For the most part, this past quarter’s return was positive, but was much more “realistic” compared to the sky-high performance of Q1 after the significant decrease in markets in Q4 last year.
The TSX lead the way this quarter, up 2.6%, however, both small caps and value lagged their large cap and growth counterparts. Small caps fell -0.3% while large gained 3.0% and value was up 1.7% while growth was up 3.9%.
US equities suffered from a stronger Canadian dollar with the broad market advancing 1.8%in CAD, compared to 4.1% in USD; again, the returns for both small caps (up 0.6%) and value (up 1.4%) fell behind the gains posted by large caps (up 2.0%) and growth (up 2.2%), all in CAD.
International & Emerging Markets
The rest of the world was mixed with developed markets advancing 1.7%, while emerging markets fell -1.5%; for the year to date, both are in positive territory gaining 9.5% and 6.0%, respectively. The trend of weaker returns for small cap and value stocks continued on a global basis.
So far this asset class has been the star performer of 2019, but pulled back slightly with Canadian REITs falling -1.5% and international down -0.7% this past quarter; year to date they are up a healthy 14.0% and 11.3%, respectively.
Alternative Fixed Income
Canadian bonds have had a stellar year so far with the Canadian Universe Bond index (a broad index of government and corporate bonds) up 2.5% this quarter and up 6.5% year to date. Growing expectations for a rate cut south of the border and the expectation that the Bank of Canada could be forced to follow suit has provided significant support to bond prices.
This was an important quarter for gold. For six years, the $1,400 USD range has proven to be strong overhead resistance and it finally broke through and made a new high of 1,442.90 in the last week of June; gold has not seen this price since May, 2013. Lower interest rates are a positive for gold and we will be watching it closely over the coming months and beyond.
We made a significant change to our models in May by swapping out the DFA Canadian Equity fund and going into the National Bank Investments (NBI) Canadian Index. This was done after very careful consideration and data analysis. We want to emphasize that this does not represent a change in our investment philosophy of highly diversified global portfolios with tilts towards small cap and value equities; however, this is the result of the fact that the Canadian economy has a significant resource sector that is highly cyclical and volatile. Tilting towards small caps and value amplifies this volatility. We have therefore switched to a Index fund that follows the S&P/TSX 60, which is comprised of the sixty largest Canadian companies.
Let’s look at two important data sets behind this decision – returns and volatility.
This is usually the first broad data point to look at to compare two funds: For the first six months this year, the DFA fund returned 12.2% compared to 15.7% for NBI; over a one year period, DFA fell -3.3% while NBI gained 4.4% and over the past 5 years, DFA gained 2.1% annually versus 5.1% for NBI; these are not insignificant differences! The picture changes a little when looking at ten years, where DFA gained 6.9% compared to 7.0% for NBI; while this different of 10 basis points may appear to be small, the effects of compounding will begin to add up over the years.
A clearer picture begins to emerge of the significant differences when comparing their volatility. DFA has a standard deviation (a measure of overall volatility, where lower is better) of 10.6 versus 9.2 for NBI; however, this measures volatility to both the upside (which is good as it means higher than average returns) but the downside is more important as those represent losses. If we continue to delve deeper and look at the downside deviation, DFA is 3.0 versus 0.2 for NBI – what a difference! What this means is that when the TSX has fallen in the past, the DFA Canadian equity fund has fallen more and more often compared to the index. Over the past nine years, the DFA fund is up 58% of the time which means it is down 42%; on the other hand, the NBI fund is up 63% of the time and down 37%.
What do all of these numbers boil down to? This means, that over long periods of time, the DFA fund will have periods of losses that are larger than the NBI fund. This also means that the DFA fund will require higher returns to recoup those losses just to break even. Therefore, over the long term, we expect the NBI fund to have fewer negative periods and overall higher returns that more closely follow the TSX 60 Index.