Some clients stand out because they’re comfortable taking investment risks, and they have the capital to do so.
But these people are rare. Only one in 10 Canadians considers himself an aggressive investor, according to a survey by the Investor Education Fund.
Still, if you do have bold clients, you need to understand that they think of investing differently. Cautious people ask “Should I pull my money out?” when the market dips, while the risk-tolerant ask “What else is there that I can invest in?” says Olivia Woo, senior portfolio manager for private clients at Mawer in Calgary. So, make sure you ask questions to determine if the client is okay with risk (see “Is your client bold?” below).
For bold investors, the portfolio possibilities are wide. That’s because they want higher returns and are willing to look to non-traditional assets in order to achieve them. So, consider using 100% equity portfolios, says Woo, and diversify with private equity, hedge funds and small-cap stocks.
Giles Marshall, vice-president and portfolio manager at Fiduciary Trust Canada in Toronto, agrees private equity and hedge funds are options, but says “getting access at a reasonable price for the retail investor is a bit of a challenge. In Canada, your pickings are pretty slim.”
Instead, use international stocks to diversify the equities portfolio. He suggests a 30% Canadian, 30% U.S. and 40% international mix. Global stocks, even in developed markets, have historically been riskier than North American ones.
Investing in cyclical sectors like mining and industrials is also appropriate for these clients, says Terry Shaunessy, portfolio manager and president at Shaunessy Investment Counsel in Calgary. When these boom-and-bust sectors are on an upswing, they can provide market-beating returns, but investors must be able to stomach the inherent volatility.
While cash or bonds may seem inappropriate for clients looking for higher returns, Woo says no asset class is out of bounds. Instead, advisors should find particular securities within a class that are suitable.
“A triple-A bond isn’t something they’ll be interested in,” she says, “but a high-yield bond could potentially generate the returns they’re looking for.”
Cash could act as a tactical reserve, says Marshall. A portion of the portfolio, for example 20%, could be in cash or short-term bonds, and clients could use that money to buy equities or riskier bonds when those assets trade at discounts. But then, Marshall cautions, “you’re getting into the realm of market timing,” which can be difficult to execute well.
In Marshall’s experience, clients with high risk tolerances aren’t more high maintenance or likely to switch advisors than cautious ones. But, for some clients, having a small amount in self-directed accounts could satisfy their inclinations for aggressive investments when an advisor is unwilling to go further.
“In a place like Calgary, where there’s deep knowledge of the energy market, some clients [also] have their own accounts to trade in areas we’re not in, and where they have some expertise,” Shaunessy says.
Some of Marshall’s clients have decided to run their TFSAs alone through a broker. Since his clients have more than $1 million to invest, the TFSA’s maximum of $36,500 is a small portion of their portfolios. He says side accounts are appropriate for younger clients with steady incomes, such as doctors or dentists, who have decades to recoup any losses. “Typically, after two or three years, they’ve given up because they don’t have the time, and their money comes back to us,” he adds.
These clients may have the tolerance and the capacity for riskier investments, but that doesn’t mean they should always have aggressive portfolios, say the advisors.
Generally, Thane Stenner, director of wealth management and portfolio manager at Richardson GMP in Vancouver, insists on time horizons of five years or more for these clients. “That way, they can actually go through a market cycle.”
If a client’s time horizon isn’t long enough, their portfolios should be conservative. For instance, if a client tells you she plans to cash out investments to expand her business or buy a house in three years, there shouldn’t be anything more risky than short- to mid-term bonds in her portfolio, says Marshall. And maturity dates should match her time horizon.
Says Stenner: “The last thing you want to do is keep investing the same way and the portfolio goes through a 15% or 20% correction, [and then] they’re forced to sell at that point to fund the business or another commitment.”
To underscore the stakes of an aggressive portfolio, Marshall shows clients annual rates of return for classes of equities with various risk profiles. He says the percentage returns are more relevant than standard deviation.
He also puts percentage losses into dollar terms and says to clients, “Your portfolio is worth $1 million today. How would you feel if it went down to $500,000?” Often, they realize they couldn’t handle such a loss.
Some clients’ reservations have been mollified by the market’s steady gains over the past five years, says Woo. To counteract that false sense of security, she explains that since stocks have enjoyed a good run, they’re more expensive and the likelihood of a correction is higher.
And, sometimes, those clients might think they can take on more risk because they’ve been enjoying such healthy returns, says Stenner. “But this is precisely the time where we have to backpedal and guide them in the other direction. Maybe we need to hedge more, which we’ve been doing, or do [other] things that are defensive.”
Is your client bold?
Investors who can handle risk:
- have liquidity and assets outside their portfolios;
- see opportunities during downturns;
- propose investments;
- may have brokerage accounts; or
- don’t panic during times of volatility.
Bolder portfolios should still be shielded from unnecessary losses. One tactic is to ensure the portfolio isn’t highly correlated with the bond or equities markets, says Stenner. He favours a one-third alternative asset allocation for client portfolios, suggesting market-neutral strategies and private equity. He also uses Commodity Trading Advisors (CTAs), or managed futures ETFs, which he says aren’t correlated with most investments and help smooth volatility. In addition to upping his alternative holdings, Stenner has increased gold exposure “because it tends to be a portfolio hedge,” and he’s raised his cash position.
Currency hedging could also offer clients some protection for exchange fluctuations, but Marshall says it’s impractical if the portfolio is made up of individual securities. “It would just be too expensive,” he says. Instead, he deals with risk by making a client’s portfolio geographically diverse. He adds that, as the U.S. dollar continues to appreciate, he wants exposure to it and so buys non-hedged U.S. equity funds.
And don’t forget to protect the portfolio from clients themselves. Marshall says advisors should check in with bolder investors at least once a year to ensure they still have steady incomes and plenty of time to invest. If not, it’s time to rebalance.
Jessica Bruno is a Toronto-based financial writer.