The Globe and Mail, Report on Business
Published October 29, 2011

By Tom Bradley 

“Creep.” The dictionary defines it as a “slow and stealthy movement.” To me, it’s something you don’t notice while it’s happening, but later when you do, you go “Wow!”

If you think about our lifestyle, we’ve slowly moved to a place where jeans are appropriate everywhere (almost), we drink a milkshake every day (otherwise known as a latte), we’ve allowed BlackBerrys and ball caps to erode our manners, and we’ve radically altered our definition of a small apartment and large home.

As for investing, there’s been plenty of creep, some of it due to poor stock returns in recent years, and the rest related to the market’s extreme volatility. Investors are slowly and stealthily moving away from their strategy of holding a diversified portfolio of long-term securities.

Caution creep

Today every investment discussion and sales pitch is laden with words like caution, capital preservation and downside protection. In the context of recent markets, this is understandable for retirees, but it’s also part of the conversation for investors who have 10, 20 or more years until retirement. As a result, investors own fewer assets with the potential to generate a return in excess of the risk-free rate.

Caution creep has taken many forms. Sometimes it’s purposeful – new money goes into a GIC instead of an investment portfolio. Other times, it’s oblivious – money is moved slowly from one account to another, or cash is left to accumulate in a bank account over a number of months. In either case, the result is the same – the overall portfolio has a lower equity weighting than the long-term plan calls for.

When changes are made, they’re often toward a more-conservative investment. Instead of an equity fund or broadly diversified Balanced Fund, it’s a Monthly Income Fund that’s focused on dividend-oriented stocks or a structured product with capital guarantees.

In a recent column, I projected stock returns of 7 to 10 per cent per annum over the next five to 10 years. I can be accused of being too optimistic, but I have a lot of room to be wrong when compared to investors who are protecting themselves all the way down to a return of 2 to 4 per cent.

Parochial prudence

Foreign stocks are a big reason Canadian investors are unhappy with their returns. Over the last 10 years, the MSCI World Index had a return of minus 0.5 per cent (in Canadian dollars). There are explanations for this lost decade – the loonie going from 70 cents (U.S.) to par; the U.S. going from glory to despair and Europe just going – but they don’t matter. Investors, who were maxing out on U.S. and international stocks a decade ago when leading companies were trading at 30 times earnings, now have minimal holdings outside of Canada when multiples are 8 to 12 times.

It’s worth noting that the most popular balanced products, the above-mentioned Monthly Income Funds, have little or no foreign content.

Hedged to the hilt

Increasingly, the foreign investments that remain in portfolios are currency-hedged. A number of fund companies offer hedged versions of their U.S. and international equity funds and virtually all foreign-equity ETFs are hedged. A volatile dollar and love for everything Canadian has moved investors away from currency diversification, just when the loonie has achieved par with the greenback.

Economists everywhere

With today’s volatility, the consequences of buying a stock or equity fund at the wrong time have been magnified. A new purchase can be down (or up) 5 to 10 per cent in a heartbeat. As a result, investors are becoming more short-term-oriented. Even fund managers who are good at analyzing companies and doing valuation work are being sucked into the macro game. I’ve talked to a number of them who’ve deferred purchase of well-priced stocks (according to their models) because they need more clarity on central bank and government policy. Yikes, stock managers are becoming economists along with the rest of us.

As investors, it’s important that our portfolios are the result of a calm, objective, valuation-based analysis, not creep. In my view, we’ve crept to a place that reflects what happened in the last 10 years, not the next 10. Market volatility has obscured the attractiveness of common stocks and past performance has put Canada on too high a pedestal.