A Balanced Approach – A Good Choice for Troubling Times and All Time

In the here and now, the Russian invasion of Ukraine is overwhelming and soul-destroying. Connecting its immediate horrific impact on Ukraine to its longer-term impact on the geo-political balance and the state of the global economy is incredibly difficult.

Supply chain disruptions, which were starting to show some improvement after two years of the COVID-19 pandemic, are now exacerbated by global trade uncertainty and broad sanctions imposed on Russia. These new disruptions have caused a spike in most commodity prices and record high prices for gas at the pumps. Inflation was already increasing at rates not seen for decades, and we appear to be at the start of a series of interest rate hikes being instituted by global central banks.

It’s at times like these that investors often feel that they need to “do something” in their portfolio to address the quickly changing and uncertain environment. However, if you are a long-term investor with a balanced portfolio of quality equity and fixed income securities, you probably shouldn’t do anything. There are plenty of other things to worry about, if you have the peace of mind that your investments are strategically designed to achieve your long-term objectives.

For years, interest rates have been mired in the low single digits, causing many people to question the benefits of fixed income in a portfolio. After taxes and inflation, the real return of bonds has been low or negative for some time, and dividend yields on broad equity market indices have been higher than those of most bonds. However, it is in tumultuous times such as today that the bonds in a portfolio rise in psychological value, even if they decline somewhat in nominal value. Behaviourally, not having one’s portfolio fully subjected to the higher volatility associated with equities makes it easier to “stay the course”, and to avoid regrettable trades, which are often a result of strong human emotions that cause people to “sell low” and “buy high”.

There is little question that over the long run, equities have outperformed bonds. From January 1, 1928 to December 31, 2021 the compound annual return of the S&P 500 (including dividends) was 9.6% (this and the following returns are based on US$ values).⁽¹⁾ The annual return on U.S. Treasury Bonds over the same period was 4.7%. Thankfully, the resilience of equities after major negative world events has been proven time and time again. More recently, from December 31, 1940 to December 31, 2021, the S&P 500 rose at an annual rate of 11.0%.⁽¹⁾ Over this period, we experienced the attack on Pearl Harbour, JFK’s assassination, the Crash of ’87, the 9/11 terrorist attacks, the Great Financial Crisis of 2008/09, and the COVID-19 outbreak. If one looks now at a logarithmic scale chart of equity returns, these events are almost indiscernible wobbles in the big picture of long-term returns.

So, why would you ever own bonds if they might be a drag on long term performance? Because the relative stability of bonds dampens portfolio volatility, making it more likely that an investor will maintain their equity exposure and sleep better at night.

The Nexus North American Balanced Fund is designed to manage this issue. The Fund is managed to a 65% equity target. The balance of the portfolio is held in investment-grade bonds, with a small allocation to cash. The equities are comprised of approximately 40 North American equities managed in-house by the Nexus investment team, as well as an allocation to two global equity funds managed on our behalf by JP Morgan in London, U.K.

The active management of both the equities and fixed income components has yielded superior returns for the Fund compared to its passive benchmark (5% Canada T-bills, 30% FTSE Canada Universe Bond Index, 40% S&P/TSX Composite, 25% S&P 500 in C$). The Fund has also performed very well relative to its peers. In the most recent survey by Global Manager Research (GMR), of 126 Canadian-managed balanced funds, the Nexus North American Balanced Fund performed in the first quartile for each of the one-, three-, five- and ten-year periods ending January 31, 2022 (see chart).

The Fund established its first ten-year return number in August 2007 (the fund’s inception date was August 1997). At that time, the Fund’s 10-Year annual return was 7.2% annualized. At that rate of growth, a portfolio’s value doubles approximately every 10 years. With the subsequent passage of each month since August 2007, a new month of performance was added to the ten-year total, and one dropped off from the back end. The average of the “rolling” annualized ten-year returns of the Fund from August 2007 to January 2022 is 7.6%. At its worst (lowest return) point, in January 2009 in the midst of the Great Financial Crisis, the Fund’s annualized ten-year return was still 4.5% per year. This was comfortably ahead of the Fund’s benchmark 10-year return at that same point of 2.9% per year.

At Nexus, the majority of our clients embrace a balanced approach to their portfolios. In many cases, we utilize a combination of our Equity and Income funds to best meet their specific personal and tax circumstances (and this combination of funds results in a portfolio that is substantially the same as our Balanced Fund). However, the Balanced Fund remains a simple and convenient way to save and invest for the long term. Not having to think about investment decisions frees up time to focus on other things. Let’s hope the other things become less troubling soon.