Before completely shifting our focus to 2022, we take a brief look back at some major milestones at High Level Wealth Management over the last year and review capital market performance.
In early 2021, High Level Wealth Management was granted registration by the Alberta Securities Commission in the category of Portfolio Manager. This was the culmination of many months spent working on the the firm’s application and fulfilling various registration requirements. As a registered portfolio manager, we can now provide securities advice and manage investment portfolios on behalf of clients. This allows us to offer a comprehensive set of services including financial planning, investment management, and personal tax preparation for an all-inclusive fee.
As a newly registered Portfolio Manager, the bulk of 2021 was spent establishing partnerships with other firms to enable our business operations. As you can imagine, there are many tools, integrations, and software licenses required to run a successful portfolio management firm. Our most impactful business decision of the year was the selection of an investment dealer to act as the custodian and executing broker for our clients’ accounts. We selected Fidelity Clearing Canada for this role based on their competitive pricing and technology-focused approach.
On the regulatory front, 2021 also brought several major changes in the form of the Client Focused Reforms. These reforms were implemented in two phases (June and December) with several key areas of focus:
- addressing material conflicts of interest
- introducing “Know Your Product” obligations requiring firms and investment advisors to understand the securities that they purchase, sell, or recommend
- updating existing “Know Your Client” obligations intended to result in more suitable investment recommendations
Given our commitment to transparency, honesty, and professionalism we welcome these reforms and have integrated the new regulations into our policies, procedures, and business operations.
Capital Market Performance
Given our belief in passive investment management, we don’t spend a lot of our time analyzing the economic cycle, worrying about current capital market valuations relative to our own estimates, or forecasting short-term returns for individual securities, sectors, or countries. Instead, we focus on long-term (i.e. 10+ years) return assumptions for broad asset classes and construct model portfolios that we expect will provide efficient returns in accordance with modern portfolio theory.
Despite our long-term focus, it can still be useful to monitor the performance of capital markets over the short and medium term to assess whether returns are evolving in line with longer-term assumptions. Chart 1 provides 1-year returns (in Canadian dollars terms) for various benchmarks/asset classes in 2021:
As demonstrated in Chart 1, there were some interesting results in 2021. Let’s discuss a few of the highlights:
- Inflation (+4.7%) was a widely covered topic in 2021. The combination of ultra low short-term interest rates, pandemic-related government programs putting cash in the hands of individuals/businesses, a shift of consumer spending towards goods (because many services were inaccessible), and global supply chain constraints all added to inflationary pressures in 2021. By the end of the year (i.e. comparing November 2021 prices against November 2020 prices) the All-Items CPI index had risen 4.7%. While the year-over-year comparison is striking (and certainly made for sensational news headlines), we are not convinced that inflation will be a persistent issue going forward. Many of the factors leading to last year’s results appear to be temporary in nature and could work themselves out as the pandemic slows down and life returns to some form of normalcy. Prior to the pandemic, technological progress, globalization, and population demographics were longer term trends keeping inflation low. 2022 should provide a gauge of whether the temporary/cyclical inflationary pressures will expand more broadly or whether secular deflationary trends will regain prominence.
- Universe Bonds (-2.5%) had their first negative annual return since 2013. Longer-term interest rates rose throughout the year as employment levels and economic output gradually recovered from pandemic-related losses and investors began to anticipate the start of short-term interest rate hikes by the Bank of Canada in 2022. The negative return for Universe Bonds should however be considered in context of the stellar performance of the asset class in 2020 (+8.4%).
- Canada Equity (+25.1%) was the best performing asset class in 2021, driven primarily by the energy sector (+85.2%), real estate (+37.4%), and financials (+36.5%). The health care sector (-23.1%) was the only laggard for the year, dragged down by its exposure to poorly performing cannabis stocks.
- U.S. Equity (+24.7%) was the second-best performing asset class in 2021 and this was all the more impressive given the exceptional returns of the asset class in 2019 (+24.4%) and 2020 (+18.5%). We do not think this string of returns is sustainable in the long run and would not be surprised to see a pull back in U.S. equities in 2022. That said, we probably would have made the same comment after 2020’s above average results, highlighting the difficulty of predicting short-term investment returns and providing a great example of why we do not attempt to time the market.
- Emerging Equity (-3.4%) was a notable outlier to an otherwise very positive year for global stocks. The return was dragged down by exposure to Chinese stocks (-22.4%), which make up about a third of the asset class weighting. A slowdown in China’s property market and new government policies targeting overvalued sectors like technology contributed to the declines.
While the 2021 annual returns are interesting, we always encourage investors to discount year-to-year swings and instead focus on the longer term. Chart 2 therefore presents capital market performance over the past 5 years:
With the exception of the U.S. dollar and international currencies, all of the benchmarks and asset classes presented in Chart 2 experienced positive annualized returns over the 5-year period ending December 31, 2021. These medium-term returns are largely in line (i.e. +/- 2%) with our most recent long-term capital market assumptions (represented by a vertical blue line for each asset class), albeit with a few notable exceptions:
- U.S. Equity (+16.5%) has experienced incredible returns over the past five years, returning the equivalent of 16.5% per year over the period. This is substantially higher than our most recent long-term return assumption of 6.1%, which incorporates an expectation for U.S. equity returns to moderate going forward. As we mentioned in our comments on the annual U.S. equity return, we do not think this string of above average returns is sustainable in the long run and would not be surprised to see some form of pull back in U.S. equities in 2022.
- Global Low Volatility Equity (+9.1%) has experienced strong returns over the past five years, returning the equivalent of 9.1% per year over the period. This is above our most recent long-term return assumption of 4.9%, which incorporates an expectation that equity returns will moderate going forward. Given that U.S. equity makes up a significant portion of the global low volatility equity asset class, it is not surprising to see the incredible returns for that asset class also reflected in the 5-year return of this asset class.
- Gold (+8.2%) has experienced returns over the past five years well above our long-term return assumption of 3.4%. The price of the precious metal is historically very volatile so it is not surprising to see large deviations from our long-term return assumption in this asset class. Gold is an optional component in some of our model portfolios, included for its diversification benefits, not because it is expected to provide consistently high (or stable) returns.
As highlighted in the capital market performance charts, 2021 was characterized by above average equity returns, below average bond returns, and the future trajectory of inflation creating much debate and uncertainty. Considering 5-year returns, most asset classes have performed fairly close to our long-term capital market return assumptions although U.S. equity clearly stands out for its outperformance and the associated potential for lower returns going forward.
Some may therefore wonder, if we expect lower U.S. equity returns, why don’t we proactively reduce exposure to the asset class in clients’ accounts? The answer is that we believe strongly in passive investment management (in fact, that is often why clients select us as their portfolio manager), and adjusting target allocations between asset classes based on short-term expectation (i.e. trying to time the market) goes against our philosophy. While we might expect lower U.S. equity returns, we can’t confidently predict when they might occur and 2022 could turn out to be an even better year for the asset class than 2021. Our model portfolios are constructed to provide efficient returns over the long term (i.e. 10+ years) and the allocation to U.S. equities within those model portfolios is tied to our long term return assumptions, not our expectations for the next year or two.
As a firm, High Level Wealth Management has a number of priorities in 2022:
- Development of new model portfolios with a focus on Environmental, Social, and Governance (ESG) factors. This is an area of finance that has received growing attention over recent years, and we understand investors’ desire for investment portfolios that align with their values. At the same time, there are many investment products advertised as “sustainable” or “impactful” that don’t actually live up to their marketing. We therefore want to take a measured and well-researched approach to the development of our ESG model portfolios.
- We made several enhancements to the My High Level Wealth client portal throughout 2021 and we will continue adding features in 2022. Improving the user experience on mobile devices is a priority, and we’d like to replace some of the reports/tools currently provided via spreadsheets with interactive client portal modules. Your feedback is always appreciated, so let us know if you have any ideas or opinions.
- As a new portfolio management firm, our primary focus in 2022 will be introducing our services to new clients. There are a variety of business models in the financial services industry with practitioners of varying skill levels all calling themselves financial advisors. Our hope is to stand out based on our professional, trustworthy, client-focused service, which is offered at a fair price. If you know someone that might benefit from our services, please let them know about us.
The past year has been particularly challenging for many and we sincerely appreciate the continued support of our clients, family, and friends as we all navigate these uncertain times together. We wish everyone a healthy and prosperous year ahead and we look forward to playing a part in your success.