Currency & Sector Liquidity Analysis Report: Q4 2020

April 7, 2021

Through 2020, investor confidence had been dampned by the pandemic to such an extent that most could no longer see the light far off in the horizon. But since the March 23, 2020, lows, the market has rebounded in ways not even the most bullish and optimistic investors may have forecasted.

From Chart 1, we can see steady declines in United States dollar and Canadian dollar values, both on in proportionate and absolute dollar levels. Overall, we witnessed the deployment of cash within Canadian investment funds for the last months of 2020. The stock market peaks reached at the end of 2020, and which many pundits thought indicated a high degree of irrational exuberance, have definitely pushed even higher this year, with the S&P 500 and Dow Jones Industrial Average trading at all-time highs through the first quarter.

Of growing concern among investors now, though, is the technology-heavy Nasdaq Composite Index. At the end of 2020, most investors who had invested in a simple ETF that tracks the Nasdaq 100 Index would have done very well for their portfolio, as it has been one of the best-performing benchmarks of 2020. Technology stocks rallied until February, pulled back to November 2020 levels, and have since mostly recovered.

However, there’s growing risk in these big technology names, as increased scrutiny and delisting seems to keep rolling out for China-based ADRs, with valuations riding on high hopes of interest rates remaining lower for longer.

We know now that the economic forecasts during the pandemic may have been too pessimistic, as we see continual positive surprises in manufacturing, jobs, and GDP growth reports. This has helped keep the wheels turning for global markets. With vaccine rollouts in full swing and massive infrastructure spending by governments in both Canada and the U.S., an expectation of surging economic growth is already baked into estimates and outlooks.

The housing market in Canada continues to glow red-hot, with obvious supply constraints. The CMHC and Bank of Canada have warned of overheating in some particular markets, a never-ending footnote issued by regulators to a market that seems to just keep moving pushing residential real estate values in urban areas to stratospheric levels.

The staggered drop in funds’ Canadian dollar holdings is very informative, as all Canadian chartered banks have reported increased dollar deposit amounts on an absolute basis. The extra cash households may be collecting in the form of government benefits seems to be finding its way into capital markets. This theory is given further anecdotal weight by the long wait times experienced at online brokerages and the record number of investment account openings.

Last but not least, it seems that investors may have more money than they know what to do with, and so are taking large and risky gambles with cryptocurrencies and stocks that have been pumped via online communities. It is worth mentioning that smart money has entered the cryptocurrency space, with a record number of new Bitcoin and Ether ETFs already launched or in the process of coming to market. It will be interesting to see how changes in portfolio holdings of these new mandates will influence a market buoyed by retail and crypto-enthusiastic investors.

Currency analysis

Our analysis focuses on the Canadian investment fund industry, and how portfolio managers are allocating capital in major currencies. The currency analysis excludes all cash equivalents, such as bonds with less than one year to maturity and collateral cash held to fulfill debt covenants. We believe by excluding these items, we can home in on the deployable cash in investment funds and assess the streets market sentiment. We then further analyze the liquidity of investment funds on a cash and cash-equivalents basis categorized by sector to help us understand which verticals portfolio managers are currently overweighting and underweighting.

Table 1 illustrates the month-over-month growth rates for the world’s major currencies.

Average portfolio weights for world currencies

Chart 1 illustrates the mean cash percentage in investment funds for nine major currencies in sequential order from January 2020 to December 2020.

US and Canadian cash on hand

The following chart illustrates the mean cash dollar value in sequential order from January 2020 to December 2020. The United States dollar had a net position of $2,862,738,151 for December 2020. The Canadian dollar had a net position of $2,997,585,436 for December 2020.

Investment Fund Liquidity Ratio

The Investment Fund Liquidity Ratio is calculated as the amount of cash in a fund relative to its total assets. It is important to assess this ratio when analyzing investments and allocating capital. It has the power to give deep insight into the overall flow of capital into specific verticals and the bullish or bearish sentiment in these investment categories. Table 2 lists the top and bottom 10 out of applicable sectors based on the mean ratio of over 3,000 investment funds with a mandate to invest in the corresponding sectors. The table lists the most bearish to most bullish sectors in descending order.

Red shading highlights the sectors with the highest ratio, which translates into underweighting their respective indexes. This could mean that portfolio managers are expecting negative performance in these categories.

Green shading highlights the sectors with the lowest ratio, which translates into overweighting their respective indexes. This could mean that portfolio managers are expecting positive returns in these categories, in the short term.

Review and outlook

The yields on U.S. Treasuries reached lows in 2020, but have come roaring back since the beginning of 2021. Consequently, investors who gave up bonds to chase yield in equity markets may finally be able to return to debt markets. We can see from Table 2 that emerging markets, especially Asian markets, seem to have a bullish stance. U.S. equity and North American equity profit-taking seems to be evident, as managers actively monitor the increased volatility.

Precious metals, such as silver and gold, had a great year in 2020, but have pulled back in 2021. Other commodities have had an excellent start in 2021, as most energy commodities are ahead by double digits in the first quarter, with WTI and Brent crude oil gaining more than 20% year to date. As such, those much-unloved Alberta-based and global oil giants may be coming back onto the radar for many investors for the remainder of 2021.

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