Welcome to Personally Invested. I’m your host, Dave Richardson. Today I sit down with Sarah Riopelle her second appearance on Personally Invested. The last time, we talked a little bit about Sarah’s life, her experience in her early career and the role that she plays in constructing portfolios where she works at RBC Global Asset Management. This time, we take it a step further. For Canadian investors, we look at Canadians’ natural home-bias towards investing assets in Canada, the need to build portfolios that have more global exposure, but also the unique challenges that are involved in building those portfolios when you open the number of choices from a limited number in Canada to literally thousands of choices all around the world. It’s an interesting perspective from someone who is hands-on building global portfolios for investors every single day. Enjoy!
Sarah, welcome back to Personally Invested.
Thanks for having me, again.
Sarah, welcome back to Personally Invested.
Thanks for having me, again.
Again! So, last time we talked about, well, a lot about you, but also about general portfolio construction and some of your thoughts around that. In the interim, we’ve had lots of guests on, from all over the world.
Not as good as me, I’m sure.
None as good as you.
You have to say that so I’ll keep coming back.
Exactly. Certainly no one as charming.
And as intelligent.
I don't know about that.
O.K. But lots of people who are managing money in all different parts of the world have talked a lot about the importance of global diversification. Most of the people who listen to this podcast are based in Canada, and so they’re Canadian investors. And they tend to – and this happens in virtually every country around the world –they tend to have a bit of a home-country bias: they tend to be more comfortable investing in Canada. So even when we bring experts onto this program and have them talk about the importance and the opportunity of growth in emerging markets (China, India, and so many countries around the world) and, obviously, the largest economy in the world just south of us (the United States), Europe, all these different areas that provide so many different opportunities to invest.Yet Canadians are more comfortable investing in Canada. Again and again we see Canadians stay home. And you’ve even got some numbers on this to talk about just how strong that bias is.
It’s not just their investments; it’s their house, it’s their jobs; they get, you know, stock options through work; and when you add all that up together, I think they probably have, the statistic I saw was 90% of their investments are invested in Canada. And, as you said, it’s not specific to Canadians. This home-country bias is true of everybody around the world. It’s just that people are more comfortable staying invested close to home. And that’s not necessarily the best option for them.
Yeah, and particularly, ¬ and we brought this up on the podcast in previous episodes: Canada only represents about 3%, a little bit less than 3% of the world’s investment opportunities.
Yeah, about 3% of the global stock market and about 3% of the global bond market. And Canada is actually the tenth-largest developed economy, so it’s quite far down the list. So, you really have to look outside of Canada for other investment options when you’re building portfolios and want to diversify those portfolios. You have to look outside of Canada because you get a lot more solutions to choose from when you look on a more global basis.
Yeah, poutine, back bacon, maple syrup, very delicious.
But if that’s all you ate, it would be a boring life and you’d probably look a lot like I do, which is why I’m doing podcasts instead of videos.
Is that why we cancelled the video?
No, that’s not why, no, no, I’ve been trying to manage my way a little bit. But, I think even Canadians, based on some of the numbers that you have, are even more biased than some other investors in other parts of the world.
Yeah, a little; the 90% number that I mentioned is one of the higher numbers that I’ve seen on the statistics, for sure, yeah. And I think some people are concerned about the risk. And they think that investing outside of Canada means investing in more risky asset classes. I actually don’t think that that’s true.
That’s odd, would be counterintuitive to most investors that I would talk to. They think investing close to home in Canada, in what they know—that there’s a comfort in that, there’s a security, maybe even lower risk. But you’re saying that’s not the way you think about it?
Well, no. I wouldn’t consider Canada be a risky country, but the Canadian equity market is focused on a couple of sectors: Energy and Financials are very important and large sectors in the Canadian equity market. And then the Canadian economy and market have a tilt towards commodity-oriented names, which are traditionally more volatile and trade with commodity prices. And so I would say that you want to diversify your exposure. Doing that doesn’t mean that you’re taking on more risk by going more global. You can go invest in German bonds or you can go invest in equities in Japan, and those are no more risky than what you would be getting in Canada. In fact, I think it would be less risky because you’re adding to your diversification, which lowers the risk profile of portfolios.
So, we’ve got a chart that we’re looking at here together. And it very clearly shows that a balanced portfolio of domestic bonds and stocks (“domestic” in this case being Canada). And if you look at the risk and return relative to a global portfolio (again balanced, fixed income and equities)
Source: RBC GAM, Morningstar, as of June 1, 2009 to May 31, 2019. Composition of global balanced portfolio: 35% Bloomberg Barclays Global Aggregate Index (Hedged), 1% FTSE TMX Canada 30 Day T-Bill Index, 4% JPMorgan EMBI Global Diversified Index, 7% MSCI Emerging Market Index, 22% MSCI World Index ex Canada, 30% S&P 500 Index, 1% S&P/TSX Composite Index. Indexes used to represent each of the asset classes shown: Cash = FTSE TMX Canada 30 Day T-Bill Index, World government bonds = FTSE World Global Bond Index (Hedged), Canadian government bonds = FTSE Canada All Government Bond Index, Emerging market bonds = JPMorgan EMBI Global Diversified Index, Global equities = MSCI All-Country World Index, Canadian equities = S&P/TSX Composite Index, U.S. equities = S&P 500 Index, Emerging market equities = MSCI Emerging Market Index. An investment cannot be made directly into an index. The graph does not reflect transaction costs, investment management fees or taxes, which would reduce returns. Past performance is not a guarantee of future results. All performance in $CAD.
So higher return, lower risk when you go more global than when you focus on domestic only. And I really think that’s the power of diversification because you get so many more options looking at a global landscape than you do looking just at your own domestic investments.
Let’s get into portfolio construction because that’s your real area of expertise. And I think, for a lot of investors, it’s just a daunting task. If I play out my food analogy: if I’ve got a fairly limited choice of only Canadian options and, all of a sudden, I bring in the thousands of different amazing food options that are available from all around the world: now I’m facing what’s almost a paradox of choice: more choice, and it’s harder for me to make decisions, there are so many different options. I don't even know where to start in terms of constructing that globally diversified balanced portfolio. What’s your advice? How do you approach it in what you do?
It’s definitely a daunting task. The more global you go, the more investment options you have to choose from. But we have an entire team that is responsible for doing that work for us and for myself when we’re optimizing portfolios. It’s about having the right tools and the right resources and the right expertise to be able to do that. We take all of our investment solutions; we have over 275 different funds and solutions to choose from when we’re optimizing portfolios. We throw those all into the machine, as we call it, and into the optimizer and we are looking for the optimal blend of solutions or funds that will give us the best return at the lowest risk. It’s an iterative process; we probably look at 30 different metrics when we’re optimizing portfolios. It’s quite complex. But we’ve been doing this for 30 years, so we know how to put these types of solutions together. And I think that’s probably one of the main reasons why the portfolio solutions-type products that are available in the marketplace have become popular with investors is because the investment landscape has become so complicated that they are looking for somebody to help them out with that analysis. And that’s sort of what you can do when you create one of these multi asset-type solutions is to answer all of those questions on behalf of investors.
So, if I’m following what you’re talking about here, in terms of, you know, an investor could, as a do-it-yourself investor, build a global portfolio.
But, as a professional investment manager you have some tools, processes, you have some advantages that just put you in a better place to get to a portfolio that will basically maximize return while limiting...while minimizing risk.
So, I absolutely think that an individual investor could build one themselves, but they could not do it at the level of expertise that we’re doing it. So for example, I’ve talked in the past about having look-through capabilities, and so if you take five funds and blend them together into a solution, you need to understand what’s going on inside each of those funds and you need to aggregate those exposures up to understand what your true exposures are, how much do you have in high-yield, how much do you have in emerging market equities, for example. Do you have a bias towards interest rates? Do you have too much value style within those portfolios? There’s an enormous number of things that we look at. Even once we’ve gone through the exercise of actually blending and doing the optimization and building a solution, that’s just the first step. The next step is to look at what have we built. how is it going to perform, how would it have performed through history, how do we think it will perform going forward based on the expected returns that we have for the various asset classes and markets and solutions that we’re using? Looking at it in a rising interest rate environment? How would it perform in a bull market or a bear market in equities, how it would have performed. When we complete one of these analyses and build one of these types of products, we probably have a hundred-page deck of analysis that we’ve done and we’ve looked at every single angle we could possibly think of to make sure that we’re comfortable that we’ve built the best possible solution that we can build for our clients. And that level of granularity and detail and expertise that go into to building those is just so much more advanced than I think an individual investor could do by themselves. Could they do it? Absolutely. Could they do it with the same level of detail? I don’t think so.
And of course, you’re working with a team of people that are up 24 hours a day, effectively, as they’re working around the globe.
Yeah, I get up very early. Usually the first thing I do is have a conversation with our head of Asian equities, Mayur [Nallamala]. Because I get up at 4:30 am and he’s just finishing his day in Hong Kong and that is, we find, the best time to have our conversations. So, I’m usually sitting at a train station waiting for a train, on the phone with Asia going through stuff with him.
Yeah, and then your connection into Europe and really all over the world, which is obviously something that is very very difficult for an individual investor to replicate.
Well, we have 22 investment teams around the world in multiple cities. They’re embedded in the regions that they’re investing in. We think it’s really important is to make sure that they are on the ground. The Asian equity team that is, you know, doing analysis on Chinese stocks. We make sure that they are going into China and visiting companies. It would be really hard, obviously, for an individual investor, who doesn’t have access to the same level of expertise and information and data and research that we have access to.
So, if you’re looking to add a particular portfolio – just playing out what you just talked about—and say you might be adding Brazil, for exposure to commodities in emerging markets. If you’re not able to look through and see what’s actually happening in that Brazil portfolio that you’re adding, that portfolio might own a bunch of banks in Brazil, which is not why you’re looking for that exposure. So it’s very important to have a very clear understanding of all the different pieces, how you’re putting them together and why, and the role that each of those pieces plays.
Absolutely. I think Brazil is an interesting example, That’s a place that you probably don’t want to have too much exposure to right now.
Well, we’ll leave that aside—I used that just for an example. But that gets to,as you look at different areas that you’re investing in, both fixed income and equity(and something that I’ve been reading a little bit about lately is portfolio engineering)a so, when you look at the individual pieces that you’re using to build the portfolio, portfolio engineering becomes a big part of each of each of those pieces. Can you explain what portfolio engineering is, and then how it’s used within the different pieces that you use to build portfolios?
So, data is becoming a more and more important tool for portfolio managers, and the availability and access to data has grown exponentially. Our fundamental job as portfolio managers is to manage the risks within portfolios. And so we need to leverage all the data that we have available to us to understand what our exposures are: our risk exposures, our factor exposures, our style exposures within portfolios. If you, as a fundamental portfolio manager, sit down and put together a collection of 50 of your best ideas, that’s great, but do you know what you’ve built when you look at it in aggregate. Do you know that perhaps you’ve built a portfolio that has a bias towards interest rates? If we think that interest rates are going to rise, that’s going to be a problem for your portfolio. If you don’t know that that’s what you’ve built inside your portfolio, then you’re surprised when the fund doesn’t perform well. And so, the portfolio engineer’s job is to work with the portfolio managers and analysts to we’ll say ‘risk those portfolios,’ to understand what the exposures are within those portfolios, communicate that to the portfolio manager, and make sure they understand. If they want those risks there, that’s fine. But, the first thing is that they need to understand that they’re there. Then, maybe they want to accept it, maybe they want to have a bias towards interest rates. That’s fine, as long as it was a conscious decision to have it there. … Or he may say, “Oh, you know what? I didn’t actually mean to do that.” Then the portfolio engineer can provide them with alternative ways they can, maybe, adjust either names or adjust weights of the names that they like, in order to reduce that bias or that risk in the portfolio.
So, that hopefully helps you when you’re building the portfolio from all these different pieces—that you know that the investment vehicle—it could be an individual fund that you’re getting from a portfolio manager— doesn’t have those biases Or it may have a bias, but the portfolio manager has chosen to have that bias, but you’re also aware of that and you can feed that into your decision-making for building the broader portfolio.
Yeah, that’s the bottom up view of it. We take a top down view of it. We’re building the funds and blending the assets together and, or the solutions together, and then from a bottom-up perspective, we want to make sure that the portfolio managers on the underlying funds have built the most optimal and efficient portfolios that they can, too, and then the portfolio-engineering aspect of it is one of the main tools that they have available to them to do that.
OK, then the optimizer, when we finish here in the room, we can go out, it’s a big machine just outside your office, and we just toss the funds in? Tell me a little bit more about the optimizer and how it works. So, now you’ve got all these funds, you understand whether there are biases or not, or, and you plug them in. What’s an example of something that the optimizer would do to make sure the portfolio is constructed the way you want?
So, we look at so many different metrics. Risk and return are obviously important; Sharpe Ratio—we want to make sure that we’re choosing portfolios that have steady risk/return profiles—we don’t want to pick a fund that had a great year one year and then four bad years and then a great year the next year, we would rather have slow and steady returns, we would like them to generate those returns with as low risk as possible. But then we look at a lot of different things like upside and downside deviation and maximum drawdowns. And, you know, there’s a whole long list of criteria that we look at, when we’re blending portfolios together and so, ultimately what we want to do is we want to build a portfolio that can generate the best risk and return metrics for clients. And sometimes we have to make some choices as to what will work and not work, and then once we’ve built that portfolio, then the next step, we might decide, actually, we don’t want, too much high-yield within that, because if you build a portfolio that has five different fixed income funds and once you’ve looked inside all of those you find that: “Oh, actually my high-yield weight is 30%” (That’s just a very extreme example.) You definitely don't want to build a multi-asset solution that has a 30% allocation to high-yield. So then you have to go back again and say: “OK, well now, we need to re-blend the funds together or choose new funds so that we don’t, by the time we’re done, end up with a 30% high-yield weight. We want to have a lower weight to high-yield and so, it really is an iterative process. And then Dan Chornous eventually gets his hands on it. So you think that you’ve gone through your 10 or 15 scenarios, and then, when he gets his hands on it, you go through 10 or 15 more because he has been doing this for such a long time that he has great insights and he always comes up with something that we haven’t thought of. So Dan throws us back into the lab to go through a number of other different scenarios, and by the time we’ve gone through this whole process, we really strongly believe that we’ve built the best product that we possibly can, because it’s gone through so much review and so many iterations and we’ve looked at every detail we could possibly think of that we feel really strongly once we’ve finally gotten the thing out of the lab and then got it ready for public consumption, so to speak.
So when an investor buys a balanced portfolio or invests in a balanced portfolio, it seems like a simple one decision. But there is so much stuff going on between portfolio engineering, optimization, through a very rigorous process. It’s extremely sophisticated, extremely complex, and it seems to me.—you can agree or disagree—that having that kind of rigorous process and all those tools—coming back to where we started—is even more important if you’re investing in a global portfolio than when you’re just buying a domestic portfolio because of all the choices you have.
So global means more opportunities, but also more investment options to choose from, which makes the optimization process more complicated but ultimately more rewarding.
Yeah. What’s more fun, a domestic portfolio, one that’s a little more slanted towards Canada, or a real global portfolio? Just from a fund manager’s perspective?
I like something that has lots of different opportunities to make tactical asset-mix calls, and so having more investment solutions available or more access to more asset classes and regions, gives me more opportunities to make calls in terms of asset mix. When I say “me,” I mean the asset-mix committee, it’s not just me. There is a whole group that is involved in these decisions. But, that’s just another example, actually, of the resources that we’ve put behind this whole thing. The asset-mix committee is 10 people who are all experts in their individual fields, and we all get together and we talk about what’s going on in the economy and markets to make decisions on the portfolios. And we’ve put a lot of resources behind that part of the process as well.
Well, thanks Sarah, I think you’ve sort of lifted the hood on what’s underneath the construction of, again, what are very very complex and sophisticated portfolios that you’re running here with your team and with your Chief Investment Officer Dan Chornous, Thanks, as always, for your time. Thank you for listening to Personally Invested. If you have suggestions for future podcasts, please email us at RBCgampodcasts@RBC.com.