How much volatility is too much?

When structuring portfolios, determining how much volatility is too much isn’t easy.

So says Stephen Carlin, senior portfolio manager of Canadian equities at CIBC Asset Management. He manages the Renaissance Canadian Dividend Fund.

Finding balance between risk and returns comes back to properly calculating clients’ risk tolerances. To do this, you need to ensure investors are being honest about “how comfortable they are in volatile market environments.”

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Also, you can’t forget that passive funds, such as ETFs, often “provide you with exactly the kind of volatility that’s equivalent to the market,” says Carlin.

So, “if a client’s not comfortable with the possibility of upside and downside swings like we’ve seen recently, then clearly they’re not comfortable” with the risks associated with some funds.

As a result, you need to “cater portfolios that allow investors to achieve their objectives, while also doing it in a fashion that provides [conservative clients] with low volatility.”

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Typically, notes Carlin, dividend-paying stocks can smooth portfolios. And even though we’re in a low-interest-rate environment, “there are Canadian stocks that [currently] generate pretty attractive dividend yields.”

When looking for quality stocks, you can zero in on Canada’s financial sector—despite the fact that “banks and life insurance companies are often viewed as interest rate-sensitive,” he adds.

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Surprisingly, the current environment has actually “been an anchor on the earnings and growth prospects of [these companies]. In a rising rate environment, [they’re] usually viewed as somewhat sluggish from a growth perspective. But it’s been quite the opposite this time around” since they’ve continued to grow their earnings and increase their dividends in the face of upcoming rate hikes.

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Also, “from a valuation perspective, both Canadian banks and [life insurers] are attractively valued. They’re not overpriced relative to their historical valuations and they’re not underpriced, so there’s a solid underpinning for [these companies] in a Canadian portfolio.”

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One sector to be wary of is real estate, warns Carlin. “If interest rates are rising and the economy’s growing, you need to [avoid] sectors where the growth rates” could start to dip.

In the real estate sector, there are strong dividends on offer. But the growth rates in a rising rate environment “would be a little less attractive than in other sectors.”

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