Volatile times ahead

However, this is “a trading environment, not a buy-and-hold market,” says Drummond Brodeur, global strategist at CI Investments Inc.’s Signature Global Advisors division in Toronto.

And according to Don Reed, president and CEO of Franklin Templeton Investments Corp. in Toronto: “You can make a lot of money. Every time stocks get beaten up, value is created.”

But taking advantage of these opportunities requires substantial research, which may be beyond the capacity of you or your clients. If so, consider adding to your clients’ assets under active equities investment management.

The alternative is taking a buy-and-hold approach — and despite Brodeur’s stance, there are some experts who think that may be a better and certainly a safer route. Your clients may miss some opportunities, but they won’t get lured into investments that may turn out badly.

Buy high-quality stocks with exposure to countries and sectors with good medium- and long-term growth prospects — then sit tight through the volatility, recommends Leo de Bever, CEO and chief investment officer of Alberta Investment Management Corp. in Edmonton. He foresees 5%-6% annual average real returns for equities over the next five years but “has no idea how that will play out.”

Choosing the right approach and, if applicable, finding the right portfolio managers are key first steps as you position your clients for 2012. Here are several other strategies to consider:

> Move Along The Risk Curve. A number of global portfolio managers and strategists think this is a good time to increase weightings of riskier assets. The time to be defensive probably has passed as valuations in defensive sectors have increased, says Charles Burbeck, head of global equities for Barclays Bank PLC’s wealth-management arm in London. So, as long as the U.S. economy continues to grow at a 2%-2.5% pace and Europe experiences no further profound economic difficulties, it could be a good time to start adding some growth stocks and financials.

Burbeck notes high-tech firms and companies exporting to emerging markets are growing — and he also points out that financials are generally trading at about 50% of book value. He prefers U.S. banks to European ones because he has more faith in the reliability of the balance sheets of U.S. firms.

More optimistic portfolio managers would go farther along the risk curve. Peter O’Reilly, head of the global equities team with I.G. Investment Management Ltd. in Dublin, and Jean-Guy Desjardins, chairman, CEO and CIO at Fiera Sceptre Inc. in Montreal, both expect good gains for European banks and some European sovereign bonds. O’Reilly points out that Italy’s 10-year sovereign bonds are priced for a 7% yield; he thinks markets will recognize this year that yields like these are much too high.

However, it’s important to keep in mind that even the most optimistic portfolio managers say the risks of serious problems this year are high. Desjardins, for example, gives only 55% probability to his optimistic scenario.

> Emerging Markets. It’s always good to go where the growth is, says Hugh McCauley, managing director and lead portfolio manager at Acuity Investment Management Inc. in Toronto. Economic growth in emerging Asia and Latin America is expected to outpace that of the industrialized world by far this year, as well as over the medium and long term.

However, you should exercise caution. Economic growth and stock market appreciation don’t always go hand in hand. Emerging-market equities dropped by around 20% in 2010 as investors fled to the safety of investments denominated in U.S. dollars, which is still the world’s reserve currency. This could happen again this year.

There are alternative ways to get into emerging markets, such as buying stocks of multinationals that sell in those regions.

There are also possibilities in fixed-income products: emerging-market sovereign bonds offer much higher coupon rates than U.S. treasuries or Government of Canada bonds. There still is currency and political risk, though, so it’s best not to become overloaded with these investments.

> Resources. The current high commodity prices are the result of strong growth in emerging markets. There may be some weakness in the first part of this year, but prices should rise again — providing China continues to grow at a healthy pace.

Oil-related stocks are particularly favoured because of the relentless increase in demand for oil as incomes rise in the emerging world. Note that oil prices dipped for only a short period during the 2008-09 recession that followed the global credit crisis.

> Rebalance. The closest thing to a guaranteed return in this investing environment can be achieved by rebalancing portfolios regularly, says Norman Raschkowan, chief North American strategist for Mackenzie Financial Corp.’s Maxxum funds in Toronto. This ensures your clients buy low and sell high. Raschkowan notes, however, that this works only if you stick to high-quality securities.

> Generate Income. With interest rates so low, government bonds don’t pay much — and once interest rates start to rise, which could be later this year in Canada, these bonds’ prices will drop.

Even so, some portfolio managers, such as O’Reilly and Nandu Narayanan, CIO at Trident Investment Management LLC in New York and manager of several funds sponsored by CI, favour government bonds issued by countries such as Canada that are in good fiscal shape and have exposure to emerging markets through resources production.

One way to beef up the fixed-income portion of portfolios is with good dividend-paying stocks — particularly those of multinationals with exposure to emerging markets’ growth. These tend to be very safe investments.

Lloyd Atkinson, an independent financial and economic consultant in Toronto, has 60% or so of his personal portfolio in “boring” dividend-payers. “It’s not a time to worry about capital gains and growth,” says Atkinson, who recommends thinking in terms of income and safety rather than fixed-income vs equities.

Most portfolio managers and strategists also point out that corporate bonds can generate good income, offering yields of 4%-5% and the possibility of appreciation if their credit ratings are raised, which could offset some of the losses in value as rates increase.

In addition, David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates Inc. in Toronto, says the current prices of corporates assume the U.S. default rate rises to 8% from the current 2%. He thinks that when the market realizes the rate is unlikely to go above 3%-4%, there will be good capital appreciation.

Some portfolio managers also suggest some high-yield bonds, which pay even more than corporates. Raschkowan sees a lot of opportunity in bonds rated BBB, BB and even B. These are just below investment-grade and, thus, less risky than “junk” bonds.

Taking advantage of these opportunities is, however, probably best done through good, actively managed bond funds whose portfolio managers will be able to move quickly when it looks like interest rates will start to rise.

However, Atkinson, for one, doesn’t think high-yield bonds pay enough to compensate clients for the risk they are taking on.

> Ratios: Book Value VS Price/Earnings. Ross Healy, chairman and CEO of Strategic Analysis Corp. in Toronto, warns against buying stocks with high book value, however inexpensive they may appear from a price/earnings perspective. Book value, excluding intangible assets, represents the actual value of a company, while earnings can be fickle.

Healy points to Telus Inc., which was trading at 2.5 times book value in 2009 and then dropped to 1.25 times as its stock price plunged. In his view, 2.5 times was much too high and 1.25 was reasonable.

He warns that BCE Inc. is currently trading at 2.5 times book. He doesn’t recommend buying stocks with book value much above one times book.  IE