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TriDelta Q2 Report – The Fed to the Rescue

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The second quarter of 2019 has felt a little like Canada’s Wonderland. You climb the roller coaster, then you experience big ‘wind in your hair’ descent, then another climb. At TriDelta, we definitely work to smooth out your portfolio returns much more than the typical stock market, but I am sure that most of you still felt a bit of the roller coaster as you reviewed portfolios online or through monthly statements.

While the overall returns for equity markets were positive in the second quarter, volatility returned in May. After the stock market continued its strong year-to-date returns in April with the S&P500 (US) rising by 3.9%, the S&P/TSX Composite (Canada) increasing by 3% and Euro Stoxx 50 (Europe) up 4.9%, May saw the reversal of fortunes with the S&P500 declining 6.6%, TSX dropping 3.3% and Europe down 6.7%. June returns were positive again at +5% for the S&P500 (although only 1.8% in Canadian dollars due to a 3% increase in CAD during the month), +0.5% for the TSX and +3.7% for Europe.

Bonds performed well with the FTSE TSX Bond Universe index rising by 2.55%. during the quarter with much lower volatility than the stock market (bonds have sold off a bit so far in July). Preferred shares continued to struggle, with the BMO 50 Preferred Share index declining by 2.4% in the quarter, but have performed well recently with a 0.5% rise in June and so far +1.5% in July. Preferred shares continue to offer high tax-efficient dividend yields, especially relative to other income investments. If bonds prices stabilize, preferred shares could also enjoy some capital gain. For more information on the Preferred Shares market, the reason for its decline, and the opportunity for positive future returns, please click here.

While declines can be stressful, even during periods of overall rising equity markets, it is worth remembering that equity markets have typically provided higher returns than most other asset classes, particularly bonds, but with much higher volatility. Even though equity markets (as represented by the S&P500 in the US) have generated positive calendar year returns roughly 70% of the time, in a typical calendar year, equity markets experience declines of 5% or more 3 times and one decline of 10% or more.

TriDelta clients on average were up between 0.25% and 1.5% during the quarter with the biggest difference being the percentage exposure to Preferred Shares. Our basket of alternative investments continued to perform in line with expectations, with private debt funds up approx. 2%, mortgage investment funds up 1%-2% and real estate up 2.5%, outperforming stocks.

So the key question for most investors is why the strength in April and June vs. declines in May? And more importantly, are we in for weak equity markets like we experienced in Q4 2018 when the S&P500 fell 20% from its peak before recovering? Or can we expect strong market conditions, like Q1 2019 when nearly all major markets were up at least 10%?

Earnings, valuations, cash flows and growth rates should ultimately dictate long-term returns for investors. In fact, most classic equity and market valuation models are based on trying to forecast future earnings and cash flows from an investment based on growth rates, but also bond yields. Sometimes, short-term declines are the result of seasonal factors, or major headlines, such as the continued trade discussions between US and China and in May the threat of US tariffs on Mexico. Often though there may be no clear reason for short-term declines. But in recent years, accommodative monetary policy has definitely been a factor in the strength of (and sometimes weakness in) the equity markets.

Why Central Banks Matter?

Central Banks main goal is to use monetary policy (primarily by setting government interest rates, but also by buying and selling government or related bonds in the market) to keep inflation at stable, predictable levels (price stability). The US central bank, the Federal Reserve, actually has two mandates of price stability and full employment.

Since 2008, central banks lowered interest rates to unprecedented levels and even engaged in quantitative easing, buying long dated bonds, to lower longer-term interest rates. The actions of central banks influence money supply, bond yields and even overall economic growth as more flexible monetary conditions can help protect companies and investors. Companies with higher levels of debt can more easily pay and finance credit. Lower borrowing costs can increase profits for corporations and can be used for dividend increases or share buybacks. Lower rates also encourage individuals and endowments to invest in riskier assets when holding cash that offers only meager returns. Higher dividend paying equities appear more attractive in a low yield environment as they offer higher yields than bonds with the potential for upside (they also have the potential for downside if prices drop). Higher valuations seem more reasonable in an environment of low rates, so stock prices go up and investors seeking higher returns bid up growth stocks.

The Q4 2018 sell-off was impacted by fears of slowing growth, a breakdown in US-China trade discussions, but also due to more hawkish central banks. In fact, when the US Federal Reserve (the ‘Fed’) raised rates in December, then commented that it expected future interest rate increases AND expected further reductions in its bond holdings, this threw fire on an already nervous equity market, accelerating declines in stocks, before recovery began just after Christmas.

Presently, US President Trump is demanding that the Federal Reserve reduce rates, Wall Street is anticipating a rate cut later this month AND at least two more rate cuts within twelve months. If this were to occur, the Bank of Canada, which has been neutral, would have to lower rates as well or see the Canadian dollar rise significantly due to the higher yield of Canadian bonds vs. US bonds. The problem is that while yes the world’s growth rate is slowing and lowering rates would help spur growth, most US economists do not see the need for rate cuts. They still anticipate GDP growth of over 2% in both 2019 and 2020, slower, but still a good growth rate for an advanced economy ten years into a recovery. They expect the unemployment rate, already near historical lows, to decline even further, and for inflation to be slightly above 2% (the Fed’s target rate), so these economists do not see a need for near-term rate cuts. (Source: Blomberg Economics, July 8, 2019). Most members of the Federal Reserve are economists. So who will win? Wall Street and the President or the more conservative economists? Much like the Kawhi Leonard watch to determine which basketball team he signed with, the Fed’s decision will also be followed and analyzed throughout the summer.

US Federal Reserve Interest Rate Expectations

The green line reflects the projected Federal Funds Rate (interest rates) per members of the Federal Reserve at July 12, 2019. The yellow line reflected those projections at December 31, 2018. For example, at the end of 2018, the Fed expected rates to stay at approximately 2.4% in one year’s time and now expect rates to be closer to 1.5% over that period.

At TriDelta, we think the result is likely to be somewhere in the middle. We will get at least one rate cut in 2019, but possibly later than July and we may see only 1-2 additional cuts within the next 12 months. If this is the case, Wall Street is likely to be disappointed and we could be in for a few months of volatility.

As a result, we have focused equally on capital preservation as well as growth. The stocks currently in the equity portfolios have higher yields than the overall market, as well as lower volatility (Beta) and cheaper valuations (as measured by Price / Earnings ratios). We also presently hold higher levels of cash in our equity funds. Our bond portfolios hold shorter terms to maturity than the Canadian bond universe and has improved its credit quality. We also continue to believe that investing a portion of clients’ portfolios in income-focused alternative investments should provide less volatility and a higher level of income than a typical stock and bond only balanced portfolio.

We will continue to monitor market conditions, particularly leading indicators, developments in trade discussions and their impact on the world economy, as well as technical factors that may give indications of potential market movements and which sectors to favour.

Update on Private Investments

At the end of Q2, both TriDelta Fixed Income and High Income Balanced Funds made additional distributions based on investments being sold or maturing. Distributions for the Fixed Income Fund were roughly 0.5% and just over 13% for the High Income Balanced Fund. Additional distributions are expected near the end of Q3 as certain bonds mature and others are sold.

Summary:

We continue to search for value in under covered areas of the market, such as a promissory note issued by a leader in the litigation finance field that pays our clients a 10% yield, as well as stocks, preferred shares and bonds trading below historical averages or offering higher levels of growth than are priced in by the market. We are also focused on capital preservation, income and reducing overall risk through prudent management and diversification.

We hope that you have a chance to enjoy the sunshine and good weather that we are presently experiencing. Summers in Canada are too short, so they must be savoured.

 

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

Q1 TriDelta Investment Review – Everything is good again….isn’t it?

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Overview


After double digit declines in Q4 2018, Q1 2019 saw a significant bounce back.

We saw double digit increases in the TSX at 12.4% and in Canadian dollar terms, the S&P500 at 10.8%, with a 7.1% gain in the Euro Stoxx 50 and 2.8% in Japan.

Leading the way in gains in Canada was the ‘Health’ sector which is primarily Cannabis names, which were up 45.9%!! I.T. was up 27.3% in Canada and 20.5% in the broad U.S. market. While the gains were fairly broad, not surprisingly, many of the biggest gains came from more volatile sectors that saw the biggest declines in the fourth quarter of 2018.

The key question is where does this leave us?

Can we relax and look for another 5% to 10% gain in stocks through the rest of the year?

Are we headed for a third straight quarter of extreme volatility?

Where do we see things today and what are we doing about it?

The last couple of quarters, we have focused on 5 factors moving markets. If we review them as of April 2019, they are now telling us the following:

  • Interest rates/bond yields – after meaningful increases in the first half of 2018 on both the overnight rates and longer term rates, the mood has definitely shifted with long term rates declining meaningfully, and short term rates seemingly on hold for a while. A stable interest rate environment gives investors the confidence to take advantage of cheap borrowing costs and increase allocations to equities, pushing the stock market higher.
  • Fears of higher inflation – in part due to lower growth expectations globally and in part due to lower wage growth in the U.S., the fear of higher inflation has meaningfully pulled back. One more fear that has eased and allowed stocks to pull forward.
  • U.S.-China Trade Wars (and broader trade conflicts globally) – The stock market has responded well to confident statements from Trump and more frequent high level meetings between the countries on trade. While there remains real uncertainty, we believe that there will be tangible improvement on this front, including an announced agreement with small ‘victories’ for both sides.
  • High US stock market valuations and earnings expectations – Today, with higher valuations and mixed earnings reports, equity valuations are becoming a little more expensive again. Forward earnings are trading about 4% higher than the long term average multiples.
  • Global Growth – Investor concerns about continued slow global growth have resurfaced, particularly after the IMF (International Monetary Fund) cut its 2019 global growth forecast this week to a mere 3.3%. Growth rates were closer to 4% just 2 years ago. The IMF stated that the world economy faces downside risks brought by potential uncertainties in the ongoing global trade tensions, as well as other country- and sector-specific factors.

So if we look at this little scorecard, three of the five are pointing more positively for stock market returns, and the last two are more negative.

Stocks

Where that leaves TriDelta after the very good returns in the first quarter, is that we have become a little more cautious. In early January, we went from higher cash levels in our funds to being fully invested in stocks. Today we are holding some cash taking a small amount off the table from Canadian and global stocks. We are not overly negative; just a little more cautious than early in the year. We are also monitoring technical indicators to see if further defensive measures should be taken.

We are also lowering our small exposure to energy after a strong increase in oil prices this quarter.

Interest Rates

U.S. – The Federal Reserve is not likely to lower rates unless we see a significant slowdown in growth. This is in part because they don’t see a strong case for lowering rates at this point, and they don’t want to send a negative signal to the marketplace. Medium and long-term rates have already come down meaningfully. We see this likely coming to an end, although medium and longer-terms yields are not necessarily rising back up for the time being.

Canada – There is a little more concern about slowing growth in Canada and the need for the Bank of Canada or the government to provide some form of stimulus. We don’t see short term rates falling in the near term, but there could be a drop later in 2019. The mid and long-term rates have already fallen meaningfully and we don’t believe there is room for much more of a decline unless the economy slows down dramatically.

Preferred Shares

We are currently leaning a little more towards straight, fixed rate preferred shares, as they offer dividend yields of over 5%, should benefit from the lower long-term bond yields and are much less volatile. Rate reset preferred shares continue to be undervalued with yields often over 5.5%, but they have shown greater volatility for longer periods than would be expected, and this could continue.

Alternative Investments

As this sector grows, it becomes even more important to understand the managers and those that have a longer track record of success. At TriDelta, we are sticking pretty close to the few managers that have delivered very steady returns and who we believe will be best able to adjust to a low interest rate environment, while strategically adding additional managers that we think can enhance portfolio returns, add stability to a portfolio or reduce volatility.

An Inverted Yield Curve – what is it and should we fear it today?

There has been a lot of talk about inverted yield curves and that it is a precursor to a recession.

An Inverted Yield Curve is one where short term yields are higher than long term yields.

Traditionally if you put money into a 5 year government bond you would expect a higher return than in a 30 day T Bill. This is due to a couple of main reasons. The first is that you will not have use of your money for 5 years vs 30 days, so there is a premium paid for locking in your funds. The second is that there is a bit of an uncertainty premium. If you invest for 5 years and interest rates go up, you are missing out on participating in those higher potential yields.

In an inverted yield curve, you have a situation where you are getting paid more for a short term investment than a long term one. This is not that common, and it is often caused by concerns about future growth, disinflation and expectations of future interest rate declines.

What creates the situation is when the market believes that interest rates will be moving lower, i.e. an expectation of future interest rate cuts by the central bankers, and there is demand to lock in longer term rates at higher yields before they decline. As more long bonds are bought, it pushes the yield down and continues until the market decides that these lower yields are no longer appealing. The end result can be an inverted yield curve. One other action that creates an inverted yield curve is when the Federal Reserve raises short term rates at a fairly fast pace and longer term rates don’t keep up.

The chart below lists the last 9 Yield Inversions in the US and duration until the subsequent recession. The average time lapse before a recession starts is 14 months in the 7 cases where there was a recession following a yield curve inversion.

Date of Inversion Time to a recession
April 11,1968 19 months
March 9, 1973 7 months
August 18, 1978 16 months
September 12, 1980 9 months
December 13, 1988 18 months
February 2, 2000 12 months
June 8, 2006 17 months
Late 1966 No recession for 3 years
June 1998 No recession for 2.5 years

 
If we keep in mind that there will always be a recession at some point in the future, and that there was not a recession for at least a year in 7 of the past 9 instances of inverted yield curves, we do not believe a recession is imminent in the U.S. If the Federal Reserve or US government react to declining growth rates, the economy can continue to grow in 2020 as well. Economists forecast that the U.S. grew at about a 1.5% pace in the first quarter of 2019 but expect 2.4% for the full year.

In Canada the current growth forecast for 2019 is down to 1.5% and could see further downside if there are negative developments on trade, housing or the energy industry. We will continue to monitor the data, but continued growth, albeit at a slow rate is our current expectation.

Overall, an inverted yield curve does not meaningfully concern us for the rest of 2019.

How Did TriDelta do in Q1?

Overall, most clients had returns in the 4% to 7.5% range on the quarter depending on their individual asset mix.

Our 2019 Q1 returns were as follows:

TriDelta Pension Pool (Stocks) 8.4%
TriDelta Growth Pool (Stocks) 8.4%
TriDelta Fixed Income Pool 2.6%
TriDelta High Income Balanced Pool 5.8%
TriDelta’s Selection of Alternative Income Funds 1.5% to 2.3%

 
Other news and items of interest:

  • Taxes – if you or your Accountant have any questions, please don’t hesitate to ask.
  • Tax Refunds – if you are receiving a tax refund it can be a good source of funds for doing 2019 contributions to RRSPs, RESPs, RDSPs and other savings vehicles.
  • World Trade – in January 2019 trade was down 0.4% year over year. It has averaged a year over year gain of 5.1% over the past 25 years.
  • Growth of Middle Class in Emerging Markets – Today India’s middle class represents 14% of the population (up from 1% in 1995). This is expected to grow to 79% by 2030 according to the Brookings Institute.
  • Retirement Savings Gap – According to a U.S. study from 2017 by the Employment Benefits Research Institute, 64% believe that they need over $500,000 for retirement. Actual savings for the average 65 to 74 year old was $126,000.
Summary

Q4 2018 was much worse than it should have been in markets, and Q1 2019 was much better than it should have been.

This leaves us at the moment with lower interest rates, low unemployment, a little lower growth, continued trade issues and slightly elevated market valuations. Overall, that puts us in a ‘not too hot and not too cold’ place where we are fairly comfortable. We don’t believe that a U.S. recession will happen this year, and expect low to middle of the range stock market returns for the near future.

At TriDelta we will continue to be nimble while focused on the client’s long-term plans. Portfolios are designed to provide a diversified asset mix that is built appropriately for the goals of each client, with an eye on tax minimization.

Here is to a beautiful spring for everyone.

 

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 – 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

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