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10/23/2020


A look at recent market performance and what might be ahead of us

The CSS Pension Plan does not intend the information in this article to be relied upon as professional advice, and expressly disclaim any liability for its contents. For assistance or advice, contact us to talk to a CSS Pension Plan Consultant or contact a qualified financial advisor at your credit union or financial institution.

In the Spring 2020 issue of TimeWise, we discussed the roller coaster behaviour global financial markets were demonstrating at the time. In May of this year we hosted a webinar discussing retirement income and investment considerations in the face of the COVID-19 pandemic. And, during the last week or so of the first quarter and throughout the second quarter of 2020, CSS staff fielded a very high volume of calls from members looking for information and assistance on what they should do with their CSS holdings to ward off the impacts of the pandemic. At that time, we were all painfully aware of the impact COVID had on global financial markets and our CSS investments.

What a difference a few months has made! Global markets have largely recovered their losses from late March, and some stock indices have even achieved significantly higher valuations at the time of writing (mid-September) than they were at the start of the year and pre-COVID. On the fixed income side of things, yields have continued to fall throughout 2020 leading to significant positive returns year-to-date (YTD), generally, for bond holders.

Members holding the CSS Bond Fund have been beneficiaries of falling market yields in 2020 (the Bond Fund YTD return was 6.92% as at September 17, 2020).1 The YTD returns for the Equity Fund and the Balanced Fund, however, are in the negative single digits (-2.65% for the Balanced Fund and -7.88% for the Equity Fund YTD at September 17, 2020). Given the amount of positive press we’re hearing about how markets have recovered and, in particular, how well some technology stocks seem to be doing, why is it that our funds with equity exposure are achieving negative YTD returns and appear to be underperforming when compared to market indices?
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Asset mixes as at December 31, 2019

1 Caution: Bonds have an inverse relationship to interest rates. When interest rates fall (as has been the case recently), bond prices rise, and vice-versa. The significant recent positive returns of the Bond Fund may not be sustainable given where market interest rates are at today so caution is warranted if considering investing in the Bond Fund based on the recent returns of the Fund. As always, we recommend you consult a qualified financial advisor before making changes to your investment funds.

INVESTMENT PHILOSOPHY

Before digging into our recent performance, it is important to understand how and why CSS approaches investment portfolio construction as we do. There are a number of core beliefs at the heart of CSS’ investment activities. These include:

  • Member outcomes are paramount – our investment activities are conducted with a view to helping members achieve their goals over the long term
  • To achieve a return that is expected to support a reasonable retirement accumulation requires taking on investment risk 
  • Diversification of investments is key to managing investment risk
  • We utilize a disciplined and patient approach to investing and we take a long-term view to our investment strategies and in assessing results

We also believe that an understanding of what investment principles and strategies have worked (and not worked) historically provides our members with the highest probability of success in the future. That has led us to build our portfolio targeting the factors that have been proven through academic and empirical research to contribute to successful investment outcomes, over the long term. These factors include:

  • Value – investing in stocks that are “cheap” or less expensive based on a variety of valuation metrics
  • Quality – companies that utilize less leverage, achieve higher returns on equity, and have strong balance sheets
  • Low volatility – lower risk of extreme stock price movements
  • Size – smaller companies rather than larger
  • Momentum – stock prices that have performed well in the recent past

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CSS is a fiduciary and our members’ best interests are at the core of what we do. In constructing our portfolio, we are very cognizant that we are investing our members’ retirement savings and these savings are needed to provide financial security to our members in their retirement. Our overall investment objective is to achieve outcomes for members that exceed the market risk/return profile, over the long term, while effectively mitigating against permanent capital losses.

For these reasons, while we target all five factors noted above, we bias our portfolio construction toward the value, quality and low volatility factors. These factors are well suited to a typical defined contribution pension plan investor because they tend, on average, to provide an investment return profile that protects on the downside, recovers from lows faster than the broader market, and have lower volatility than the market.

RECENT MARKET EXPERIENCE


Over the past number of years, certain growth stocks (or glamour stocks as they are sometimes known), which tend to primarily capture the momentum factor, have outperformed value stocks and the general market overall. The margin of outperformance of these stocks has only intensified recently during the COVID-19 induced recession and subsequent recovery.

In particular, the technology sector and technology-like stocks have been star performers as of late. In the U.S. equities market it has been the FAANG+M (Facebook, Apple, Amazon, Netflix, Google, Microsoft), some of the largest weighted stocks in the S&P 500 index, which have dominated. In Canada, the technology sector leader is Shopify, which has recently become the largest capitalized stock in the Canadian equities market.

Facebook, Amazon, Apple, Google, and Microsoft, which are over 20% of the weight of the U.S. index, have returned approximately 35% YTD (as of August 2020), whereas the remaining 495 stocks in the index were in the red YTD. Shopify is up over 150% YTD while the rest of the TSX 300 is down approximately 5% YTD. Given our portfolio biases and core beliefs noted earlier, our investment strategies have not captured the recent added value in this narrow sector of the market.

If you believe as we do, that history may have lessons to teach us, it is important to note that over the last 100 years value stocks have outperformed growth stocks by four times despite their significant underperformance in recent years. While it’s possible that “this time is different,” an opinion shared by CSS and its external investment consultant is that we have yet to see convincing academic and empirical research and data that leads us to believe that we should be dramatically changing our investment philosophy and strategies.
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SPEAKING OF HISTORY

Although we do not know what the future will hold, we do know that history does have past periods with some similarities to the current market’s characteristics and investor behaviour. The Tech Bubble of the early 2000’s and the “Nifty Fifty” market in the 1970’s come to mind. The “Nifty Fifty” was a period where blue chip stocks with high growth characteristics (think Polaroid, Xerox, McDonald’s, Coca-Cola, IBM, and JC Penny) became investor favorites, as most believed they were a “sure thing.” This behavioural bias amongst investors of the day drove prices of these “can’t miss stocks” up to 2X the ratio of the broader market. In 1973 these stocks crashed with some of the names falling 60% to 80%, dragging down the S&P 500 39%. A number of the stocks took over 10 years to recover to their previous price highs.

The Tech Bubble of the late 1990’s is a similar story as internet stocks became the market darlings and investor’s fear of missing out (FOMO) drove these stock prices up 165% more than the broader market. The tech sector accounted for one third of the S&P 500. When the bubble burst the tech sector collapsed by about 80% from its peak and drove down the broader market by 49%.

Keep in mind that the current situation is a health crisis brought on by a global virus that currently has no effective vaccine or treatment. So, from that perspective, our current situation is different than past markets and it’s anyone’s guess how markets will behave in the coming months and years. Nonetheless, we believe there are lessons to learn from these past markets, and we believe that we should be wary of the concentration risk that is currently present.

WHAT ACTION IS CSS TAKING

While current market conditions and recent performance of our equity-exposed funds certainly has our attention, in short, the core action CSS is taking is to stick to our long-term plan. This includes:

  • Ongoing monitoring of the performance of our external asset managers
  • Continued evaluation of the underlying reasons for our negative performance variance to market benchmarks
  • Periodic analysis of long-term return projections of capital markets (provided to us by our external global investment consultant and other global investment houses) and, where warranted, asset allocation changes to improve the probability of meeting our long-term objectives
  • Periodic portfolio studies (a study is being conducted in 2020) to maintain a well-diversified portfolio that is expected to outperform in the longer term, even though it may underperform in the short term
We can appreciate that being different than the market (for example, being underweight the high-flying stocks of the day in our equities portfolio) can feel awkward, stupid, and downright wrong in the short term, however, our objective is to achieve better than the market risk/return profile for members over the long haul. Without compelling evidence to suggest that our core beliefs and investment philosophy described earlier is wrong or is no longer applicable to a defined contribution pension plan, we believe our best course of action is to stay disciplined.

SOME CONCLUDING THOUGHTS

While most equities markets have recovered from their lows in March, it is important to recognize that there is currently a lot of uncertainty about what will occur in the coming months and years. Equities market valuations do not currently appear to be “in synch” with general economic conditions. In most countries, governments have stepped in with significant fiscal stimulus and assistance for individuals, small businesses, and communities. Unemployment rates are high, GDP has been significantly curtailed, debt levels at the individual, business and government levels are elevated. And, it is still too early to fully understand what long-term impacts the pandemic will have on global economies. It is quite plausible that we could see another market drop or correction in the short term if the ill-effects and uncertainty of COVID carry on for some time.

Members close to retirement, in particular, should be thinking about how to position their CSS holdings to protect against short-term market downturns as this could significantly impact their retirement plans. As always, we recommend contacting a CSS Pension Plan Consultant or qualified financial advisor for assistance with your own individual circumstance. From our perspective, one of the best courses of action is to have a plan and to stick to it.

Article from the fall 2020 issue of TimeWise.