The Case For Avoiding Unnecessary Complexity

There are no certainties in investing, but investors with reasonable ambitions stand a good chance of achieving them over longer horizons with a straightforward strategy: combining a meaningful allocation to growth assets with a complementary allocation to safe-harbour investments. The keys to successfully implementing this strategy are resisting the allure of more complex alternatives and avoiding the most common pitfalls that can undermine its effectiveness.

At IMCO, this is the practical approach we take to deliver resilient long-term results for our public sector clients across Ontario.

Growth assets tend to work over time

The most straightforward way to pursue solid long-term returns is to hold a diversified portfolio of growth assets such as public equities, infrastructure, real estate, and credit. While these investments can be volatile in the short term, over longer periods they have historically generated solid results. For example, the S&P 500’s long-run annualized return since 1928 has been about 10% (including dividends).

There will inevitably be macro environments where a growth-oriented portfolio will struggle, like depressions (such as the 1930s), periods of stagflation (such as parts of the 1970s), or periods of extended economic and market disruption following major crises (such as after the 2008 Global Financial Crisis). Fortunately, these environments represent a relatively small share of history. Since World War II there have been no rolling five-year periods where the US had negative real GDP growth, and the S&P 500 has generated positive total returns in 90% of rolling five-year periods over the same period. A bias to growth is reasonable over the long term.

While the S&P 500 has been an effective way to gain diversified growth exposure over the last century, today investors with scale can build better diversified growth portfolios with exposure to both public and private assets, a balance of geographies and market segments (small-cap, large-cap, and different industries). At IMCO this is the approach we take.

Alternative strategies often disappoint

Some investors pursue alternatives to the straightforward approach of owning a diversified growth portfolio. However, the most common alternatives, market timing, stock picking, and significant leverage, are generally less reliable.

Trying to time the market or buying/selling individual stocks based on a view that they are under- or overvalued, is notoriously difficult. Things that aren't supposed to happen regularly do happen: markets took off during the Covid pandemic, and they have continued to power upwards during the current disruption to global energy trade. A widely cited market adage captures this reality: “Markets can stay irrational longer than you can stay solvent.” This is why at IMCO we don’t pursue investment strategies that are based on predictions of short-term market events.

Stock picking is equally challenging. The S&P Dow Jones Indices’ SPIVA scorecards have for many years tracked active managers across geographies and sectors and consistently found that the majority do not outperform their benchmarks over multiple time horizons. This is likely, in part, because it’s been found that a relatively small number of stocks account for a disproportionate share of long-term returns. This is why we only engage in active public equity strategies in a very focused way. And the pursuit of outperformance in any asset class never drives us to an allocation to that asset class or a segment within an asset class that is disproportionately large.

Leverage is another technique some investors use to try to generate equity-like returns without holding a broad portfolio of growth assets. This typically means buying less-volatile investments and using borrowing to enhance returns. But it can also mean combining leverage with market timing strategies to enhance the impact of big market calls. Either way, excessive use of leverage can be extremely dangerous. In periods of market stress, leverage can force selling and turn liquidity problems into permanent losses, or insolvency. Well-known examples include Long-Term Capital Management (1998), Bear Stearns (March 2008), Washington Mutual (2008), Lehman Brothers (2008), UK LDI pension funds (September 2022), and Silicon Valley Bank (2023). IMCO client portfolios carry a very modest amount of leverage at the total portfolio level, if at all.

What can undermine a growth portfolio?

Even if investors accept the case for growth assets and avoid these alternative strategies, they also need to avoid common implementation mistakes.

1) Forced sales at the wrong time

Investors can only benefit from the tendency of growth assets to earn higher returns over the long term if they can hold on to them through drawdowns and participate in the recovery and subsequent compounding. To meet liquidity needs during crises, investors without complementary safe-harbour investments (like government bonds) may be forced to sell growth assets at the worst possible time.

For example, during the Global Financial Crisis, the S&P 500 fell about 57% from its October 2007 peak to its March 2009 trough but then delivered roughly an 18% annualized total return over the next 10 years. An investor forced to sell even a small portion at the bottom would have locked in losses and not participated in that long bull run.

This is why IMCO places a strong emphasis on maintaining sufficient high-quality liquid investments alongside growth assets.

2) Concentrated positions and bubbles

Big bets can also undermine the strategy of owning growth assets. Individual companies and market segments regularly reach excessively high valuations, then suffer steep drops in value with prolonged or no recovery. Japanese equities peaked in 1989, Nortel peaked in 2000, Russian equities peaked in May 2008, BlackBerry/Research In Motion peaked around 2008, U.S. technology stocks peaked in 2000, and North American REITs peaked in 2021. They all then fell in value. Some recovered over a very long time. Some are still recovering. Some will never recover.

A large allocation to any one of these companies or market segments would have materially detracted from an investor’s long-term portfolio returns. Avoiding the exuberance that can build around individual companies and market segments takes discipline. This is why IMCO explicitly avoids outsized allocations to any single asset class, sector, investment or theme.

Diversified growth with adequate liquidity generates resilient results

For long-term investors, the most straightforward way of meeting return objectives is not a complex strategy, but a disciplined one: maintain broad diversification across growth assets and maintain sufficient high quality liquid assets to avoid being forced to sell growth assets in downturns. This is IMCO’s approach.