Kevin Kirkwood, CFA
President & Chief Investment Officer
February 25, 2020

Today’s Markets

Alitis’ Investment Committee has been watching the evolving Coronavirus story and working to ensure that the Alitis Pools are positioned to ride out this volatility while still being able to participate in the inevitable upside which generally follows these declines.

Various stock markets were down yesterday, and this will always get media attention but what did not get headlines was that bonds did relatively well. Below are how some major investments fared yesterday:

Returns for Monday, February 24, 2020 (C$)

Investment	Symbol	Category	Gain/Loss
Vanguard Total Bond Market Index	BND	US Bonds	0.73%
iShares Core Canadian Universe Bond Index	XBB	Canadian Bonds	0.24%
iShares S&P/TSX 60 Index	XIU	Canadian Stocks	-2.31%
SPDR S&P 500 ETF	SPY	US Stocks	-2.92%
Vanguard FTSE Emerging Market Index	VWO	Emerging Markets Stocks	-3.12%
Vanguard FTSE Pacific Index	VPL	Asian Stocks	-3.40%
Vanguard FTSE Europe Index	VGK	European Stocks	-3.91%

Our Conservative Allocation to Stocks

The Alitis Growth Pool is the most exposed to the effects of the coronavirus on equity markets as it contains the greatest percentage of stocks. However, this exposure is only about 50% of the Pool’s assets as we had already positioned the Pool conservatively in anticipation of the market challenges that we see now. Because of our defensive stance, the declines in equity markets may cause the Growth pool to decline about half as much as the markets. Presently, the Alitis Growth Pool has the following asset class exposures:

Alitis Growth Pool – Asset Allocation

Asset Class	Current Allocation
Cash	30.3%
Stocks	48.4%
Real Estate	21.3%

Our View on the Coronavirus

The only other Alitis Pool that has an allocation to stocks is the Alitis Income & Growth Pool. This Pool’s stock allocation is less than 15%, while its allocation to fixed income is almost 42%. Again, we believe that this conservative positioning will help to mitigate any negative performance caused by further declines in stock markets.

The world has experienced many viruses over the years – some worse than the current coronavirus and some better. Our view on the coronavirus is that it is certainly a situation that needs to be considered, but in a realistic and rational manner that looks at the facts, while understanding the emotion which often drives hasty, ill-planned decisions.

The Spread of the Coronavirus

It appears that the Chinese have started to get their outbreak under control, but two events in the last few days have changed the story quite dramatically. First, Italy has had a significant outbreak near Milan. Having an outbreak in Europe, especially near a major economic centre like Milan, makes the spread of the virus throughout Europe quite likely. This event is what has caused the major stock market declines yesterday.

The other major news – and the one that has local implications – is the outbreak in Iran. According to the health authorities in Iran, there are only 64 cases in the country with the first one being diagnosed on February 19^th:

Coronavirus in Iran⁴

Date	Cases (new)	Cases (cumulative)	Deaths (new)	Deaths (cumulative)
19 Feb 2020	2	2	2	2
20 Feb 2020	3	5	0	2
21 Feb 2020	13	18	2	4
22 Feb 2020	10	28	2	6
23 Feb 2020	14	43	2	8
24 Feb 2020	21	64	4	12

However, on February 20^th BC’s provincial health officer announced that a woman who returned from Iran to Greater Vancouver on February 14^th – a full five days prior to any official cases being reported in in that country – had tested positive for the virus. It would appear that Iran simply had no idea about the spread of the virus or did not have the capacity to detect or deal with it properly. That failure has had direct implications in BC and around the world. What may turn out to be a major source of the virus went undetected for quite some time and may allow it to spread to other countries and, most importantly, very close to where we live.

The takeaway from last two events is that it is unlikely that the spread of the virus can be stopped. The measures undertaken by governments around the world has slowed the spread – which is good – but the virus is most likely coming our way.

Death Rates

While Alitis is an investment firm and the impact on investments is important to us, it is the effects on people that truly matter. Obviously, the loss of life is the most worrisome aspect of the coronavirus. But so far, the statistics⁵ indicate that overall mortality rate is 2.8% for men and 1.7% for women. However, as noted previously, it is almost certain that the actual number of cases of coronavirus is much higher which will reduce these rates. As well, the vast majority of reported cases are presently in China which certainly has different demographics and health care standards than Canada. For example, 47.6% of Chinese men smoke versus 17.7% of Canadian men¹. Given that coronavirus’ greatest impact is on the lungs, smoking is likely a major determinant of the outcome. Age is also a consideration as this virus, like most others, impacts the elderly and health compromised more than any other group. Children, on the other hand, do not appear to be as susceptible to the virus².

To put all this in perspective, the regular seasonal flu also kills many people. The US Centers for Disease Control and Prevention (“CDC”)³ measures the number of cases and deaths each year, with the most recent years summarized below:

Flu Statistics for the United States

Season	Cases	Medical Visits	Hospitalizations	Deaths
2015-2016	23,504,319	10,642,006	276,198	22,705
2016-2017	29,220,523	13,633,446	496,912	38,230
2017-2018	44,802,629	20,731,323	808,129	61,099
2018-2019	35,520,883	16,520,350	490,561	34,157
2019-2020 (est)	29,000,000 – 41,000,000	13,000,000 – 19,000,000	280,000 – 500,000	16,000 – 41,000

Quarantines, Disruptions and the Markets

As you can see, a lot of people die in the US every year from the flu and it appears that 2017-2018 was a particularly bad year. It is likely that due to proximity alone, Canada experienced similar results.

The biggest impact is coming from the measures taken to contain the virus. As we have all seen in news reports, the Chinese government has been very aggressive in working to contain the virus and slow its spread through quarantines and travel restrictions. Italy has also imposed restrictions on many of its citizens this last weekend. These measures will likely help slow the spread of the virus, but there is always a cost.

At the local level, people simply change their habits to protect themselves from the unknown. Fear drives people to stop going out and spending money as they usually would. In the Vancouver area, there is plenty of anecdotal evidence that spending in restaurants and malls that cater to Asian communities has declined significantly over the last few weeks. That is not good for the economy. On a grander scale, any quarantines and travel restrictions would seriously impact business’ ability to operate and to ship goods. This is already happening, with the most famous example being Apple which has stated that sales in China will definitely be down this quarter and that there may be a shortage of iPhones since these products are assembled in China.

Impact on the Markets

Obviously, the short-term impact on the stock markets has not been good. There was a short-lived drop in late January when the virus first popped up on the radar, but it would appear that this current drop may have more staying power. That being said, we do not expect the impact of the coronavirus to be a long-term problem. As mentioned earlier there have been many viruses which have caused problems, but they have always resolved themselves. Based on this history, the coronavirus situation should be no different. There will be some short-term pain with stocks, but we have a ready supply of cash to invest when times look the bleakest as that is when the best opportunities usually arise. On the other hand, fixed income has done well recently but that could change when money starts flowing back into the stock markets.

Longer term changes are far more interesting. Two major manufacturing trends over the last 40 years have been: (1) just-in-time manufacturing, and (2) outsourcing production to cheaper locations overseas – particularly to China. The coronavirus has exposed the risk in these two strategies. Having only a limited supply of parts on hand because new ones can be ordered just-in-time does not leave a lot of room for error if new supplies are not forthcoming. As well, a lot of manufacturing has been moved to China as a way of reducing costs on products. Generally, this has been great for consumers, but it has also increased the risk that something could go wrong with supply chains. It is very likely that a lot of firms will be reassessing their manufacturing processes and supply chains to try and mitigate the problems that are presently being experienced. Longer-term outlooks for certain markets will likely change.

Alitis is Preparing

Although it is highly unlikely that we will need to enact this, Alitis is also preparing for how the firm would continue to operate should the virus arrive in BC and people change their behaviour or, more critically, health officials impose quarantines. Alitis has become very web-based over the last few years and most staff have the ability to operate from home offices. Today, I requested that we look into enabling all staff to work from home so that Alitis could continue to function should these unlikely scenarios unfold. As well, we are re-assessing the business continuity plans for our major service providers to ensure that they will be able to continue operating. Again, it is doubtful we will need to go to these measures, but as prudent managers of your investments and associated risks, we prefer to be prepared for all known potential risks – this is our hallmark.

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I hope this communication provides some realistic and rational information about the coronavirus and its implications on your investments, society, markets, and Alitis itself. We are on top of the situation, we have your interests in mind, and we are prepared to continue Alitis operations should the situation in BC deteriorate. If you have any concerns, please contact your adviser and we will work to help you address them.

Sincerely,

Kevin Kirkwood, CFA
President and Chief Investment Officer

 

References

1. https://worldpopulationreview.com/country-rankings/smoking-rates-by-country
2. https://kidshealth.org/en/parents/coronavirus.html
3. https://www.cdc.gov/
4. https://en.wikipedia.org/wiki/2020_coronavirus_outbreak_in_Iran
5. https://www.worldometers.info/coronavirus/coronavirus-age-sex-demographics/

At Alitis, we spend a lot of time reading and learning about the financial markets. We stay up-to-date on current events, we constantly monitor our positions, and we are always keeping an eye out for new investments that could improve our portfolios and their diversification.

That being said, we do understand that the financial marketplace can be a complex and confusing place, and there are some common pitfalls that we need to be mindful of. One of those pitfalls is called naive diversification.

Naive Diversification

Naive diversification occurs when someone has bought many different investments that they incorrectly believe to have the benefits of having either a low or negative correlation. They hope that they are protected from having large losses across their portfolio at the same time, but unfortunately, they are not.

An example would be someone that has “diversified” their portfolio by buying all the bank stocks in Canada. This is better than putting all of one’s money into only one bank stock, but there are plenty of factors that would affect all Canadian bank stocks at the same time. The same could be true of a portfolio containing all stocks in the world, as stock markets globally have similar exposures and are highly connected.

Imagine having a closet full of different shoes, but they are all high heels. You have hundreds of pairs of high heels, full of colourful designs, patterns and fabrics, but only high heels. If we asked you, “Do you have many pairs of shoes?” your reply would be, “Of course! I have hundreds of pairs!”

We would think that you must be well-prepared for all occasions with so many shoes. However, the next time you go to buy groceries after it snows, or you go to mow the lawn, or you go on vacation to Europe and have to walk down a cobblestone street, you may be surprisingly ill-equipped.

Our Approach to Diversification

At Alitis, we take a great deal of time and effort to ensure that your portfolios are both well-dressed and well-suited for a variety of market conditions. We select investments with purpose and keep in mind how new investments will complement the rest of the portfolio. After all, how your entire portfolio performs is more important to us than any single investment.

We look to create meaningful diversification across many asset classes and markets with the goal of providing a stronger risk-adjusted return than our benchmarks. And we are proud of that.

Doing little things right over the course of your life can make a big difference to your family’s financial well being. Tax Free Savings Accounts (“TFSA”s) are one such thing whose benefits can really add up over time.

While contributions are made to a TFSA with after-tax dollars, these plans are attractive in that the investment growth (Canadian interest, Canadian dividends and capital gains) accumulates tax-free. Better yet, all this accumulated principal and growth can be paid out tax-free. This rule applies when one makes withdrawals for personal spending or for gifting, and when TFSAs are left to your heirs as part of your estate plan. The other good news is that simply holding a TFSA or withdrawing from one during your lifetime does not negatively impact income-tested benefits and credits, like the Guaranteed Income Supplement, Old Age Security payments (claw back) or the age credit. Tip #1: the TFSA provides great tax and non-tax benefits to people of all income levels and is of great value to heirs.

You can either designate a spouse as a successor holder for your TFSA in your Will (with proper terms included) or an even easier way is to make the successor holder designation right in the plan documentation with help from your financial adviser. A successor holder spouse who inherits the plan gets to preserve their spouse’s built-up plan contributions plus they can contribute to the inherited TFSA by adding on their own accumulated contribution room. They can keep two plans or choose to combine the inherited plan with their own existing TFSA. Using a successor holder designation for your TFSA avoids probate fees on the plan and continues the tax preferences of the inherited TFSA on to the spouse. Tip #2: naming a spouse as successor holder makes for smart tax and estate planning.

You may also name someone else as a beneficiary (e.g. child, grandchild or sibling). In this case, the TFSA at your death would be de-registered and those TFSA assets would transfer tax-free to the beneficiary and they would benefit from the bumped-up cost base. Although other beneficiaries do not inherit your contribution room, as a spouse can, these beneficiaries can establish their own TFSA from the inherited assets and use their own unused accumulated contribution room. Using a beneficiary designation for your TFSA avoids probate fees on the plan. Tip #3: even if you name a spouse successor holder, you should still name a beneficiary in case the successor holder dies before you.

A common practice has been to hold interest-bearing investments inside TFSAs to shelter highly taxed interest income. While this makes logical sense, holding capital gain growth assets in your TFSA may be a good alternative if these assets are planned to be kept and can serve to minimize tax on high growth assets down the road or at the time of death. Also, while Canadian dividends and interest are specifically tax-free in a TFSA, non-Canadian dividends, such as those paid by U.S. stocks, or foreign interest are subject to withholding taxes in a TFSA and there is no way to get these taxes back. RRSPs do not have withholding taxes applied so are better vehicles to hold foreign securites, as are non-registered accounts where at least you can claim foreign tax credits on your income tax return. Tip #4: review with your financial adviser the asset composition of all of your investment accounts and allocate assets to the TFSA based on your personal situation.

The good news is that the annual TFSA limit has gone up to $6,000 as of January 1, 2019. If you are age 18 and over and are a Canadian Resident you can contribute to a TFSA. If you have never contributed to a TFSA, depending on your age, you could contribute up to $63,500 (for those who were age 18+ in 2009). Tip #5: contribute the newest amount early in 2019 and any accumulated limit for yourself, your spouse and as financial gifts for children or adult grandchildren to maximize the tax benefits of the TFSA for your family.

If you’d like more information on this or other investment strategies, please contact a member of our team at info@alitis.ca.