Q2 2018 | Portfolio Commentary - Income

Volume 2 | Issue 2

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Two roads diverged in a yellow wood, and sorry I could not travel both.
— Excerpt from Robert Frost’s poem ‘The Road Not Taken’

Q2 2018: 

2018 has been a wild ride thus far. The S&P 500 index, which measures the aggregate value of the 500 largest publicly traded companies in the US was up 7% by the end of February, only to abruptly shed 10% of its value.  After such a smooth 2017, volatility reemerged with a vengeance.  We started fielding calls such as “is it time to get out of the market?,” and “What is happening to NAFTA?” and “What are you guys doing about President Donald Trump?”   

Although the S&P 500 finished the second quarter up 2.0% (year-to-date) that growth has largely come from just 5 companies in the index colloquially called the FAANG stocks (Facebook, Apple, Amazon, Netflix, Google).  These five companies represent 1% of the companies on the S&P 500 but are responsible for 24% of the index’s gains on the year. 

We often get asked about the FAANG stocks and whether we are properly positioned to capture their growth.

Source: Morningstar Research Inc. and Bloomberg L.P as of December 31, 2017

Source: Morningstar Research Inc. and Bloomberg L.P as of December 31, 2017

“Two roads diverged in a yellow wood, and sorry I could not travel both.”


We believe it is impossible to be positioned for both downside protection and maximum upside capture. We don’t try to “time the market” or “chase performance” rather our goal is to generate the best returns for a certain amount of risk.  While it is tempting to ride the hot investment wave (be it Cryptocurrency, Marijuana or FAANG stocks), we have learned that the hot trends often end badly.

This is why the key tenet of our investment philosophy is to keep our clients invested by limiting unnecessary swings in their portfolios. We continue to stress the importance of a balanced approach.  And throughout the first half of 2018, in the midst of trade war talk, inflation and rising interest rates, our model portfolios have been exceptionally boring, which is exactly our intention.  



In anticipation of rising rates across Canada and the US we purchased First Asset US & Canadian Lifeco Income ETF (FLI) in June 2017. Research has demonstrated that life insurance companies tend to perform well in rising rate environments. This is because life insurance companies need to hold a lot of ‘safe capital’ to pay out anticipated future claims. As interest rates rise, the amount of safe capital required decreases which increases return on equity.

Therefore, with the concern of rising interest rates we purchased FLI, 13 months ago. As of June 3rd, 2018, the position has returned -2.47% (including dividends), despite 3 rate increases in the Canada and 4 in the US.

Source: https://www.firstasset.com/solutions/overview/?fund=First+Asset+U.S.+%26amp%3B+Canada+Lifeco+Income+ETF

Source: https://www.firstasset.com/solutions/overview/?fund=First+Asset+U.S.+%26amp%3B+Canada+Lifeco+Income+ETF

So what happened?  The timing of our call was right as we saw 7 interest rate hikes in North America over the last 12 months but while the short end of the curve has gone up, the 10-year bonds in Canada and the US have been slower to adjust.  This combined with a few large write-downs by some of the insurance companies in the ETF have resulted in a capital loss during the holding period.

Our thesis has changed on the interest rate trade.  We continue to believe that interest rates will rise long term, however we feel the US 10-year yield will continue to be stubborn and take a lot longer to rise than we are willing to wait.  Therefore, we have decided to part ways with FLI due to the opportunity cost of holding it. 

With the proceeds we have purchased TD US Mid Cap Growth Class.  

We have chosen the mid-cap space because US tax reform and protectionist trade policies should be favourable to companies who are more domestically focused.  We see these as the “Make America Great Again” benefactors.  Mid-sized companies tend to have a lot, if not all their revenues based locally in the US.  This greatly lowers the risk from a trade war as well as currency risk.  With US unemployment at record lows and a tight job market, we anticipate the later stages of this economic expansion to be felt more domestically.

TD US Mid Cap Growth Class has an exceptional track record of 5, 10, and 15 years. Whenever deploying active management, we always want to see consistent outperformance beyond the benchmark. This justifies the extra cost we pay when using an actively managed mutual fund. As you can see it handily beats not only its peers but also the index. 


TD US Mid Cap Growth Class

Source: MorningStar AWS, TD US Mid-Cap Growth Class - F (CAD) as of 06-30-2018

Source: MorningStar AWS, TD US Mid-Cap Growth Class - F (CAD) as of 06-30-2018

There will no doubt be further volatility in the year ahead as mid-term elections in the US dominate the news, but we also feel that there is still more runway left in this market cycle. While we remain reasonably defensive we continue to expose ourselves to some of the growth that may still come out of this bull market.

The changes listed above were made to your accounts this week.  If you have any questions about the trades or your portfolio, we would love to hear from you.


Matthew Evans, CFP®, CIM®  | Portfolio Manager
HollisWealth®, a division of Industrial Alliance Securities Inc.

Lorenzo Pederzani, CFA, CFP®, FCSI®  | Director, Private Client Group & Portfolio Manager
HollisWealth®, a division of Industrial Alliance Securities Inc.


This information has been prepared by Lorenzo Pederzani and Matthew Evans who are  Investment Advisors/Portfolio Managers for HollisWealth® and does not necessarily reflect the opinion of HollisWealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisors/Portfolio Managers can open accounts only in the provinces in which they are registered.

HollisWealth® is a division of Industrial Alliance Securities Inc., a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.