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Turchansky: Volatile Markets an Opportunity for Investors

Edmonton Journal   
Ray Turchansky

EDMONTON – In the face of high stock market volatility, investors can learn from history, but at the same time profit from trends the investment world has never seen before.

Harry Marmer, executive vice-president with Toronto-based Hillsdale Investment Management, told financial analysts with the Edmonton CFA Society that stock market volatility during the financial crisis of 2008 was the greatest it’s been during the past 84 years. It surpassed the volatility during the 1987 crash, which in turn had topped gyrations during the Great Depression of the early 1930s.

We went through a period of low volatility from 2003 through 2007, when annual returns on the S&P/TSX composite index ranged between seven and 24 per cent, but from 2008 through 2011 those returns varied between a gain of 30 per cent and a loss of 35 per cent.

“Part of the problem today is that the market has a myopic aversion to risk,” Marmer said. “They’re looking at volatility over very short periods of time. They’re looking at the headlines we see; now we’re reading about Spain.”

Marmer used a chart of the S&P 500 index in the United States to make four points about volatility – it changes over time, it goes up during recession periods and bear markets, it tends to cluster or persist, and it has been constant and high during the past four years.

“Investors are driven by the fact that they’re trying to avoid losses, which is through GICs, which stand for Guaranteed Inferior Compounding. Somehow we have to rewire our thinking to understand that there is a potential to lose money in the short term, but in the long term capital markets do work.”

Volatility plays havoc with the performance of money managers, bringing into debate the value of investors having managers actively change portfolios and try to beat stock market benchmarks, versus just buying passively managed indices through index or exchange traded funds.

“Your success as a money manager depends on your skill set and your capability or breadth,” he told analysts. “And this was shown from 2008 to 2011, when inter-stock correlations went very high, in other words all stocks moved down together. This made it very difficult for active managers to apply their skills in picking stocks.”

You want a money manager who follows a large number of stocks and funds, and who will be able to pick winners when stocks don’t all move in tandem, as occurred during the first quarter of this year when the volatility index or VIX subsided.

VIX and inter-stock portfolio correlation fell off the cliff, so if you had an active manager who didn’t do very well the first quarter, you may want to ask him or her a few questions.”

The problem, quoted Marmer, is that “active management is usually called into account at the wrong time.” He noted that during 2011, the median active manager — half did better, half did worse — added 7.2 per cent to returns above what indexes did.

He added that “people have to come to realize that market cap indices are really inefficient.”

Just as different management styles have various success rates at different times, the same holds for company size, or market cap.

“There’s a theory that small cap companies perform differently than large cap companies, and that there’s a small cap premium, that small cap companies will have on average excess returns, adjusted for risk, that is superior to large cap companies.”

However, large caps outperformed small caps from 1983 to 1998, and some academics proclaimed the small cap effect was basically dead. But Marmer said that “small companies can go through long periods of time when they do outperform large companies, and I think they should be an allocation in your portfolio.”

Another development in investing is the new importance of stock dividend yield, especially in relation to bonds and other fixed income.

“We are really living through quite a change in paradigms, the fact that equity dividend yields are higher than both cash and bond yields in Canada and the U.S.,” Marmer said. “So you can go out there and buy stocks that are yielding four or five per cent, generally low volatility stocks (compared to 10-year bonds yielding around 2.15 per cent). We have a great buying opportunity.”

Indeed, Canaccord Wealth Management calls quality high dividend paying stocks an “all weather strategy,” that performs well during periods of both high and low volatility. It says that dividends traditionally have accounted for 40 per cent of total equity returns on the S&P/TSX.

In early 2010, Canaccord launched its list of top dividend-yielding stocks, which included Capital Power, Crescent Point, First Capital Realty, Telus, Toronto Dominion and TransAlta.

Recently it unveiled a list of expected top dividend growers, namely Alaris Royalty, Algonquin Power, Amica Mature Lifestyles, AutoCanada, Bird Construction, CI Financial, Pembina Pipelines and Suncor Energy.