Should institutional investors consider a balanced portfolio 2.0?

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business chart showing financial success © Сергей Толмачев / 123RF Stock PhotosWhile traditionally, balanced portfolios had 60 per cent in stocks and 40 per cent in bonds, about 90 per cent of the risk budget went to equities, said Perry Teperson, vice-president and portfolio manager at Leith Wheeler Investment Counsel Ltd., speaking at the firm’s institutional investor forum.

This is where a balanced portfolio 2.0 comes into play, he said, noting this would involve replacing some equities and potentially some bonds with real assets and looking to get more global diversification in the equity portion of the portfolio.

Smaller and mid-sized funds are starting to go to balanced portfolio 2.0 because there are more products available, including real estate and infrastructure, he said. Low interest rates and the pursuit of diversification are also driving plans.

Adding real estate to a balanced portfolio may have advantages helping smooth returns and gain diversity, said Teperson. Returns in more aggressive real estate with high levels of leverage can actually be equity-like and present low correlation with stocks, he added.

Leith Wheeler ran a balanced 1.0 portfolio and then ran it with 10 per cent opportunistic real estate funding from stocks, he noted. “And we found that returns were basically the same, which underscores the point that real estate and stocks delivered actually the same return for this series. Now we found that we dropped the volatility quite nicely and we got a better risk-adjusted solution, which is the Sharpe ratio.”

Even in downturns, when real estate can get hit, this can smooth out an otherwise bumpy road, said Teperson. Looking back to 2009, real estate hit its low later than equities. “There was no place to hide in your real estate portfolio. It fell about 40 per cent if you’re in those aggressive real estate funds. But here’s the key point: When did it fall? It fell eight months later than the fall in the equity markets.”

This can be useful because it helps to smooth returns, he said, noting privately owned real estate also benefits from lags in the valuation process.

Teperson cited another example of moving away from a balanced 1.0 by replacing some stock and bond allocation with opportunistic real estate, highlighting this would boost returns. Yet in a drawdown, the lows weren’t different, he added, because of the smoothing. “In other words, if your test of risk is loss of capital and drawdown, this adjustment to having more real estate, and [selling] some bonds even to fund that real estate and some equities, produced a no worse drawdown impact.”

Another aspect of a balanced 2.0 portfolio is looking to add diversification within equities, he said, since global markets are changing and emerging markets are accounting for a bigger piece of the pie.

“The emerging markets space, we think, is very interesting because that volatility is actually highly attractive to us as value managers. We have more entry points under pressure, more cloudy situations with companies that are less covered that enable us to get in and buy at prices that look to us to be really attractive because the stocks are less covered.”

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