indicatorMarket Commentary

Market Volatility Q&A April 2020

By ATB Investment Management Inc. 9 April 2020 6 min read

COVID-19 has caused international economic disruption, which has made for tumultuous financial markets in the first quarter of 2020. How have the CompassTM Portfolios performed throughout this volatility?

The Compass Portfolios declined through the period of heightened stock and corporate bond volatility that began in late February. Returns for the first quarter of the year ranged from -5.5% for the Compass Conservative A portfolio to just under -17% for the Compass Maximum Growth A portfolio.


How are the Compass Portfolios performing in comparison to peers?

We continually compare the Compass Portfolios to about sixty different portfolio programs offered throughout Canada, and classify each portfolio in each program to the Compass portfolio asset mix that it most closely resembles. Each of the six resulting peer groups contains portfolios with a similar stock/bond mix to the closest Compass portfolio. The allocation to Canadian, American and overseas stocks is also quite similar between each Compass portfolio and its peers.

Compass vs. peer-group average
2020 YTD returns, to March 31, 2020

Graph of Compass versus peer-group

Source: Morningstar

The Compass Portfolios’ returns for the first quarter were largely in line with their peer-group averages; all were down for the period, due entirely to the market decline that began in late February.


How did the active managers in the Compass Portfolios fare during this period?

Six of the seven actively-managed stock (equity) mandates in the Compass Portfolios exceeded their benchmarks during the first quarter. That's (pleasantly) surprising to us because this market drop wasn't a classic "bursting of a bubble," during which active equity managers have historically outperformed the broader market. Instead, this market decline was largely indiscriminate and affected nearly all industries in nearly the same manner, other than for the more pronounced declines in the energy sector.

Unfortunately, all three actively-managed bond (fixed income) mandates in the Compass Portfolios lagged their benchmarks slightly during the quarter. This underperformance occurred because the focus in these mandates is corporate credit and not government bonds, a focus followed because government bond yields have been exceedingly low and unattractive for over a decade now.

The underlying holdings in these bond mandates at the start of the year consisted mainly of shorter maturity and higher quality corporate bond issues, not high yield or "junk" bonds. Despite their conservative positioning to protect the portfolios, these mandates underperformed because corporate bonds significantly underperformed government bonds as credit markets seized up during March, and as the earnings outlook for corporate bond issuers deteriorated in light of the looming economic slowdown.


Did anything else affect Compass' performance this quarter?

The partial currency hedges in the Compass Portfolios also detracted somewhat from the portfolios' performance. A currency hedge insulates a portfolio from the currency movements associated with the portfolio's foreign securities.

However, its hedges prevented the Compass Portfolios from fully participating in the US dollar's rise this quarter. The net negative impact for the quarter ranged from about a half-percent for the Compass Conservative Portfolio to nearly one-and-a-half percent for the Compass Maximum Growth Portfolio.The US dollar's rise against the Loonie during the March stock market panic didn't seem to be a widespread "flight to quality", unlike the 2008 financial crisis. On the contrary, several major currencies such as the Euro, Yen and Swiss Franc were either flat or even rose against the US dollar in March.

% change vs. US dollar
March 2020

Graph of Compass versus US dollar in March

Source: Bloomberg

As a result of the decision by Saudi Arabia and Russia to increase the oil supply and start a price war, the oil price fell from $60 at the start of the year to $45 at the start of March, and then to only $20 per barrel by the end of March. This was likely the reason that the Loonie fell against the US dollar; two of the three worst-performing currencies in March belonged to the oil exporting nations of Canada and Norway.


Why are we seeing such a decline in the value of stocks?

There's significant uncertainty about the global economy and therefore about companies' earnings prospects. We're in a very steep government-mandated economic slowdown prompted by the urgent need to slow the spread of COVID-19. We've never experienced such a scenario and so the magnitude of its economic impact isn't yet clear. What is clear is that this situation will only be temporary: either a vaccine or vastly enhanced prevention measures such as widespread testing and mask usage will eventually enable life to return to normal, but the timeline for these measures is still very much unknown.


Are the equity-focused sub-advisors in the Compass Portfolios making changes to their holdings?

There have been only modest changes made so far within the actively managed equity mandates. This market decline hit most companies and industries in a relatively indiscriminate manner, save perhaps for energy companies, and so very few industries have yet "gone on sale" relative to other industries.


Are the bond-focused sub-advisors in the Compass Portfolios making changes to their holdings?

There have been some changes made in the Canso Corporate Value fixed income mandate. As March progressed and corporate bonds sold off, the difference between the yields of corporate and government bonds widened significantly. Canso began to shift its portfolio towards some lower-rated bonds to take advantage of their much-higher yields, albeit accompanied by higher perceived risk.


Are there any asset mix changes being made to the Compass Portfolios? Has this changed the cash position?

The cash position within the Compass Portfolios has always been held to a bare minimum because cash provides virtually no return, and because clients can hold cash very effectively on their own.

The asset mix of the Compass Portfolios was rebalanced several times during the March downturn by selling bond holdings and buying stock holdings, to keep its actual equity weights from falling far below their targets. As the panic in the stock market eased slightly, the Compass equity target weights were also increased twice. The equity target weights are not yet at their maximums but now lie above the neutral positions with which they entered this year. For example, in the Compass Balanced Portfolio the neutral equity weight is 55% and the new target weight is 57%.

The Compass Portfolios' currency hedge weights - the amount of protection against currency movement -  were also adjusted upwards as the US dollar rose against the Canadian dollar.


Overall, do any changes to the portfolios differ from what ATB Investment Management Inc. (the fund manager) has done historically during periods of volatility?

The changes we made are very much consistent with what we've done in the past.

For example, during the 2008 financial crisis we raised the target equity weights in several steps as stock market prices dropped sharply, much as we did this March. In late 2008 we also increased the portfolios' hedge ratio as the US dollar rose, as we also did this March.


After global concerns surrounding COVID-19 dissipate, what happens next for markets?

In nearly all recessions, stock and corporate bond prices decline well before the measured economic downturn. They also turn upwards long before the economy has recovered, and often even before the economy begins to recover. Although the cause of this recession is unprecedented in modern times, what is not in question is that - at some point - we'll develop a better method of dealing with COVID-19 and life will begin to return to normal. As that point becomes at all visible, financial markets will start moving upwards in earnest.

As such, we counsel now what we counselled during the last 17 years. The volatility over the last few months is the short-term cost we occasionally pay in order to obtain the higher longer-term returns on tap from stocks and corporate bonds. The journey to investment success thus involves making a long-term investment plan that acknowledges the bumpy road inevitably encountered along the way, and then sticking to that plan during both the bad times and the good.

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