Free Lunch? - Real Diversification

CI ETF Pulse

When speaking of investing, Nobel Laureate Harry Markowitz once said, “Diversification is the only free lunch”. In times of crisis, correlations between asset classes tend to move towards one, effectively reducing the level of diversification investors may have thought they had. This can also happen with increased volatility, uncertainty around inflation, and other market conditions that may change the interaction between assets. On top of this, given a tendency for home bias and the U.S. exceptionalism of the past decade, as well as near 0% interest rates, investors may have been tempted to move fixed income allocations towards equities, and to move international and EM allocations to North America, resulting in under-diversified portfolios.

2022 was an example where the correlation of equities and bonds rose, reducing the diversification investors counted on. The correlation of Canadian bonds to U.S., Canadian, and international equities rose by ~2.5x as they all fell together.

Source: Morningstar Direct, as of January 31, 2025.

PORTFOLIO DIVERSIFIERS

Alternatives

Alternatives have long been used by institutions as an additional diversifier to portfolios; however, they came with several challenges. These strategies were often illiquid, requiring long lock-up periods, came with high fee structures (2, 20%), required large minimums which made diversification across strategies difficult, and they were only for accredited investors. Liquid alternatives solved many of these challenges, and bringing liquid alternative strategies to traditional mutual funds and ETFs has provided a useful portfolio tool available to all investors to build more complete portfolios.

The CI Auspice Broad Commodity Fund (CCOM) is a broad commodity, rules-based strategy that attempts to capture upward trends while minimizing downside risk during downward trends in 12 diversified commodity futures contracts: soybeans, corn, wheat, cotton, sugar, crude oil, natural gas, gasoline, heating oil, copper, silver, and gold. The strategy has the ability to go long in any of the commodity subsectors or go flat (i.e., cash) as price trends dictate. The strategy does not short any of the underlying components. If long, each position has the ability to go long 1/12th of the total portfolio risk budget.

• The strategy is sub-advised by Calgary-based Auspice Capital Advisors, whose team has years of experience in commodity and energy market trading
• CCOM is the only broad commodity ETF available in Canada at a competitive management fee of 0.52%
• This unique strategy invests in a portfolio of broad commodity futures, providing a strong diversifier to portfolios

CI Gold Bullion Fund (VALT, VALT.B, VALT.U)

Gold has historically been a store of value, has shown benefits in hedging inflation, and has shown low correlation to traditional assets, providing benefits as a portfolio diversifier. The CI Gold Bullion Fund (VALT, VALT.B, VALT.U) is the lowest cost gold bullion ETF in Canada, charging a management fee of just 0.155%. VALT was designed as an institutional-grade physical gold investment, accessing the London Gold Market (one of the largest physical gold markets in the world) and transacting only in London Good Delivery Bars (standard purity and size, accredited refiners, responsible sourcing) to provide pure gold exposure.

Portfolio Benefit

By reducing equity and fixed income allocations to create a sleeve of diversifying positions, portfolios can improve returns and reduce risk by adding a small weight of low correlation assets. Adding the CCOM Index and a gold allocation to a portfolio provides strong portfolio benefits through real diversification. The strategy wins by losing less, with 76% of the down capture leading to a capture ratio of 1.21 (asymmetric upside), as well as improved max drawdown and standard deviation.

HYPOTHETICAL GROWTH OF $10,000

Source: Morningstar Direct, January 1, 2005, to January 31, 2025.

RISK

Source: Morningstar Direct, February 1, 2005, to January 31, 2025.

DRAWDOWN

Source: Morningstar Direct, as at January 31, 2025.

Diversification When You Need it

When investors counted on diversification to help dampen volatility, gold and the Auspice Broad Commodity Index both provided strong returns. In 2008-09, when both equities and bonds were volatile, these assets provided strong positive returns. Then in 2022, when correlations rose and both equities and fixed income fell, these strategies provided positive returns.

2008, 2009 & 2022 RETURNS

Source: Morningstar Direct, as at January 31, 2025.
Auspice Broad Commodity Index shown (LCL returns as CCOM is CAD-Hedged). Other indexes are in CAD returns.

FREE LUNCH

Source: Morningstar Direct, as at January 31, 2025. Other indexes are in CAD returns.

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Glossary of Terms:

Beta: A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

Correlation: A statistical measure of how two securities move in relation to one another. Positive correlation indicates similar movements, up or down, while negative correlation indicates opposite movements (when one rises, the other falls).

Drawdown: Measures the peak-to-trough decline of an investment or, in other words, the difference between the highest and lowest price over a given timeframe.

Sharpe Ratio: A risk-adjusted return measure calculated by using standard deviation and excess return to determine reward per unit of risk. The higher the Sharpe Ratio, the better the portfolio’s historical risk-adjusted performance.

Sortino ratio: An evolution of the Sharpe ratio. Ignores “good volatility” (upward price movement) and focused solely on returns per unit of “bad volatility” (downward price movement), which is more indicative of the risk of loss.

Standard Deviation: A measure of risk in terms of the volatility of returns. It represents the historical level of volatility in returns over set periods. A lower standard deviation means the returns have historically been less volatile and vice-versa. Historical volatility may not be indicative of future volatility.

Volatility: Measures how much the price of a security, derivative, or index fluctuates. The most commonly used measure of volatility when it comes to investment funds is standard deviation.