Case study: New portfolio for high-earning spouses-to-be

Client profile

Mauricio Robustelli, 33, and Bev McPhee, 32,* just got engaged and plan to marry in a year. Both are high earners and want to overhaul their portfolios, one of which is with a robo-advisor.

* This is a hypothetical scenario. Any resemblance to real persons or circumstances is coincidental.

The experts

David Bluteau

Senior vice-president, Bluteau DeVenney Caseley Group | National Bank Financial Wealth Management in Halifax, N.S.

Darren Caseley

Investment and wealth advisor, Bluteau DeVenney Caseley Group | National Bank Financial Wealth Management in Halifax, N.S.

The situation

Mauricio used to work at a technology firm, earning about $85,000 a year. Two years ago, he took a chance by leaving his job to start his own company, specializing in mobile apps.

Last month, an industry giant bought one of his apps for $5 million. He expects the transaction to close in about two months. He’ll reinvest half the proceeds in his business, and add the rest to his investment portfolio.

6

Degree of difficulty

6 out of 10.

6 out of 10. The main challenge is tempering Mauricio’s risk-taking. While it’s helped his app business succeed, he seems convinced he can’t lose. Bluteau and Caseley have an ally in Bev, but they’re careful not to take sides with one spouse. They lay out their case for the 65%/35% split, and leave it to Bev and Mauricio to work out their differences.

Mauricio started DIY investing about five years ago. He had a rudimentary ETF portfolio: half in an S&P/TSX ETF, and the other half in an S&P 500 ETF. Last year, he switched to a robo-advisor, but the stubborn, risk-taking entrepreneur didn’t alter much. He insisted on staying 100% in equities, adding only European and other developed market exposures through an EAFE ETF.

Read: How market volatility affects correlations

Bev’s a family physician with her own practice, which launched two years ago. Although she’s a high earner, business startup costs have left little for investments. She has $60,000 in balanced mutual funds through an independent advisor.

The couple wants to bring their assets together and transfer them to a fee-only advisor. Bev’s more level-headed than Mauricio when it comes to risk—she knows they should have a strong equity component, but understands Mauricio’s 100% allocation is untenable.

The solution

David Bluteau and Darren Caseley, both advisors at National Bank Financial in Halifax, N.S., suggest a 65% equity, 35% fixed-income mix that includes active, passive and hedged vehicles. The advisors target a minimum of 50% outside of Canada. A young couple with Mauricio and Bev’s assets, earning potential and time horizon might typically have a higher equity allocation. “But physicians tend to be more risk averse,” notes Caseley, and Bev fits this profile, so a 65%/35% mix is more psychologically palatable (see “Portfolio breakdown,” below).

Asset transfer

Bluteau and Caseley would do an in-kind transfer of Mauricio and Bev’s assets, which are all currently in RRSPs.

“But we need to be careful about DSCs on Bev’s mutual funds,” says Bluteau.

Read: A new method of diversification

She’s held them long enough that there would only be a 0.5% penalty for exiting. Bluteau says it’s worth taking the penalty, especially since her MERs far exceed the 1% to 1.15% fee she and Mauricio will pay after the switch.

It would be different if it was earlier in the DSC schedule. “I’m not a big fan of her taking a 5% hit,” says Bluteau. Instead, he would redeem all the units currently beyond the penalty stage, and redeem the remaining units when the penalty drops to a nominal amount. Fortunately, Bev’s mutual fund holdings represent only a small portion of the couple’s investable net worth.

Mauricio’s current ETF holdings overlap with Bluteau and Caseley’s recommendations, so it’ll be a straightforward transfer.

Portfolio breakdown

Active equity

“For an alpha manager, we use EdgePoint Wealth Management. We put clients in their Global Portfolio fund 1 and expect them to beat the index, net of fees over a 10-year period,” says Bluteau.

Top sectors (as of January 30, 2015) include:

• industrials at 19.96%;
• information technology at 19.04%; and
• healthcare at 12.86%.

Top holdings include:

• Alere Inc. (5.84%);
• TE Connectivity Ltd. (5.36%);
• Service CorporationInternational (5%); and
• Wells Fargo & Co. (4.92%).

They add the Sprott Enhanced Equity Fund 2 for downside protection. “The aim isn’t necessarily to beat the index, but to reduce volatility,” says Bluteau. “I won’t be concerned if the Canadian market makes 20%, and the fund only makes 16%.”

As of January 30, 2015, the geographic allocation is:

• U.S.: 53.8%
• Canada: 44.9%
• Netherlands: 5.5%
• U.K.: 2.6%

Passive equity

The passive component has five elements, all in ETFs:

• Canadian (S&P/TSX) 3
• U.S. (S&P 500) 4
• International (EAFE) 5
• Canadian banks 6
• Infrastructure 7

Bluteau and Caseley say any ETF providing these exposures would work. Exposure to Canadian banks is through an S&P/TSX index ETF, plus a specialty ETF holding solely banks. “[Banks] continue to do well and we have a preference for yield-based securities,” says Bluteau. With a good dividend yield, clients are effectively getting paid to wait out sideways markets.

To add diversification, they include infrastructure exposure through the

iShares Global Infrastructure Index ETF.

Hedged equity

Hedged equity funds provide growth with downside protection due to low correlation to broader equity markets. Bluteau and Caseley use National Bank’s Non-Traditional Capital Appreciation Private Pool 8, a fund of funds. The bank develops the investment theme, but brings in outside firms to execute.

Fund breakdown (as of December 31, 2014):

• Global equity anti-benchmark fund (TOBAM): 55.05% 8a
• Alternative growth fund (Globevest Capital): 14.18% 8b
• Global market neutral fund (Picton Mahoney): 11.07% 8c
• Canadian market neutral fund (Picton Mahoney): 8.58% 8d
• Structured notes (National Bank): 9.09% 8e
• Cash and other assets: 2.03% 8f

Apart from the infrastructure play, which gets a 5% allocation, all funds in the equity portion get equal weight, which works out to about 8.57% each.

Fixed income

The fixed-income portion has five components, all equally weighted.

• Bluteau and Caseley recommend a one- to five-year laddered corporate bond ETF 9. “With interest rates as low as they are, we recently moved out of the DEX Universe Bond Index ETF,” says Bluteau.
• They also add East Coast Fund Management’s Investment Grade Income Fund 10, which hedges interest rate risk through a combination of long and short positions. Last year, it was long on names such as JP Morgan Chase, Penske Truck Leasing and Loblaw. It shorted Canadian government bonds.
• Another position is the Russell Canadian Fixed Income Fund 11. “If rates were higher, we’d have a larger weighting. But we’ve pulled back,” notes Caseley.
• The fourth piece consists of in-house pooled funds made of investment-grade Canadian bonds 12.
• Finally, Bluteau and Caseley use money market funds for clients’ cash positions 13.

Fees and insurance

Mauricio and Bev will have fees between 1% and 1.15%, covering asset allocation and financial planning. They may also need insurance coverage, which has a separate fee structure.

Since Mauricio and Bev are both self-employed, they should consider disability and critical illness insurance. “Most people don’t want to talk about it,” says Bluteau. “Mauricio may say, ‘My wife’s a doctor, we don’t need [the coverage].’ But she won’t be working every day if he gets cancer.”

The financial impact could be even worse if Bev gets sick, since Mauricio’s in a volatile industry.

Bluteau and Caseley add it’s early for estate planning, but the couple’s wills should be updated. And once they have children—as they plan to do—they may be candidates for life insurance.

Read: Seven deadly sins of distribution portfolios

Client acceptance

8/10

Bev manages to rein in Mauricio’s appetite for excessive risk, and they accept the 65%/35% split. She also convinces him to get disability and critical illness insurance. As a physician, she’s seen many lives turned upside down by unforeseen health emergencies, so she’s not willing to take chances. Redeeming her mutual fund holdings is an easy decision—the 0.5% she loses from DSC penalties is offset by lower advisory fees.

Dean DiSpalatro is a Toronto-based financial writer.