A real-life stress test

Times of heightened volatility often mean a few things:

1. Angst, fear and capitulation with the media and casual investor, which leads to further volatility;
2. The opportunity for investment managers to shine as the new-found volatility opens up new prospects; and
3. Uncertain markets provide the chance to stress test plan structure in a real-life situation.

Read: More Canadians turning to global equities for retirement savings

This high level of volatility doesn’t appear to be going away anytime soon for Canadian investors. The price of oil has tumbled and, with it, the Canadian dollar.

There is a bit of a tug of war taking place with inflation; low oil and commodity prices are putting downward pressure on all goods leading to increased concerns about deflation, while the low loonie is pushing up prices from fruits and vegetables to new cars.

Read: 5 ways low oil prices and the falling loonie can affect the federal books

The days of a stable Canadian dollar may not return for some time. The dollar is a key factor for our economic and financial health leading to a call for potential central bank reaction. Currency changes are very high relative to growth and inflation right now, which creates a situation where the investment environment can be dominated by these currency movements. This scenario can lead to sudden periods of investment pain when we would otherwise be enjoying positive returns.

It all translates to more extreme ups and downs for investors compared to recent experience. Case in point, the domestic equity market has been bumpy of late – it was one of the worst performing equity markets globally in 2015, down 8.3%, and significantly behind the returns of the major global indices that all saw double-digit returns when brought back to Canada.

Read: Pension plans feel effect of January’s volatile markets: survey

The relative difference was highly influenced by the Canadian dollar, which registered one of its sharpest single-year declines ever down 16.2% versus the U.S. dollar. The volatility only intensified in the new year as we watched the Canadian equity market fall 11.5% over the first few weeks only to come back to where it started the year at the time of writing; quite the roller-coaster ride.

The result is a more volatile environment for businesses as well. The currency factor impacts companies’ earnings and investment decisions, and therefore feeds back into the overall economy and from there into monetary policy. We may very well see the Bank of Canada raise interest rates simply to provide some stability to the dollar, although this is certainly not the current consensus.

The born-again volatility in financial markets reminds us that stocks are risky and brings us back to why we put in place a Statement of Investment Policies and Procedures (SIPP) in the first place. Times of stress allow us to test our process and ensure we are getting the results we expect.

Read: New SIPP requirements take effect

Skilled money managers have an opportunity to shine. It also allows us to hold something up and ask: “Are they doing what we hired them to do? Are they staying true to their process and philosophy and does it work?”

Having a robust, ongoing performance and risk reporting mechanism in place means answering these questions is a breeze. Without it, there’s no way you can manage such volatility and it’s also likely you’ll fail to identify areas in the portfolio management process where improvements are, in fact, required.

In times of low growth, low inflation and high volatility, it’s increasingly important to know what’s going on; if you’re a fiduciary, you simply can’t be left in the dark – your members are depending on you to monitor their retirement assets. No one else is going to do it.

Read: 92% of pension funds plan to upgrade governance: report

Leclair and Powell’s next column will cover investment policy.