Counsel Views – Episode 2: Sarah Riopelle

Stu Morrow:

Good day, everyone, and thank you for joining us for this edition of Counsel Views. I’m your host, Stu Morrow, Vice President, Head of Investments at RBC PH&N Investment Counsel.

Since the third week of March, financial markets have been on a steady move higher, recovering almost all of the losses as a result of the COVID crisis. Yet this recovery has been rather swift and seemingly out of sync with the bad news reported by some of the media.

Today, I’ll be discussing with our guest speaker, the importance of a well-tuned investment process to help navigate these volatile markets. We will also briefly touch on the low interest rate environment, private market investing, and other topics as part of a long-term growth strategy.

Please feel free to reach out to your investment counselor with any questions or comments related to what we discuss in this audio recording. And with that, I’m very pleased to welcome our guest, Sarah Riopelle, who is Vice President and Senior Portfolio Manager, Investment Solutions at RBC Global Asset Management.

And with that, I’m very pleased to welcome our guest, Sarah Riopelle, who is Vice President and Senior Portfolio Manager, Investment Solutions at RBC Global Asset Management.

Welcome, Sarah. How you doing today?

Sarah Riopelle:

I’m great. How are you?

Stu Morrow:

I’m good. I’m good. Good. Thanks for joining us. Maybe before we—

Sarah Riopelle:

[Thanks, Stu.]

Stu Morrow:

—we kick off with some questions, can you give our listeners a quick overview of the various mandates under your care?

Sarah Riopelle:

Yeah. Sure. So my team manages all of our Balanced and Multi-Asset strategies, as well as anything that’s sort of structured as a fund-on-fund or a [wrap] solution. So that includes the target risk profiles solutions, like the RBC Global Select and Select Choices portfolios, as well as, um, target date portfolios such as Retirement and Target Education. And then we also manage a variety of currency-neutral products and ETFs because those are structured as fund-on-fund. So in total, my team manages over 100 different strategies on behalf of our clients.

Stu Morrow:

So many strategies, I’m sure you’re such a good, very busy person, Sarah. So from a process perspective, how do you sort of handle the noise out there? Whether it’s, you know, politics? It’s COVID-19-related? Something else in the market that’s, you know, has been bugging people? As a headwind? Are there certain indicators that you tend to watch more than others? And if so, like, could you give us a sense of—of sort of what you watch, day to day?

Sarah Riopelle:

Sure. So we have to sift through an enormous amount of data every day, to try to identify changes in trends and enter new information that’s coming at us. We have a large team dedicated to that. We have access to sophisticated macro forecasting tools and the expertise so, you know, lots of people and lots of tools that are dedicated to this process. So we have lots of info. And we’ve built composites and macro dashboards to help us to digest all of this information, so we try to aggregate all of the different indicators into, sort of, what we call bite-sized chunks, to make it a little bit easier.

Uh, things have been moving fast over the last couple of months, so we’ve put some special reports in place. We have Eric Lascelles’ weekly economic update, which is really excellent, so I encourage everybody to read that. There’s also daily tracking of the COVID numbers around the world because we found it’s really important to, to really closely watch the numbers in different countries and different regions around the world, different states in the United States, and sort of track what’s happening there.

During the depths of the crisis, we created a chart book of indicators that we actually updated and circulated on a daily basis. So now that things have calmed a bit, we’ve switched to updating that weekly. It’s not short; it’s about 40 pages long. It contains a lot of different data points that we think are important to monitor during this particular period.

It looks at a broad range of indicators, including traditional metrics such as your earnings, yields, inflation, but some higher frequency indicators such as [novel] searches, airline traffic, restaurant bookings, public transit occupancy, mortgage applications, some of those sort of higher twitch indicators that will give you a little bit more of a real-time pulse on the economy.

Stu Morrow:

Right. Wow, it’s a lot. It’s quite a lengthy package. And you touched on—mentioned yields and inflation. So you know, if you take a step back and think about the interest rates environment for a moment, fixed-income yields at historic lows, how should our investors and clients think about, you know, the interest rate environment, moving forward? You know, whether it’s the next few years? Or a bit longer term?

And do you—how do you think about inflation? Is it ever going to be a problem for investors again? Or is it, you know, sort of, as people think about it, it’s dead in the water right now and not to come back?

Sarah Riopelle:

Wow. Yeah. I love two-part questions. So let’s tackle interest rates first. So the pandemic has reinforced many of the trends that were already in place before the virus, so we’re stuck in an indefinite period of slow economic growth, low-interest rate, highly accommodative central bank policies. Over the past 40 years, the 10-year US Treasury bond has fallen from 15.8% to 0.5% and now rests near its lowest mark in 150 years. So it’s definitely something that we need to think about.

Around the world, the real rate of interest has plunged and the causes for that indicate that this lower real rate of interest is probably here to stay for quite some time. You know, that’s things like aging populations, the emergence of emerging markets as a core asset class, an increased preference for saving versus spending, and just that slower economic growth that I talked about a moment ago. These are all unlikely to reverse course any time soon.

So sustained low real rate suggests a long period of below-average returns lies ahead for traditional sovereign fixed-income. And with rates so low, government bonds are probably going to be less of a portfolio diversifier in the context of a balanced or a multi-asset portfolio. So as a result, balanced portfolios of stocks and bonds, like the—the ones that my team manages—are probably going to be challenged to deliver the strong returns that we’ve seen over the last decade or two.

So our view that stocks are probably going to provide superior returns to fixed-income in this situation, or in this scenario. Returns on sovereign bonds are probably going to be quite low. That’s actually caused us to adjust the strategic or neutral weights for all of our Balanced portfolios in favour of more equities and less bonds. We think that investors will be reasonably well rewarded for accepting a journey that’s a little bit bumpier in the short term, to capture that additional returns from the higher equity weight in the longer term.

And we announced this change at the beginning of June, when Dan Chornous released the strategy update. And then we also backed that up with a white paper that he wrote, and we released about a month ago. So I encourage you guys to read that. But overall, low expected returns for fixed-income have led us to increase the equity rate and lower the bond rate in the context of a multi-asset portfolio.

Um, and then I think the second part of your question was inflation. So, you know, most of the major central banks target at a 2% inflation rate. Following the 2008 financial crisis, investors were concerned about inflation following ultra-low interest rates, quantitative easing programs. But that inflation never really materialized, so we’ve been stuck in this low inflation period for the past decade.

Again, with the COVID-19 crisis, we’ve seen expanding central bank balance sheets, interest rates at extremely low levels—similar scenario as we did before. There are some circumstances unique to this pandemic that could argue for higher inflation. But we think that the depressed economic activity is likely going to limit pricing power going forward.

So there’s lots of reasons why inflation could increase, but there’s also lots of limits on how far in prices can move. So on balance, we continue to expect the world to remain in a low to moderate inflation regime. But we think the risk probably points upward more than downward at this point.

Stu Morrow:

That’s great. That’s great. Very helpful. Thank you.

One of the things I want to come back on is you talked about in your comments about bonds and portfolio diversification. So as you know, one of the most important parts of our investment process at RBC PH&N Investment Counsel is portfolio diversification, of course.

So how are you and, you know, RBC Global Asset Management, thinking about portfolio diversification across all asset classes? And, you know, regions? And investment styles today, please?

Sarah Riopelle:

Yeah. Well, that’s one of my favourite topics, is diversification because I really, strongly believe that’s one of the core tenets of a strong investment plan. I think it’s the most important decision that you’re going to make when you’re building a portfolio. You need to decide which asset classes you want to own, and how much of each, and you need to be diversified across asset classes because that’s going to create a smoother and more consistent return profile and keep your clients invested, especially during times of stress, which is what we’ve been through over the last few months.

Um, so there’s many ways to diversify a portfolio. So there’s the high-level asset mix, cash, bonds, stocks, within asset classes. So in fixed income, you can own sovereign, credit, high-yield, emerging market, different regions around the world in equity, so emerging markets versus Canada and the US. We diversify by fund. So within Canadian equities, we own five different Canadian equity funds, um, because they all have different investment process and different strategies.

We diversify it by managers, so same thing, is that, you know, we want funds managed by different teams and different portfolio managers, so we can diversify by investment process because not every portfolio manager is going to be doing well at the same time, so we want to take a diversified approach there.

And you mentioned factor and style. So we diversify by factor as well. So for example, the PH&N US Multi-Style All-Cap Equity Fund owns core growth and value strategies, as well as small, mid, and large-cap strategies, so that we can diversify across those style factors within that portfolio as well.

Overall, we take a risk-budgeting approach to portfolio construction. So we set the weight so that no individual asset class accounts for too large a portion of the total risk budget, and that approach helps us to lower volatility and prevent a single position from dominating outcomes.

Stu Morrow:

Yeah.

Sarah Riopelle:

So for example, in sovereign bonds, they have a lower expected return and risk. So therefore, you can have a much larger portion of the risk budget is still assigned to sovereign bonds. But when you compare that emerging market equities, at the other end of the spectrum, which have a higher risk profile, higher volatility profile, you’re only going to be able to assign a smaller weight or a smaller portion of your risk budget to emerging market equities because of that higher volatility and risk profile.

And so our goal is to make sure that no one debt or one commission takes up more than 20% of the risk budget. So it’s something—it’s great to be diversified. It’s great to own a variety of different asset classes and strategies and funds. But use a risk-budgeting approach to make sure that the rate that you’re assigning to those different strategies is not too large in the context of the risk-and-return profile.

Stu Morrow:

Very well said. And how is the view from the firm evolved over the years, as it relates to private markets? Or less liquid asset classes? You know, just maybe talk about how you’re thinking about that asset class as part of portfolio construction and diversification?

Sarah Riopelle:

So we’re always looking for new tools, new asset classes, new solutions to add to the mix, but it’s finding ways to add alpha because we believe—Dan Chornous calls it scratching out the inches. You know, every basis point counts.

So you should look for assets that have low correlation with traditional asset classes that you’re invested in because low correlation means greater opportunities for diversification, which we just talked about. So given the low expected returns for sovereign bonds that we talked about earlier, investors just are going to be rewarded for renovating their multi-asset programs to include assets to the degree possible, mimic the prior benefits of sovereign bonds while contributing to portfolio returns, close to those that are embedded in savings and investment programs. And I think that private markets could fulfill that role.

In Canada, we began building a capability in direct real estate in 2018, launched our first fund in the fall of last year. Many of our balanced funds were, for the first time, able to gain exposure to a diversified portfolio of Canadian real estate. And we hope to build on those positions going forward. Direct real estate is a highly useful diversifier for stocks, while also offering superior yields, which offset some of that pressure from the sovereign bond side of the portfolios.

Similarly, mortgages with yields that exceed those on sovereign bonds, offer a substitute as well. Our experience in the asset class stretches back decades. And over the past couple of years, we’ve been adding in the management talent to our mortgage portfolio and are looking to expand our reach in that area as well.

So real estate and mortgages are a work in progress, and we’re always looking at other asset classes, such as infrastructure or expanding our real estate exposure beyond Canada as well, so lots of work on that side of the business.

Stu Morrow:

Very, very interesting stuff.

I also notice there is a new strategy launched by RBC Global Asset Management recently in the Chinese onshore market. Can you give us a short introduction to that fund? And how that might fit into a portfolio?

Sarah Riopelle:

Sure. Well, it’s a complicated and large market, so I’m not sure how short it’s going to be, but I’ll just do my—

Stu Morrow:

[laughs]

Sarah Riopelle:

So yes, we launched the RBC China Equity Fund in April, and we started buying it in the multi-asset funds in May. So the Asian equity team actually published a thought piece on investing in China in support of the launch of that fund. So that’s a good way to get some information about that asset class.

So as I mentioned, China’s a huge market, a huge economy. And with the opening of that market and the increased inclusion in different indexes around the world, it’s becoming a large asset class that can’t be ignored. So we added a separate allocation to Chinese equities within our portfolios. It adds to our diversification goal. There’s that theme of diversification again that we talked about earlier.

And it’s a large equity asset class with relatively low levels of correlation to the other global indices, which is why we want to add it to the balanced portfolios. You know, the growth model in China is changing from an asset-intensive, old-economy-type structure to one that’s more technology-based, digital products, low asset intensity, and a high IP-driven industry. So that basically means there’s plenty of good companies to invest in.

And we believe there’s lots of alpha to be had in that market, so it’s a good place for active managers. That’s back to that theme of scratching out the inches, looking for every basis point that we can and so, looking for markets that have a high likelihood of generating alpha for active managers.

And we especially think that those who incorporate ESG into their investment processes will be rewarded because governance is still a challenge for many companies in that market. But our Asian equity team who manages the strategy has a very strong and robust ESG process that is incorporated into their investment philosophy.

Stu Morrow:

Well, you did a great job. I know it’s a complicated market, and it’s an exciting opportunity. You did it well in that short bit of time. Thank you for that. And definitely, we could circulate that piece written by the team around the Chinese onshore market.

Maybe, if you can talk to, you know, the backdrop over the last six, seven months, you know, as it relates to investment process and risk management, you know, is there anything that you think our clients and investors and listeners would want to know about? Things that you may’ve learned? Or you found that have worked well? Maybe not have worked so well? And maybe how that may’ve impacted your process?

Sarah Riopelle:

Yeah. Well, two things jump to mind, which I think we’ve covered a little bit already but just sort of summarize them here.

So the first one would be to stick to your investment philosophy, even in times of stress. I would probably, actually, adjust that to say especially in times of stress. For us, that relates to our disciplined rebalancing process. It would certainly have been easy to abandon our rebalance process in mid-March, as we were continually adding to equity positions as the market sold off. And so it certainly didn’t feel good at the time.

But if we had not stuck to it, we wouldn’t have been positioned with a full equity weight when the bottom came on March 23rd and we saw the subsequent recovery in markets. And the portfolios have really benefitted from having that full equity weight in the recovery that we’ve seen since then. So that’s the first piece.

The second piece is around risk budgeting, which we talked about earlier. I just think that’s really key. It’s important to risk budget everything that we do, whether it’s at the asset class level or all the way down to individual securities, whether it’s Shopify in Canada, or it’s the bank stocks in the US. You need to make sure that you’re positioned in a way that the continued rise of those names, are not going to hurt you too much if you are positioned with an underwrite position.

So yes, Shopify is expensive. Everybody agrees that the valuation is quite extreme. But it’s the largest weight in the index, so you have to balance that expense evaluation against the potential impact on tracking error and performance of not owning a stock with an 8% weight. And so that just reinforces the need to risk budget everything that we do and, you know, balance the pros and cons of every decision that you’re making.

So I think those are probably two key things that we’ve learned over the last six months.

Stu Morrow:

Well said. Well said. Thank you. Sarah, as we close off each one of these sessions, I ask guest speakers for a book recommendation or their favourite podcast or audio recording related to investing and finance. Is there any sort of, you know, things that you’ve come across, uh, you know, you’re reading today or listening to, that you would recommend to our clients?

Sarah Riopelle:

So Dan Chornous, our Chief Investment Officer, keeps us busy with book suggestions. Um, he sends them along frequently to the investment team and when he sees a good book, he likes to share it with us. And so one of the ones he shared with us early in the crisis is actually called—we’ve read it before but he read it again, um, and thought it was really important to share with the investment team. It’s called /The Checklist Manifesto./

Stu Morrow:

Mm.

Sarah Riopelle:

It’s a really great book. And for those of you who don’t know me, I’m pretty Type A. I love to make lists. So this book, reading it, really, really enforced why I do that.

The basic principle is that we live in a world of great and increasing complexity, and you need to find ways to cope. And a great way to do that is to break each task or problem down into a series of steps and create a checklist of what is needed for each step.

So I think this is a really great tool in my business. You know, we create over 100 funds every day, each with a custom mandate or trade requirement. So checklists are needed to ensure that all funds are looked at, all rules are followed, and all steps are completed on a daily basis.

And we’re also using the checklist idea in all of our error meetings as well. So we occasionally have trading errors. And we want to make sure that we learn from them. And so we want to know, how did the error happen? What steps are we going to put in place to make sure it doesn’t happen again? And often, creating a simple checklist, um, so repetitive process can help prevent reoccurrence of that. So that’s just a couple examples of how we’re using the checklist idea from that book in our investment process and our day-to-day, you know, trading of the funds.

Stu Morrow:

That’s great. I’ll definitely check out the book, and the recommendation is much appreciated.

Sarah, thank you for taking the time to speak with me today on Counsel Views. I know our clients really do appreciate your insights and your thoughts on the market, as do I. And hope that you and the family stay safe and healthy and enjoy the rest of your summer break.

Sarah Riopelle:

Thanks for having me.

Stu Morrow:

Any time. Hope you come back. Thanks, Sarah.