The Champagne portfolio
The Canadian stock market bounced off its October lows and is tantalizingly close to being in the black for the year. So, instead of lumps of coal, investors might dream of new all-time highs while they sip their bubbly this holiday season.
The possibility of new highs prompted me to take a second look at the Champagne portfolio. It invests in the Canadian stock market after it hits new all-time highs and hides out in Canadian bonds the rest of the time. I was particularly interested to see how it fared during this year's unusually bad market for bonds.
More concretely, the Champagne portfolio uses the S&P/TSX Composite Total Return Index as its proxy for Canadian stocks and the S&P Canada Aggregate Bond Total Return Index for Canadian bonds. It checks to see if the stock index hits a new all-time high at the end of each month. When the index does, the portfolio moves entirely into stocks for the next month. Otherwise, it invests everything in bonds.
Stocks have fared better than bonds over the long term. The stock index climbed at an average annual rate of 9.0 per cent from the end of January, 1993, through to the end of November, 2022. The bond index climbed 5.1 per cent annually over the same period. (The returns herein are based on month-end data from Bloomberg. They include dividend reinvestment, but do not include inflation, fund fees, taxes or trading frictions.)
The Champagne portfolio invested in the stock index about 28 per cent of the time over the period. It sat in bonds the other 72 per cent of the time. Despite being in bonds for most of the time, the portfolio gained an average of 7.6 per cent annually over the period, which is a big premium to the returns from the bond index.
You can examine the gains of the Champagne portfolio and indexes in the accompanying graph. But I'm going to put the good-return bubbly on hold for the moment, because I'm fascinated by downside risk. The second graph shows how far the portfolio fell in downturns as a fraction of its prior peak, along with similar data for the indexes.
The stock index generated the worst downside by far. It fell by more than 40 per cent from its prior peak twice. The first time was after the internet bubble popped in 2000, and the second was in the 2008-2009 crash, based on monthly data.
On the other hand, the worst decline for the bond index came at the end of October of this year, when it fell 20 per cent from its prior peak. The plummet was a shock for many bond investors, who expected better from their bond portfolios.
The worst downturn for the Champagne portfolio also occurred this year. It fell 15 per cent by the end of October, largely due to the bond market's decline. On the other hand, the stock index fell 14 per cent from its prior peak this year.
Despite its recent drubbing, the Champagne portfolio still looks pretty good. It offers strong upside potential along with a history of much better performance than the stock index during most crashes.
But investors thinking about employing it should be aware that the portfolio requires a good deal of attention and maintenance. After all, you have to check in on it every month. It also performed an average of roughly two swaps each year since January, 1993 - moving from stocks to bonds or vice versa. The frequent swaps indicate the approach is best used in suitable tax-sheltered accounts.
Buying the Canadian stock market when it reaches new highs has historically been a good idea. Active index investors might think about quaffing some bubbly should Santa deliver new highs for the stock market this holiday season
First published in the Globe and Mail, December 4 2022.
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