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TriDelta Investment Counsel Q2 Review – Interest Rates are only part of the picture

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How did the markets perform?

The second quarter of 2013 was very mixed across the globe.

  • The Toronto indices were all negative for the quarter, the TSX was down 4.1% and the TSX Small Cap was down 8%.
  • The Canadian Bond Universe was down about 2.4%
  • The U.S. stock markets continued to perform well. The S&P 500 was up 2.9% in local terms and 6.5% in Canadian currency as the Canadian dollar was weak during the quarter.
  • Global stocks were generally down in local terms but still positive when factoring in the weaker Canadian dollar. The EAFE Index (Europe, Australa, Far East) was down almost 1% in local currency and up 2.8% when priced in Canadian dollars.
  • The MSCI Emerging markets index was down 8% and down 4.7% with currency.

So the message for the quarter:

Many markets were down and the Canadian markets were in the middle of the pack.

 

How did TriDelta perform?

Overall, the second quarter was fairly flat for TriDelta clients – but very positive in comparison to the Canadian market for stocks and bonds.

Virtually all clients outperformed the Canadian Stock and bond markets during the quarter with a range of returns from 1.0% to -2.5%.

The range of performance was primarily determined by model selection and asset mix. The Core (Growth) bond and equities portfolios outperformed the Pension equivalent and portfolios. Those with higher stock allocations outperformed portfolios holding more bonds.

The rationale for Pension underperforming Core during the quarter relates to some of the more defensive and stable dividend paying sectors like Utilities and Telecom which were two of the three worst performing sectors down 5.5% and 9.4% respectively. The worst performing sector for the quarter was Materials which includes mining stocks, was down 23%.

Once again all of our portfolios performed reasonably well under poor stock market conditions.

The key reasons for our decent performance would include:

  1. Meaningful stock exposure to the U.S. Market. At some point this may decline if we feel that the US market valuations are getting ahead of themselves, but we do not believe that is the case today. In addition, the US market gives us strong global exposure to several sectors that Canada lacks.
  2. Very low exposure to Materials stocks, especially precious metals. We never say never when it comes to sectors of the market. There may come a time when we begin to build more in these sectors.
  3. Growth outperformed Value. In general stocks with strong earnings growth profiles performed much better than stocks with very cheap valuations as investors looked for more certainty during the volatile quarter.

What are we doing about rising interest rates?
This seems to be the big question of the day. Clearly one of the big challenges in the quarter was the significant increase in long term interest rates.

This increase that reached a full percentage point for 10 year government bonds was the largest short term increase since 1994.

The immediate impact was for bond prices to fall. Longer term bonds fell more than short term, and corporates fell a little more than government bonds.

In addition, stocks that are deemed interest rate sensitive such as utilities and telecom stocks also fell with the rise in interest rates.5197885_s

The first thing to know is that we believe that the interest rate moves were overdone, and expect bonds to actually perform quite well over the next quarter. We do believe that interest rates will ultimately rise, but it will happen over time and not in major jumps. As a result, we expect the major jump in yields that we just experienced to slowly move lower over the coming months, before it moves ahead further.

We did make a move in late April to shorten the term of our bond holdings, and that helped our performance. We are now moving again to lengthen the term of bond holdings. This is not necessarily a long term move, but one that we believe will bring outperformance through the rest of the year.

In terms of stocks, we continue to believe in dividend growers, strong balance sheets, and consistent earnings, but we are also looking at some sector shifts within these parameters. From a historical perspective, certain sectors do tend to outperform during mid stages of a market recovery and in rising interest rate scenarios. We will continue to be looking for some opportunities in sectors like technology and energy. This is a slow shift that we believe will position portfolios better for growth in 2014.

For those who believe that it is time to sell all bonds and go into stocks, keep in mind the purpose of bonds is both for income and stability of the overall portfolio. Bonds can go down in value as they did last quarter, but in the last 61 years, the very worst period was from June 1980 to July 1981. During this unique time of soaring interest rates and high inflation, the prime rate surpassed 20%.

The total return for the bond market during that period was minus 11%. This is certainly a poor return, but keep in mind how different the inflation scenario is that we see today. In most years, bonds provide steady single digit returns. Stocks have been much more volatile. This basic fact leads to a fundamental investment belief.

The right mix of stocks and bonds for an individual can see some shifting based on markets, but in general, if you are risk averse, and holding 30% in stocks, we do not believe you should make a radical shift. The market will do its thing regardless of everyone’s beliefs, and you need to maintain your appropriate asset allocation and risk profile. To make major changes (often after the fact) is usually one of the biggest investment mistakes people can make.

More thoughts on Bonds

  • The latest bond sell-off was due to a combination of news that the US Fed sees “diminished downside risks to the outlook” and Bernanke’s comments that the Fed may trim its $85 billion bond buying initiative. The timing suggested it could start this year and end around mid-2014 if the economy grows in line with their forecast. This was not new news. This news has been in the market place as early as the turn of 2013. However, it certainly triggered a flight from bonds.
  • Fast money, ETF trading, and new pricing levels were the catalyst for the extreme ranges traded in such a short period. Get me out – now – mentality prevailed, and once that trade has passed, more rational trading ensued.
  • Tame inflation expectations and mixed economic releases argue for a new trading range with 10-yr yields between 2.00% and 2.50%, but not for the higher yields doomsayers are suggesting. If the recovery continues, ending of Quantitative Easing is still not tightening of US monetary policy. It’s a move to neutrality, and if history is a guide, central banks could be neutral for quite a while.
  • As active managers, and with an extremely liquid portfolio of holdings, we have positioned our portfolios to take advantage of the volatility that will be the norm until the markets enter the next interest rate cycle.

Why less Quantitative Easing is Just a Shell Game

We believe that a reduction in Quantitative Easing purchases will potentially overlap with reduced borrowing requirements of the US government. How ironic would this be if the pay down of debt matches the gradual reduction to Quantitative Easing? At some point, the disappearance of Quantitative Easing will overshadow the reduction of supply; however, by then, market participants will be focused on the next big issue.

 

What about the rest of the year?

For the rest of 2013 we expect the markets to move around in the ranges already established during the first half of the year. In other words we see limited upside and a couple of short term corrections that will provide some decent buying opportunities.

The risks and news items that may cause a correction are many and are well know to the market as they have been climbing these walls of worry since late 2012 and include the following:

  • The U.S. Fed slowing quantitative easing
  • Sequestration in the U.S. continues and is a drag on economic growth
  • Portugal, Italy and Greece continue to struggle
  • Growth in China slows
  • Continued political turmoil in many Emerging Market economies

Overall we continue to see the positive side winning out in the longer term:

  • Earnings growth continues to be positive
  • The U.S. jobs and economic data continue to improve
  • Stocks are still attractively priced
  • Few alternatives for investment dollars since GIC and cash rates are still very low
  • Global support from central banks to stimulate the economy continues to be in place

We have been raising cash in all portfolios recently and are continuing to looking for opportunities to sell call options for some clients on a number of holdings to help generate excess return and income if the markets pull back.

Dividend changes

Many of our holdings continued to increase their dividends during the second quarter. The following nine companies increased dividends and none of our holdings decreased their dividend paid over the last three months.

Company Name % Dividend Increase
Suncor Energy 53.80%
Potash Corp 25.00%
Apple Inc. 15.09%
Exxon Mobile 10.53%
Weston 10.50%
Baxter Intl 8.90%
Johnson & Johnson 8.20%
National Bank 4.80%
Canadian Imperial Bank 2.10%

 

Summary

Investment management is never easy, and the rush to get out of bonds is a great example of emotional decision making. It can be very hard to act against the emotional pull to sell something when everyone seems to be bailing.

When we step back and look at the world in July 2013, we see reasonable market valuations. Keep in mind that from deep recessions come long recoveries. We believe we remain solidly in this recovery phase. It won’t rise in a straight line, and we may very well see more volatility this summer, but the general trend remains positive for stock markets, with room for decent bond returns on an actively managed basis.

 

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

TriDelta Investment Counsel – Q1 2013 Investment Review and Outlook

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How did the Markets Perform?

The first quarter of 2013 was one of degrees of good for stock markets.

  • For the U.S. stock markets it was great. S&P 500 was up 10.5% (in Canadian currency).
  • For Global stock markets it was very good. The Global (outside of the Americas) EAFE was up 8.3% (in Canadian currency).
  • For the Toronto stock market it was good. The TSX ended the quarter up 3.3%.

The Canadian Bond Universe was up about 0.6%.

So the message for the quarter:

Everything was up, but Canada was a bit of a laggard versus the rest of the world.

 

How did TriDelta Perform?

The first quarter of 2013 was a very good one for TriDelta.

Virtually all clients outperformed both the Toronto Stock market and the Canadian bond index. Returns ranged from 3% to 7%.

This range of performances is tied closely to the clients risk tolerance.  Those with more of a stock & growth focus have outperformed to a larger extent than those with a conservative, fixed income weighted portfolio.

What is key for TriDelta is that our portfolios overall have a lower risk profile designed to outperform in poor stock markets. This is why we are particularly pleased that we also managed to outperform in strong markets.

The key reasons for our strong performance would include:

  1. Meaningful stock exposure to the U.S. Market. This has been a focus for TriDelta, and will likely continue for the foreseeable future. Among the reasons is that for risk management, we believe that Canadians need greater diversification than the Toronto market provides, and that at this point, there still remains many cases of better value outside of Canada.
  2. Focus on corporate bonds vs. Governments, and a belief that greater returns will be found in longer term bonds. We believe that long term interest rates will continue to remain low for the near future, and will allow us to deliver better bond returns than in the short term end of the market. This view may change during the course of 2013, but not today.
  3. Focus on companies with growing cash flows, which leads to growing dividends. This is not a get rich quick strategy. This is a ‘slow and steady wins the race’ strategy. This quarter, 16 of our holdings raised dividends and not one lowered. These are signs of stable growth.

 

Will we see Good Markets the rest of the Year?

In 2iStock_000000674097XSmall010, markets were up over 10%. However, there was still a period of over 15% decline during the year.

In 2012, the S&P 500 was up over 10%. During the year, it still had a 10% decline during the year.

The answer to the question is that at some point in 2013 there will likely be a meaningful decline. Possibly trading down to a 10% decline from its high. We’re unlikely to see consistently good markets for the rest of the year, but the key word is ‘consistently’. The markets remain volatile as they trend higher or lower, but we see many reasons to be positive for the rest of the year.

They include:

  • The U.S. economic trend is positive. There is growing house prices and an improvement in the unemployment numbers.
  • This positive economic trend is coupled with U.S. Government economic stimulus which is allowing companies (and individuals) to borrow funds at incredibly low rates. This combination is very rare and leads to extra strong stock market returns. The U.S. government is essentially committed to most of this stimulus through the end of the year.
  • If not investing in the market, you can only earn 1% or 2% (if invested well) on GICs and cash. The safe alternative is looking much weaker.
  • Europe is bad but stable. The Cyprus banking ‘crisis’ was met with a yawn from Global markets.  This was because of the confidence that is now in place in the European Central Bank and major governments to be able to stick handle their way through. Perhaps this confidence is unfounded, but it seems to be in place.
  • Asian growth appears to be on track despite some bumps over the past year.

One other note might be helpful for those looking for more positive signals.

There have been nine years since 1960 in which the S&P 500 rose more than 5% in January. 2013 is the tenth year it has happened. In eight of those nine instances, the market finished those years higher, with the lone outlier coming in 1987, due to the October crash.

The S&P 500 has averaged a 13% gain from February through the end of the year in those nine years.

 

When will Canadian Markets catch up?
This is a tough one to answer. Because of the concentrated nature of the Toronto Stock Exchange, the question really is, “When Will Energy, Mining and Precious Metals Do Better than the US Market?”

There are certainly components of the Canadian market that remain strong and steady, but Energy and particularly Mining and Precious Metals has underperformed. The Global Gold index is down 22% over the last year!! The Energy index is down 2%, while the Global Mining Index is down 12%.

These areas of the market are very cyclical and because of their volatility, tend to be areas that TriDelta is often underweight. We’re typically overweight companies that are under-valued, have good balanced sheets and have growing dividends. While these aren’t the hallmarks of energy and metals stocks, because of the downturn, there are several names that are looking more attractive.

While we are not going to predict when this cycle will turn, the catalysts will include strong growth signs from China and India, along with the natural sector rotation from a hot sector like Health Care (up 28% in the past year) to a cold sector. We consistently seek value among names regardless of sector, and look to sell some winners that become expensive. Given what has been happening in the market, this may involve some new money going into energy and metals in the coming months.

 

Dividend changes

We are strong believers in the power of dividend growth, and look to hold stocks that based on our analysis, are good bets to grow their dividends over time. This quarter was no exception, with 16 companies increasing dividends, and none decreasing.

 

Company Name % Dividend Increase
Cisco Systems 21%
Magna International 16%
Canadian National Railways 15%
Atco 15%
Rogers Communications 10%
Colgate Palmolive 10%
Canadian Utilities 10%
United Parcel Service (UPS) 9%
3M 8%
Pason Systems 8%
Lorillard 6%
Bank of Nova Scotia 5%
TD Bank 5%
RBC 5%
Transcanada Corp. 5%
BCE 3%

 

SUMMARY
At TriDelta we look forward to providing our current clients and new clients with three key deliverables:

  • A financial plan that gives you a roadmap, financial peace of mind to do more with your wealth and smart tax planning.
  • An investment plan that fits within your larger financial plan. An investment plan that will help you to achieve the long term life goals that you have set out.
  • An investment approach that lowers volatility, delivers increasing income, and uses proven financial discipline and mathematics to underscore buy and sell decisions.

The first quarter extends our strong 2012 performance, and has been a great example of achieving above average risk adjusted returns. In a world of low interest rates and low growth, we strongly believe our investment approach and philosophy is well suited to outperform.

We look forward to the challenges and celebrations in front of us in the remaining 9 months of 2013.

 

TriDelta Investment Management Committee
 

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

 

Ted Rechtshaffen

President and CEO

Anton Tucker

VP, Business Development

 

4th Quarter Investment Review and 2013 Forecast

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report2012 was another year of recovery with some scary moments along the way.

Globally, there continues to be many signs of improvement, but still a very slow recovery from a deep recession. The key from an investment point of view is not to get caught up in your current surroundings, but to focus on the direction. Today, that direction is positive. As a result, we are optimistic for the year ahead.

Even with a positive general outlook, we see a few red flags ahead of us this year which will likely see temporary pull backs in the market. We will try to use these pullbacks as buying opportunities. These might include:

  1. The United States will see meaningful government spending cuts take place which will slow their growth a little this year. It will come about as part of the negotiations to raise the debt ceiling. These cuts didn’t get done with the Fiscal Cliff negotiations, but look for them to happen around March – and will likely hurt markets in the
    weeks leading to an announcement.
  2. The quiet in Europe is a little disconcerting. Expect some noise as new governments come in to power, continued austerity measures cause public uproar, and look for more standoffs between expectations of EU bailouts and countries that still don’t meet the criteria required to receive them.
  3. Asia and Emerging Markets seem to be moving in the right direction at the moment, but when it comes to China in particular, it is often hard to really know the whole picture. As a result, you always want to be wary about counting on China to lead markets forward. We will be looking for any government announcements that could
    lead to a slowdown in growth.
  4. Canada faces some challenges around possible declines in real estate valuations and the increasing energy production out of the United States. Despite these concerns, we continue to see many positives in Canada, but in some cases there may be less room for growth here than in other recovering nations.

 

How did we do?

2012 was a positive year for TriDelta clients. While the TSX returned 4.0% and the DEX Bond Universe returned 3.6%, most TriDelta clients had a net return somewhere in the 4% to 10% range depending on their risk tolerance.

In addition to strong net returns, our clients had a much smoother ride than the Toronto stock index. Most clients never had a month with a loss of more than 1.3% during the year, while the TSX suffered a loss of 6.3% in May. This risk minimization is important for our clients as they are looking for peace of mind from their long term financial plan,
and from their month to month investment portfolio.

This combination of beating the stock market and bond market index with lower than average volatility is a fairly rare feat, and one that we are quite proud of.

 

What worked well

We remained significantly underweight precious metals and energy for most of the year. We added to our energy weight in the fall, and managed to capture much of the upside in the sector. Our stock weighting was 1/3 US based. With the US markets meaningfully outperforming Canada on the year, this was a value driver as well.

Our higher than average cash weightings (often 10% to 20%), didn’t slow us down much, helped to smooth out the bumps, and as discussed in the Q3 Investment commentary, we were able to buy in on a couple of pullbacks during the year – because the cash was available.

At TriDelta, we place the primary focus on capital preservation followed closely by a dividend growth approach to growing the assets. We seek risk adjusted returns, which means that at times of elevated market & economic risk we’re happy to give up some returns to ensure the safety of your hard earned capital.

On the fixed income side, we made the right call in terms of holding some longer term bonds. These bonds appreciated from the continuing decline in long term rates and stable short term rates.

Our best investments have been:

  • Pason Systems up 45% on the year – a smaller Canadian company that provides instrumentation systems for the oil and gas industry. It was purchased because it has a very clean balance sheet, steady growth in earnings and dividend growth, and appears to be very well run. We were looking for some additional exposure to energy with a well-managed service provider.
  • Southern Copper up 37% on the year – US headquartered Copper miner with very strong cash flow and dividend. Net profit margin over 35%. No debt issues and growth is currently powered by internal cash flow. We wanted some mining exposure but with good dividends and strong cash flow.
  • Baxter International up 38% on the year – US health care firm that provides products
    and services for hospitals and medical research. We saw similar fundamental strengths
    as others here, and a good valuation for entry.
  • Catamaran Corporation (formerly SXC Health Solutions) is up 63% on the year – Canadian based provider of pharmacy benefits management services and healthcare IT solutions to the healthcare benefits management industry. Great products, fast growing but managed growth. No dividend is paid here, so more of a growth name held by higher growth clients.

 

What did not work well

Sometimes our risk minimizing approach does keep us away from opportunities. One of those situations could be found in the second half of the year, as we saw strong gains in Europe and emerging markets that we did not participate in. These gains were not driven off economic strength as much as they were a bounce back from some of the significant declines over the past couple of years – and relative calm. We have started to add more non-North American exposure to portfolios.

Another investment that has hurt us in the short term was a Canaccord preferred share. We continue to hold the name as we see solid income, low valuations, and expect some recovery in 2013.

It can be difficult at times to hold poor performing investments, but we go back to the same numerical analysis that led us to own the investments originally. If there is no major change to the financials of the company, and it would pass our buy criteria today, then we won’t typically sell these investments. If something meaningful changes and the companies would no longer meet our original buy criteria, we will sell.

Our weak investments have been:

  • Joy Global lost 33% – occasionally a company doesn’t do what it should do based on the numbers. It may require more time, but in this case, we bought Joy Global because it was a diversified drilling equipment supplier with a steady growth profile. While the stock has improved a little from where we sold it, we were able to reinvest funds into Tesoro and other companies that made solid gains. In this case, we felt that other companies in the sector were holding up better and could provide more upside than holding Joy.
  • TransAlta lost 10% – we replaced it with Atco which is up 17%. In this case we made a relatively quick decision to move out of a company that had been underperforming its industry for a company that had been outperforming. Sometimes the best move you can make with an investment decision is to get out quickly. It requires an ability to be analytical and unemotional, something that many investment managers lack. In this case, the negative ended up a positive with Atco.

 

Dividend changes

We are strong believers in the power of dividend growth, and look to hold stocks that, based on our analysis, are good bets to grow their dividends over time. This quarter was no exception, with 9 companies increasing dividends, and none decreasing.

Southern Copper paid out a special one-time dividend which accounts for its 1,046% dividend growth.

Company Dividend Increase (%)
Southern Copper 1046%
Accenture 20%
Home Capital 18%
McDonalds 10%
Pason Systems 9%
George Weston 6%
National Bank 5%
Emera 4%
Merck 2%

 

Our view of the past quarter and the year ahead

Prior to last quarter we said that we expected a 5% pullback due to one of a variety of factors, one of which being the Fiscal Cliff negotiations.

As it turned out, we did see this decline correctly after the US election in mid-November, and we took advantage over the past few weeks by buying McDonalds, Cisco, 3M, and Cognizant across various portfolios. All have seen gains of 3% to 10% since.

Another move we made late in December was an interesting approach to tax loss selling. As mentioned earlier, we had purchased a Canaccord preferred share which we believe in, but had experienced losses in 2012. This was a Series A preferred share. For those clients who held the security in a taxable account, we sold in late December to capture the tax loss. Because we believe in the company, and didn’t want to risk being out of the name for the required 30 days, we immediately purchased the Canaccord Series C preferred share. If we bought back the same stock, we would lose the benefit of the capital loss, but by purchasing a different (although very similar) security, we remained fully in the investment, but are still able to capture the capital loss for this tax year. As it turns out, this was a good move, as the investment is up 14% in the past 3 weeks.

Our general view of things is similar to that entering 2012. We see choppiness driven by the news cycle in the U.S. and Europe. We see things as generally positive, but not significantly so. We see short term rates remaining flat, and still see some room for long term rates to fall – leading to some opportunities for capital gains in bonds.

This general belief continues to support our core themes of dividend growth, large cap, long term bonds, and some increasing international exposure.

On the positive side, the US is indeed showing the classic signs of a solid recovery – increased manufacturing, improving employment and increasing housing prices. We expect that this will continue – along with a terrific investment environment of low interest rates and government stimulus.

China also looks to be showing meaningful signs of improvement. This bodes well for much of the global economy and in particular for Canada and its commodities.

Speaking of interest rates, we continue to see gains for long term bonds – at least for the first half of the year. Assuming declines in government spending, a strategy of easy monetary policy, modest job growth, and low inflation, we see these combining to keep higher interest rates at bay.

The U.S. Federal Reserve will keep overnight interest rates near zero, and continue with forcing a flatter yield curve until there is both a “sustainable” and “substantial” improvement in the employment situation. The Canadian bond market will essentially be dragged accordingly; however, the Bank of Canada may want to depart (like they did in early 2012) from the dovish stance, but on balance it is unlikely.

As a result, TriDelta will continue to hold longer term bonds for higher yield and capital gains. A great example of this strategy in action was our switch from a Manulife bond with a 2015 redemption date that had a current yield near 3.75% to one with a current yield of almost 6%, an $86 price and a redemption date of 2041. Since the 2041 bond was purchased in September, the bond has increased in price by 6% on top of the yield. The bond that was sold is up 1% over the same time period. We are unlikely to hold this 2041 Manulife bond long term, but will be happy to continue to receive the high income over the short term, and hopefully get a 5% to 10% capital gain when it does get sold.

We see low growth in North America, likely in the 1% to 2% range – certainly not significant growth rates.

We see continued strength in the Canadian dollar, possibly gaining a few cents during major Debt Ceiling debates. This strength in the Canadian dollar vs. the U.S. dollar will underpin the need for increasing Canadian partnerships with Asia across many industries, energy in particular.

 

Summary

At TriDelta we look forward to providing our current clients and new clients with three key deliverables:

  • A financial plan that gives you a roadmap, financial peace of mind to do more with your wealth and smart tax planning.
  • An investment plan that fits within your larger financial plan. An investment plan that will help you to achieve the long term life goals that you have set out.
  • An investment approach that lowers volatility, delivers increasing income, and uses proven financial discipline and mathematics to underscore buy and sell decisions.

Our past year has been a great example of achieving above average risk adjusted returns. In a world of low interest rates and low growth, we strongly believe our investment approach and philosophy is well suited to outperform.

We look forward to a great year ahead.

TriDelta Investment Management Committee
 

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

 

Ted Rechtshaffen

President and CEO

Anton Tucker

VP, Business Development

 

Tired of rolling the dice?

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If we truly are in a period of low growth and low interest rates for the next several years, how do you invest for income? How much risk do you need to take to get a 5% yield?

The answer is not that much.

Today, many income investors tend to share the following traits:

  • Looking to generate income from their portfolio that will be at least 4%
  • Have no corporate pension
  • Are increasingly focused on capital preservation
  • Understand that 2% GICs/T-Bills are not a good long-term solution
  • Want to be tax efficient

In our discussions with clients, the general comment is that they don’t need a 10% return, they are fine with 5% or 6% returns, but they can’t have a -10% return or worse.

This type of focus leads to some new thinking on portfolio management and investment solutions.

Here is one fact that has supported this new thinking. According to a research study by BlackRock’s Richard Turnill and Stuart Reeve, 90% of U.S. equity returns over the last century have been delivered by dividends and dividend growth.

Turnill and Reeve head the global equity team for the world’s largest money manager. It kind of makes you wonder why you would ever own something that doesn’t pay any income.

Investing for income can be very simple. Only buy what has a big yield.

Sometimes that strategy can actually work, but usually in an environment where you are going from a high level of market jitters towards one of market confidence.

The problem is that big yields are usually a sign of greater risk. Either a company is paying a very high yield because they need to do so to get people to buy it, or what was once a modest yield has become a large yield because the price of the security fell a great amount.

The other problem is that with common stocks in particular, a company can easily cut or eliminate their dividend, and as with Yellow Media last year, you go from having a high yielding security to one with no yield.

I believe in five components that are needed to achieve solid income, with moderate risk:

Bonds – Any bonds with a BBB rating or better (although you can’t ever truly trust the credit agencies). All companies need to be closely analyzed on a free cash flow basis and their existing debt obligations need to be understood. No bonds are to be held with a yield to maturity of less than 2%. Bonds can be traded to adjust duration of the portfolio or to take advantage of lateral improvements in yield to maturity.
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High Interest Cash – Given the low interest rate environment, it makes little sense to hold a ‘risk’ asset like a bond when risk free daily interest bank accounts will pay 1.75%. This cash component is the bedrock of the portfolio, and by having it in place, it allows for some risk in the bond portfolio to achieve a reasonable yield return.

Preferred Shares – These holdings are used primarily for the tax advantage of dividend income in a taxable account. If someone has an income of $75,000, in Ontario they will get taxed at 33% on bond interest, but just 14% on dividends. In Alberta, the number goes from 32% on interest down to 10% on dividends. While not equal in risk to corporate bonds, they are close, especially if there is some form of redemption or rate reset feature. In some cases today, the yield on preferred shares is meaningfully higher than bonds with similar risks.

Stocks – The goal is to hold dividend “payers” and dividend “growers”, and to do the work necessary to identify companies at risk of dividend cuts, very early on. According to Ned Davis Research, based on the S&P 500 from January 1972 to April 2009, the annual gain for stocks of dividend growers and dividend initiators was 8.7%. Stocks which did not pay dividends returned less than 1%. Stocks that reduced their dividends at some point, earned 0.5% per year.

To build off of this information, one would start with the requirement that all stock holdings must pay a dividend. The companies should have a dividend yield that equals or exceeds its industry group. They must be growing earnings on a forward looking basis. They must be large cap companies. They must have a history of maintaining or growing dividends. They must have a payout ratio that is reasonable as compared to their industry peers, and not exceed 80% of earnings.

A US model that has followed a similar approach, has managed to average an 11.1% annual return over the past 18 years, while having meaningfully lower volatility (a Beta of 0.7 or 30% less volatile than the overall index) than the S&P 500.

Covered Call Writing – This strategy can be complicated, but in a nutshell it lowers risk and increases income. Exactly what the income investor likes. The downside is that it will lower returns in very strong markets, so if the TSX returns 20% in a year, your portfolio might return 15%. The net result of using covered calls is that you boost the income of the portfolio, you generally outperform in down markets, you generally outperform in flat to slightly improving markets, and underperform in strong markets.

It can be achieved using some new ETFs from companies such as BMO and Horizons, or you can find some investment counsellors and brokers that have a particular expertise in this area.

One of the big positives of this strategy is that the income generated is considered capital gains for tax purposes. Not only is this a lower taxed type of income, but for those with a build up of capital losses over the years, this is one of the only ways to ensure a capital gain – effectively getting income with no tax (until you use up your losses).

Given the objectives of the investor (protect capital, boost income, more stability), this covered call option strategy can be very effective.

With these five components, you are able to have an entire investment portfolio without going out too far on the risk front with any security, but generating an income yield easily exceeding 4%. The reason is that the yield on bonds, preferred shares and common stock dividends should be close to 4% on its own. When you add on the income from covered call options, it will easily move you close to the 5% mark.

The key benefits for income investors to this approach are:income yield somewhere between 4% and 5.5% without holding high risk investments; lower volatility; better tax efficiency; total flexibility on cash withdrawals to meet personal needs.

This portfolio is almost certain to outperform the stock market in a down year but just as certainly it will underperform in a strong stock market. However, if many pundits are correct, we may not be seeing many 15%+ years in the market in the near future.

How to Achieve True Wealth

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We all seek it, but very few of us are fortunate enough to grasp the sense of true wealth.

I’m not referring so much to the amount of money you have, but to achieving complete fulfillment in your life. To find the answer, I will take you on a short journey and demonstrate why your best efforts to date might not have delivered on your aspirations and dreams.

Firstly, I believe most of us set ourselves up for failure from the outset by looking for the quick fix. We confuse speculation with investing. Let’s not kid ourselves; most of us spend more time planning where we are headed over the holidays than our future well-being. We’re trained in fields other than financial management yet somehow feel we have the smarts to do it ourselves.

Some of us have realized that it would be wise to consult an expert, which is a positive step but still fails to consider how each of the different financial initiatives affect each other. By working with a mutual fund salesperson you may have achieved a good RRSP plan, but not given any thought to adequate insurance coverage or paying down the mortgage. One step forward, two steps back in my humble opinion.

Once an overall plan has been put in place the role of the specialist can be better defined

I’m a strong advocate of financial planning as the one discipline that considers all aspects of your financial situation and the development of a plan to suit your individual and family needs. Once an overall plan has been put in place the role of the specialist can be better defined whether it is investing, insurance, debt consolidation or estate planning.

Having dealt with literally hundreds of clients over the years has confirmed my belief that the only sure path to success is to have a holistic plan. Sounds simple enough, but is rarely achieved.

True wealth is…

As a professional financial planner, I start off by challenging clients to really think about their lives in a way that they haven’t before. I’ve developed a number of tools to challenge my clients to evaluate where they stand and articulate future life aspirations.

In the simplest terms, our lives can be divided into five categories:

  1. Financial
  2. Health
  3. Relationships
  4. Adventure
  5. Spiritual

While these are obviously interconnected, each one is distinct and should be considered separately. I then focus on incorporating a plan that is needed to allow them to achieve ‘true wealth’. This is about finding the ideal balance between all the various elements of financial planning as it relates to their specific goals and aspirations.

At TriDelta, we look at your lifestyle and get you involved to clarify your priorities before we start on a financial plan. We offer unbiased advice and solutions because our compensation has no bearing on the product or package you select. We are about the big picture and we focus on finding the right balance between all the aspects of your financial life – investment management, protection (insurance), estate planning, tax minimization and cash flow management to achieve your goals.

We are part of a new breed of financial boutiques whose growth is being spurred by clients looking for better value than they get from their bank.

How do you define true wealth? What do you value in a financial planner? We encourage you to take the next step towards true wealth by contacting us.

While you’re here, please leave a comment below.  This article was written by Anton Tucker, VP of TriDelta Financial. You can follow him on Twitter or connect with him on LinkedIn.

5 Investment Scams You Must Avoid

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That salesman may seem nice but take some precautions before signing away your savings (Thinkstock/Getty Images)

Bernie Madoff got our attention. We wondered: could it happen to us?

The reality is that these scams are as old as time, and are going on right now. There are also ways to avoid them. Here’s how:

“We truly, truly believed this man.”

This was a quote from a recent victim of a 38-year-old real estate entrepreneur from Oakville, Ontario. Trusting someone takes time and is an important thing. The problem is that all victims seem to say the same thing. If someone seems honest and respected in the community, they probably are. However, don’t invest your money based on that. It has cost people billions of dollars. There needs to be something much more tangible beyond personal trust.

“The rates of return are so good.”

One of my clients made a comment about the GIC rates at Stanford International Bank in Antigua. They wondered if they should put some of their safe money there because they could get 5% and 6% rates on short-term GICs. The questions that need to be answered fully are always, ‘why such a good return? What is the investment in? What is so special about how the underlying investment is to achieve this extra return?’  If you keep asking questions and get clear answers, then it might very well be a good investment. The problem is if you are not in a position to know what questions to ask, it can be difficult to discern between a real investment and a not-so-real one. The other obvious sign to run is when you ask questions about the investment or its structure and you don’t really get straight answers.

“Can I see the value of my investments?”

This is another warning sign. In most Ponzi schemes, the value shown on a statement was a made-up number. The value behind the number was not entirely clear. Anytime you invest in something that isn’t publicly traded or held at a large financial institution, you are taking greater risk.

For example, if you own 100 shares of Royal Bank according to your custodian at TD Bank Financial Group, you can be pretty certain you actually own 100 shares of Royal Bank. You can then look on the public and open stock market and see the value of those 100 shares. If you have money in Stanford Bank (even though it was very large) in Antigua, you will get a statement showing a balance of dollars. You had better be confident in the banking regulator in Antigua that they have a strong enough system to ensure those dollars are actually there.

“First I put in $20,000. It did well, so I put in $50,000. It did well, so I put in $250,000.”

Humans are greedy by nature and it’s tough to overcome. When something appears to perform well, it is natural to want to have more money invested in it. If the investment is growing on paper, how certain are you that it represents a real number? The toughest scenario is when you put money in and take it out before making further investments. It is then real cash. It instills confidence. It builds trust. This is why Ponzi schemes are so successful. Unless there is a run on the money, as long as new money is going in, most investors can get their funds out. Don’t be fooled by an initial good investment by betting the farm.

“I trusted my gut feelings that this was a good investment.”

Don’t trust your gut. Trust your brain and do your homework. Your life savings are too important to risk on “liking the guy” or “they seemed honest.”At the end of the day, investment is always a balance of risk and reward. Always understand the true risks you are taking. If the cheque is written out to a small entity or person — please do a triple check before handing the money over. The next Ponzi scheme is being set up right now.

Do you have an additional tip for avoiding a scam? Leave a comment below or message us on Twitter or Facebook!

Ted Rechtshaffen is president and CEO of TriDelta Financial, a firm that provides independent financial planning and investment advice. This article was originally published in National Post.

 

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