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TriDelta Investment Counsel – Q1 2015 investment review

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Executive Summary – Good times in the stock markets may last a while

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Another quarter rolls by, and overall, it was another quarter of very solid returns for our clients. Can the good times for investment markets continue?
 
The pessimists of this world say “this has got to end soon”. The optimists say “maybe this is the new reality”. Our general view is that both are wrong. History teaches us that there are few to no “new realities” – eventually it repeats itself. At the same time, should we expect strong stock markets to end in the near future? We don’t think so.
 
Here are three reasons:

  1. Valuations are not unreasonable. The chart below is from JP Morgan based on the US S&P 500 index as of March 31, 2015. It shows current Price/Earnings ratios today as a percentage of the 20 year average of Price/Earnings ratios – so 100% would suggest things are at the 20 year average, 110% would be 10% over the average and 90% would be 10% under the average.
     

      Value Blend Growth
    Large 116.4% 104.3% 91.7%
    Mid 124.4% 118.1% 98.5%
    Small 114.3% 107.1% 97.4%

    This chart shows that while the overall market has a higher P/E ratio than the 20 year average, the higher valuation is skewed toward Value stocks, and in fact Growth stocks currently have valuations that are UNDER the 20 year average – especially among large companies. While this can provide some guidance for which types of names to buy in the market, it would suggest that on a purely valuation basis, despite several years of good markets, corporate earnings have mostly kept up. On its own, valuations would not drive us to lower our stock weightings.

  2. Rising interest rates should actually help stock markets. Over the past 52 years, a study of weekly stock market returns (S&P500) and 10 Year US Treasury yields, showed that when the Treasury yield was under 5%, there was a positive correlation between rising rates and stock market returns. Once the 10 year yields were over 5%, it became a negative correlation. Today’s 10 year US Treasury Yield stands at 1.9%.
     
    Based on this data, the next 3% of interest rate increases will actually correlate to a rising stock market. It is our view that this process will take a few years. When you consider that German 10 year bonds are trading at 0.15%, you realize that there still is room for US 10 year bond rates to decline from here. Even if there is no decline, at least rising rates will be constrained within this type of Global rate environment.
     
    There are a couple of reasons why stock markets would rise as interest rates climb. The first is that rising interest rates are often connected to growth in an economy, and if that growth is coupled with cheap money in the form of interest rates under 5%, it tends to be a good environment for stocks.
     
    The other reason might be that rising interest rates are not good for bond returns, and if that is coupled with bond yields under 5%, it tends to be a weak incentive to invest in bonds. If money doesn’t want to be in bonds, it tends to create inflows to stocks. If bond yields were 10%, but there were some capital losses, most people would still be comfortable holding bonds.
  3. Retirees are forced to invest in stocks at these interest rates. Today, a 65 year old couple has a 47% chance of at least one of them living to age 90. Essentially this means that 65 year olds need their money to last at least 25 more years – probably 30 years to be ‘safe’.
     
    If you have $1 million and GICs pay 8%, then they can spin off $80,000 a year and even with high inflation, you are in good shape.
     
    Today, retirees can invest it in GICs and it will spin off $18,000 if they are lucky. This means they would have to drawn down their savings each year to make ends meet. Can retirees afford to do that for 30 years?
     
    As a result, those with the largest portfolios (mostly those aged 65+), who used to have a much lower portion invested in stock markets, will need to be meaningfully invested in stocks (or high yield bonds) at least until they can get 4% or 5% on their GICs. That will take a while.

In the short term anything can happen. We fully expect there to be a 5% to 10% downturn at some point in 2015 because that happens most years. However, overall, we think that valuations, interest rates and demographics remain supportive for stock markets.

The Quarter that Was

The TSX had an OK start to the year, with a 1.8% return over the quarter. Of course, energy was down another 1.9% and financials were down 1.1%, but most of the smaller sectors helped to keep returns above water.
 
Declining crude prices continued to put pressure on energy stocks, but technically stocks are behaving well having put in what may be their low in December with higher highs and higher lows since then.
 
TSX earnings seem to have stabilized. Trailing 12 month corporate earnings numbers continue to fall, but the forward 12 month estimates have started moving up.
 
The Canadian financials have recovered from a very weak January where the index was down more than 8% on fears of a weaker Canadian economy (mainly Western Canada) and housing market.

The US S&P 500 was up just 0.4% in the quarter. But currencies added 9.1% for Canadian investors!!
In the US the best performing sector was Health Care, up 6.1%. The worst sector was Utilities, down 6.0%.
 
There was a very weak start in U.S. stocks on lackluster Q4 earnings where concerns over a strong dollar and slowing global growth were a recurring theme. This seems to have recovered somewhat.
Consumer sentiment has held up with the Consumer Confidence Index hitting a 7 ½ year high in January in the U.S.
 
Economic numbers were mixed with decent housing starts but weaker consumer spending, which may be somewhat related to the cold winter and heavy snowfall in the Northeast.
Earnings are stable as trailing numbers and forward estimates continue to rise.
 
With continuing drops in interest rates, bonds had a very good quarter, up 4.1%.
Global Central Bank policies continue to be the focus of headlines.
In Europe the ECB maintained a bias towards lowering rates and quantitative easing (governments buying their own bonds to keep rates low) in an attempt to keep their currency low and to stimulate growth.
 
In Canada, the Bank of Canada surprised with a 25 basis point rate cut on January 21st when no policy move was expected. The overriding concern is how Canada and its economy will deal with a US$50 a barrel environment for oil.

In the US, the Federal Reserve was quick to change its tone towards keeping rates steady instead of an expected increase. This was driven by deflationary concerns that came about from lower energy prices coupled with a strong US dollar.

How did TriDelta Do?

First quarter 2015 was very positive for TriDelta clients. Depending on risk tolerance/asset mix, most clients were up between 3% and 5.5% for the quarter, with the high growth oriented clients doing better, and the most conservative returning at the lower end of that range.
 
The TriDelta High Income Balanced Fund – was up 7.1% on the quarter.
 
The fund – which currently delivers a yield of over 7% – aims to provide income from diversified sources that include Global Bond yields, options, dividends and leverage. The fund is essentially a Global Balanced fund but we utilize a wide number of investment tools to achieve higher returns.
 
Some good regulatory news came through this quarter, which will allow all TriDelta clients the opportunity to own the fund (as opposed to only Accredited investors). This will come into effect in May and will allow for new investments as of the end of May.
 
Given a TSX return of 1.8%, we were very pleased with the results overall.
 
Our two biggest drivers for outperformance were:

  1. Between 30% and 40% of our stock weighting has been outside of Canada (U.S., Europe and Emerging Markets). Because of US currency gains and strong stock markets in Europe and Asia, these parts of the portfolio have done better than Canadian stock numbers.
  2. TriDelta has been significantly underweight energy, particularly with our Pension clients. In July we sold one of our two pure Energy stocks (Suncor), and bought the Pharmacy, Jean Coutu. To date, this trade has been a 40% swing to the positive. While we may find the value in Energy compelling at some point, for the most part, we find that our clients don’t want the volatility that comes with a high energy weighting, and we can find other industries and names that are more appropriate alternatives.

What worked well in Q1?

In our equity portfolios we continued to see the US$ working in our benefit. The leading performers had a US and technology slant with Avago Technologies and Apple leading the way.
 
Best Equity Performers – Core – Avago Technologies +31.0%, Fairfax Financial +18.9%, Moody’s +18.9%
 
Best Equity Performers – Pension – Apple + 23.7%, GlaxoSmithKline +22.1%, General Mills +16.9%
 
In the Bond and Preferred space, lower interest rates produced some nice winners.
 
Highway 407 6.47%, July 27,2029 bond was up 9.0% on the quarter as it benefits from a high yield and declining long term rates.
 
Brookfield Asset Series 18 preferred share was up 8.1% on the quarter.

What did not work well in Q1?

Before we talk details on what didn’t work, we have been asked by some industry colleagues “Why do you show people what didn’t work?” Our answer to that is simple:

  1. Transparency with clients is important
  2. It always helps an organization to review what isn’t going well
  3. It reminds everyone that even strong investment management returns include weak performers in a portfolio
  4. We like to be a bit different from the rest of the industry

This quarter, after the currency effect, Canadian stocks lagged the US (and most other world markets). Energy, Canadian Financials, and any business that seemed closely tied to Western Canada suffered.
 
Our weakest performing stocks were as follows:
 
Core – Michael Kors -4.3%, TransCanadaPipeline -4.3%, TD Bank -1.5%
 
Pension – Home Capital -10.9, ConocoPhillips -7.3%*, Corus Entertainment -6.5%
 
In the Core/Growth model, we still own all 3 of the weaker performers from this quarter. While we continually review our holdings for signs of problems, for now we are planning to continue to hold these names (always subject to change).
 
In the Pension model, we only continue to hold Home Capital. Its decline was largely based on fears of real estate declines and risk among non ‘A’ level borrowers. Home Capital is such a strongly managed company that has been able to work through much worse times than today, and we continue to like the name.
 
ConocoPhillips was actually sold on January 8th so we didn’t really participate in the losses for the quarter. Corus was sold (just in time) at roughly $22 on March 13th. It has since dropped 20%!
 
In the Preferred Share space, all rate reset preferreds (those that have dividends that will reset to a rate that is tied to the Government of Canada 5 year yield) had a very poor quarter. While we don’t see much in the way of increased interest rates in the very near future, we do believe that this sector of the market has been overly beaten up and is undervalued – and we may add to some beaten up names.
 
Cannaccord Series A 5.5% Variable was down 24.3% in the quarter, and represented our worst holding.
 
Its 5.5% dividend won’t reset until September 30, 2016, and at that time will reset at 3.12% above the 5 year Government of Canada yield, which today stands at just 0.6%, but could certainly rise in the next 18 months.

Dividend Changes in Our Portfolios

We continue to be pleased with a steady flow of dividend increases and no dividend cuts in our investment portfolios.
 
This quarter in our income oriented portfolios the top four dividend increases were:

Company Name % Dividend Increase Company Name % Dividend Increase
Canadian Utilities +10.3% Home Capital +10.0%
Potash +8.6% General Mills +7.3%

In our Growth portfolios, the overall dividend yields tend to be lower, but some of the trends of dividend increases have been very solid. Below are the four biggest percentage increases in the quarter:

Company Name % Dividend Increase Company Name % Dividend Increase
Sherwin-Williams +21.8% Moody’s +21.4%
3M +19.9% Magna +15.8%

What do we see in the Quarter Ahead

  • More volatility by sector – you won’t see as much of the overall market moving higher or lower as much as a few sectors pushing much higher or lower.
  • Interest rates remaining mostly stable to lower in Canada and Europe. The United States won’t likely see the Fed raising rates this quarter, but we still expect to see it this year.
  • Oil looks to have found a base from a technical perspective and may allow for some trading gains, but we can’t see any big move forward as long as oil inventories keep pushing new heights. We believe it will be a lot of ‘one step forward, one step back’.
  • Canadian dollar remains under some pressure, but seems to have found some support in the 78 to 80 cent range unless Oil makes a major move from here in either direction or there is another Bank of Canada rate cut.

Summary

TriDelta Financial is celebrating its 10th Anniversary this month and we are very thankful to our clients for helping us to reach this milestone.
 
We are planning to do a couple of special client thank you events in the coming year to celebrate – details to follow.
 
Enjoy the soon to be realized Spring!!

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor

TriDelta High Income Balanced Fund

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Today’s investors face significant challenges, not least of which is generating sufficient income in the multi-decade low interest rate environment.

We launched the TriDelta High Income Balanced Fund in late 2013 and have since delivered significant returns to early investors. Our fund overview can be reviewed.

Opportunities to invest are restricted to ‘accredited investors’ currently, but the exciting news is that from May 5th 2015 regulations have been amended by the Ontario Security Regulators to all non-accredited investors to participate as well. This is however subject to it being an appropriate investment given the elevated risk profile. We will however review your situation carefully to determine this beforehand.

The Financial Post published this recent article about our fund:

Article

Click here to read the entire story.

Collateral Mortgages – The Good and the Bad

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Most people think of mortgages as pretty straight forward products. Our message is don’t be fooled, they are not. Finding the right solution is best done by partnering with an expert such as a mortgage broker.

The last couple of days have delivered the lowest rates ever, which is great news for those of us needing a mortgage, but again be diligent in working with the right partner to find the solution that is best for your particular situation – talk to us and we will guide you.

A relatively new option is a collateral mortgage solution. Most people are not familiar with this type of mortgage, but it has some unique features that may be beneficial.

We asked one of our preferred mortgage brokers, Jacques du Preez of Mortgage Allies to clarify things and provide his advice on collateral mortgages:

What is a Collateral Charge?

It is an alternative way for lenders to place a mortgage against a property. A collateral charge can contain more than one mortgage component such as a classic mortgage and a secured line of credit. Collateral mortgages are also re-advanceable.

What is good about collateral mortgages:

  • Borrowers have access to the equity that they have created by paying down the mortgage principal.
  • The borrower does not have to qualify for borrowing inside the collateral limit.
  • This can be a great tool for business people to cash flow their businesses.
  • The increasing equity can be used for investment purposes.

What is bad about collateral mortgages:

  • Collateral mortgages are not transferrable. This means that the borrower will have to pay full legal fees to transfer the mortgage to a different lender at term maturity.
  • These products are used as forced loyalty tools by lenders.
  • They are often the source of increased debts and can be a hindrance to become mortgage or debt free.
  • Collateral mortgages are not portable, nor assumable.
  • They block out any other loans against the subject property, which means a borrower has no way of securing any other emergency funding if they need it.
  • Collateral charges can lead to Power of Sales of properties.

Collateral mortgages are not for everyone and they should always be entered into as a result of a strategy.

Here are a few guidelines:

  • Only allow the financial institution to collateralize the property for the total borrowings. Some institutions collateralize above the borrowing limit or even to 125% of the property’s value. There is no need for this and does not serve the borrower’s best interest.
  • If a mortgage is above 80% of the value of the property the mortgage should not be collateralized. Under government rules there is no potential for future borrowings so there is no need to place a collateral on the property.
  • Disclosure about collateral charges are usually only provided in the lender’s Standard Terms package which the borrower sees at the solicitor when the mortgage is closed. This is too late so insist to see your bank’s Standard Terms when you enter into mortgage discussions.

The golden rule: Don’t allow your lender to place a collateral mortgage on your property unless you have a reason to do it.

starlogo
Ellen Roseman of The Toronto Star also wrote an article highlighting the differences between a conventional and a collateral mortgage.
Read the entire article.

Anton Tucker
Compiled By:
Anton Tucker, CFP, FMA, CIM, FCSI
Executive VP
anton@tridelta.ca
(905) 330-7448

Less than half of Canadians will contribute to an RRSP this year

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ted_bnn_23feb15According to a recent poll done by a leading Canadian bank, more than half of us won’t be contributing to an RRSP this year.

BNN invited Ted Rechtshaffen to discuss the findings and share his insights on saving for our retirement.

To better assist you in making effective savings decisions and as importantly how best to invest it, we invite you to connect directly for a no obligation discussion – simply click here and we will have one of our Wealth Advisors connect with you.

We also recently outlined the differences between an RRSP and TFSA (Tax Free Savings Account) contribution.

Other key findings of the bank sponsored poll include:

  • 54 per cent of Canadians indicate that they will not make an RRSP contribution for the 2014 tax year
  • 32 per cent of Canadians intend to contribute
  • 16 per cent have already made their RRSP contribution
  • 16 per cent say they plan to contribute
  • 14 per cent say they are undecided about contributing
Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

Renting during retirement? 10 cases where it might be right for you

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ted_banner
Home ownership is the deeply ingrained Great Canadian Dream. Adding to the dream is retiring as a homeowner without debt. Although that dream is alive and well, and something that most retirees hope for, there can be some very good reasons not to be a homeowner in retirement.

While renting in retirement may not be your goal, perhaps some of these 10 scenarios might get you thinking differently.

  • You can’t afford it. Either you have never been a homeowner because of the high costs, or you were a homeowner but simply needed the liquidity and access to the capital that was tied up in your home. While there are certainly ways to remain a homeowner and access some of the capital, the greatest access to capital is to sell your home.
  • You don’t want to carry debt in retirement. You can make a good case that having debt in retirement is just fine as long as you have home equity that is much larger than the debt. Having said that, it is understandable that many retirees don’t want the worry of debt. Usually the best way to achieve this is to sell real estate and use the capital to pay off debt (often debt still owing on the house).
  • You don’t want the responsibility of maintaining a house. Let it be someone else’s problem. It can be very nice to suddenly realize that the leaking faucet is no longer up to you to fix. It can be even nicer to know that the roof that needs replacing isn’t going to come out of your pocket (at least directly).
  • You don’t want to pay any more realty commissions and land transfer taxes. You may be at a stage of your life where health concerns are either a reality or looming larger. One less home purchase can save you tens of thousands of dollars by eliminating the money that disappears to real estate commissions and land transfer taxes.
  • You don’t want to be trapped in a home you can’t sell quickly. You don’t know how long you will be staying in your home. By renting, you have much greater flexibility to move, and with far fewer worries than if you own your home. This can be an even bigger worry outside of urban centres where it can take many months or even years to sell a home.
  • You want to spend more money while you are healthy enough to enjoy it. With a major amount of money freed up, you may feel more comfortable spending on vacations, cars, boats or other items that you have long dreamed about. Of course, this should be done with a long-term financial plan in place to ensure you can actually afford it. I have found that while many retirees can afford to do all of these things, “realizing” the cash in their homes often gives them the psychological comfort to start spending.
  • retire_rentYou want more diversification in your investments. While most people view their home as more than an investment, it can certainly be looked at as a large and extremely concentrated one. Let’s say someone owns a home worth $700,000, and they have a decent pension from work. They could very well have few other assets in their net worth. Maybe $150,000 in other investment savings. This person’s net worth is over-concentrated in real estate, and not just diversified real estate, but 100% in residential real estate in one location. By selling and investing the funds, they can now be much more diversified across a wide range of industries and types of investments.
  • You want to be able to test out different homes and places. Some people know they want to move to a condo. Some want a backyard garden. Some know the neighbourhood or city or small town they want to live in, some aren’t so sure. By renting you may be able to try out a few options to see which one is the best fit. I am not suggesting that moving is a fun or easy process, but it is a lot easier when you are just renting, as opposed to being an owner.
  • You may be needed out of town. Many retirees are happy to finally have their freedom and some independence from family. Others may want or need to move to be closer to children, grandchildren or increasingly elderly parents. Renting may allow you the freedom to spend significant time with family in other cities, without still being responsible for real estate back home.
  • You are spending less and less time at “home” anyway. Florida, Arizona, the south of France. Some of these places can be quite compelling in retirement. As you spend less and less time in Canada, does it really still make sense to own a home? By renting you may save a lot of money, especially if you are able to rent for only three or four months at a time. The monthly costs will likely be much higher due to the flexibility, but when compared to a full year of rent for a place that you won’t be in for months at a time, the cost savings and flexibility can be of great value.

Reproduced from the National Post newspaper article 27th January 2015.

Ted Rechtshaffen
Written By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

Turn a spouse’s loss into your gain

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Before rebalancing a portfolio for a new client, I make it a habit to confirm the Adjusted Cost Base (ACB) of any holdings in non-registered investment accounts.   In knowing the ACB, I’m able to know the capital gain (or loss) that would be triggered and the associated tax liability (if any) of selling the portfolio.  Now, we don’t want to let the ‘tax tail wag the dog’ so to speak; if the portfolio needs to be changed it needs to be changed.  But if we can save taxes while doing so clients certainly appreciate it!

I recently came across a situation where using a little known strategy, I was able to do just that.  Let’s call these clients Bob & Sue.

Sue is a high income earner (48% marginal tax rate) while Bob earns less and has a marginal tax rate of 20%.  Sue has a non-registered investment account in her name only, with a capital gain position of $30k.  Bob also has a non-registered investment account in his name with a capital loss position of $30k.  The tax liability for the household ‘as is’ would be $4,200 as follows:

Sue:  ($30,000 gain x 50%) x 48% = $7,200 owing.
Bob: ($30,000 loss x 50%) x 20% = $3,000 value of carrying loss forward.

If Sue had capital losses from previous years she could use them to offset her taxable capital gain.  In this instance, she did not.

Bob has a capital loss which he can carry back three years, or carry forward indefinitely to offset gains in other years.  However, being the lower income spouse the loss is less valuable to the household.  This is where the strategy comes in.

Bob sells the securities in his account for $40k (with an ACB of $70k) incurring a capital loss of $30k.  Sue immediately buys the same number of shares of the securities for $40k.  This step triggers the superficial loss rule, which comes into play when a taxpayer sells securities at a loss, and the identical property is acquired by the taxpayer, their spouse, or a corporation controlled by the taxpayer or their spouse within a 61-day period around the sale (30 days before the sale and 30 days afterward).  Under this rule Bob is denied use of the $30k loss, and the amount is added to the cost base of the securities purchased by Sue.

Sue’s cost base has now increased to $70k.  She must hold the securities for at least 30 days, but can sell them any time after that.  If we assume the share prices stay the same during that period, she will be able to declare a loss of $30k on the sale.  This loss can be applied against the capital gains in her account thus eliminating the $4,200 tax liability for the household.

While this wouldn’t apply to too many clients, it is an example of the types of strategy that we at TriDelta try to consider for all clients – wherever it can add value.

Brad Mol
Written By:
Brad Mol, CFP, CIWM, FMA
VP, Wealth Advisor
brad@tridelta.ca
(416) 802-5903
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