While equity markets are anxious about ongoing macro-economic pressures and trade tensions and Brexit uncertainty, Judith Chan remains conservatively positioned in the $38 billion in mutual fund assets spread across a range of portfolios at Scotiabank and its affiliates. With key indicators on both sides of the spectrum of market sentiment, Chan is neutral on the strategic direction of the portfolios.
“Market cycles don’t die of old age. Since quantitative easing years ago, the markets are flush with liquidity and that has driven a very long bull market cycle,” says Chan, lead portfolio manager at Toronto-based 1832 Asset Management, a unit of Bank of Nova Scotia. “We are still relatively constructive given that economic conditions remain resilient. There is low unemployment, wage growth is still positive, and there is strong consumer confidence. With interest rates staying low that’s very supportive of financial conditions, and risky assets.”
Chan notes that equities and bonds are expensive and there are drivers to keep them that way for longer. “But that [factor] alone is not a driver for a correction,” argues Chan, who was born and raised in Hong Kong and has worked in the financial services industry since she graduated in 1996 with a bachelor in economics from Vancouver’s Simon Fraser University. “There have to be changes in other factors. For example, the PMI [purchasing managers’ index] for many industrialized countries has turned below 50, which is a sign of contraction. That’s a material change compared to 15 months ago. We also expect company earnings to weaken, which will weigh on the markets.”
Estimation-evasive issues
What is more difficult to determine, says Chan, are issues that are complex and cannot be estimated. Trade and tariff wars, for instance, have long-term effects that are hard to calculate for their impact and the length that they may persist. “The full impact of tariffs cannot be fully estimated because trade patterns change,” says Chan, who oversees over 50 portfolio funds, including the $3 billion, gold-rated Scotia Partners Balanced Growth Portfolio Series F.
“Trade has a long-term impact. The negative aspects cannot be fully estimated. The ramifications for the individual companies [that we hold through various mutual funds] are hard to calculate at a high level. What is harder to estimate is investor confidence. Sentiment is driving short-term price movements. Volatility will definitely be high. But it won’t drive our investment decisions. They need to be based on fundamental valuations of the companies we invest in. Where we cannot use traditional valuation metrics to gauge [the companies] is what worries me.”
Chan and her team of three dedicated analysts in portfolio construction strive to ignore market “noise,” that often drives volatility which can be distracting. Instead, the team remains strategic and focused on staying disciplined. “We try not to over-react to short-term noise,” says Chan, who joined Toronto-based Scotia Securities Inc. in 2005 and helped to build the framework for the oversight of the Scotia mutual funds family. In 2010, Chan became lead portfolio manager of the Portfolio Solutions team. “Our managers invest from a strategic fundamental perspective.”
Scotia Partners Balanced Growth Portfolio has an asset mix of 40% fixed income, which is comprised of five funds such as Scotia Canadian Income Fund and Dynamic Total Return Bond Fund, and 28% Canadian equity, with six funds such as Scotia Canadian Dividend Fund and Dynamic Small Business Fund. There is also 32% in foreign equity, which includes nine funds such as Mawer International Equity Fund and AGF Global Dividend Fund. All told, there are 20 different funds within the portfolio. Chan and her team monitor the fund regularly and re-balance it whenever the need arises. Along with other Scotia Partners-branded products, which in aggregate account for $9.6 billion in assets, it is sold through the Scotiabank branch network.
In a similar vein, the team monitors the DynamicEdge Balanced Growth Portfolio, which is split between 35% fixed income and 65% equity. Like other DynamicEdge funds, it is comprised entirely of funds from the Dynamic brand and is sold through the financial planner community.
Long term strategy, daily cash
"We are very strong proponents of a strategic asset mix and use a daily cash-flow investing methodology,” says Chan, adding that the team uses an asset allocation framework that is based on medium to longer-term expectations and fundamental valuations. “Our asset mixes don’t stay static, but we invest positive cash flow into the funds that are below target allocations. We do not believe that market-timing can consistently produce added value—especially now when markets are so unpredictable, and not based on fundamental valuations. As for our most recent asset mix meeting, the conclusion was to remain neutral in the strategic asset mix.”
Bearish and bullish makes defensive and diversified
Chan has the flexibility to make overweight or underweight decisions whether it pertains to fixed income or equities, or within the asset classes. “We are remaining neutral. Because there are as many reasons to bearish, as there are to be bullish,” says Chan.
In seeking to add value, Chan and her team have selected a group of best-in-class managers most of whom, in turn, are favoring defensive names. “We use high-quality managers with a strong risk-management framework. They are very focused on staying diversified and invest in defensive companies,” says Chan, adding that her team uses quantitative and qualitative tools to create optimized portfolios of funds and to ensure they don’t have unintended biases.
From a performance standpoint, Scotia Partners Balanced Growth Portfolio has returned 10.78% year-to-date (as of Sept. 24), compared to 12.6% for the Canadian Equity Balanced category. Over the past five years, the 5-star rated fund averaged 5.15%, compared to 4.26% for the category. On a 10-year basis, the fund averaged 6.07%, versus 6.13% for the category.
Looking ahead, Chan professes not to have a crystal ball that will help foretell the market’s direction. But she is confident that it will continue to be volatile. “Volatility will be higher as economies continue to moderate and are not showing as much growth as in the past couple of years. We also have a lot more geo-political noise. That will not help investor confidence,” says Chan. “We are not expecting trade talks to yield a lot of meaningful results. Earnings will continue to moderate and multiples are really high. And it’s really hard to find a catalyst for more upside in the near future.”
“It’s not a good time to take extraordinary amounts of risk,” says Chan. “So we are conservatively positioned and investing in companies that are well-equipped to weather a downturn. But we are not running for the hills. We’re not expecting a recession in the near term.”
