Initial Value $10,025.04
March 10, 2013
Update Value $12,254.79
June 12, 2014
The three months ending April 30 was another solid quarter for our Couch Potato Portfolio, posting a very respectable 3.6% gain. For the past 12 months, it has gained 8.7%, and since inception, the annualized compound return is 3.2%. While this may look to be unremarkable, it is fairly impressive considering the portfolio was launched in January 2008, just a few months before the worst financial crisis in decades.
It was the iShares S&P/TSX Composite Index ETF (TSX: XIC) that was responsible for most of the gains, rising nearly 7%, thanks to a nice bounce in the financial, energy, and gold sectors. The U.S. equity exposure was also a strong contributor, rising nearly 6%, thanks largely to the XSP’s currency hedge. Had the hedge not been in place, returns would have been about a third lower than they were. This was also the case for the international exposure in the portfolio, XIN, which has a fully hedged currency position.
Looking forward, the one area of this portfolio that causes me great concern is its fixed income exposure. Approximately 40% of the portfolio is in the iShares DEX Universe Bond Index ETF (TSX: XBB), which invests in a mix of Canadian government and corporate bonds. At the end of April, it held about two-thirds in government bonds, with the balance in investment grade corporate bonds. This results in a duration of nearly seven years, which indicates a very high level of interest rate sensitivity. For every 1% increase in bond yields, it is expected this portfolio will drop by nearly 7%.
With fixed income, I have been suggesting that investors become more defensive with their holdings. There are a couple of ways to do this. The first is to shorten the duration of your fixed income holdings. This can be done by investing in short term bond ETFs and adding some floating rate bond exposure. The iShares Canadian Short Term Bond Index ETF (TSX: XSB) is my top pick in the short-term space. For floating rate exposure, PowerShares Senior Loan CAD Hedged ETF (TSX: BKL) would be mypick.
Another way to be more defensive is to be a bit more offensive. By that I mean you can move out the risk curve and bring in some exposure to non-investment grade fixed income and some global bonds into the mix. With high yield, I am concerned about valuation levels, given that spreads are as narrow as they have been in recent memory. I’m not sure I’d be comfortable taking on any exposure at these levels, and would likely wait until we see a bit of a pullback in spreads. I have not yet found a global fixed income ETF I am comfortable with, as most of the Canadian offered ETFs are U.S. focused, rather than global. I’d likely hold off entering these areas for the near term.
If you do decide to make some or all of the changes discussed above, you are in essence abandoning the philosophy of the Couch Potato Portfolio, which is to find a handful of high quality investments you can just invest in and forget about. You will then have to become more active in managing your portfolio, as many of the strategies discussed may require a more hands-on approach.
Another way to help protect your fixed income holdings would be to invest in a high quality, actively managed bond fund. This could help you to still keep your portfolio very simple, yet have an actively managed component to help preserve value when rates creep higher. My top pick for this role would be the Dynamic Advantage Bond Fund (DYN 258), which employs a very active duration management strategy to help preserve capital in a rising rate environment. I would expect it to lag in a bond market rally, but is expected to outperform over the long term on a risk adjusted basis.
Here is the latest report on the Couch Potato Portfolio performance. Results are based on the closing prices as of April 30, 2014.
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