TriDelta FinancialArticles

A proven path to higher and stable returns

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December 11, 2018 Anton Tucker

The global equity markets have been very volatile and have understandably rattled investors confidence. The ‘winds of change’ to one of the longest bull markets have arrived and our portfolio safety metrics are being tested.

At TriDelta we set out to construct conservative portfolios designed to deliver in all market cycles for financial peace of mind.

Investors understandably remain nervous as year end approaches and we expect more volatility as concerns over the China trade deal, elevated market valuations and Brexit uncertainty. Other concerns include the inverted yield curve and rising interest rates that may stall any ‘Santa Claus’ rally this year.

At TriDelta Financial we come well prepared and deliver highly diversified portfolios that typically include a significant allocation to Alternative Investments that include global real estate and private debt.

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.

We have long held the view that traditional equity and bond investment portfolios simply do not deliver consistent wealth accumulation. Portfolios require more diversification to ensure uncorrelated, multi-factor protection against downside risk. We manage our clients wealth in the same way pension funds do by strategically building portfolios that include a number of investment types and strategies.

We use stocks, bonds and preferred shares, but also include Alternative Investments such as global real estate, private debt solutions and hedge funds. Alternative investments compliment and add real value to portfolios by:

Provide high income
Diversification to reduce risk
Lowers portfolio volatility
Enhances returns
Protects capital during market weakness

The major pension portfolios are constructed in a very similar way. Here is an Extract from the CPP Investment Board 2018 Annual Report on how they diversify and reduce portfolio risk:

Diversifying sources of return and risk – the Strategic Portfolio

As noted, we manage the Investment Portfolio to closely match its total absolute risk with that of the Reference Portfolio. But that does not mean that we simply hold 85% of the Fund in equities, or even in equity-like exposures. This would be imprudent, as the portfolio’s downside risk would be almost completely dominated by a single risk factor – that of the global public equity markets.

We can, however, build a portfolio with a superior return profile for a similar amount of risk by blending a variety of investments and strategies that fit CPPIB’s comparative advantages. Each of these strategies offers an attractive return-risk tradeoff of its own, and their addition clearly reduces the dependence on public equity markets.

First, we can invest in a higher proportion of bonds and add two major asset classes with stable and growing income: core real estate and infrastructure. By themselves, these lower the risk of the overall portfolio. This risk saving then allows us to add a wide variety of higher return-risk strategies, such as:

Replacing publicly traded companies with privately held ones;
Substituting some government bonds with higher-yielding credits in public and private debt;
Judiciously using leverage in our real estate and infrastructure investments, along with increased investment in development projects;
Increasing participation in selected emerging markets; and
Making significant use of “pure alpha” investment strategies, which rely on the skills and experience of our managers.

CPP Investment Board 2018 Annual Report

To help put the current market turmoil into perspective, here are a few opinions from the large US investment firms:

JPMorgan Chase see the pessimism in equity and high-yield bond markets as overdone, as it sees only a 20% to 30% chance of a recession in 2019, with an increased probability in 2020.

The bank’s strategists, led by John Normand, analyzed equity valuations and credit spreads for high-yield bonds in the period leading up to past economic recessions.

The team continues to favor stocks over corporate bonds in developed markets and takes a neutral view on emerging markets.

“It is right to anchor portfolio strategy in a late-cycle framework that anticipates below-average returns into and through the next recession, but we note it is also excessively pessimistic to price so much downside now as equity and HG credit markets are doing,” the analysts wrote.

Goldman Sachs generally believes the bull market will continue in 2019, but it could get choppier as the year continues and investors begin to worry about a recession in 2020.

Here are some of the investment bank’s predictions for next year:
The S&P 500 will rise 5 percent to 3,000 by year-end 2019 (after closing 2018 at 2,850).
Investors should raise cash.
Investors should be defensive.
The market could be in for big trouble from tariffs.

Bank of America ML believes that “the long bull market cycle of excess stock and bond returns is expected to finally wind down next year, but not before one last hurrah.

Their Research team forecasts 2019 to deliver:
Modest gains in equities.
A weaker US dollar.
Emerging markets are cheap and under owned, they could be a big winner in 2019.
Higher levels of volatility.
A notable slowing in global earnings growth.

Morgan Stanley believes US stocks will underperform and Emerging Market stocks will outperform.

They see a number of macro changes as a result of slowing global growth in US and developed markets, rising rates, higher inflation and tighter policy. They believe these shifts will result in reversals of some key market sectors as follows:
US dollar strength will weaken once the Federal Reserve pauses on rate hikes.
US stocks outperformance will change to underperform.
US and European rates will converge.
Emerging markets have underperformed, but will retake the lead and outperform once China easing starts working.
Value portfolios will start outperforming growth.
Emerging market sovereigns will start outperforming US high yield bonds.

The TriDelta Approach:

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:

Alternative Investments are often restricted only to Accredited Investors (those with family income of $300,000+ or an investment portfolio of $1 million+)
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
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.

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

Real Estate – Is now the right time to downsize?

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TriDelta Financial

By: Vivien Sharon

It was my pleasure to host an exclusive event at Sotheby’s International Realty Canada in Toronto recently.

The subject was: THE BIG QUESTION: IS NOW THE RIGHT TIME TO DOWNSIZE?
Special guests included Ted Rechtshaffen, who discussed income & tax planning for Boomers and Ismail Barmania, a lawyer specializing in estate planning for Boomers. I discussed the real estate choices facing Empty Nesters planning to Downsize.

From a real estate perspective, here are 5 key concerns that Downsizers face:

What to do with all our stuff?
How do we prepare our home for sale?
Where to move to and when should we sell?
Will your next move be by choice or circumstance?
What is our house worth and can we afford to move?

What to do with all our Stuff?

That is one of the biggest concerns. If you are like most people, you’ve accumulated a lot of “stuff” over the course of a lifetime.

Quite often, with the exception of a few family heirlooms, neither adult children nor grandchildren will be interested in these items.

Here are a few ideas that will make the downsizing process easier:

Make a list of your furniture and household possessions. Decide what things you want to take with you to your next home.
What does your family want? The best way to handle any potential disagreements is to have family members work it out themselves.
What to do with valuable items that neither family nor friends want? Depending on the value, an auctioneer may be your best bet. There are auctioneers, appraisers, valuators and other experts who are knowledgeable.
What can I donate? There are many charities that are interested in donated items that can be picked up or dropped off, usually for a tax receipt.
Who can help? Fortunately, there is a network of specialists such as transition specialists, (downsizers), movers, packers, home stagers, decorators, contractors, etc., who can simplify the process.

I understand your concerns first-hand. I downsized myself, 15 years ago from a large North York home to a city condo.

Specialized Real Estate Agents for the Boomer/Senior Market

In the past 20 years the idea of specialization by real estate agents has become very popular. There are agents who only work with Buyers, some only with Sellers. Then there are agents like myself, who have chosen to make Boomers and the Seniors market a speciality. I have specialized training in working with Boomers, Seniors and their families as a Master-ASA (Master-Accredited Senior Agent).

I have been trained in what is important to this demographic and the extra time that is required when contemplating a late-in-life move.

What has changed in real estate?

If you are like most Boomers and Seniors, you haven’t bought or sold real estate in many years. The basics of the business hasn’t changed, it’s still all about helping make your move (or your family’s move) as easy as possible.

Agency Representation

Prior to 1995 in Ontario and 1994 in British Columbia, all real estate agents were representing the interests of Sellers. This was confusing to Buyers, who thought the agent helping them buy a home was working for them, when in fact, they were working for the Seller. Since the mid-90’s, Buyers are typically represented by an agent they have “hired”, so there is no confusion as to whose best interests the agent is protecting. In all jurisdictions of Canada, a real estate professional is required to present you with a written explanation of how representation works, at the beginning of a working relationship.

Different Commission Models

Sellers pay the Commission to the Listing Brokerage (for Sellers) and also to the Co-operating Brokerage (for Buyers) upon closing.

When dealing with such a large investment as your home, which is also a huge nest egg, it would be penny-wise and pound-foolish to base your decision solely on the fee. As with professionals in all areas of life, you really do get what you pay for.

Who Pays Land Transfer Tax?

Buyers of houses and condos pay Land Transfer Tax when they purchase a property. Each province has its own set of rules when it comes to Land Transfer Tax. Sellers never pay. Your lawyer will arrange for land transfer taxes to be paid when the deed to the new home is transferred in your name on closing day. The cost of your land transfer tax is a percentage of your home’s value.

The Paperwork

There is a significant amount of paperwork when you embark on a real estate transaction, whether buying, selling or both. A real estate agent will orient you on all the required paperwork. The forms are standard on a provincial basis, so real estate lawyers will be very familiar with them.

Please contact me if you have any real estate questions or concerns. I am happy to help.

Vivien Sharon, BA, Master-ASA, Seniors Real Estate
Real Estate Broker
Sotheby’s International Realty Canada
vsharon@sothebysrealty.ca

Meditation

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Anton Tucker

I have always been fascinated by the practice of meditation, yet somehow never really adopted the discipline. Not because of time limitations or anything other than not knowing how best to learn the basics and get involved.

I spent some time reading on the subject and for those interested here are a few starting points for the novice, like me:

It seems that a basic framework is necessary or at least very helpful to start the journey of meditation discovery. Meditation means to think, contemplate, devise and ponder, mindfulness. The meditation practice of ‘mindfulness’ and ‘refuge’ are done to support and enable a meaningful life.

What is Mindfulness?

It is the basic human ability to be fully present, aware of where we are and what we’re doing, and not overly reactive or overwhelmed by what’s going on around us.

A Few Things to Know About Mindfulness:

Mindfulness is not obscure or exotic. It’s familiar to us because it’s what we already do, how we already are. It takes many shapes and goes by many names.
Mindfulness is not a special added thing we do. We already have the capacity to be present, and it doesn’t require us to change who we are. But we can cultivate these innate qualities with simple practices that are scientifically demonstrated to benefit ourselves, our loved ones, our friends and neighbors, the people we work with, and the institutions and organizations we take part in
You don’t need to change. Solutions that ask us to change who we are or become something we’re not have failed us over and over again. Mindfulness recognizes and cultivates the best of who we are as human beings.
Mindfulness has the potential to become a transformative social phenomenon. Here’s why:

Anyone can do it. Mindfulness practice cultivates universal human qualities and does not require anyone to change their beliefs. Everyone can benefit and it’s easy to learn.
It’s a way of living. Mindfulness is more than just a practice. It brings awareness and caring into everything we do—and it cuts down needless stress. Even a little makes our lives better.
It’s evidence-based. We don’t have to take mindfulness on faith. Both science and experience demonstrate its positive benefits for our health, happiness, work, and relationships.
It sparks innovation. As we deal with our world’s increasing complexity and uncertainty, mindfulness can lead us to effective, resilient, low-cost responses to seemingly intransigent problems.

-Mindful.org

What is Refuge?

‘Refuge’ means many things including safety, peace, presence, protection, deep relaxation, trust and much more.

The meaning of Refuge becomes deeper and deeper as one proceeds along the Buddhist path and its real depth and magnitude is only known at enlightenment. To put it very simply, to take Refuge is to turn decisively towards the most powerful, sublime, true and meaningful force in the entire universe, seeking its strength, protection and guidance. These will be necessary in order to successfully rid one's mind of confusion and suffering and to attain the peace, wisdom and qualites of enlightenment. This process - of connecting profoundly with the absolute - begins formally with the ceremony of 'Taking Refuge' and is thereafter developed through study and meditation to become a deep inner strength. It is also a commitment to the Buddhist path.

By taking the Refuge ceremony, one becomes a Buddhist. From then on, the inner confidence and support that comes from taking Refuge daily forms a psychological basis for all the work of self-knowledge and transformation of the Buddhist 'path of peace'. Like the foundation of a house, Refuge is the basis upon which all other Buddhist practice is built.

Here are two introductory videos that may get you on the meditation path:

I have included meditation on my 2019 to do list. I encourage you to join me.

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

FINANCIAL FACELIFT: This couple started saving too late for retirement and now face some tough choices

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November 19, 2018 Matthew Ardrey

Below you will find a real life case study of a couple who are looking for financial advice on how best to arrange their financial affairs. Their names and details 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.

Written by: DIANNE MALEY
Special to The Globe and Mail
Published November 16, 2018

Sometimes, it seems you can work hard all your life and end up with less than you hoped for in your middle years.

That’s what happened to Evelyn and Rocky, who have had to help out parents and children alike over the years. He is 66, she is 54.

Their consulting business nets about $12,500 a month after taxes and business expenses, although their commission-based earnings are lumpy.

“We started late,” Rocky writes in an e-mail. “Nineteen years ago, we both came out of previous marriages with no assets to speak of other than a seven-year-old car.” Last spring, the family-related financial pressures eased and Evelyn and Rocky began saving aggressively for retirement, which for Evelyn can’t come soon enough. They hope to retire from work with $6,500 a month after tax.

They plan to sell their Toronto house, pay off the mortgage and move to a condo townhouse in St. Catharines, Ont., investing whatever is left. They’d continue to spend winters in their Florida condo. For extra income, they want to buy an investment property in the United States.

“How can we improve what we are doing?” Rocky asks.

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

What the expert says

First, Mr. Ardrey looks at whether the couple’s plan is viable.

They sell their Toronto home next spring for $675,000, net of selling costs, and buy a townhouse in St. Catharines for $325,000. They pay off their existing mortgage and use the balance to max out their registered retirement savings plans and tax-free savings accounts.

Evelyn would retire from work at the end of 2019 and their cost of living would rise by 2 per cent a year on average.

“Once Evelyn retires, they will be able to sell their business for an estimated payment of $100,000 per year over two years,” Mr. Ardrey says. This will be split equally between them. He assumes Rocky keeps working part time, earning $3,000 a month after taxes and expenses.

Rocky is already receiving Old Age Security benefits of $465 a month, reduced because he has been in Canada only since 1991. He will also get reduced Canada Pension Plan benefits, which he has opted to take at age 70. Evelyn will begin collecting CPP and OAS benefits at age 65.

For 2018, they have saved $11,630 to their RRSPs and $41,386 to their TFSAs. In addition they have saved about $39,000 for a down payment on a U.S. rental property.

A review of their investment portfolio – mainly mutual funds – shows a historical return of 4.28 per cent with investment costs of almost two percentage points. “With inflation assumed at 2 per cent, this leaves very little available for a real rate return,” Mr. Ardrey says.

To boost their income, Rocky and Evelyn plan to buy an investment property for US$120,000 that would generate about US$250 a month net of expenses.

Will their plan work?

“Based on these assumptions, Evelyn and Rocky fall way short of their retirement goal,” the planner says. They would run out of savings by 2031, when Evelyn is only 67. To make the plan work, they would need to reduce their target spending by 35 per cent to $4,250 after tax a month.

“There is no magic bullet for retirement planning. You have to retire later, save more, spend less or improve returns.” In Rocky and Evelyn’s situation, it is a combination of these four factors.

Even if they retire at the end of 2022 when Rocky is 70 and Evelyn is 58, they will run out of savings by 2045, when Evelyn is age 81, Mr. Ardrey says. Alternatively, they would have to reduce their spending by about 25 per cent to $5,000 a month.

To meet their goals, Rocky and Evelyn will have to make several changes. First, they need to improve their investment returns.

After they sell their house next spring, they will have enough money to hire an independent investment counsellor with a view to improving returns and lowering costs.

Mr. Ardrey suggests their new investment strategy include alternative assets, such as private debt, global real estate and accounts receivable factoring.

“This should increase their return to 6.5 per cent while reducing their investment costs to 1.5 per cent.”

(Many investment counsellors keep a list of alternative strategies – alternatives to stocks and bonds – that the firm has vetted and considers suitable for its clients. Investors whose income may not be high enough to buy directly from an alternative asset manager can buy these securities if they are working with a portfolio manager or investment counsellor.)

As for the U.S. investment property, Evelyn and Rocky should forget about it and direct the money instead to their investment portfolio, Mr. Ardrey says. At some point, they may also need to consider selling their Florida condo.

Client situation

The people: Rocky, 66, and Evelyn, 54

The problem: Can they afford for Evelyn to retire soon and still meet their spending goal? Should they buy a U.S. investment property?

The plan: Take steps to improve investment returns. Forget about the U.S. rental property. Consider working longer or lowering spending target.

The payoff: A more workable plan.

Monthly net income: $12,500

Assets: Cash $4,300; savings account $39,000; his TFSA $37,600; her TFSA $24,360; his RRSP $66,300; her RRSP $64,700; residence $675,000; Florida condo $175,500. Total: $1.09-million

Monthly outlays: Mortgage $1,275; property tax $350; home insurance $135; utilities $345; Florida condo fees $295; maintenance $50; transportation $620; groceries $900; clothing $40; charity $40; vacation, travel $460; dining, drinks, entertainment $260; personal care $50; pets $255; subscriptions, other $40; doctors, dentists $100; drugstore $50; health, dental insurance $355; life insurance $670; phones, TV, internet $365. Total: $6,655. Surplus $5,845 goes to TFSAs, other savings.

Liabilities: Mortgage $133,000

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

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

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

FINANCIAL FACELIFT: Can an uncertain investment help this 60-year-old retire early?

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October 22, 2018 Matthew Ardrey

Below you will find a real life case study of a woman who is looking for financial advice on how best to arrange her financial affairs. Her name and details have been changed to protect her identity. 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.

Written by: DIANNE MALEY
Special to The Globe and Mail
Published October 19, 2018

Turning 60 got Sylvia thinking about a time when she will no longer have to work for a living – and hoping it will come soon.

She earns $75,000 a year in a middle-management job and is single with no dependants. Her postwork income will come from her savings and investments, including from the Saskatchewan Pension Plan, a defined-contribution pension plan open to all Canadians. She also has an annuity that she took instead of a cash payout when a previous work pension plan was wound up.

The wild card in her retirement plan is her equity interest in a private corporation. The investment has paid well, yielding her $15,000 a year in dividends over the past five years, but this is not assured. The future value of the shares is uncertain because they are not readily marketable.

“Basically, I have no control over this investment, but it has turned out to be an excellent investment for me even if I never get another penny from it,” Sylvia writes in an e-mail.

She wonders whether she can retire from work early, whether her investments will generate her target income of $45,000 a year after-tax and when she should start drawing government benefits.

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

What the expert says

Sylvia has almost $750,000 in investments saved to date, Mr. Ardrey says. Of that, $200,000, or 26.67 per cent, comprises shares in a private corporation. “In Sylvia’s estimation, they could be worth more than this, less or nothing at all,” the planner says. “This is a potentially significant risk to her retirement plans.”

Sylvia contributes $6,000 a year to a defined-contribution pension plan, $8,400 to her registered retirement savings plan and $5,500 to her tax-free savings account. She has a cash surplus of about $7,000 a year, including her RRSP refund.

Sylvia plans to work part time for another few years after she retires, earning about $3,000 a year. Her annuity will pay her $6,036 a year starting at 65. In drawing up his plan, Mr. Ardrey assumes Sylvia retires at 62 and begins taking Canada Pension Plan and Old Age Security benefits at 65.

Sylvia plans on spending $45,000 a year, plus another $3,000 a year for travel until she reaches 80. She will need a new car before long at a cost of $22,000. “All expenses are indexed to inflation, which we assume is 2 per cent a year.”

Looking at her portfolio, Sylvia has slightly more than 25 per cent of her investments in cash and guaranteed investment certificates. “This is placing a significant drag on her portfolio performance,” the planner says. She has an average net return on her investments of 4.1 per cent a year.

Still, if she is able to realize the $200,000 value on her private shares, Sylvia will reach her retirement spending goal and be able to retire at 62, Mr. Ardrey says. With a 4.1-per-cent rate of return, she would have a cushion of $6,000 a year over and above her target of $45,000.

“My concern with her plan is it all is riding on the private shares being worth what she hopes they are worth,” Mr. Ardrey says. “If they fall to 50 per cent of her expected value, all of her spending cushion will be eliminated,” he adds. “If they end up being worthless, then she will fall short of her goal, running out of investment assets by her age 80.” She would still have her CPP and OAS, her annuity income and her home.

“Sylvia should be looking for a strategy to divest herself of the private shares,” Mr. Ardrey concludes.

Sylvia’s asset mix is 27 per cent private shares, 25 per cent cash equivalents, 30 per cent Canadian equities, 8 per cent bonds and 10 per cent U.S. and international equity, held in various accounts. Excluding the private shares from the total, her asset mix becomes 34 per cent cash equivalents, 41 per cent Canadian equities, 11 per cent bonds and 14 per cent U.S. and international equity.

“If we improve Sylvia’s investment strategy across all her accounts to 50 per cent geographically diversified equities, 25 per cent fixed income and 25 per cent alternative investments – strategies such as private debt, global real estate and accounts receivable factoring – she should be able to achieve a conservative net return of 5 per cent,” Mr. Ardrey says.

This would improve her returns (because alternative investments tend to yield more than her fixed-income holdings), and lower her equity risk because the alternative investments tend not to move in lockstep with the stock market.

If, instead of getting her current 4.1-per-cent return on investments, Sylvia could achieve that 5-per-cent rate of return, she would meet her retirement spending goal, though without a cushion for extra spending. “This is a vast improvement over running out of investment assets at age 80.” If the private shares can be sold for $200,000, and she earns 5 per cent on her investments, then she would have a spending cushion of $12,000 a year, over and above the $45,000 target.

Client situation

The person: Sylvia, 60

The problem: Is she on track to retire before 65 with $45,000 a year?

The plan: Rejig portfolio for greater diversification with a target return of 5 per cent a year. Explore ways to sell the shares in the private company.

The payoff: If all goes well, not having to keep her nose to the grindstone until she is 65.

Monthly net income: $4,535

Assets: Bank accounts and GICs $78,000; potential value of shares in private corporation $200,000; TFSA $69,000; defined-contribution pension plan $141,105; other RRSP accounts $256,915 (of which $112,395 is cash and cash equivalents); residence $250,000; present value of non-indexed annuity $85,070. Total: $1.08-million

Monthly outlays: Property tax $145; home insurance $40; utilities $240; maintenance, garden $100; transportation $285; grocery store $500; clothing $100; gifts, charity $200; vacation, travel $250; dining, drinks, entertainment $320; personal care $40; pets $75; sports, hobbies, subscriptions $100; health care $150; phones, TV, internet $180; DC pension plan $500; other RRSPs $700; TFSA $460. Total: $4,385 Surplus goes to savings.

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.

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

Q3 TriDelta Investment Review – TriDelta is Expanding, but What About the Market?

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October 16, 2018 Tridelta Investment Counsel

Overview

We wanted to kick off the fourth quarter with some TriDelta news, by announcing the opening of TriDelta’s Edmonton office.

The office is led by Arlene Pelley, an industry veteran who is joining the firm and planting the TriDelta flag in Western Canada. Click here to learn more about Arlene’s background.

Turning from TriDelta growth to the markets, we see reason for some caution after a meaningful pullback to start October and negative returns for most equity and fixed income indices in September. Through this period, we have been holding higher levels of cash at approximately 10%-15% in the equity funds, and while we see more short term volatility this month, we will be lowering our cash position shortly as the pullback is bringing with it lower valuations and opportunities to buy good companies at cheaper prices.

What is causing the pullback and what are we doing about it

Looking at things from a purely 2018 point of view, the recent pullback has been caused by:

Rising interest rates – which lead to higher borrowing costs for companies, and higher returns on lower risk investment alternatives like GICs (although they remain low historically)
U.S.-China Trade Wars (and broader trade conflicts globally)
Fears of higher inflation
High US stock market valuations and difficulty in companies beating high earnings expectations

Of interest, the reason it is so hard to predict the exact timing of a pullback is that the factors listed above are not new. Interestingly, on the trade front, the signing of the new NAFTA deal (USMCA) should have somewhat lowered trade concerns in Canada, US and Mexico, but all of those equity markets are down since September 30. These have all been issues of concern for many months, yet for some reason early October has been the time for a meaningful pullback. It is worth noting that in a typical calendar year, equity markets experience at least two drops of 5% and one drop of 10%+, yet in the vast majority of cases, equity markets still return highly positive returns year over year.

Looking at things beyond 2018 and from more of a long term seasonal perspective, the timing of the pullback and heightened volatility is not unexpected. Also from this same seasonal perspective, the weeks ahead may bring solid investment returns.

The chart below is the VIX index, which looks at volatility in the U.S. markets. The chart shows that over the past 27 years, volatility has definitely peaked in October. Studies of the S&P/TSX in Canada have demonstrated similar high volatility levels in October.

Source: www.cboe.com/products/vix-index-volatility/vix-options-and-futures/vix-index

Of interest, high volatility does not necessarily translate into poor overall returns. In fact, for the S&P500 index in the U.S., since 1950, October has had an average monthly return of +0.78%. Historically, the two best months of the year are November +1.39% and December +1.53%. Over the past twenty years, the TSX has had the following returns over the same three months: 0.7%, 0.9% and 1.8%.

The chart below comes from equityclock.com. It looks at the TSX over the past 20 years from a seasonality perspective, meaning, when is the most and least productive times of the year to invest. Of interest, it suggests that one of the best times for new investment is around mid-October.

From a purely seasonal standpoint, it suggests that it is worth hanging on through the October volatility as there is often a strong payoff during the fourth quarter.

In addition, in both Canada and the U.S., the third quarter has historically been the worst quarter for returns while the fourth quarter has been the best.

Interest rates: one of the most talked about concerns for the stock market is the fear of rising interest rates. Over the past 30 years, there have been six periods of meaningfully rising bond yields as measured by the U.S. 10 year Treasury yield. During those periods of rising rates, the stock market actually performed very well – as the following two charts from a study for CNBC show.

The market rose big during five of those instances and only fell slightly during the one lagging period.

As the chart above shows, the S&P 500 rallied 23 percent on average in those time periods and the Dow Jones Index was up in all six periods.

The message is that rising bond yields often do not correlate directly with declines in stock market returns. It also should be noted that bond yields in the past week have been flat to declining.

When we factor in the reasons for the pullback, our expectations on earnings growth (which remain reasonably good), the history of similar pullbacks and seasonality effects, we think there are more reasons for optimism than pessimism.

In terms of TriDelta’s direction from here, we have been a little cautious on stock markets but we are feeling a little more comfortable in deploying more capital following the early to mid-October declines. We have reduced our weighting in non-North American and Emerging Market stocks in our Pension fund, and will be using some of that cash to soon add to Canadian and to a lesser extent, U.S. names.

We have been adding some money to Preferred Shares. There are many good quality preferred share issuers yielding over 5% in tax preferred income. In some cases, we even see the potential for some small capital gains opportunities to add to the 5%+ yields.

In the bond market, we have been adding to some names in the “belly of the curve”, the 5 year to 10 year maturity range. We have added recently-issued bonds from BMO and TD maturing in five and ten years respectively and currently paying in the mid-3% range. We also added a bond from first-time issuer Sysco Canada (a U.S. based food services company), with a seven-year maturity, paying 3.7%.

One of our beliefs is that there is a real possibility that the projected interest rate hikes from the Bank of Canada may not fully play out. The market is currently anticipating approximately four interest rate hikes by the Bank of Canada over the next 12 months. While we do expect a hike at the end of this month, we think additional hikes are less certain due to slowing housing activity and moderating inflation pressures. As a result, we are seeing some signs to be a little more bullish on bonds for the first time in a while.

In terms of currency, it was informative to see that the Canadian dollar climbed for only a very brief time and a relatively small amount upon the approval of the USMCA (or NAFTA for those of us who are resistant to change). We are fairly neutral on the dollar at this point, but would look to be more exposed to the Canadian dollar (i.e. sell some US$ back to CDN$) if we see our dollar get down under 76 cents.

How Did TriDelta do?

Overall, most clients had returns in the 0% to 1% range on the quarter, with more growth oriented clients having a weaker quarter based on the Growth fund’s negative return.
Looking specifically at the third quarter of 2018:

TriDelta Pension Pool	1.8%
TriDelta Growth Pool	-1.8%
TriDelta Fixed Income Pool	-0.4%
TriDelta High Income Balanced Pool	-0.2%
Most Alternative Investments	1.7% to 2.1%

By comparison almost every equity and fixed income market outside of U.S. stock markets had a weak quarter – especially in Canadian dollar terms.

The TSX was down 1.3%.
Euro Stoxx was down 2.1% in Canadian dollars.
The UK Based FTSE was down 4.4% in Canadian dollars.
Hong Kong based Hang Seng was down 5.0% in Canadian dollars.
The Canadian Bond Universe was down 1.3%.
On the other end, the U.S. S&P500 was up over 5% in Canadian dollar terms.
The Canadian Preferred Share index was up 1.5%

These numbers do speak to the value of a portfolio that is diversified globally and by asset class. At TriDelta we talk a great deal about lowering volatility, and the third quarter of 2018 was a good example. While most of our clients were flat to slightly up on the quarter, the major individual stock markets saw returns ranging from up 5% to down 5%. By limiting the downside, we are better able to maintain our long term investment focus, and reduce the temptations to change course after markets decline.
Even with a fairly flat last quarter, most TriDelta clients are up around 5% over the past 12 months to the end of September.

Summary

By planning long term and adjusting a well-positioned investment mix a little along the way, we can avoid the pull towards major changes when people are most nervous. There is a lot of reason to believe that there are some good returns ahead between now and February, and you don’t want to miss them. This doesn’t mean that all is fine in the world and things will only go straight up. What it means is that your investment portfolios already have some pretty good shock absorbers. This should help you to avoid getting too aggressive in good times and too nervous in bad times.

We hope that you get to enjoy some spectacular fall foliage whether in Ontario, Alberta or other parts of the country, and we thank you for your continued trust.

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Ted Rechtshaffen

President and CEO

Anton Tucker

Exec VP and Portfolio Manager

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor