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Q4 TriDelta Investment Review – Out with the old and in with the new

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Overview

Out with the old and in with the new
Q4 and in particular December, was a period to forget from an investment perspective.

An example of the damage includes the following quarterly returns in their home currency:

S&P 500 (US) -14.6%
TSX (Canada) -11.1%
Euro Stoxx 50 -11.7%
China Stocks -12.1%
Japan Stocks -16.4%
Oil Prices -40.0%
CDN Preferred Shares -11.6%

Fortunately, TriDelta clients were cushioned somewhat from the damage by three main factors:

  1. A diversified portfolio that is not close to 100% in stocks.
  2. Exposure to our select group of Alternative Investments that were mostly up in the range of 1% to 2.5% on the quarter.
  3. The Canadian dollar decline helped to boost the return of foreign investments.

Most TriDelta clients ended the quarter down in the range of 3% to 5% depending on their exposure to stocks and overall asset mix.

What do we see in 2019 and why

As mentioned last quarter, 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
  • Declining earnings growth in the U.S. following the one time benefit of a new lower tax policy.

We are now fairly positive on stocks for the short term – and the rationale goes back to the four points above.

  1. We see interest rates in a stable range in 2019 with few if any rate hikes. While this is somewhat a comment on the general economy, we believe that stock markets will mostly react positively to news of slow to no rate hikes.
  2. While the U.S.- China Trade war is the hardest to predict for a variety of reasons, we do believe that there is a good chance of a “deal” taking place in the next few months and the stock market reacting positively on a global basis. The Chinese stock market fell 24% in 2018. U.S. markets were negative. Both countries are looking for a way to show investment growth in 2019 and the one area they can control is the negotiations and substantive agreements.
  3. As Oil prices fell 40% in the quarter, this has had a meaningful impact on inflation. Central banks in Canada and the U.S. like to keep inflation in the 2% range. Canadian inflation dropped to 1.7% in November, and U.S. inflation rate was at 2.2%. These rates ease some fears of higher inflation.
  4. The 20 year average of stock market valuations in the U.S. as measured by price/earnings, is 15.8. On December 31st it stood at 14.4 times earnings, almost 10% below its average. The TSX has a forward price earnings ratio of only 13 times earnings, compared to its 10 year average of closer to 15 times earnings. For the first time in several years, stock markets are ‘undervalued’ with Europe, Japan and Emerging Markets trading at even lower multiples.

The last reason that we are more positive about stocks is captured in the chart below. The chart looks at the S&P500 since 1940, focused on the seven worst quarters it has experienced. It then looks at the market performance in the one year, three year and five year periods after that terrible quarter.

Most investors would have been happy with the one year return in six of those seven scenarios, and happy with seven of seven scenarios for three year and five year returns.

Essentially, the stock market tends to go up in the long term. When it has a particularly bad period, it tends to bounce back, based in part on simply catching up to fair value.

Our positive outlook is not blind to some of the prevailing risks, which include:

  • higher U.S. borrowing costs
  • increasingly high debt levels (both government and consumer)
  • political gridlock
  • unwinding of previous stimulus

Nevertheless, we are looking to see decent stock market growth in 2019.

Our fearless predictions for 2019:
  1. Better than average stock market returns in most major markets including Canada and the U.S., barring a breakdown on global trade.
  2. Interest rates being mostly flat with maybe one ¼% increase in both Canada and the U.S with a real possibility of an interest rate decline in Canada before the year is out.
  3. The Canadian dollar being fairly flat vs. USD, but being tied more to oil than we have seen in the recent past.
  4. Oil prices rising, but only slowly.
  5. Preferred Shares having a strong year, bouncing back from their late year steep declines.
  6. Marijuana stocks will see a general decline overall as high valuations and uncertain revenues work their way through, but with increasing gaps between the winners and losers. In fact, we expect to see several bankruptcies in 2019 among the weak players in the market, and at least one major blow up of a more established firm (we just don’t know which one).
  7. Corporate bonds outperforming Government bonds.

Based on these short term beliefs, we have reduced our cash weightings in our stock funds down to essentially fully invested in both our Pension and Growth funds.

In the Growth fund, which is more active in terms of adjusting industries, we will be adding to Energy and Industrials, while reducing Telecoms and Utilities.

In the Fixed Income world we are looking to add some High Yield Debt and Preferred Shares to the fund.

How Did TriDelta do in 2018?

Overall, most clients had returns in the 0% to -5% range on the year depending on their individual asset mix. Given the major stock market declines, most of our clients did much better than the average Canadian investor for the year.

Our 2018 returns were as follows:

TriDelta Pension Pool (Stocks) -2.2%
TriDelta Growth Pool (Stocks) -8.1%
TriDelta Fixed Income Pool -2.2%
TriDelta High Income Balanced Pool -1.9%
Most Alternative Investments +5.2% to +10.5%
Other news and items of interest
  1. The 2019 Edition of our TriDelta Retirement Income Guide has just been released. It contains a wide range of tips and information on the different sources of retirement income, and how best to draw that income. Ask a TriDelta Wealth Advisor for a copy.
  2. A reminder that now is a great time to top up TFSA’s. They have added $6,000 per person to contribution room in 2019. If you have the funds, January is also a good time to do 2019 contributions to RRSPs, RESPs and RDSPs, as appropriate, as it will help you to have tax sheltering for a full year.
  3. U.S. consumer debt payments as a percentage of disposable income were 9.9% in 2018. That is the lowest rate in over 30 years.
  4. For a 65 year old couple (male and female), there is a 22% chance that a male will reach age 90, a 33% chance that a female will live to age 90, and a 48% chance that at least one person in the couple will live to at least age 90, so investors need to plan for the long term.
  5. According to studies by the U.S. research firm Dalbar, in the 20 year period from 1998 to 2017, the S&P 500 averaged a 7.2% annual return, the U.S. bond market averaged a 5.0% return, yet the average U.S. investor only averaged a 2.6% annualized return. The reason for this underperformance is primarily attributable to too much trading and shifting of portfolios, particularly moving away from risk after stock markets have declined, and too heavily to stocks when markets are peaking.
Summary

As long term investors know, down markets eventually recover and great markets don’t last forever. Right now we believe that we are in the ‘down markets recover’ stage and are acting accordingly.

In the very short term, anything can happen (all it takes is one Tweet). Having said that, most stock markets historically go up 7 years out of 10, and are more likely to go up in the year after having declined. Even for our older clients, there is usually lots of time to recover. There is an old adage that says “Investing is about time in the market, not market timing.”

At TriDelta we will continue to be nimble while focusing on the long-term plan. This would include a steady and diversified asset mix that is built appropriately for the goals of each client, and an eye on tax minimization.

Here is to a better investment year in 2019.

 

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

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

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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

Q2 TriDelta Investment Review – Global Trade: Long Term Problems or Short Term Worries

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OVERVIEW

As we languish in summer heat, we feel anguish in summer Tweets.

If there has ever been a larger global megaphone than President Trump’s Twitter account, we don’t know what it is. While we try our best to ignore most of it in order to prevent overreactions when it comes to investing, the prospect of a major shift in U.S. global trade policy could have major investment implications.

In this report we will look at the risks but focus on why we believe the heightened trade tensions are temporary and not a long term structural change to the markets. We believe that NAFTA will get resolved with some notable wins for the United States, and most other ‘trade wars’ will settle down without significant changes.

We also review how TriDelta did and what we see going forward.

Global Trade – Where it is headed and who will be the winners and losers

Changes to the global trade order may start with President Trump, but the facts on trade will determine how it all ends.

Our views on what will happen to global trade are based on two key items. The first is the facts on trade; who the U.S. trades with, the respective trade balance with each of these countries and how reliant they are on one another for trade. Secondly, we look at how reliant each country is on the United States.
The second focus helps to truly understand President Trump’s end goals and negotiation strategies. So let’s review.

The United States has five major trading partners. The EU, China, Canada, Mexico, and Japan. These five partners represent 69% of all US foreign trade, and 86% of the U.S. trade deficit.

From the list below you can see the high level details.

US Trade in 2017 – Top 5 Trading Partners (according to the International Trade Administration) in USD millions.

Rank Country/District Exports Imports Total Trade Trade Balance
World 1,546,273 2,341,963 3,888,236 -795,690
1 European Union 283,269 434,633 717,902 -151,363
2 China 129,894 505,470 635,364 -375,576
3 Canada 282,265 299,319 581,584 -17,054
4 Mexico 243,314 314,267 557,581 -70,953
5 Japan 67,605 136,481 204,086 -68,876

When it comes to Donald Trump’s approach, he wrote about his 11 winning negotiation tactics in his 1987 book The Art of the Deal.

His first one was:
Think big

“I like thinking big. I always have. To me it’s very simple: if you’re going to be thinking anyway, you might as well think big.”

He has said consistently that he believes that the U.S. has been taken advantage of on trade and that he will put a stop to that. If he is going to do that he will focus on his biggest trading partners and he will start by asking for everything.

Another key item on Trump’s list is pretty common for most negotiations. He wants to find points of leverage and during negotiations to act as cool as possible – showing no interest or worry about resolving matters.

Use your leverage

“The worst thing you can possibly do in a deal is seem desperate to make it. That makes the other guy smell blood, and then you’re dead.”

If the U.S. wants leverage from its trading partners, the two easiest countries on the top 5 list would be Mexico and Canada. For Mexico, 81.0% of its exports go to the U.S.. For Canada, the number is 76.4%. Mexico and Canada need the U.S. in a big way.

On the flip side, the percentage of U.S. exports going to Canada is 18% and it is 16% for Mexico.

Percentage of a countries exports that go to the United States:

Mexico 81.0%
Canada 76.4%
Japan 20.2%
China 18.2%
India 16.0%

Another of Trump’s tactics is:
Get the word out

“One thing I’ve learned about the press is that they’re always hungry for a good story, and the more sensational the better…The point is that if you are a little different, a little outrageous, or if you do things that are bold or controversial, the press is going to write about you.”
Clearly, Trump can use the media to get his side of the story out in a loud and large way. For us it remains important not to put too much stock in individual comments that Trump makes when it comes to trade issues. He will say anything to keep the focus on him and his issues.

Fight back

“In most cases I’m very easy to get along with. I’m very good to people who are good to me. But when people treat me badly or unfairly or try to take advantage of me, my general attitude, all my life, has been to fight back very hard.”
This can certainly explain his reaction to Trudeau and others. It is par for the course with Trump, and while the personal attacks are unseemly, they are not likely to lead anywhere as long as there is real negotiation leverage to fall back on.

This now brings us to China. For China, the U.S. is its largest trading partner, and represents 18% of exports and 9% of imports, but as you can see from these numbers, the Chinese economy is fairly diverse and not overly reliant on the U.S. In fact, 80% of China’s GDP is from domestic consumption. Purely based on the numbers, the United States doesn’t have nearly as much leverage with China as it has with Canada and Mexico. To top it off, China is the largest foreign holder of U.S. debt at over $1.5 trillion. Needless to say, the United States needs to be careful in its negotiations with China.

Basically, we see NAFTA as something that will end up being resolved, likely with some clear wins for the United States. The threats, loud complaints, and the personal attacks do not worry us. They are all on the Trump negotiating tactic list. If we had to guess, one potential loser from a NAFTA agreement will be the Dairy Industry in Canada as it has been the centerpiece of many Trump attacks and one that he will most want to raise as a sign of victory. Keep in mind that many Canadians themselves criticize the structure, high costs and unfairness of the Canadian dairy industry.

At the end of the day, Canada and Mexico are negotiating from a point of weakness and ultimately may give more than they want in order to get a deal done. But it should be noted that despite no tax cuts in Canada and with the uncertainty of trade, Canadian GDP growth is expected to be quite strong in the second half of the year.

When it comes to China and trade imbalances, the United States simply does not have the leverage to win this trade war. Where Canada and Mexico need the U.S. more than the other way around, that simply isn’t the case with China. If only 20% of China’s GDP are exports, and the U.S. is 18% of its exports, that means the U.S. market represents only 3.6% of China’s GDP. Because he holds the loudest megaphone, Trump can still claim victories along the way, but when it comes to China, the U.S. is fighting a battle that they won’t win. The one exception is in technology and intellectual property as is evidenced by the action against Chinese giant Tencent. China is reliant on US technology, particularly semiconductors, to fuel its growth and this is an area where concessions can be earned.

We think their discussions with the EU may be a little more productive, but will most likely end up closer to status quo than see any major wins for either side.

This leads to one of Trumps final negotiation tactics:
Maximize the options

“I never get too attached to one deal or one approach. I keep a lot of balls in the air, because most deals fall out, no matter how promising they seem at first.”
This tells us that while Trump may go after every big region to try and negotiate a better deal, he recognizes that he won’t win them all. From an investment risk perspective, it means that we should be less worried about Trump fighting five different trade wars at once. Once he has a big win he can ‘Trump-et’, the others may fade.

TriDelta’s View of the Risk of Global Trade Wars

In summary, we believe that NAFTA will get resolved and Trump will claim a big trade victory, but it should only negatively impact a few select sectors. He can use this as proof that he is a good negotiator and that he is winning points for America. This may take pressure off of him on other global trade deals that the U.S. can’t win to any great extent.

While trade tensions may cause turmoil, we do not believe it will bring on impending market doom.

How Did TriDelta do in Q2 and over the first half of the year?

The TriDelta Growth Fund has had a strong run. It was up 3.0% in Q2 and up 5.6% over the first six months of 2018.

The TriDelta Pension Fund which focuses on dividend growing stocks and is a lower volatility fund, has seen slower growth after a couple of very good years. It was up 2.2% in Q2 and up 2.8% over the first six months.
The TriDelta Fixed Income Fund was up 0.4% in Q2 and 1.1% in the first six months.

The TriDelta High Income Balanced Fund was up 3.2% in Q2 and 3.3% in the first six months of the year.

Overall most clients are up between 1.5% and 4% year to date depending on their asset mix.

By comparison, the TSX was up 1.9% in the first half of the year, the Canadian Bond Universe was up 0.6% year to date to June 30th, while the S&P 500 in Canadian dollars was up 7.7%. Global equities outside of the U.S. have been mostly negative this year.

We continue to be pleased with how our portfolios have been able to smooth out much of the market volatility that we have seen over the past 6 months. Most clients experienced losses of less than 1% in February when the S&P500 experienced a short term loss of 13%. At TriDelta, the more we can avoid those declines in the first place, it makes it easier to stick to and achieve the long term plans. By reducing volatility, stress is reduced, and more rational investment decisions can be made.

Central Banks, Interest Rates and Bond Markets

Central Banks

Bank of Canada governor Stephen Poloz, with his extensive background in trade-related issues and global trade contacts from his prior post at the Export Development Corporation, is perhaps best suited of all the embroiled nations’ bankers to assess what the escalating trade war with United States means. The announced tariffs on metals and other goods between the two nations implies that consumer prices are set to rise in the coming months. As the anticipated “loser” in any trade battle with the US, the very real prospect of a weaker Canadian dollar could also be the source of further inflationary pressure as buying foreign goods becomes relatively more expensive. Typically, a central bank will raise interest rates to keep inflation at a comfortable level. In the past, however, the Bank of Canada has recognized that certain types of inflation are not responsive to adjustments in its overnight rate and is likely to regard tariff- and currency-related price increases as a one-time “supply shock”. Furthermore, as a relatively small and open economy that derives 25 percent of its economic activity from exports to the U.S., Poloz must also contemplate a downgrade to near-term growth estimates and be less likely to raise rates at the margin as a result.

The conundrum faced by the U.S. Federal Reserve is somewhat more complicated. With unemployment at a 20 year low, the economy expanding at a nearly four percent annualized rate in the current quarter, more fiscal tailwinds on the way and some inflation measures already at the high end of its comfort zone, the Fed has signaled its intention to continue to gradually raise interest rates.

Although the Congress is divided on the evolving tariff policy, it has shown a proclivity to tax cuts and spending and could opt for more of the same to cushion any economic drag – particularly as they are a few months away from what promises to be a hotly-contested mid-term federal election.

Bond Market Response

Understandably, risk appetite in fixed income markets diminished as the second quarter drew to a close. Nevertheless, corporate bonds in North America managed to approximately return their running yield (meaning little change on bond prices). Government bonds themselves, after a mid-quarter test of the three percent yield level on US government ten-year bonds, retraced their path to settle down slightly for the quarter. We anticipate some more volatility while the trade representatives work begrudgingly towards compromises that are politically palatable in their respective countries. Risks to that view include a meaningful increase in inflation expectations amongst US consumers, which might prompt the Federal Reserve to raise rates more aggressively. There is also the potential for China state-owned entities to sell US treasury bonds in large quantities as a means of retaliating against tariff action and defending its own currency, which has come under pressure in recent weeks.

Stock Markets

In the stock markets, given our belief that heightened trade tensions are temporary and not a long term structural change to the markets, we believe that there will likely be some relief rallies as trade news improves.

Despite this view, we stand ready to react if things do continue to escalate. We would increase cash and sell calls into higher volatility in order to generate income. This speaks to good investment management in general. You develop a core thesis and manage to that expectation, however, you always acknowledge that things change and you need to be ready to quickly change your investment approach as the facts come in.

As far as individual names or sectors are concerned, TriDelta has a disciplined process that starts with equity screens that focus on selecting companies with attributes that outperform over time. The increase in tariffs can artificially impact earnings (positive or negative). As a result, when we look at key factors such as earnings estimate changes, growth in earnings and earnings based valuation metrics, more scrutiny is needed when evaluating a company to determine if recent increases or decreases in these key variables are affected by the addition or removal of tariffs.

These are the key items and thinking that is keeping us busy on the investment management front.

SUMMARY

The biggest megaphone doesn’t mean the most important news. Today, global trade wars and threats are the loudest stories, yet by studying the situation a little deeper, we believe that we can be a step ahead of these issues as they develop.

We hope that you have a great rest of the summer, 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

Q4 TriDelta Investment Review – From Great to OK – Moving from 2017 to 2018

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2017 – the year without a stock market correction

The Ebola Virus, Greek Crisis, Debt Ceiling, Refugee Crisis, Global Warming, Brexit, Trump, North Korea…there is always something scary for the media to report and make us nervous. Usually, these headlines frighten investment markets. For some reason, 2017 didn’t see this. In many major markets, there was not one decline of 5% during the year, and outside of Canada’s 6% stock market growth (which was among the weakest in the World), most stock markets saw returns well in excess of 12%.

Like a sports team that makes it through a season with no major injuries, 2017 was one of those years. To count on that happening again is to bet against history. The question isn’t so much what will cause greater volatility, as much as when. The next question is whether we should really fear volatility, especially if markets end up alright in the end?

How Did TriDelta do in 2017?

While those holding individual stocks and bonds would see bigger differences in portfolio returns, our TriDelta funds provide a good overall picture of our investment performance. These returns are before fees:

TriDelta Growth Equity Fund 13.3%
TriDelta Pension Equity Fund 12.5%
TriDelta High Income Balanced Fund 10.0% (the four year return on the fund is 9.2%)
TriDelta Fixed Income Fund 6.5% (this was among the top 1% of Canadian Bond Funds)

Our lower exposure to Canada helped the funds meaningfully outperform the TSX return of 6.0%.

The 6% yield on the High Income Balanced Fund, along with some stock exposure provided solid returns.

The outperformance on the Fixed Income Fund was largely due to strong active management. Our portfolio manager anticipated when to shift from shorter dated to longer dated bonds and from corporate to government exposure. Returns were also helped by some small Preferred Share exposure and opportunistic currency decisions.

Without further ado…

Our Investment View for 2018

Valuations are high, particularly in the U.S., which often indicates low or negative equity market returns, but we have searched for signs and signals of a market pullback, and we are not seeing it in the near term.

This doesn’t mean that it won’t happen during the course of the year, it most surely will. Yet, for the early part of 2018, we remain bullish on stocks.

We believe the following:

*Stocks will remain positive but returns will be better outside of North America. Geographically, the U.S. market appears to be further along the cycle than markets in Europe and Japan and much further along than Emerging Markets. This is based on higher valuations, Central Banks’ raising interest rates, and Consumer Confidence Indices.

As a result, we see Non-North American markets benefiting more in 2018, due to the same low interest rates and quantitative easing that helped the U.S. in 2017.

*Interest rates will not rise as much as expected. While it looks very likely that Canada will raise interest rates this month, and the U.S. will likely raise rates in March, both central banks will be cautious about further rate hikes. Of interest, if the market is expecting 3 rate hikes, and there are only 1 or 2, the bond market is likely to perform better than expected. In Europe and Emerging Markets, some decrease in quantitative easing is expected, but little in the way of actual rate increases will be seen in 2018.

*Marijuana stocks and cryptocurrencies will see major declines in 2018 (from January 9th). This is based on the simple fact that Marijuana stocks are at valuations today that are priced beyond perfection for most companies and cryptocurrencies have yet to see the wrath of the IRS or other major Government agencies. In addition, they use an enormous amount of energy and often originate from poorly regulated countries. Government actions will be coming very soon under the guise of regulatory stability and countering tax evasion, and we expect most cryptocurrencies to see a bubble burst during the year.

*The Canadian Dollar will continue to surprise, but should decrease overall. The difficulty in predicting currency is that there are many important moving parts globally and locally. In the case of Canada and the U.S., NAFTA, the price of Oil, interest rates, and US$ repatriation will all be key drivers of currency changes and will result in several shifts during the year. We believe that interest rates will start to play a lesser role in the currency than it has in the past few years, as the other factors mentioned increase in relative importance.

We expect that the lowering of U.S. Corporate tax rates will drive some Corporate M&A activity. This may result in more Head Offices moving back to the U.S. and shifting dollars and taxes along with it. This will be an important strength contributor for the U.S. dollar in 2018.

*Toronto and Vancouver Real Estate Markets will be more stable….but still grow. Despite changes to mortgage rules, China’s flow of foreign funds, and Canadians comfort with high debt, the main thing that will truly pull back residential house prices is meaningfully higher interest rates. Increases in rates and tighter mortgage rules will help to restrain rapid growth, but until we start to see 5%+ five year fixed mortgage rates (you can still find low 3% rates), we won’t see a significant pullback. We may be a couple of years away (or longer) from seeing those rates.

*Alternative Income Investments should boost returns in 2018. We continue to look at and occasionally add investment options that we believe will provide returns of 6% to 10% most years, have a very low volatility, and little connection to stock market returns. These investments are similar to those that are a key part of portfolios that make up the Canada Pension Plan, Ontario Teachers’ Pension Plan and the Harvard Endowment Plan.

Compared to a world of only stocks and bonds, these alternative investments can help lower overall portfolio risk, add to returns and generate income. The downside is that these are Private Investments, not fully available to all investors, and liquidity is lower than for public investments (stocks and bonds).

One TriDelta advantage is that due to our strength in this area we have been able to negotiate institutional rates, resulting in lower costs for our clients from certain providers.

*Preferred Shares will see more normalized returns but remain an important part of the mix. After a year which saw Preferred Shares gain 13%, we see more typical 4% to 7% returns out of this asset class in 2018. The advantages of Preferred Shares are the tax benefit of Canadian Dividends (many retirees and middle income Canadians pay a tax rate of 10% or less), as well as the ability to benefit from both rising and falling interest rates – depending on whether you own fixed rate or rate reset preferred shares. This flexibility provides an important distinction from bonds.

As a result of these beliefs, we enter 2018 with the following tactical asset allocation.

Based on these factors, we are increasing our exposure outside North America – both to Developed and Emerging Markets. We are decreasing our exposure to the U.S. market, and maintaining an underweight to Canadian markets.

SUMMARY

Early 2018 will likely see the continuation of the strong stock markets that we saw in 2017. At some point, however, we expect to see the U.S. market buckle a little. The catalyst could come from increased pressure of a mid-term U.S. election that may shift control of the House and Senate from Republican to Democrat hands. Traditionally, a Republican President and Democrat House and Senate have not been ideal for stock markets.

When technical market indicators suggest reducing risk, we will ease back on stock weightings. By maintaining strong portfolio diversification from Alternative Investments, Preferred Shares and active Bond management, we will aim to reduce volatility for clients. Our best guess is that most clients will see positive, but lower returns in 2018 than 2017.

Lower volatility, a long term plan, tax efficiency and financial peace of mind are the hallmarks of TriDelta.

We will do our best to continue to deliver that to our clients in 2018 and for the long term.

All the best to our readers for a healthy and prosperous year ahead.

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

Q3 TriDelta Investment Review

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How did Markets do?

The 3rd Quarter report would have had a different feel if it was written in early September.  At that point Bonds were down, Canadian stocks were down, and with a strong rise in the Canadian dollar, US stocks were down in Canadian dollar terms.

Fortunately the quarter ended on September 30th, with Bonds recovering some of their losses and stock markets globally and locally all ending up stronger.

The Canadian dollar, however, had a negative impact on U.S. dollar based investment returns, as the Canadian dollar ended up 4% on the quarter (after posting a 2.8% gain in Q2).

The TSX was up 3.7%, but the U.S. S&P500 in Canadian dollar terms was actually down 0.1%.

Other Non-North American stock markets were strong, in particular Emerging Markets, which were up 8.3% (4.3% after the Canadian currency impact).

The FTSE Bond Universe (previously the DEX Bond Universe) was down 1.8% on the quarter, in large part based on sooner than expected interest rate hikes in Canada.

How did TriDelta do?

The third quarter of 2017 was a mixed bag.  Most growth oriented clients ended the quarter up in the area of 1% to 1.5%.  Most conservative clients ended the quarter closer to flat. 

The difference was twofold.  Growth stocks outperformed Value and more conservative clients had higher exposure to Bonds as well.  Currency negatively impacted all clients.

Our TriDelta Growth Fund had a 2.2% return on the quarter.

Our TriDelta Pension Fund was down 0.1% after a strong first half of the year.

Our TriDelta Fixed Income (Bond) Fund was down 0.2%, but that was in a quarter when the Bond Universe was down almost 2%.  Overall, while the Bond market has done poorly, TriDelta has meaningfully outperformed.

Our TriDelta High Income Balanced Fund was down 0.5%, largely due to its high Bond exposure.

Our Preferred share portfolio continued to do well, led by rate reset Preferred shares, with a 2.1% gain on the quarter.

Most of our Alternative Income strategies continued to do what they are supposed to do, which is provide consistent annual income and growth of 6% to 10% a year, regardless of stock or bond market performance.  This translated into a 1.5% to 2.5% return on the quarter.

Our current view of the world ahead
  1. Interest Rates – Canada has raised rates twice in Q3, and while some believe that another rate increase is coming by year end, we do not believe it will happen. To some degree these rate increases have come from greater confidence in Canada’s economy.  We believe there will not be another Canadian rate increase for several months for four reasons:
    1. 4%+ GDP Growth Numbers are unsustainable and will be coming down, removing some of the support for future rate hikes.
    2. NAFTA uncertainty will take some confidence away from the Bank of Canada.
    3. Canada is a real estate economy these days, and the Bank of Canada and others do not want to risk a real estate decline by raising rates too fast or too soon.
    4. Oil appears to be in oversupply at the moment, especially with the flexibility of fracking production. We believe this limits Canadian dollar upside through price increases.

    The implication of this is that a lack of rate increases should help Canadian bond returns to be stronger this quarter.  No further interest rate increase should also support high dividend yielding Utilities and REITS, but may be a little bit negative for Banks and Insurers. 

    We do expect the U.S. Fed will be raising rates again before year end, and likely again in the first quarter of 2018.  This will impact our U.S. bond positions and will likely have the opposite impact on certain stock sectors that we discussed above.

  2. Canadian Dollar – The Canadian dollar moved from 72.5 cents to 82.5 cents over a period of less than 4 months. In the past month, the Canadian dollar has declined back under 80 cents.

    As per the interest rate discussion, we believe the Canadian dollar will likely lose more ground this quarter.  Rising rates in the U.S. coupled with flat rates in Canada will be the biggest driver.

    NAFTA discussions that have pushed the Mexican peso meaningfully lower, have had little impact on the Canadian dollar thus far, but we believe it will have some negative impact.  However, these discussions could drag well into 2018.

    A last note relates to U.S. Tax changes.  If there is some headway on these Corporate Tax changes in the U.S., we believe it will lead to a sizable repatriation of U.S. Corporate dollars from foreign subsidiaries back to the United States which could translate into special dividends, share buybacks or acquisitions.  This will also strengthen the U.S. dollar.

  3. Stock Markets – We have recently lowered our cash weightings in favour of adding some money to Canadian and International Markets. While we believe that the U.S. economy and corporate earnings remain solid, we will not be adding significantly to a market that has high valuations and is showing signs of being in the latter stages of its long bull market run.

    Canada, Europe, Japan and Emerging Markets all have lower valuations and have certain sectors which are trading below their long term historical averages.  Despite expected increases in interest rates in the United States, we believe that rates will remain very low in these other markets, which will continue to provide a backdrop supportive of stocks.

  4. Preferred Shares – For the past 18 months, Canadian Preferred shares have been an excellent investment, particularly Rate Reset Preferred Shares that have gone up alongside higher bond yields. While we believe that Fixed Rate Preferred Shares may outperform in the period ahead, both Fixed Rate and Rate Reset Preferred Shares continue to provide strong tax preferred dividend yields of 4.5% to 5.5% from some of the strongest companies in Canada. 
  5. Alternative Investments – TriDelta continues to like these high yielding investments that are not correlated (don’t move up and down) with stock markets. Our expertise in this area is allowing us to be exposed to more innovative investments and in some cases receive lower fees than most others in the industry.  This should lead to higher returns for our clients.

    It is worth reminding clients that these investments are less liquid than stocks and bonds.  There is a possibility that during periods of market disruption these investments could be ‘gated’, meaning that withdrawals are restricted until they can be done without hurting the underlying investments.  This is the reason that, even though we are very positive on these types of investments, we like to maintain at least 70% of a portfolio in more liquid securities.

  6.  

    Spotlight – TriDelta’s Top Performing Fixed Income Fund

    Edward Jong, the Portfolio Manager for TriDelta’s Fixed Income Fund, likes to say that there is an ability to make money in Bonds in declining, flat or rising interest rate environments.

    He has worked through all scenarios in his 25 years managing Fixed Income investments, although it would be safe to say that declining interest rates have been the predominant direction during his career.

    Over the past year, Edward’s active approach has led to a 3.6% return.  On its own, that return isn’t overly exciting, but in comparison to the -3.1% return of the benchmark (BMO Aggregate Bond ETF), it is a 6.7% ‘beat’.  As a result, the fund ranked in the top 3% of all Canadian Fixed Income funds in the past year.

    Clients who transitioned to the fund on day 1 (May 2016), are up 8% over the past 17 months – during a time of rising interest rates.

    The fund takes an active approach and that can be seen in the various tools that are used to generate this performance.

    Two months ago the fund had:

    *A shorter duration than the index, meaning that it had a higher exposure to bonds with a short term to maturity, and a lower weighting in long term bonds.  This was done to reduce the funds exposure to the expected interest rate increases.

    *The fund had significant exposure to Corporate bonds and little to Government bonds.  This was reflective of our view that the overall economy was strong, and that the higher yields on Corporate bonds would come with a relatively low level of risk.

    *The fund had some exposure to higher yielding names – again reflecting a comfort in both the names and the overall economic environment.

    *We owned some Preferred shares in the fund as they provided higher yields and Rate Resets actually benefit when interest rates are increased.

    *We owned some U.S. $ bonds, but had a partial currency hedge in place to lessen our U.S. dollar exposure.

    Today, two areas of the fund have changed:

    *Due to our view that Canada will not be raising rates in the coming few months (while the market still believes this is a reasonable possibility), we have extended duration on the fund, essentially selling some short term bonds and replacing them with longer term bonds.

    *We have removed the U.S. dollar currency hedge, and are exposed to currency fluctuations on our U.S. holdings.  We believe that the Canadian dollar will decline, and it will improve our overall returns.

    The bottom line is that in this low yield environment with flat to rising interest rates, it is this active approach to the market that enables our clients to significantly outperform on the Fixed Income portion of their portfolios.

    Summary

    The current mood is steady as she goes, while keeping a firm hand on the tiller.

    The level of stock market volatility over much of the year has been ‘unseasonably’ low.  In fact, in the United States, the largest market decline this year at any point has been just 3%.  Almost every year you will see a decline at some point of at least 5% to 10%.  That is normal.  What we have seen this year is not.

    While we are confident in markets overall, we should also keep in mind that there will likely be a decline in stock markets of 5% to 10% in the months to come.  We should mentally prepare for it.  The good news is that when this happens, a diversified portfolio of Bonds, Alternative Investment Solutions, Preferred Shares and maybe cash, help protect your capital and lower your risk. 

    In cases, where your stock weightings have grown beyond their traditional weights, we will be working to rebalance portfolios by taking a little profit over the coming weeks.  Consider it to be our TriDelta version of the Squirrel busy putting some nuts away for the long winter.

    All the best and our continued appreciation for putting your trust in us.

    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

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

 
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