Risk speedometers: Investor appetite continues to be balanced and global
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By Fund Library News Wire  | Friday, December 29, 2017


By Todd Schlanger, Senior Investment Strategist, Investment Strategy Group, Vanguard Group, Inc.

Key highlights of Vanguard’s Risk Speedometers

* Our risk speedometers show investors’ willingness to take on risk edged slightly higher over the past month as stock prices continue to rise.
* Investment risk continues to be well balanced overall, which is an encouraging sign amid Canadian and global equity market outperformance.
* The trend toward global diversification continued as flows went into global categories and out of Canadian categories.

In November, we introduced Vanguard’s Canadian risk speedometers. We found that investors were well balanced in their risk appetite, which was an encouraging sign given that higher risk equity-type assets had outperformed more conservative bond-like investments in recent periods.

In Figure 1, we update the risk speedometers for the periods ending October 31, 2017, and find that risk has edged slightly higher in October relative to September, but continues to be well balanced over all periods.

Similar to last month, we regard that balance to be an encouraging sign considering that the Canadian equity market has outperformed the Canadian bond markets by 1.0%, 4.7% and 11.3% over the past 1-, 3- and 12-month periods, and global equities have similarly outpaced hedged global bonds by 4.8%, 7.0% and 18.0%, respectively, over the same periods with volatility remaining low.

This period does appear to be somewhat different than the typical pattern of increased risk appetite and performance-chasing that we have seen in other similar periods when equity returns have been above average and volatility below average. However, this could change as investor behaviour typically lags market returns, and there was a small period of outperformance by Canadian bonds in 2015, making the duration of the Canadian equity markets outperformance less than two years. The other thing to keep in mind is that a balanced risk appetite may reflect an environment where valuations are high and risk premiums compressed across asset classes.

Nevertheless, moderate risk appetite is an encouraging sign and shows that investors could be embracing the benefits of a well-balanced asset allocation and rebalancing to an appropriate asset mix in a period of market strength.

There are two other positive signs that Canadian investors could be embracing strategic asset allocation. The first is the global nature of net cash flows, shown in Figure 2. Indeed, all but one of the top three net inflow categories over the 1-, 3-, and 12-month periods were into global investments while the corresponding outflow categories were all from Canadian investments. Combined with a balanced risk appetite, these global flows provide greater diversification relative to the concentrated Canadian equity and bond markets, reducing idiosyncratic risks and providing exposure to a greater number of securities, markets, sectors, and economic and inflation environments.

The second positive sign to note is that to the extent that trends in the Canadian markets trail those of the U.S., it can often be seen as a leading indicator of trends that could emerge within Canada. In the U.S. we publish similar risk speedometers and have found the trend to asset allocation even further along amid an equity bull market that has been greater in magnitude and longer in duration. Against this backdrop, the October U.S. risk speedometers are below those of the Canadian market over all periods, suggesting rebalancing is occurring.

When examining net flows relative to their asset base, we find conflicting signals. Significant growth in the global bond category over the past 12 months of 42% is consistent with our hypothesis of a shift toward global asset allocation. However, other more niche and specialty categories dominated the list of both positive and negative relative flows. While these flows were not large enough to make it into the top three net flow tables in absolute terms, growth of speculative asset categories like volatility-based, inverse/leverage, and trading-based investments would seem to run counter to the hypothesis, although on the other hand they were the three most negative categories over the 12-month period. Significant growth of higher risk yield-centric categories, such as preferred share bonds and floating-rate loans, also buck the diversification trend.

If there is a trend to global asset allocation, it could be the result of fragmented behaviour within the investor base of individual, advisor, and institutional investors or that these investments are being used as smaller satellite allocations alongside a more diversified core investment portfolio, or both. Given complications arising from analyzing aggregate flows from a diverse population of investors, it is difficult to know for sure.

As time passes, we will continue to monitor the risk appetite and net flows of Canadian investors and comment on these and other trends as they develop.

Todd Schlanger, CFA, is a senior investment strategist in Vanguard’s Investment Strategy Group (ISG) based in Toronto, Canada, where his responsibilities include research on the capital markets, portfolio construction and design, and investment market commentary.

Notes and Disclaimer

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “ Research & Commentary” page of the Vanguard Group, Inc.’s website. Used with permission.

Important information

The views expressed in this material are based on the author's assessment as of the first publication date (December 2017), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The authors may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise.

This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation.

Please consult your financial and/or tax advisor for financial and/or tax information applicable to your specific situation.

While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use.

All investments, including those that seek to track indexes, are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market.

In this material, references to "Vanguard" are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.

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