Advisors need to strike a balance between a possible near-term downturn and the regret of missing out on future gains.Natalya Kosarevich/iStockPhoto / Getty Images
Rising stock markets, rich valuations and the threat of a bear market that never seems to come are creating a conundrum for money managers: how to invest new client money.
Whether it’s an investor moving assets from another firm, an inheritance, or a big year-end bonus, advisors are grappling with how much new money to put into equities immediately and how much to leave in cash or even fixed income to protect it from a possible downturn.
It’s trickier when markets keep grinding higher as they have been since April, despite concerns about an artificial intelligence bubble and slowing economic growth. Both the S&P 500 and the S&P/TSX Composite Index are up about 40 per cent from their lows in early April.
“To see those kinds of gains is worrisome,” says Rebecca Teltscher, portfolio manager at Newhaven Asset Management Inc. in Toronto.
“Knowing that every single stock you buy can go down is very difficult, but at the same time, you can’t just be 100 per cent in cash all the time, because you don’t know how long this bull market is going to last.”
Advisors need to strike a balance between a possible near-term downturn and the regret of missing out on future gains – even when the money is being invested for clients’ long-term financial goals.
Ms. Teltscher believes the safest way to invest new money is to average it in, regardless of market performance.
“In a correction, we may move faster, but we wouldn’t go all-in on Day 1,” she says. “So, the pace of investments may change depending on where markets are, but the strategy of deploying cash over time remains consistent. It’s almost impossible to time the top or the bottom of the market.”
A year ago, she says her firm would have initially invested about 40 per cent of a new client’s money into the market. That dropped to about 25 to 30 per cent this fall, given the market run-up.
Ms. Teltscher says her firm’s goal is to buy stocks with reasonable valuations that it believes will perform well in the long term.
“I think valuation plays an important role,” Ms. Teltscher says, noting that stocks with higher valuations tend to fall further in a correction, even if they’re considered high-quality companies.
Given her firm’s focus on dividend-paying stocks, she also looks at dividend yield relative to cash yield, especially as interest rates have fallen. Today, she notes that money market funds yield just more than 2 per cent, while a stock such as Enbridge Inc. pays a 6-per-cent dividend yield.
“We try to counsel our clients to focus on the income that comes into the account more than looking at stock prices,” she says. “Stock prices will fluctuate in the short term, but the dividend income remains consistent.”
Reducing ‘regret risk’
Brianne Gardner, senior wealth advisor and co-founder of Velocity Investment Partners at Raymond James Ltd. in Toronto and Vancouver, says her strategy is to invest about 25 per cent of new money immediately – even when markets are trading close to record highs – so it can grow if markets continue rising before potentially pulling back.
“With new money, we’re not always waiting for the perfect entry point because that rarely appears when we want it. So, investing in tranches helps to reduce that regret risk investors may have,” Ms. Gardner says.
The remaining cash is then deployed weeks or months later, depending on market conditions.
“When markets are fully priced, there’s less margin for error,” she says. “So, we focus on the companies with more durable earnings visibility, strong balance sheets and pricing power, and companies or stocks that are benefiting from long-term structural trends, not necessarily short-term momentum.”
And if the market – or a particular stock she likes – drops by five or 10 per cent, she’ll speed up buying. If economic data signals a pending correction, she’ll hold cash longer and own more fixed income, which she notes tends to do well in downturns – most of the time.
“Our job isn’t to predict the next move. It’s to manage risk, control entry points and protect our clients’ capital,” Ms. Gardner says.
She expects markets to be more volatile in the first half of next year, but still sees overall gains.
“For new clients coming to us, we’re being patient on redeploying their capital and articulating that to them because we know how emotional money can be,” she says.
Her strategy is slightly different for clients who are transferring equities rather than cash, taking capital gains into account when selling to substitute them for other stocks.
“The rebalancing can be a little bit faster because they’re already in the market, but how we change up their allocation could be based more on the tax implications,” she says.
‘It’s more about what you own than how much’
John Zechner, chairman and lead equity manager at Toronto-based J. Zechner Associates Inc., is a little bit more defensive with new money in the current market.
“The stock market is a tough call right now,” he says. “You need to have all of your hedges in place a little bit more.”
His defensive strategy includes dividend-paying stocks in sectors such as energy infrastructure (including pipelines, power and engineering companies) as well as a mix of long- and short-term bonds and gold. He’s underweight in sectors such as energy and financial services that he believes could be more volatile in the near term.
He’s also adding new money slowly, targeting about 50 to 55 per cent in stocks, diversified across Canada and the U.S., and the rest in bonds and cash.
Like others, Mr. Zechner believes it’s important to put some of the new money to work immediately, as timing the market rarely works.
“Long-term money needs to be in the equity market. Don’t try to get too cute about it,” he says. “It’s more about what you own than how much you have in there.”