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Alternative Investments – A proven path to higher and stable returns

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Equity markets have recovered significantly in recent years and are now considered fully valued or overvalued.

Bond markets have experienced 30 years of declining interest rates and are also expected to have low returns for a while.

This suggests it’s time to consider other asset class solutions such as global corporate real estate, infrastructure, private debt and hedge funds.

In fact a review of asset shifts amongst the world’s largest pension and endowment plans reveal that this so called smart money has already shifted their investment allocations significantly to alternative investments and reduced stock and bond exposure.

Alternative investments can complement and add real value to a portfolio by:

  • Providing high income
  • Diversification to reduce risk
  • Lowering portfolio volatility
  • Enhancing returns
  • Protecting capital during periods of market declines

 

The case for investing in alternative investments

At TriDelta we research the marketplace for viable portfolio solutions including an analysis of where leading pension and endowment funds invest. They have been reducing their bonds and, to a lesser extent, their publicly traded stock portfolios. Under the catch-all phrase of alternative investments, many pensions and endowments have instead been investing between 25 per cent and as much as 75 per cent (Yale University Endowment Fund) in alternative investments.

Consider that the top 1,000 pension plans in Canada shift allocations to various asset classes each year. Of particular note is that allocations to alternative investments have nearly doubled over five years since 2011.

What are Alternative Investments?

Alternative investments are essentially any asset that is not a public stock, bond or cash security. Alternative investments often provide higher returns than traditional assets by focusing on less efficient or private asset classes, such as infrastructure and private equity.

They can generate stable, high levels of income by investing in private income oriented investments, such as real estate and private debt. Hedge Funds, such as Market Neutral Hedge Funds can also reduce volatility by using sophisticated hedging strategies.

 

1. Returns can be meaningfully improved and risk reduced by including alternative investments

According to JP Morgan research, portfolio returns were improved by more than 10% p.a. and volatility was significantly reduced by adding 20% to alternatives.

A balanced investor with 50% invested in stocks and 50% invested in bonds would have seen their return improve and their risk reduced by moving to an asset mix of 40% stocks, 40% bonds and 20% in alternative investments.1

Growth oriented investors with a 70% stocks, 30% bonds asset allocation would also have benefitted by including alternative investments to earn higher returns and reduced risk.

2. Invest where the ‘smart money’ invests

The ‘smart money’ generally refers to professional investment managers. We research where they invest given that they have consistently achieved superior investment returns versus more traditional models. We then fine tune our own investment allocations and strategies.

The Pension Investment Association of Canada, which includes Canada’s largest pension plans and nearly $1.6 trillion of assets under management, provides an annual asset mix report. As the chart below highlights, in 1990 alternative assets comprised only about 10% of the total asset mix. By 2015, alternative assets comprised over 33% of the asset mix, an increase of over 200%.

Years ago a Canadian Government bond portfolio could fund a long, prosperous retirement when the yield was between 8 & 12% (1980 – 1990s) and a few years ago they delivered about 5%, but this is certainly not the case today.

The new normal of ultra-low global yields and interest rates poses an unprecedented challenge for all investors and it’s no wonder that endowment giant Harvard only has a 12% portfolio allocation to bonds.

U.S. Endowment funds, such as Harvard and Yale University and Canadian Pension Funds, such as the Ontario Teacher’s Pension Plan have achieved some of the highest returns for their clients over the past 30 years. During that time, they have been significantly increasing their allocation to Alternative Investments to enhance overall returns and reduce volatility.

3. Changing Times

The world has changed in recent years; investors need to look beyond only traditional investments to achieve their goals of income, stability and growth. As the chart below demonstrates, in 1990 an investor could earn 9.9% on a 10 year Government of Canada bond vs. only 1.5% today.

The equity market in 1990 was also much cheaper with a Price Earnings ratio of only 15 times vs. over 22 times today.

Investors are also expected to live much longer, meaning that their investments have to work harder to meet their cash flow and spending needs.

1990 2017
Bond Yield* 9.9% 1.5%
Equity Market P/E Valuation** 15 x 22 x
Baby Boomer 35 years old 61 years old
Retiree (OTPP) Worked for 29 years; Retired for 25 years Worked for 26 years; Retired for 30 years
Life Expectancy*** 77 years 82 years

Sources: *bankofcanada.ca **S&P500 average P/E based on historical ***statcan.gc.ca

The world is different and we believe it’s time for your portfolio to change as well.

4. The TriDelta Strategy

TriDelta’s Alternative Assets Investment Committee focuses on putting the odds in our clients’ favour by focusing on:

  • Proven managers with strong track records and disciplined investment philosophies
  • Earning more stable returns
  • Generating premium yield in less liquid investments
  • Solutions that lower clients’ portfolio volatility
It is often difficult for investors to access these investments for three reasons:

  1. Alternative Investments are often restricted only to Accredited Investors (those with family income of $300,000+ or an investment portfolio of $1 million+)
  2. Many large Canadian financial firms simply do not make them available to their clients because alternative investments are often more complex and require a specialized skill set to analyze, review and select managers; and
  3. Many of the best alternative managers provide only restricted or limited access to their funds.

At TriDelta Investment Counsel, we solve all of these problems.

As an investment counsellor, we are able to offer these investments to all clients on a discretionary account basis. Alternative investments are a key element of our overall investment strategy.

 

Contact to Discuss:

Ted Rechtshaffen

President and CEO
Toronto
416.733-3292 X 221
tedr@tridelta.ca

Anton Tucker

Exec VP and Portfolio Manager
Oakville
905.330-7448
anton@tridelta.ca

 

The question on every Toronto retiree’s mind: Do I sell my house now?

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ted_banner

There are early indications that residential home prices in the Greater Toronto Area are starting to level off. Between changing mortgage rules, a new foreign buyers’ tax, and banks placing tougher standards on property valuation, there is definitely some downward pressure from many sides.

This possible peak often gets my older clients to think harder about their biggest asset. One of the most common questions I receive is, “Should I sell my house now?” This is often followed by “If I decide to rent or move to a retirement residence, how can I best fund all of the fees?”

While these questions can best be answered as part of a broader financial plan, here are my basic answers:

‘Should I sell my house now?’

The decision to move from a house to a condo or to a retirement residence should be driven by lifestyle more than money. It is extremely difficult to time any market, and the real estate market is no different. The time to sell the long-term family home is when you are ready to make that next step — physically, emotionally, and if necessary, financially.

The one concern is that people occasionally make the move from their long-term home later than they should. It really is best done before you are forced to move for physical reasons. Change is hard for everyone, and it can be a very emotional decision for some people. In my experience, if you are starting to seriously consider moving, it probably means that you should have done it a couple of years before.

‘Should I rent or should I buy something else?’

One of the biggest real estate costs is the transaction itself. From real estate commissions to land transfer taxes to staging costs to legal and moving costs, getting from property A to property B can cost you as much as 8 per cent to 10 per cent of the average cost of the two properties. This is effectively wealth that has disappeared. The only way to recover that cost is to own real estate that is going up in value, and to amortize it over many years by not moving very often.

This is crucial to answering the question of whether someone in retirement should buy or rent. My rule of thumb is that unless you expect to be in your new property for at least 6 years, you should definitely be renting. Like most life decisions, nothing is guaranteed, however, given your age and health, and expected plans, you should be able to make a pretty good guess at this question. If you are going to do an extra buy-and-sell transaction that could easily cost you over $100,000 in expenses in Vancouver or Toronto, you want to be fairly sure that your time in the new property will make it worthwhile.

‘How will my house proceeds pay for all of the new monthly fees I might face?’

If you move from your paid off house to a rental property or retirement residence, suddenly there are monthly expenses that you never had before. Nice retirement residences can now easily see fees of $4,000 to $6,000 a month. Rent on a nice condo will often be $2,500 to $3,500 a month. Obviously these are higher-end estimates, and each area of the country will have different costs. The key is, how best to fund these new expenses. Even if you choose to sell your house and then buy a condo, there could be monthly fees north of $1,000 a month.

Before the sticker shock causes you to stay in your house for another few years, the first thing to think about is how much of these costs are actually additional, as opposed to simply replacing current expenses. If your house taxes are $6,000 a year, and your average repair bill is $12,000 annually, that works out to $1,500 a month that you are no longer spending. In some cases, there are also utility bills covered in monthly costs — especially in a retirement residence.

For the sake of argument, let’s say that you are adding $2,500 a month in living expenses, or $30,000 a year.

Let’s also say that in selling your house, you cleared $1 million. This means that depending on tax rates, maybe you would need to generate 4 per cent or $40,000 of income on this portfolio pre tax to cover the extra $30,000 in living expenses — without touching the capital.

Here is a sample portfolio that we might put together for this type of goal:

• 15 per cent bonds — yields 3 per cent

• 15 per cent preferred shares — yields 5 per cent

• 15 per cent  TriDelta High Income Balanced Fund, mix of bonds, stocks and alternative income — yields 5 per cent (with some additional capital growth)

• 20 per cent Select Alternative Income Funds in Global Real Estate and Private Lending (with no Canadian real estate exposure) — yields 8 per cent

• 35 per cent Dividend Growth stocks — yields 3.5 per cent (with some additional capital growth)

• Total portfolio yield: 4.8 per cent

• Long-term capital gain expectation: 2.5 per cent

• Expected long-term return before fees: 7.3 per cent.

• Expected long-term return after fees: 6 per cent + (fees would depend on the overall size of portfolio managed and would be tax deductible).

It is important to keep in mind that this focuses on selling real estate to fund living expenses for the rest of your life. It doesn’t look at other savings and other expenses.

Is now the time to sell your long time family home? Only you can really answer that question. What I can say is that in the vast majority of cases, the monthly costs of rent or retirement home fees shouldn’t be holding you back from selling your home. The growth and income alone from your house sale proceeds (especially in Toronto and Vancouver) should cover you for life.

Ted can be reached at tedr@tridelta.ca or by phone at 416-733-3292 x221 or 1-888-816-8927 x221

Reproduced from the National Post newspaper article 6th June 2017.

Major changes to the Ontario Disability Support program

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By John Dowson.

The Ontario disability support program (ODSP), the income benefit for adult Ontarians with a disability, aged 18 years to 65, was introduced in 1998. The ODSP benefit replaced the old Family Benefits Allowance (FBA) which had been in place for a number of years, however on September 1 2017 the ODSP will undergo a number of major changes. These are the first major changes to the program since it was introduced 19 years ago.

Over the past 19 years the income benefit has been increased in increments of between 2% and 1% to the current maximum monthly benefit of $1,128 for a single person living on their own. On the other hand the changes in the asset limits and cash gifts for people who receive ODSP have changed little, that will change on September 1 2017. The changes will help to enhance the lives of the more 400,000 Ontarians who receive support through the ODSP plan.

The Ontario Disability Support Program (ODSP) increased the exemption limits on compensation awards for loss or injury in order to allow individuals to benefit more from these awards without reducing their income support. Compensation awards for pain and suffering have been increased from $100,000 and are now fully exempt as income and assets for individuals receiving Ontario Disability Support Program (ODSP). People with disabilities are now able to use their compensation for day-to-day living expenses or to reduce any debt, not just for pre-approved disability-related costs. This change was effective as of August 1st 2017.

The Changes to ODSP

These changes are part of a larger set of social assistance improvements that will be effective on September 1st, which include:

  • An increase in the monthly maximum deduction for disability-related employment expenses under ODSP from $300 to $1,000.
  • Changes to health benefits available under the Transitional Health Benefit to include batteries and repairs for mobility devices.
  • A full income exemption under ODSP of all donations received from a religious, charitable or benevolent organization for any purpose.
  • The basic cash exemption limit for a single person will be increased from $5,000 to $40,000
  • The basic cash exemption limit for a spouse included with the person will be increased from $7,500 to $50,000
  • Payments from a trust fund, or segregated fund: gifts and other voluntary payments will be increased from $6,000 for a 12 month period to $10,000
  • Gifts to purchase a principal residence will be exempt as income
  • Gifts to purchase a Primary motor vehicle will be exempt as income
  • Gifts to pay the 1st and last month’s rent will be exempt as income

The benefits of the Changes

These changes are welcomed, and people who receive ODSP no longer have to fear the loss of the monthly benefit if their bank account exceeds the $5,000 or $7.500 limit. Liquid asset limits of up to $40,000 or $50,000 will no longer be considered income in the month its received so they won’t lose their ODSP benefit that month. People on ODSP can even save a small amount from their employment income to buy a new coat, a new TV, furniture, a suit or dress, take a vacation or have a nice meal in a restaurant just like everyone else. They will no longer be forced to spend their small inheritance or hide the money from their case worker. They now have some breathing room to spare.

The New Regulations

The regulations have yet to be published so as they say, the devil is in the details. We expect to see the regulations published by September 1st. There are still many unanswered questions, can an individual who receives ODSP own a life insurance policy or segregated fund policy on their own lives with cash values of up to $100,000 without losing their disability benefits?.

Living on ODSP

Living on the ODSP monthly benefit is still not living in the lap of luxury. The rising cost of living makes it impossible to meet basic needs and people suffer as a result. Finding an apartment is next to unattainable on the current ODSP. Still parents will welcome the new changes because their hands will no longer be tied to an impossibly delicate $5,000 asset limit.

Case study vs the new asset limits  

A dentist, who has a daughter with a disability, employs her in his office. He pays her the minimum income allowed within the ODSP guidelines but his daughter is unable to save anything beyond the $5,000 liquid asset limit. Now with these new asset limits he can increase her salary and she can save money in her bank account to purchase those little extra’s, or buy her own clothes, and things that make her life just the same as other children who have part time jobs. She will no longer have to live within the confines of a $5,000 limit.

Case study vs a gift over the asset limit

Some time ago woman called me in despair, she was upset and crying. She told me her preauthorized rent payment had bounced because her ODSP office discovered she had received a $20,000 advance on her mother’s inheritance and her ODSP benefit had been cut off without notice. The estate trustee had given her the advance to buy a car because she lives in the country and she needs a car for shopping and doctor’s appointments in Toronto and other necessary trips. We began preparing her appeal to the Social Benefit Tribunal (SBT). She only had 30 days to prepare her case and submit her appeal to the SBT. However after September 1st this person will not lose her ODSP benefit and her rent payment won’t bounce because the asset limit has been increased to $40,000.

A case study vs a structured settlement

For people who receive structured settlements the unlimited awards will go a long way to assisting them with the lifestyle, for which the courts granted the settlement, to only to have the ODSP office take their benefit away. In most cases a structured settlement can take years to settle. In one case it took three years to settle the law suit. During that time the individual applied for and received a total ODSP income of approx. $40,000. In addition he also received  a lump sum payment of $63,000 in back payments from Canada Pension Plan Disability Benefits (CPPD). He had to repay ODSP the $40,000 he received over the three years, because he had an over payment. However through some creative planning we managed to dispose of the settlement and retain all but $125,000 which was paid to his mother for his personal costs and expenses. However when the new structured settlement regulations are in place he will only have to repay ODSP $25,000, and he can keep all of the structured settlement. He can use the funds in the settlement for what the courts intended, to maintain his lifestyle. 

John Dowson has dedicated his life planning practice to helping parents of children with disabilities plan for their care and financial security. John may be able to assist you as well.
www.life-trust.com
(800) 638 7256

FINANCIAL FACELIFT: New worlds to explore for couple eyeing retirement

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Below you will find a real life case study of a couple who are looking for financial advice on when they can retire and how best to arrange their financial affairs. The names and details of their personal lives have been changed to protect their identities. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by: DIANNE MALEY
Special to The Globe and Mail
Published Friday, August 25, 2017

When he retires this fall, Chuck hopes to enjoy that magical combination of time and money that proves so elusive for people while they are still working. He and his wife, Charlene, hope she can hang up her hat at the same time.

He is 59, she is 51. They have two children, ages 17 and 23. The younger lives at home.

Chuck makes more than $160,000 a year working for an auto maker, while Charlene is self-employed and earning $143,000. Chuck has a defined-benefit pension plan, Charlene has none.

As a widow and widower in their second marriage, each collects a Canada Pension Plan survivor benefit. Charlene also gets a portion of her late spouse’s work pension, so they will have various income sources when they retire. They also have substantial investments.

But will this be enough to allow them to retire with $120,000 a year after tax, their goal? Should Chuck take the lump-sum value of his pension or the monthly cheque? Is Chuck right in calling Charlene’s investment fees “ridiculous, especially with the low return?”

We asked Matthew Ardrey, a vice-president and certified financial planner at TriDelta Financial in Toronto, to look at Chuck and Charlene’s situation.

What the expert says

Mr. Ardrey starts by totting up the couple’s future income. When he retires in October, Chuck will get 22 months of severance pay ending in July, 2019. They get a combined $6,926 in CPP survivors’ benefit, while Charlene gets $20,000 a year (not indexed to inflation) from her late husband’s employer. They have a sideline that will generate $3,000 a year until mid-2030.

If Chuck opts for the pension, he will choose a 100-per-cent survivor benefit for Charlene, giving him $39,357 a year, plus a CPP supplement to the age of 65 of $4,864 a year. Neither is indexed. In drawing up his plan, Mr. Ardrey assumes they will begin collecting (full) CPP and Old Age Security benefits at 65 and live to 90.

In addition to their $120,000 goal, Charlene and Chuck plan on spending another $12,000 a year on travel until Chuck is 80 years old. They plan on buying two new vehicles soon for $30,000 apiece.

The key to achieving their goal lies in their investment returns. Given their current holdings, Mr. Ardrey projects a rate of return of 4.15 per cent – the historical average of the underlying asset classes they are invested in – with a 1.65-per-cent management expense ratio. “By the time we account for the 2 per cent assumed inflation rate, the real rate of return on their portfolio is almost zero,” the planner says. “Based on these assumptions, they will not be able to achieve their retirement goal.”

Either Charlene would have to work for another five years or they would have to pare their spending by $11,000 a year to $109,000.

What if they were able to earn more on their investments with lower fees?

By shifting from retail mutual funds to an investment counsellor, the couple may well be able to raise their return to 6.5 per cent on average and lower their fees to 1.5 per cent a year, for a net return of 5 per cent. This way, they would not only meet their spending target but surpass it by $15,000 a year. “The shift is $26,000 per year in after-tax, inflation-adjusting spending.”

They have 53 per cent of their investments in cash and fixed income, which is “definitely placing a drag on their returns,” the planner says. More than half of their equity exposure is to Canada. Mr. Ardrey recommends 50-per-cent equities, divided among Canadian, U.S. and international stocks; 30-per-cent fixed income; and 20-per-cent in alternative investments, which tend to have a low correlation to the stock market and potentially higher returns than fixed income.

Next, the planner looks at whether Chuck should take a lump sum or a pension. “If he took the lump sum, $515,000 could be transferred to a locked-in retirement account, while the remaining $390,000 would be taxable,” he says. “Using the 5-per-cent net rate of return [assumed above], the difference between the two would be almost nil.” They would be able to increase their spending by $17,000 a year rather than $15,000.

In making this decision, Chuck should consider the following points: Does he believe the pension is secure? Does he feel comfortable investing the money? Would he prefer if the money was available for his children in the event both he and Charlene died in an accident? Does choosing a lump sum result in the loss of other company benefits such as health care?

+++++++++++

The people: Chuck, 59, and Charlene, 51

The problem: Can they both retire this fall without compromising their retirement spending goals? Should Chuck take the cash or the pension?

The plan: Either scale back spending expectations, work longer or take steps to improve investment returns.

The payoff: All their financial goals realized.

Monthly net income (past year): $20,660

Assets: Cash in bank $25,000; GICs $75,000; his taxable portfolio $180,000; her taxable portfolio $726,000; his TFSA $64,200; her TFSA $57,500; his RRSP $100,000; her RRSP $839,000; commuted value of his DB pension plan $979,000; estimated PV of her survivor pension $340,000; RESP $70,000; residence $1,000,000; her cottage $500,000. Total: $5-million

Monthly disbursements: Property tax $600; water, sewer $100; property insurance $325; electricity, hydro $250; maintenance, garden $500; auto lease $800; fuel $350; parking, transit $400; grocery store $1,000; clothing $200; gifts $200; charity $550; vacation, travel $1,000; dining, drinks, entertainment $720; grooming $75; club memberships $150; pets $200; sports, hobbies $335; subscriptions $25; drugstore $20; life insurance $70; disability insurance $80; telephone, cellphones, internet $340; RRSPs $2,690; investment account $5,000; TFSAs $915; his pension plan $305. Total $17,200. Surplus: $3,460 (had been going to savings and investments)

Liabilities: None

Want a free financial facelift? E-mail finfacelift@gmail.com

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230

Q2 TriDelta Investment Review – What a Rising Interest Rate World Means

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Are Central Banks Starting to Hit the Brakes?

On July 12th, the Bank of Canada raised interest rates for the first time in seven years.  While the pace of interest rate increases in Canada is likely to be slow and very gradual (0.25% increases at a time), it does reflect a significant change for the investment landscape, as it seems most major central banks are either raising or at least considering raising interest rates.  Low and in some cases negative interest rates have been a central feature of the world economy since the financial crisis of 2008.  This change in stance by the central banks could have significant implications on the world economy, investments and in particular our clients’ investment portfolios.  In this quarterly report, in addition to a discussion of the past quarter, we will focus on what central banks do, why they matter and our views of the effects of the likely interest rate increases.

The Highlights – Generally Positive Performance in a Lacklustre to Negative Market

Following a strong first quarter, most world equity markets retreated from their highs during Q2.  While market watchers may have rejoiced over US TV networks talking about all-time highs for US stocks throughout Q2, the reality for most markets was quite different.  The TSX declined by 2.3%, Europe declined by 1.7% and the US market was up only 0.2% in Canadian dollar terms (it gained 2.9% in USD).   Most of the drag came in the final few weeks of June when central bankers globally took a more hawkish tone with the Bank of England and the European Central Bank (ECB) both talking of potentially higher rates and less accommodative monetary policy in the near future.  In particular, Mario Draghi of the ECB proclaimed that deflationary issues in the Eurozone were over.  The US Federal Reserve reconfirmed that it plans to continue gradually raising interest rates and discussed reducing its balance sheet.  The Bank of Canada, gave hints of raising rates as well (this was confirmed with a 0.25% rise on July 12 – the first increase in seven years).  The Canadian dollar rallied against other currencies, particularly the USD as a result. 

On a political front, the Centrist, Emmanuel Macron won the presidency in France and his party then won a majority in the legislature.  His victory has already resulted in substantial increases in consumer confidence in France and throughout Europe with expectations that he will usher in pro-business reforms, such as tax cuts and needed labour policy reform, as well as pushing for greater integration in Europe.  In the US, the Trump bump has diminished significantly with most analysts expecting the promised tax reform and cuts and / or infrastructure spending will not happen in 2017, if at all, as the Republican congress is not fully united and the President continues to be under pressure.  Geopolitical concerns remain, including North Korea’s launch of more advanced ICBM missiles and continued military campaigns in the Middle East, but none of these concerns seem to be impacting equity or fixed income markets for the time being.

TriDelta’s Results

Overall, most of our clients earned positive returns for the quarter as our Fixed Income pool was up 1.4%, preferred shares were positive and the Pension Equity Pool was up 1.6%.  The Fixed Income pool benefitted from holding bonds with shorter durations / terms to maturity and its 5% weight to rate reset preferred shares.  These securities typically go up in value when bond yields increase.  The TriDelta Pension Equity Pool gained from its overweight position in US health care and limited commodity exposure in Canada.  Our Growth Equity Pool and High Income Balanced Fund were both down about 0.5% with losses concentrated in June. 

Our short list of recommended alternative investment funds focused on private credit, factoring, and real estate benefitted client returns in Q2 averaging about 2% for the quarter. 

Actions that we had taken at the end of Q1, which we described in the last quarterly report, helped protect performance as we took a more conservative tone by:

  • adding to cash
  • reducing our US equity overweight position
  • reducing the duration / term to maturity of our bond portfolios.

For the quarter ahead we remain cautious, but opportunistic.  Bond yields may rise a bit further in the coming weeks, but this could give us an opportunity to buy longer dated bonds at much more attractive yields.  With interest rates likely increasing in the US, Canada, the UK and potentially in Europe, equity markets will be much more reliant on companies increasing their earnings to generate positive returns.  The good news is that earnings in the US are expected to grow by about 8% this quarter and by over 20% for the year; European equities are expecting similar earnings growth as well.  In Canada, earnings growth is expected to be closer to 30%, albeit from depressed levels due to the drop in commodity prices in 2015-2016. This is offset by the fact that equity valuations remain high, so strong earnings and beating analyst expectations will be necessary for the markets to move up in the short-term.  Consequently, the changes that we put in place at the end of Q1 are still in place going into Q3, as we look for better opportunities to deploy capital. 

Central Banks – What They Do?

Central Banks, such as the Bank of Canada, the US Federal Reserve and the European Central Bank, implement monetary policy to help control money supply.  Most central banks attempt to keep inflation within a target range by either restricting or increasing money supply, primarily by setting the overnight interest rate.   Some central banks, in particular, the US Federal Reserve, also have an agenda of using monetary policy to encourage full employment.  Since 2008, the role of central banks expanded enormously as they provided emergency funding, lowered interest rates to zero percent and in some cases negative yields to encourage banks to lend, consumers and corporations to borrow to help kick-start the global economy while limiting the economic damage from the financial crisis.  Central banks also attempted to stimulate the economy through quantitative easing, which is explicitly buying longer dated government, mortgage and in some cases corporate bonds in an attempt to lower longer-term interest rates and flatten the yield curve, e.g. if a corporation knows that rates will remain low for 5-10 years, they may be more interested in borrowing funds to expand production or for a longer-term project, which leads to more jobs, more consumer spending and economic growth. 

Why They Matter

These very low interest rates became the norm for nearly all major economies and they have had significant impacts on both the economy and the financial markets.   These lower rates helped support fixed income (bonds) and stock returns in a variety of ways.  

1) Bonds – when interest rates decline, longer dated bonds are more valuable because investors earn a much higher return relative to short-term cash investments.  As a result, more investors buy bonds, their prices go up while their yields decline.  As an example, a 10 year Government of Canada bond yielded approximately 3.7% in September 2008, prior to the financial crisis.  For the next 8 years yields declined so that the  10 year Government of Canada bond was yielding less than 1.0% by mid-year 2016.  These bonds are currently yielding about 1.8%.  Easy monetary policy is a large part of the reason that bond investors have earned average returns of 4.5-5.0% per annum since 2008. 

2) Corporate Earnings – easy monetary policy meant that it cost less for companies to borrow.  Consequently, smart CEOs and CFOs issued a lot more debt over the past 8 years to make accretive acquisitions and expand production as well as using the funds to buy back stock and increase dividends.  All of these measures have resulted in higher earnings per share for companies and higher returns for investors. 

3) Stock Valuations – investors constantly have to decide where to invest their money to earn the highest return relative to their risk tolerance.  The easy monetary policy over the past 8+ years has made stocks more attractive.  When your options are very low rates on GICs and bonds, investors have been putting more money into the stock market.  In fact, many investors earned higher levels of income by buying dividend paying stocks than they could on bonds and they had the opportunity for capital appreciation.  As a result, stock prices continued to climb from their lows in 2009, with the exception of a few corrections along the way, and stock valuations, the multiple that investors are willing to pay of a company’s projected cash flow and earnings, are presently at much higher than historical levels. 

What Impact Will Higher Interest Rates Have?

While most major economies are now increasing or at least no longer cutting interest rates, what is still to be determined is the pace and total level of these increases.   It is also uncertain as to what impact they will have on financial markets, but our thoughts are below:

1) Bonds – Higher interest rates typically are a negative for bond holders.  Bond prices drop as yields increase.  The offset has been that the credit spread, which is the additional yield you earn by owning a corporate bond vs. government bonds, tends to shrink, meaning that corporate bond holders earn higher returns.  Presently, credit spreads are tighter than average, so the upside from spread compression will be limited.  Our view is that passive bond investors should expect to earn the current yield of the bond index, which is approximately 2.5%, but with some volatility. 

We actively manage our bond portfolios, adjusting duration, sectors, credit quality, and taking advantage of special opportunities, such as preferred shares, to enhance yield and overall return.  While we presently have a cautious stance, we will take advantage of longer dated bonds when yields are at more attractive levels or investor sentiment changes, as well, we will continue to look out for opportunities to extract additional returns from high yield bonds, USD pay bonds and preferred shares.  We believe that through active management and being nimble, additional returns can be earned in this asset class.

2) Corporate Earnings – Economic growth accelerated globally in the past year, particularly with Europe, Japan and most Asian emerging markets advancing at much faster paces.  As a result, business and investor sentiment have been going up (although recently declining moderately in the US), purchasing manager indices have been rising and consumer spending has also increased.  Consequently, while companies will be paying more for their debt, higher revenues may more than offset any of these increases.  In addition, if operating margins continue to improve in Europe and Asia to levels similar to those enjoyed by US companies, corporate earnings could increase further. 

3) Stock Valuations – Valuations are likely to decline as a result of central banks tightening the money supply, but higher corporate earnings may be able to more than offset this decline.  In the US market for example, stocks currently trade at a price multiple of 21.5 times earnings, but with earnings expected to grow 20%+ over the next 12 months, the forward earnings multiple is closer to 17.6 times, which is much closer in line with the historical average of about 15-17 times earnings.  The TSX is currently trading at about 21 times earnings, but if the earnings forecast over the next 12 months is correct, then it is trading at less than 16 times those projected earnings, a level more consistent with its historical average.   Europe, Japan and emerging markets are presently trading at valuations similar to their historical averages, so if growth continues at its forecasted rate, they will actually be trading at a discount.  Therefore, even with higher interest rates, equity markets can still provide positive returns if earnings increase at the anticipated rates and could generate stronger returns if corporate earnings beat analyst expectations.

Consequently, changes in central bank policy are important for us to monitor and anticipating those changes plays a role in our asset allocation and security selection decisions. 

In closing, we think that the central bank slowly and gradually raising interest rates is warranted given the improving economic fundamentals.  Stock markets should be able to absorb these changes as projected economic growth should lead to solid corporate earnings growth.  There is likely to be some volatility along the way, especially if policy changes are misunderstood by the market.  Companies meeting or exceeding projected earnings will become even more important without the support of the accommodative monetary policy of the past eight years. 

We have positioned our portfolios defensively looking to take advantage of potential volatility, while protecting client capital.  We believe that our patience will ultimately be rewarded with some solid buying opportunities.

Wishing all our clients and their families a relaxing, warm and sunny summer.

  

TriDelta Investment Management Committee

 

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Exec VP and Portfolio Manager

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor

FINANCIAL FACELIFT: How can this couple make sure they’re prepared for retirement?

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Below you will find a real life case study of a couple who are looking for financial advice on when they can retire and how best to arrange their financial affairs. The names and details of their personal lives have been changed to protect their identities. The Globe and Mail often seeks the advice of our VP, Wealth Advisor, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by: DIANNE MALEY
Special to The Globe and Mail
Published Friday, July 7, 2017

Mark and Marianne moved to Canada in 2003 “at an advanced stage of their careers.” He was in his late 30s, she in her early 40s. This posed a challenge faced by many immigrants, Mark writes in an e-mail.

“By the time you get professionally established, you are already late to the game of financial and retirement planning.”

Today, both have good jobs in higher education, earning a combined income of $250,000. Mark has a work pension plan but Marianne, who works on contract, has none.

“Now that we are in our early 50s, we feel we are not well prepared for retirement,” Mark writes. They have been focusing on paying off their mortgage.

They have questions about how pension entitlements earned in their home countries can be combined with Canadian pension benefits and Old Age Security. As well, their teenage daughter will be off to university next year and they have not yet saved enough to cover the cost of her education.

We asked Matthew Ardrey, a vice-president and financial planner at TriDelta Financial in Toronto, to look at Mark and Marianne’s situation.

What the expert says

Mark and Marianne are concerned that they are behind the “Joneses” when it comes to their retirement planning, Mr. Ardrey says. They want a better understanding of where they are today and how best to meet their goals for tomorrow.

They show a substantial surplus, but that has only come about in the past year as Marianne’s salary has increased. Their next project is to renovate their two bathrooms, estimated to cost $20,000. By allocating some surplus funds to their savings account, in addition to the $17,400 already saved, they will have enough to complete the renovation next year, the planner says.

They have been saving $5,000 a year toward their daughter’s education to take advantage of the Canada Education Savings Grant. Because their daughter plans to live at home and attend a local university, Mr. Ardrey assumes education costs of $10,000 a year for four years. That would leave a shortfall in their registered education savings plan of $21,400. The shortfall in the third and fourth year can be made up by the couple’s cash-flow surplus and savings.

“It is important to note that the key assumption under which the short-term goals are met is that the monthly surplus of $3,600 is correct,” Mr. Ardrey says. If their budgeting is out by much, “it will have a significant impact on their plan.”

Mark and Marianne will be mortgage-free by the end of 2020, so they will have an additional $3,770 a month in their pocket starting in 2021. The plan assumes they will save half of this amount, with the other half going to increased lifestyle spending. The planner assumes they both take full advantage of their tax-free savings accounts, catching up on unused contribution room.

Marianne has about $33,800 in unused RRSP contribution room. With her salary of $46,800, she will generate an additional $8,435 in contribution room annually. Mr. Ardrey assumes she averages out the prior year’s contribution room over her remaining working years, as well as making her annual RRSP contribution, for a total annual RRSP contribution of $11,820. Mark has no contribution room because of his pension adjustment.

Starting in 2021, Marianne and Mark will be able to start saving money in a non-registered investment account. With their current surplus, minus RRSP and TFSA savings, they will add almost $20,375 a year to the non-registered account. In addition, they will have $22,260 (50 per cent of the mortgage payments), for total savings of $42,995 a year.

Mark has a defined-benefit pension plan that will pay him about $7,725 a month when he retires at 65. The pension is not indexed to inflation, but has a 60-per-cent survivor benefit. He also has registered savings overseas toward which his parents have been contributing. The overseas plan will pay out an estimated lump sum of $230,000 when he turns 65. The planner assumes this will be fully taxable. Mark will also get a foreign government pension of $530 a month starting at 67, indexed to inflation. Both Mark and Marianne will be entitled to reduced Canada Pension Plan and Old Age Security benefits when they retire.

In looking at the couple’s investments, Mr. Ardrey used the couple’s actual rate of return and asset mix. The underlying asset classes of the mutual funds in which they are invested show a historical return of 4.54 per cent with a 2.38-per-cent management expense ratio.

“By the time we account for the 2 per cent assumed inflation rate, the real rate of return on their portfolio is almost zero!” Mr. Ardrey said. Even so, Marianne and Mark can achieve their retirement spending goal of $90,000 a year, in current year dollars, inflation adjusted, and have an additional $10,000 a year in travel spending until Mark turns 80, the planner says.

When Mark turns 90, they will have an investment portfolio worth $1,065,000, plus their real estate and personal effects, he notes. “Alternatively, if they spent all of their investment assets, they could increase their lifestyle spending by $22,800 per year.”

Mark and Marianne could greatly improve their situation by reviewing their investment strategy and cutting costs. With some portfolio rejigging, they should be able to increase their rate of return to 6.5 per cent and reduce their fees to 1.5 per cent, for a net return of 5 per cent a year.

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The people

Mark, 52, Marianne, 55, and their daughter, 16

The problem

Are they on track to meet their retirement goals?

The plan

Continue paying off the mortgage, then shift the extra money to retirement savings. Use up unused TFSA contribution room. Look to lower investment-management fees and improve returns.

The payoff

Financial security with all their goals met.

Monthly net income

$15,555

Assets

Bank accounts $17,410; current value of overseas registered-savings plan $71,305; his TFSA $49,900; her TFSA $31,465; his RRSP $3,865; her RRSP $17,620; estimated present value of Mark’s DB plan $338,195; RESP $21,390; residence $800,000. Total: $1.35-million

Monthly disbursements

Mortgage $3,770; property tax $235; water, sewer $60; home insurance $90; heat, electricity $190; maintenance, garden $350; car lease $265; parking, transit $295; other auto $360; grocery store $1,300; clothing $340; vehicle loan $265; gifts, charitable $155; vacation, travel $500; house cleaning $240; dining, drinks, entertainment $410; grooming $150; clubs $95; sports, hobbies $60; subscriptions $15; child’s activities $165; doctors, dentists $30; vitamins, supplements $250; life insurance $145; telecom, TV, Internet $295; RESP $415; TFSAs $400; pension-plan contribution $1,085. Total: $11,930. Surplus $3,625

Liabilities

Mortgage $154,330; Home Buyers Plan loan $8,570; car loan $47,420 at zero per cent. Total: $210,320

Want a free financial facelift? E-mail finfacelift@gmail.com

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor
matt@tridelta.ca
(416) 733-3292 x230
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