October 2020 Portfolio Updates

October 2020 Portfolio Updates

This year has been one for the history books on many counts.  When we made the changes to our portfolios at the beginning of the year, we mentioned that we hadn’t experienced a bear market (i.e. 20% or greater decline) in over a decade.  While we did not know what would cause one, we knew (from a purely statistical standpoint) that we were on borrowed time and proactively adjusted our portfolios accordingly.  It turned out that the timing of our derisking was extremely timely.  When we made the changes to our portfolios, it was done so out of prudent investing decisions; not out of emotional distress.  This is one of our tenants of superior investing, not letting emotions or biases control our investment decisions. Here is our October 2020 portfolio updates.


It is with the same process that we reevaluate our portfolio allocations throughout the year, not letting emotions related to the elections guide us, but a strategic repositioning based on the changes in the markets over the past 10 months and the future expectations.  The question then remains, what changed, and what changes are we making?


Interest Rates

While interest rates were still near historic lows, they had been on an upward trajectory prior to COVID, and the expectation was that this trend would continue.  With the economic shock that came with shutting down the economy, the Fed stepped in to provide monetary and fiscal stimulus.  One of those levers was a reduction in interest rates.  The Fed has reiterated numerous times that there are no plans to raise rates until 2023 at the earliest.


So how does this affect the portfolio?  Well, bonds are an important component of a properly diversified portfolio. Bond returns are comprised of both the interest they pay and any gain/loss recognized along the way. The gain/loss can be related to buying the bond at a discount/premium initially, or the price you sell it at (if you don’t hold it through maturity). These changes in price are related to increases/decreases in interest rates since the bond was originally issued.  With interest rates dropping further this year, the interest paid amount that we (you) earn has also been further reduced and isn’t expected to increase materially in the near term. One opportunity to find higher interest payments is to look to a category that may have gotten a bad rap in 2008, Mortgage-Backed Securities (MBS).  What most people don’t know is that there are two types of mortgage-backed securities, Agency and Non-Agency MBS.


An agency MBS is one that is backed by Fannie Mae or Freddie Mac, which are in turn backed by the federal government.  This means that they essentially carry the same level of risk as a government bond, but pay higher interest rates.  In such a low interest-rate environment, finding any increases in income, without taking on additional risk, can be very beneficial to a portfolio. Non-agency MBS are those that are issued/backed by all other lenders. While non-agency MBS typically pay higher interest rates, they also carry significantly more risk.


We’ve added a low-cost, actively managed MBS fund into our portfolios that invests primarily in agency MBS, reallocating funds that were previously in US Treasury and short-term bond funds. While non-agency MBS may provide significantly higher returns, our goal here was to increase income without any material increases in risk.


Environmental, Sustainable, Governance (ESG)

This one is less of a time-sensitive change but more of an increase in conviction related to our philosophies regarding the way businesses should operate. Our belief is that companies that are well managed, treat their employees well, provide products/services that will improve the world, and are conscious of their impact on the environment, all while continuing to be profitable, will be better long-term investments than those that don’t. While ESG investing has been a growing trend over the past couple of years, it’s not new. The difference today is that there are significantly more reporting and data tracking related to ESG metrics available than there had been in the past.


We initially added the US and Emerging Market ESG funds to the portfolio earlier this year. This move has turned out well, with ESG funds outperforming their counterparts in the portfolio by a relatively wide margin since then.  We see the trend continuing as more and more investors demand that companies take responsibility for their actions and seek to improve the world as a whole.


In line with this, we’ve increased our allocation to ESG in most of our portfolios, shifting funds from the S&P indexes into their ESG counterparts.


Continue to be safe and responsible during these exacting times while we help you Traverse these turbulent markets.