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Risk speedometers: Slight decline for third quarter

10 January 2019 | Todd Schlanger

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  • Risk appetite decreased to slightly below average in the third quarter of 2018
  • Overall, risk appetite remains well balanced over all periods and Canadian investors continue to favour global over domestic investments
  • Going forward, we will be moving to a quarterly publication of the risk speedometers for 2019

A little over one year ago, Vanguard launched our Canadian risk speedometers, publishing them on our website each month.

The risk speedometers—which measure the difference in net cash flow between higher-risk asset classes, such as stocks, and lower-risk asset classes, such as fixed income—gauge the level of risk investors are taking in a given period by comparing the current risk-taking with prior levels and longer-term averages.

Overall, risk appetite has been well balanced over the past year. That's good news for Canadian investors, as they have remained well balanced in their investment decisions. We have also seen a trend of Canadian investors favouring global over Canadian investments, consistent with a general declining of home bias in the portfolios of Canadian investors.

When looking at the markets this quarter, global equities outpaced global bonds by +1.76% as Canadian equities trailed global bonds by -1.71%. Over the 12 months ending August 31, 2018, however, global and Canadian equities continued to outperform their corresponding bond markets by +13.19% and +3.84%, respectively.

Against this backdrop, we update our risk speedometers in Figure 1 and find that given flows into higher and lower-risk asset classes, overall risk appetite decreased to slightly below average in the third quarter. Over longer-term periods, there was a modest decrease in risk appetite over the past 6 months but holding steady at slightly above average over the past 12 months.

Figure 1: Vanguard's Canadian risk speedometers as of September 30, 2018

Notes: Vanguard's risk speedometers measure the difference between net cash flows into higher-risk asset classes and lower-risk asset classes, in this case within the universe of Canadian mutual funds and ETFs. The lighter-shaded areas represent values that are within one standard deviation of the mean, which means they occur roughly 68.2% of the time (34.1% higher and 34.1% lower). The middle shades represent readings between one and two standard deviations from the mean, occurring 27.2% of the time (13.6% higher and 13.6% lower). The dark edges represent values more than two standard deviations from the mean, occurring the remaining 4.6% of the time (2.3% higher and 2.3% lower). Speedometer values for previous periods may change from what was initially reported as the current value in prior periods because of changes made in Morningstar, Inc., data, and to the updating of the five-year average.
Sources: Vanguard calculations, using data provided by Morningstar, Inc., as of September 30, 2018.

A more detailed look at cash flows relative to returns

While our risk speedometers offer a broad view of investor behaviour, there can also be value in looking at more detailed cash-flow data. To that end, the tables below shows cash flows over a wide range of periods and also the categories' relative return performance.

How to read this table: The top left square tells you that for quarter ending September 30, 2018, Morningstar's Global equity category had the largest absolute inflows, while its return placed it 7th out of 60 categories.

Figure 2: Net cash flows by investment category in absolute dollars

Top 10 net cash inflows by category

Top 10 net cash outflows by category

Notes: Data represents mutual funds and ETFs available for sale in Canada as of September 30, 2018. Currency is Canadian dollars.
Sources: Vanguard calculations, using data from Morningstar, Inc.

In Figure 2, we examine net cash flows by investment category and find that global equities were the top attractor in the third quarter, followed by global balanced products. This is consistent with the theme we have been following where, on balance, Canadian investors favour global to Canadian investment categories. Another trend worth noting this quarter were allocations that appear to be made in response to the yield environment – Canadian short-term bonds, floating rate loans, and preferred share loans. While many of these investment categories offer lower investment rate sensitivity, they are also more concentrated and contain their own unique risks so this is something we will be following in the quarters ahead. Finally, along with an increase in global market volatility, the volatility-based investment category made an appearance in the top 10 inflow categories as assets under management in this category increased by 63% in the quarter (shown below in Figure 3).

A more detailed look at cash flows relative to assets under management

The tables above provide detail on the largest flows from an absolute dollar perspective. Because flows for categories with large existing AUM are common, it's important to keep an eye on flows as a percentage of AUM. The table below provides that narrower view.

Figure 3: Net cash flows by investment category relative to assets under management

Leaders

3-month inflows (% of AUM)6-month inflows (% of AUM)12-month inflows (% of AUM)
Category% of AUMCategory% of AUMCategory% of AUM
Volatility 63.1% Volatility 74.1% US Money Market 46.9%
Floating Rate Loans 9.9% Floating Rate Loans 23.1% Floating Rate Loans 41.7%
US Money Market 6.5% US Money Market 15.5% Preferred Share Bond 31.1%

Laggards

3-month inflows (% of AUM)6-month inflows (% of AUM)12-month inflows (% of AUM)
Category% of AUMCategory% of AUMCategory% of AUM
Trading-Misc -46.4% Trading-Misc -34.4% Multicurrency -70.6%
Large Blend -15.5% Large Blend -33.8% Single Currency -54.5%
Greater China Eqty -10.8% Multicurrency -24.1% Large Blend -46.0%

Notes: Data represents mutual funds and ETFs available for sale in Canada as of September 30, 2018. Currency is Canadian dollars.
Sources: Vanguard calculations, using data from Morningstar, Inc.

When examining relative net flows by investment category (as a percentage of AUM), these tables contain mostly smaller and/or specialty asset categories. This can be seen as further evidence that investors are continuing to allocate to more diversified strategies with the majority of their assets.

Going forward, we will be moving to a quarterly publication of the risk speedometers and will continue to monitor the risk appetite and net flows of Canadian investors and comment on these and other trends next quarter.

Important information:

The views expressed in this material are based on the author's assessment as of the first publication date (December 2018), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The authors may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise.

This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy.

While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use.

In this material, references to "Vanguard" are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.

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