Pavilion Flow-Through’s low correlation and gold exposure can improve portfolio performance
DECEMBER 05, 2019
AUTHOR: DAN PEMBLETON
Pavilion Flow-Through’s low correlation and gold exposure can improve portfolio performance
Pavilion, as we are all aware, has exceptional tax savings and good prospects for a return on capital beyond the tax savings, but those aren’t the only reasons to own it. Pavilion was designed to be an investment first and as such it has a place in an investor’s overall portfolio with attributes which contribute to the portfolio other than the large tax saving. Two features whose value on a portfolio wide basis is often overlooked are Pavilion’s non-correlation and, especially in these uncertain times, exposure to the gold market.
Correlation, or its opposite, non-correlation, refers to the tendency of two things to move together on a statistical basis. The measure of correlation is expressed between -1.0 and +1.0 where -1.0 means that two things being compared move exactly opposite to one another and +1.0 means things move in perfect coordination. Zero means a move in one asset has no connection to the other and movements are random between them. When building a portfolio, it is most beneficial to have assets that move independently from one another, meaning very low or even negatively correlated assets making up the portfolio are highly sought after. In practice this is difficult to achieve. Stocks and bonds generally have an approximate long-term negative correlation of about -.35 which is why the finance industry has always repeated the mantra 60/40 asset allocation between stocks and bonds. The investment industry has long relied on bonds to offer diversification and stability to investors’ portfolios.
However, with bond yields now very low, they don’t contribute much to portfolio returns, so although they may be attractive from a correlation and stability viewpoint, even that is lessened because interest returns were part of the reason for the negative correlation. That creates two challenges for bonds; including them may hamper overall portfolio returns and their diversification power is decreased. This leaves the industry looking at using a lower proportion of bonds in portfolios, to maintain or buffer expected returns, but the effect of that is higher volatility portfolios. The portfolio building exercise, from a correlation perspective, is to add assets that have lower correlation to one another. This helps to build a less volatile portfolio while maintaining expected returns or at least reducing the returns by the least amount practical. This is an area where Pavilion Flow-Through funds really help, by adding a very useful asset to the advisor’s toolkit.
In the past, we commissioned an independent report which included measuring correlation of Pavilion Flow-Through to the TSX Venture. This study was done in 2014 and although a bit aged, we have no reason to believe the results are less valid. In this study, past Pavilion funds which were operating more than 18 months (“seasoned”. I.e. eliminating the initial start-up period where initial costs and other 1-time events can impact statistical behaviours), have shown a measured statistical correlation from -0.25 to +0.39 across 7 funds, with an average correlation of 0.05, which is effectively zero. These are very low levels of correlation. What this means is that the presence of Pavilion in an investor’s portfolio has a stabilizing or counterbalancing effect on the value of the overall portfolio or at the very least does not contribute significantly to portfolio volatility. When some parts of your portfolio is going up or, more importantly, down, the Pavilion fund is moving independently and not magnifying the move. This property allows Pavilion to have a stabilizing effect on an investor’s entire portfolio. It behaves similarly to private equity in this respect even though Pavilion is predominantly composed of listed equities. The longer term nature of Pavilion in the Flow-Through world helps it produce better returns and it helps that while investors hold the investment looking towards those returns, they see other positive benefits from holding Pavilion Flow-Through.
The second big portfolio asset allocation feature that Pavilion Funds bring to an investor’s portfolio is exposure to gold and precious metal equities. The precious metal exposure of Pavilion funds is an element of causality as to why the funds have a low correlation, because precious metals as the underlying asset also tend to have low or negative correlation. Therefore, equities related to them would also be expected to exhibit this behaviour. There are roughly four ways for an investor to get exposure to precious metals in increasing order of volatility and also on expected potential returns; the metals themselves or ETFs based on them, large cap mining equities, mid cap mining equities and junior resource explorers. Junior resource stocks are one of the four ways to get exposure to precious metals and they are also the most volatile while also being potentially the highest returning. Volatility and potential return does tend to go hand in hand in investing.
In summary, a Pavilion resource fund tends to provide a low or no correlation asset to an investor’s portfolio, with the added feature of being an excellent way to gain exposure to the precious metals market (and selective other commodities for further diversification). This is good for the overall portfolio, but I want to circle back and remind you of the other big advantage. By acquiring the investment exposure to precious metals through Pavilion Fund, the investor also receives very large tax write-offs from the most powerful and flexible government sponsored tax saving program. These tax advantages go a long way to reducing the capital at risk, which reduces risk and enhances potential returns on capital.
While many or most investors and advisors focus intently on the tax advantages of Pavilion, with good reason because they are significant, that is not the only part of the Pavilion Flow-Through story. While we are waiting for the funds to mature and reach liquidation stage, they are still providing portfolio enhancement through their low correlation and their exposure to precious metals.
Keep this in mind when thinking about your Pavilion investment or proposed investment.
A Pavilion investment is more than just great, flexible tax savings. It has proven to be a portfolio improvement by being uncorrelated to the market, which helps to reduce volatility, and it gives exposure to gold to hopefully provide a portfolio buffer in times of uncertainty and risk. Pavilion offers a unique portfolio improvement to its investors.
