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Market Turmoil – Why your portfolio is not as bad as the market

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Over the past 6 weeks, but especially in the past week, the stock markets have experienced a meaningful pullback.

From its peak to close yesterday, the TSX was down 11.5%.

The US S&P500 was down 7.9% from its peak.

Dow Jones Germany was down 14.8% from its peak.

Our clients have typically fared much better during this period for the following reasons:

  1. The Canadian Bond Universe is up 0.7% since September 1. This is one of the main reasons to own bonds – in most cases they act as a counterbalance to stocks during weakness in the stock market. In addition, it isn’t just owning bonds, but also making the right choices in terms of corporate bonds vs. government bonds, and owning long term bonds vs. short term that can further benefit a portfolio. Fortunately, at TriDelta we have been predicting lower long term bond yields, and have benefitted from owning longer term bonds.
  2. TriDelta looks at volatility risks and builds stock portfolios that are meaningfully less volatile for our more conservative clients, but even for our growth clients, there is an element of capital preservation in our stock selection. As a result, while our stock portfolios have declined in value, we have meaningfully outperformed the TSX index over this rough period. Conservative clients would have outperformed the TSX by 8% on the stock part of their portfolio since the beginning of September (decline of only 3.5%). Growth clients would have outperformed the TSX by 3% on the stock part of their portfolio.
  3. All this means that your asset allocation and risk profile have an important impact on performance when things are going well, and when things are not going so well. For example, a conservative TriDelta client with only 40% in stocks would be down roughly 1% since September 1st. A growth TriDelta client who is 80% in stocks will be down roughly 7% since the peak of the market. In addition, our High Income Balanced Fund is down just 1.5% since September 1. While we never want to be down, this should give you a better sense of how your portfolio has fared within the pullback.

13797194_mA final note on asset mix. We believe that if your asset mix was right for you 6 months ago, it is probably still correct for you today. The only reason for a meaningful change is if your cash flow needs have changed significantly or if your overall financial position has had a meaningful change. If those haven’t happened, we wouldn’t recommend changing now. Keep in mind that in February 2009 it was almost impossible to get people to invest in the market – with most late RRSP contributions going to cash. For the full year 2009, the TSX had a return of 35.1%. The point is that it is very difficult to pick a market bottom, but we do believe it isn’t far off from here. When the bottom hits after a sudden pullback, there is quite often a very strong rally. Investors with a long term perspective do not want to miss that rally.

We will continue to monitor various factors closely, and may make some changes to portfolios as we do throughout the year, but for now, we believe it is not the time for major changes.

One factor we are monitoring is Ebola. We do not know what Ebola will become on a global basis. We do know that over the past 90 years, the fear factor on ‘new’ diseases and viruses has been much greater than the actual global impact. How many of us even remember the Swine Flu? In June of 2009, the World Health Organization and the US Centers for Disease Control announced that it was a Pandemic – and fears were rampant. While not equating the two, we believe that it is very likely that today’s fear will prove to be overdone on a global basis.

As always, we are happy to talk to and meet with all clients at any time. If you have questions or concerns, please do not hesitate to contact your Wealth Advisor.

Thank you.

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

Lorne Zeiler

VP, Wealth Advisor

Why We Own Stocks

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With the equity market sell-off at the beginning of August, investors have been reminded once again that there is risk to investing in the stock market, but before hitting the panic button, it is worthwhile to review why we suggest allocating at least part of your portfolio to equities and why stocks are still likely to offer the best total return over the medium to long-term.

While some people have called the stock market a casino or worse, investors need to be reminded that each share of stock represents a fractional ownership of a business. When you buy shares of Apple, Pfizer, BCE or TD Bank, you are becoming a fractional owner in those enterprises. The value of that business is based on the future earnings and cash flow that those companies generate. Buying shares of good companies at a reasonable price has been and likely will continue to be one of the best methods of building long-term wealth.

The main reason that people have bought equities is to generate higher returns in their portfolio. This is called the Equity Risk Premium (ERP). The ERP represents the additional return that investors have earned owning equities over other asset classes. Historically, equities have provided a 4% higher return than bonds1 per year. If the investment is in a taxable account, that premium is even higher as equities generate capital gains and dividends, both of which are taxed at much lower rates than bonds (interest income). Please note though that the 4% premium is an average, meaning in some years the benefit will be much greater than 4% and in other years equities may earn a lower return than bonds or a negative return.

Inflation Hedge: While bonds offer security – a fixed coupon payment from issue to maturity date as long is there isn’t a default, investors bear inflation risk. This is the risk that if inflation increases, the fixed coupon payments from the bonds will have a lesser value, because these cash flows will not be able to buy the same amount of goods and services, i.e. have less purchasing power.

1727060_sSince equities are public companies, typically when inflation rises, these companies find ways to continue generating higher profits by raising prices and /or cutting costs. E.g. if inflation rises, Walmart, McDonald’s, Royal Bank and TransCanada Pipelines typically find ways to continue increasing profits (and potentially dividend payments to shareholders) through changes in pricing or cost cutting measures, thereby protecting the investor’s purchasing power.

Participate in Economic Growth: While economies do experience contractions from time to time, typically Gross Domestic Product (GDP) increases over time. As the economy expands, so should earnings of quality public companies (equities). Historically, these companies will generate more in sales and be able to increase prices during periods of economic expansion, and be able to reduce costs during periods of economic weakness, which should lead to higher earnings per share (EPS). Higher EPS typically leads to higher stock prices and often to higher dividend payments over time. In short time periods, particularly recessions, equity prices may decline even if earnings rise, but on a long-term basis, equities have been one of the best ways for investors to benefit from economic growth.

Low Interest Rates: While interest rates are expected to rise in the first half of 2015, we expect the increases to be small initially and the pace of the increases to be slow. Low interest rates benefit equities in a few ways: 1) relative attractiveness – institutions and individuals need to put their investment dollars somewhere. When interest rates are low, the relative attractiveness of stocks, particularly those that pay a dividend, is greater, i.e. when your choices are investing in a GIC paying less than 2%, and a government bond paying less than 2.5%, investing in stock that pays a 3% dividend and offers the potential for capital gains is quite appealing. 2) enhanced earnings – with low interest rates, companies need to devote less of their revenues to debt payments, which enhances profit margins and overall earnings. Higher earnings typically leads to higher stock prices. 3) Share buyback – many companies are using their savings on debt costs to buy back their shares on the market. If the number of shares outstanding decreases and earnings remains relatively the same, earnings per share (EPS) improves as well. From Q2 2013 to Q2 2014, U.S. companies bought back approximately 3.3% of their shares outstanding2; these share repurchases increased earnings per share.

While we do not expect equity returns similar to 2013 or 2014 in the year ahead, we still expect equities to outperform other asset classes in 2015. Because of their many benefits, equities should remain a key part of each investor’s portfolio over the long-run.

The overall percentage of equities to own in an investment portfolio, and the type of equities to hold (large capitalization vs. small capitalization, developed market vs. emerging market) are best determined by meeting with a trusted investment counsellor and /or financial planner. A trusted planner reviews their clients’ income and cash flow needs as well as taxes to determine the clients’ needed rate of return. An investment counsellor analyzes investments to determine the best return prospects relative to each investor’s willingness and ability to take risk in his investment / retirement portfolios.

 

[1] http://www.seeitmarket.com/quantifying-equity-risk-premium-13202/. Quantifying Equity Risk Premium, Allan Millar, January 30, 2013. Based on S&P500 Index return vs. U.S. Government and Corporate Bond Indices. Data set from Ibbotson 1926-2010.

[2] http://www.factset.com/websitefiles/PDFs/buyback/buyback_6.18.14. FactSet Quarterly Buyback S&P500, June 18, 2014.

 

Lorne Zeiler
Written By:
Lorne Zeiler, MBA, CFA
VP, Portfolio Manager and Wealth Advisor
Lorne can be reached by email at lorne@tridelta.ca or by phone at
416-733-3292 x225
Cameron Winser
Written By:
Cameron Winser, CFA
VP, Equities
Cameron can be reached by email at cameron@tridelta.ca or by phone at
416-733-3292 x228

First quarter earnings

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TriDelta offers investment solutions that consist of a variety of targeted, discretionary portfolios to deliver superior, risk adjusted returns. These include Canadian, US and global solutions ideal for non-registered, RRSP and TFSA’s.

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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

 
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