In this issue:
President's message | The surprising thing about a post pandemic future | From tragedy to triumph: China's handling of COVID-19 | The hindsight vision you needed in 2020 | Should I stay or should I go? Defined benefit pension plans vs commuted value options
By Matt Evans, CFA
President & CEO
Three months ago, we presented the autumn issue of Grow Together with our thoughts on change, growth and renewal, all prompted by the turning of the season. In this final issue of a remarkable year, we turn our attention to another seasonal custom: reflecting on the nearly-completed calendar year, with a commitment to applying our learnings as we plan for growth in the twelve months to come.
There is no doubt we will collectively remember 2020 as the year of the COVID-19 pandemic. This is completely appropriate based on the extraordinary human cost alone. The combination of severe global economic disruption, alongside the many unpredictable outcomes in global financial markets, brings to mind the most overused word of the year: unprecedented. And rightly so. Even now, we are not yet clear of the pandemic’s second wave, and the ripple effects will surely be evident for many years to come.
We are, however, encouraged by the recent approval of several highly-effective vaccines, for which distribution is now underway. It will take time for governments to execute comprehensive roll-out plans and fully stem the spread of COVID-19 globally, but it is beginning to feel as though we can see our way to the other side of the pandemic experience. Before putting it behind us, we contemplate within this issue: whether the pandemic has permanently altered the path of future economic growth; which global markets are best-positioned to emerge in a position of strength; and what we have learned as investors about how to respond when circumstances challenge our plans.
To begin, Scott Blair, Chief Investment Officer, reflects on pre-existing social and economic trends that accelerated as a result of the pandemic. We know the future was pulled forward. Scott considers which impacts may be temporary, and what may separate the future winners from losers within various industries. For his part, Ric Palombi, Head of International Equities, sustains the theme around contrasting opportunities. Ric explores the investment outlook for China in comparison to western markets, where the response to COVID-19 played out on varying timelines with different approaches. Closer to home, Orest Fialka, Assistant Vice President and Portfolio Manager, revisits the emotional ups and downs faced by investors through the extraordinary market volatility we experienced this year. In stark, quantitative terms, Orest further develops the theme from our autumn issue on the value of having a plan and sticking to it.
Speaking of planning, it would be a mistake to convey that every decision where clients sought our advice this year was pandemic-related. Our client families faced the same range of complex planning considerations in 2020 as they would have in any other year, despite the additional complications from COVID-19. Recognizing that reality, Jim Grant closes this issue with an illustration to address the commuted value pension decision faced each year by the millions of Canadians who participate in defined benefit pension plans.
Our value as professional financial planners and investment managers was tested this year. With the benefit of 20/20 hindsight, I am proud of how we performed.
We contributed to greater peace of mind through personalized advisory experiences every day. That is our mission, year in and year out. As we look ahead to a safe and prosperous 2021, we are grateful for the opportunity to continue to serve our growing community of client families. Now representing the combined strengths and established heritage of four distinct private wealth organizations, I am excited for CWB Wealth Management to continue to meet the evolving needs of successful families across Canada.
But first, we will pause to enjoy the holidays. However you celebrate or use the time off, this holiday season promises to be different in much the same way that the previous nine months departed from the norm. To put the pandemic behind us for good, many of us are preparing for a quieter, more socially-distant season than we would otherwise prefer. We are doing so to ensure that our future holidays are full of the social engagement we hold so dear. In other words, we are deferring enjoyment today, so that our enjoyment can multiply in the future. In that way, we can think of this year-end experience as a solid investment in service of a sound plan, with dividends to be paid in health, wellness and prosperity.
By Scott Blair, CFA
Chief Investment Officer
While it’s impossible to know exactly what a post-pandemic world will look like, we can make some educated guesses on which changes will be permanent, and which are likely to revert to some former semblance of their previous state.
The development of effective vaccines for COVID-19 has given a huge boost to financial markets despite new cases and deaths hitting pandemic highs.
It’s reasonable to think the virus will be with us well into 2021, if not beyond, as it will take a significant amount of time to vaccinate the globe. However, if all goes well we should gradually return to a more “normal” way of life through next year, with 2022 representing our true “new normal”. While many of our behaviours will have changed in the interim out of necessity, our basic needs and desires are likely to swing many of these changes back to where they once were – or something very close to it.
When discussing long-term impacts of the current pandemic, perhaps the best starting point is to look back at the 1918 flu pandemic. In reading about this pandemic, there were many short-term impacts to society primarily due to a much higher mortality rate, a much younger demographic impacted (worst on 20 - 40-year-olds) and far fewer social programs.
The main long-term impact seemed to be an acceleration of universal healthcare, which was a concept that had already been circulating, but only really got off the ground in many countries after the pandemic. What’s truly surprising is how little else changed and how quickly society moved on.
The rise of the machines
In similar fashion, the biggest changes to modern-day society will probably also come from an acceleration of current trends that were already in place pre-pandemic.
For instance, the global economy has been undergoing a digital transformation for decades. The rise of ecommerce is well known and the pandemic has certainly accelerated the adoption of online shopping to a level we would not have otherwise seen for years.
It’s been clear for years that the future of retail as an omni-channel experience, where the ability to service customers as they wish – online, in store or a mix such as click and collect – would be key to any retailer’s survival. That future now appears to be fully on us with many retailers that had been unable to adapt closing their doors for good or shrinking their network.
If one phrase could sum up 2020, for many, that would be ‘work from home’ (WFH). Prior to this year, working from home was a concept that was gaining traction, however many firms still limited the practice due to the fear of productivity loss or prohibitive technological costs and constraints.
The pandemic has provided no other option than to limit the number of employees on site, which forced the rapid adoption of WFH practices, system upgrades and the adoption of new technologies. Undoubtedly, we’re not going back to pre-COVID work practices, but it’s also unlikely that the future of workplaces will be fully remote either.
Increasingly, we’re seeing WFH fatigue due to endless zoom calls, lack of human contact and a work day that never seems to end. It’s difficult to build relationships with co-workers or to onboard new employees. Although many see the future as WFH, we see a hybrid version with the option of working from home for part of the week, with the expectation that there will be some office days. This means we may see a downtick in demand for office space, but the effects of this are unlikely to be disastrous.
On the other hand, all the new technology could mean fewer business trips. Why spend thousands on flights and hotels when the technology is finally accessible and working?
A hundred years from now
While we see real parallels between 1918 and 2020, the main changes we can expect going forward will likely come from trends that were already well established before the pandemic hit, and most of these are related to technology. In most cases though, many things will likely stay the same.
People will still want to travel and will crave experiences such as concerts and sporting events – even more so than before. In fact, we’ll likely make up for lost time by crowding into bars and restaurants when it’s safe to do so. And major city centres will continue to be magnets for people interested in a vibrant lifestyle.
If 1918 is any guide, the surprising thing a hundred years from now will be how little we learned and changed due to the pandemic – not how much.
By Ric Palombi, CFA
Head of International Equities
CWB McLean & Partners
China is known for its decisive action in the face of adversity. It enacted one of the largest stimulus packages in the world during the financial crisis in 2009, and once the Chinese authorities grasped the scope and potential health crisis that COVID-19 may cause, they acted quickly. Let’s examine the actions they took to combat the crisis from health and economic perspectives, and assess the resulting economic impacts.
What did the Chinese do to combat COVID-19?
On January 22, China locked down the city of Wuhan and two days later the entire province of Hubei, locking up 50 million people. The lockdown was very strict and even in Beijing and Shanghai, some restrictions were implemented to slow the spread of COVID-19. Wuhan emerged out of lockdown on April 8.
After removing the lockdown on Wuhan, China started mass testing populations wherever a cluster emerged. The most well known is the lockdown China imposed on Qingdao in October. China placed the city under full lockdown, tested its 9 million residents in five days, isolated the sick and reopened the city. Since then, there have been no further known incidences of local transmission of COVID-19 (Figure 1).
Figure 1: Daily new COVID-19 cases per 1 million population, 7 day average
What did China do to combat the economic impacts?
China took decisive action on the economic front as well. First, what China didn’t do.
Unlike other central banks, The People’s Bank of China (PBoC) did not cut interest rates because it felt this would cause a future bad loan crisis. The PBoC opted instead to cut the bank reserve ratio (RRR) on average by 100 bps since the beginning of 2020, which resulted in higher liquidity.
The RRR is the amount banks must hold in reserve to meet liabilities. A cut in this ratio increases the money supply because the banks hold less in reserve, which increases their ability to lend. It also provided various lending facilities at low interest rates to support companies, including loan deferrals. As a result, financing to the economy grew by 13.5% and loans and liquidity increased by US$2.73 trillion (20% of GDP), assisting 31 million companies.
In addition, the government unveiled a stimulus package of US$500 billion, issued US$153 billion of special treasury bonds and increased the bond quota for local governments by US$250 billion, encouraging them to spend this money on infrastructure.
As a result of the lockdowns, Q1 GDP declined substantially. However, the decisive action taken to stop the COVID-19 spread, and the substantial economic support the government announced, helped GDP bounce back the following quarter. It’s now back to its pre-COVID potential growth (Figure 2).
Figure 2: China’s GDP growth returns to potential
Furthermore, China’s COVID-19 economic recovery has been driven by domestic demand, in particular, the services side of the economy and retail sales (Figure 3). Our thesis about investing in China is predicated upon the second largest economy in the world continuing to evolve from an export- driven economy to a more stable and predictable one, which is fueled by the burgeoning Chinese consumer.
Figure 3: China indicators, percentage per year
The economic policies enacted by the Chinese authorities to combat COVID-19 and the trade war with the U.S. have not only reinforced that belief, but may have actually accelerated this process.
Lessons for the West
If there’s one lesson to take away from this pandemic, it’s that you have to win on both the economic and health fronts.
China was decisive in dealing with the virus and with stimulating the economy – and it paid off.
Many western nations have been decisive on neither, and the results have not been optimal. The U.S. is the poster child for this behaviour. Although it’s easier in a country with fewer freedoms, like China, to act decisively, it’s hard not to see that the West should have done better.
China will exit the pandemic with a larger and stronger economy relative to the rest of the world, which comes as a surprising twist given that it’s the origin country of the virus itself.
By Orest Fialka, P.Geo, CFA
AVP, Portfolio Manager
There’s been much ado in 2020 about lacking the hindsight vision desired to predict the markets in a COVID-19 world. However, most investment professionals will tell you that short-term vision becomes less of an issue when you look to long-term historical market trends to help guide you through periods of volatility.
In last quarter’s Grow Together article, Staying the course – risk capacity & tolerance, we discussed how timing the market is incredibly difficult, so the best way to protect capital is to stick with your long-term plan. To further prove this point, we can take a deeper look into this year’s equity market correction.
The year 2020 has again shown us that hindsight is ‘20/20’ and we’ve followed a similar pattern to prior market cycles.
On March 19, 2020, two days before the market bottomed, I vividly recall a conversation with a worried client. He was quite concerned with the market sell-off caused by the COVID-19 pandemic, but his experience during the 2008-09 Global Financial Crisis market sell-off had helped him learn and understand that markets do recover, and sticking with his plan was the right course of action.
We didn’t know that the market was going to bottom the following week, or that a powerful rebound was about to unfold. Had he not stayed the course – or worse yet, sold near the market lows – the outcome would have been much different from his experience today.
What a difference a day makes
After that call, history would repeat itself yet again when some of the best trading days occurred within weeks of the bottom. For 2020, it was within the first week of the bottom! Figure 1 shows how the S&P 500 rallied by 51.5% from its March 23 bottom to August 18, when it recovered to the previous peak and started setting new highs. It also shows the effect of missing the best five and three trading days after the market bottomed. If our client did not stick to his plan, he would have missed part or all of this rebound. It’s amazing the difference just a few days can make to investor returns.
Figure 1: 2020 S&P 500 market recovery March 23 – August 18 (USD)
It’s time in – not timing!
Figure 1 also shows the perils of ‘market timing’ versus ‘time in the market’ as all five of the best trading days occurred within 2 ½ weeks of the bottom. If an investor missed the five best trading days of the rebound, their portfolio would only be up 14% by the time the S&P 500 had fully recovered – much lower than the full 51.5% rebound!
Moreover, by missing the five best days, an investor would have only started generating positive returns later in May 2020, and the portfolio would still have a long way to go to fully recover as it did at the end of November.
Since the turn of the century, we’ve experienced four major stock market corrections where markets declined about 20% or more: the 2000 – 2002 Dotcom Bubble, 2008 – 2009 Global Financial Crisis, 2018 Q4 Correction, and 2020 COVID-19 pandemic. Stock markets declined in each of these periods for different reasons, however, the recovery from every low point has followed a similar pattern in that a handful of the top trading days came early after each low. In each recovery, 3 - 4 of the best trading days occurred within 1 - 2 months of the downturn, with the majority of them in the first week.
Figure 2 shows a hypothetical $100,000 investment into the S&P 500 at each of these market bottoms, what that $100,000 would be worth if fully invested for the duration of the recovery, and what it would be worth if the investor had missed the five best trading days.
In every case, the investor’s returns would have been materially lower if they’d missed the five best trading days during the recovery period.
This again, shows the risk of trying to time the market.
Figure 2: Hypothetical growth of $100,000 in S&P 500 (USD) from lowest point to full recovery in past four market corrections
Recovery is key
For the investor that may try to time the market, there’s another lesson here. If you don’t jump back into the market after it bottoms, you’ll miss the most powerful part of the recovery thereby hampering your returns.
2020 has been a stark reminder of this. Nobody is going to ‘ring a bell’ shortly after a market bottom to let us know that it’s time to jump back into the market. And for the average investor, this would take extreme courage and discipline as it would be investing near the time of maximum psychological pain and investor pessimism.
Near the end of November, I had a follow-up discussion with the previously mentioned client as he needed some funds to purchase a new car. We reviewed his portfolio, his positive returns for this year and discussed the timing of his withdrawals. We also talked about how neither of us had known in March where the markets would be by year-end, and were happy we’d stuck with the plan. Although the rebound came more quickly than we’d anticipated, he was well positioned when it occurred.
While it was anybody’s guess how this year would play out, it turns out that the 20/20 vision you really needed was of the long-term rather than short-term variety. Because when you look back far enough, the hindsight wisdom of staying the course was all you needed to see things clearly.
By Jim Grant, CFP®, CIM®, FCSI®
Senior Planner, Wealth Advisory Services
In 1982, The Clash famously sang the lyrics echoed in the above title. While they were referring to a romantic relationship, the inner conflict they described could just as easily apply to the way we all feel at times when making life decisions. In the context of this article, the relationship in question is whether it’s in your best interest to stay with your defined benefit company pension plan, or go it alone and control your own nest egg with a commuted value option.
So, what’s the right decision?
The answer isn’t a simple one because sometimes your heart can “clash” (pardon the pun) with your head. Thankfully, with some careful consideration and support from a financial professional, you can analyze your personal situation to set yourself up for the best possible outcome. That way, you won’t have to rely on your heart (instincts) to get it right.
In reviewing your options, you’ll need to consider things like your age, marital status, risk tolerance, expenses, required income and what assets you may have – or yet acquire – before retirement. First, you should know the high-level differences between each option.
Defined benefit option
Let’s start with the pros and cons of the defined benefit pension plan. The way it’s calculated can vary from company to company, however the goal is the same – to provide you with an income for life. In some cases, you may have options to extend this income to a surviving pension partner. As long as the plan and employer are solvent (regardless of what may happen to interest rates and the markets), with this pension you can count on a set income every month, every year for life.
Some plans are even indexed to provide a small raise based on the Consumer Price Index (CPI). However, you should keep in mind that the defined benefit option is not an asset, but an income stream. You will have no access to the assets of the plan, either during life or after.
Commuted value option
When taking the commuted value option, you’ll have total control of your money – including any potential risks and rewards.
In this option, you’ll receive the asset, have control of it, have access to it, and you may even have some left over to provide a legacy for your family.
With longer-term employees, you may receive some of the money that would be required to remain locked in until a certain age. That excess money could go into your RRSP or TFSA account should you have contribution room available, to non-registered investments, or to an insurance policy or annuity. The amount in excess of the locked-in money will likely be taxed at source, which will reduce the initial amount you have to invest.
A case study
To better illustrate the outcomes of each option, let’s consider a recent case study. Saverio, age 33, had been working for his company for less than 15 years, so his pension credits haven’t been built up over a long career. His two options are:
- Receive an annual pension of $22,071
- Receive a settlement of $400,000 of which $150,000 will need to go to a Locked-In Retirement Account (LIRA)
Let’s look at the variables before deciding which option he should take.
Given the time between now and when he could receive his pension, there was no indexing for inflation. He knew today that at age 60, he would receive an annual pension of $22,071. His alternative offer was to receive a settlement of $400,000 of which $150,000 was to go to the LIRA. We deposited $37,000 to his personal RRSP as he had unused contribution room to receive that, then, assuming a $63,900 tax deduction at source, we deposited $149,100 into a non-registered investment account. Assuming a 3.65% net investment return (60/40 stock/bond FP Canada return minus a 1.25% fee), here are our findings;
- At age 60, his LIRA would have grown to $323,255 producing an income (at max) of $14,720
- At age 60, his RRSP would have grown to $79,736 producing a minimum income of $2,572
- At age 60, the cash account would generate $8,252 of income in perpetuity without encroaching on the then principle of $273,933
- Total assets at age 60, $676,924 and at age 90, $322,043
- Total income at age 60, $25,544 that will fluctuate with RRIF and LIF factors and market returns
In comparison, by staying in the pension plan, at age 60 his income would be $22,071 compared to a potential of $25,544 with no assets to pass to the family on death in the pension and an assumed $322,043 by taking the lump sum commuted value.
Should the above assumptions hold true, there’s a clear benefit to considering the commuted value option over the defined benefit. However, not all plans are the same – nor are all situations. So, take the time needed to work with your financial planner and portfolio manager to figure out the best option for your personal scenario. Your head – and heart – will thank you.