and steepening yield curve expectations fueled gains.

  • While still fond of the economic drivers behind the asset class, we have elected to decrease exposure this quarter as the rally has pushed valuations into over-stretched territory.

  • Chilean equities were purchased with the view that a restoration of the asset class’ historical relationship to copper prices would help it recover from depressed levels.

  • However, after a sharp recovery, the investment outlook has been clouded by constitutional revisions which threaten to pivot Chile further away from the pro-business political environment than we initially expected.

  • Chilean equity exposure has been liquidated in balanced and growth-oriented strategies this quarter.

Gross-of-fees performance ($CAD) as of June 30, 2021. Returns for periods greater than 1 year are annualized.

Performance statistics for ETF Managed Portfolios are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Past performance is no indication of future results. A rate of return for one year or less is not annualized.
Portrait of David Kletz, VP & Portfolio Manager of Forstrong Global.

David Kletz

Vice President, Portfolio Manager

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