Canadian MoneySaver Model Portfolio: Year In Review

2024 is coming to an end, which has marked a solid year for equity in both Canada and the U.S. markets, due to a favourable macro backdrop of interest rates easing and a meaningful slowdown in inflation. It has been a while since our last update of the CMS Model Portfolio. Before we go into details about the performance and changes to the portfolio during the year, we wanted to briefly discuss the strategy and the objectives of the portfolio.

Investment Objective And Long-Term Strategy

The investment objective of the portfolio is to build a balanced strategy that is slightly tilted toward the growth sector of the market. We believe having some growth within a balanced portfolio could provide investors with some “optionality” on the upside potential while managing the downside risks prudently. Most of the holdings focus on the Canadian and U.S. markets.

We think a passively managed, low-cost portfolio that is well diversified across asset classes, geographies, currency and style strategies could provide investors with decent returns over a long period of time. We think investors can add value to the portfolio by tactically adding names with “asymmetric upside”—meaning large gains with downside protection based on certain macro views. For example, we added more to both iShares Russell 2000 Growth Exchange-Traded Fund (ETF) (IWO) and Vanguard Information Technology Index Fund ETF (VGT) earlier this year, which have performed decently since then.

Rebalancing

Maintaining a well-balanced portfolio is a critical element in successful investing. The key objective of rebalancing is to manage risk, not maximize returns. Most investors build a foundation for a portfolio with a targeted allocation to different exposures and themes. However, market value fluctuations lead to deviations from the initial intended targets. This makes occasional rebalancing especially important, as it helps reduce the volatility of the overall portfolio. Typically, there are two methods of rebalancing:

Calendar-based rebalancing: investors set a time in their calendar (quarterly, semi-annual, etc.) and rebalance accordingly. Investors need to be disciplined on the timing of this.

Threshold rebalancing: investors set a target range of weightings that they are comfortable with and rebalance when a holding moves widely outside of the range. For instance, investors might be comfortable with a particular ETF at a 10% weight and would allow the position to run as high as a 15% weight at most. Whenever the fund exceeds 15%, the investor would rebalance back to 10%. Conversely, when the allocation drops below five per cent, investors would need to add to the position to bring it back to 10%.

We tend to rebalance the CMS Model Portfolio based on the threshold rebalancing. In addition, we tend to be more flexible in terms of the weights that drift from initial weights. For example, we feel more comfortable letting the winners run because we think over a lifetime of investing, a few winners will carry most returns of the portfolio.

We think investors who rebalance the portfolio too frequently could be at the risk of “cutting the flowers and watering the weeds.” We only rebalanced in an extreme case, where a huge winner became such a significantly large portion of the portfolio (a high-class problem to have).

Taxes

Each individual investor’s tax situation can be vastly different, so it is difficult to construct a “one-size-fits-all” model portfolio that takes taxes into consideration. With that said, we prefer the approach of building with low turnover to limit unnecessary costs. In addition, at the end of the day, total return is what matters. Taxes should always be a part of the decision-making process, but still a secondary priority. Investors should not “let the tail wag the dog” by putting too much emphasis on tax optimization at the expense of long-term total returns.

2024 Review

Coming into 2024, it was expected to be a volatile year for the U.S. market due to the November presidential and federal elections. In November, the market experienced a strong rally after President-elect Donald Trump was elected. Investors expect Trump’s policies of putting America first to help corporate earnings over the next few years. As a result, not only broad market indices like the S&P 500 and Nasdaq did well, but risky asset classes, such as small-cap, high-growth stocks, cryptocurrencies, etc., all have performed strongly and hit new record highs this year.

As a result, 2024 turned out to be a nice year for both the U.S. and Canadian markets, each of which provided double-digit returns for investors. The Model Portfolio also benefited from the relative strength of the equities markets. The key themes that drove the strength of the broad U.S. market (the SPY and the Technology ETF, VGT), are the solid performances of the Magnificent Seven tech names and, the developments in Artificial Intelligence (AI). In addition, our holdings in iShares Russell 2000 Growth (IWO) benefitted from the long-expected recovery in small-caps, which surpassed the highs of 2021.

Not all holdings performed well. Specifically, our conservative allocation to bonds did not do that well relative to equities. For example, most of the portfolio’s fixed income allocations including iShares 1-5 Year Laddered Corporate Bond ETF (CBO), iShares Core Canadian Universe Bond Index ETF (XBB), and iShares U.S. High Yield Bond Index ETF (XHY) all provided single-digit returns, which turned out to be a drag on the portfolio performance.

Turning to the CMS Model Portfolio, no rebalancing was made throughout the year. However, there were three large additions to the portfolio earlier this year, as the cash portion built up and we saw opportunities to invest it. For example, we added meaningfully to the iShares Russell 2000 Growth ETF (IWO) and the Vanguard Information Technology ETF (VGT) in February 2024, and another addition to the Vanguard FTSE Emerging Markets Index ETF (VEE) in July. All of these have performed well since then.

Rebalancing And 2025 Outlook

With cash nearing four per cent and the equity allocation growing over the years, we think the cash level is appropriate. We would be willing to put some of this cash to work in 2025 if opportunities present themselves, although we will be patient and only buy things that look attractive on a risk/reward basis.

We continue to like the mix of ETFs in the Model Portfolio, and although bonds could be a drag on the portfolio if performance in the equities market continues to be solid, we think the bond allocation would act as downside protection for the portfolio in bad times. We do not know what the next year will hold, but we know there will be points of uncertainty, fear, and doubt, which investors should be aware of and be “greedy” to act when attractive opportunities present.

With the macro backdrop of the interest rates easing and the continued softening of inflation, along with solid momentum, we would not be surprised if the markets would have another year of solid uptrend in 2025. Despite the fact that there are some frothy signs in the market, the vast majority of sectors still trade at reasonable valuations. We don’t think timing the market would add value to investors over time. Rather, we think a simple approach of only buying things when they are cheap, which is supported by secular tailwinds, could work wonderfully for long-term investors. We continue to view the CMS Model Portfolio as a solid starting point for an investor looking for more of a passive, market-based portfolio while providing some potential for above-market returns over time.

Michael Huyhn is an Investment Analyst with 5i Research.

5i Research.ca