Monday, 27 October 2014

Why I still like Low Volatility ETFs

The recent equity market air pocket turbulence has added a bit more comfort and confidence to my decision to devote a substantial part of my Canadian equity allocation to BMO's low volatility ETF (TSX symbol: ZLB). The Google Finance chart says it all - less than half the price drop in October compared to the broad market TSX Composite ETF from iShares (TSX: XIC). What correction?






iShares' low vol ETF with symbol XMV also has a lower drawdown than XIC. I notice also that iShares' value ETF symbol XCV behaved just like XIC. That doesn't seem to offer much support to those who complain that low vol is just the value factor in disguise.


Dave Dierking writing in Seeking Alpha found the same pattern in the USA with the SPLV ETF compared to the S&P 500 SPY fund.

Wednesday, 25 June 2014

WaterFurnace Renewable Energy - All's well that ends well

WaterFurnace (TSX: WFI) is being acquired by a Swedish company in the same business, bringing to an end the four-year holding that I posted about in 2010 when I first bought shares in WFI. Though WFI's price took a big jump up from recent $25 or so to about the $30.60 acquisition price, that has only made for an "ok" investment overall. As the Yahoo Finance chart shows, shortly after I bought it, WFI took a prolonged downward slide that it only recently has recovered. Compared to an market index ETF like iShares TSX Composite XIC, the ride has been a lot bumpier to get to pretty well the same place, though dividends are not included and that would put WFI ahead of XIC since its yield in 2010 was 3.5% while XIC's would have been 1% or so lower - thus 5 years x 1% = 5% more return for WFI bumping it slightly ahead of XIC. Anyhow it's a friendly acquisition so is almost sure to go ahead and thus is the end of the line for WFI.


Here are my takeaways from the experience:

  • Extreme patience is required and the only way to be able to exercise patience is to have some confidence in the on-going value of the company. The seemingly endless downward slide of WFI's stock price from 2010 through 2011, 2012 and 2013 didn't feel great. Stagnant actual company results didn't help much. In early 2013 when I posted after the release of 2012 results, it looked as though the stock price could only be worth $20 max. Regular in-coming dividends - WFI even increased its dividend during the downward slide of stock price - also help greatly to exercise patience. You are getting something back out of the investment. Funnily enough, WFI's recent business results haven't been inspiring enough to think significantly higher stock prices are justified so I am more than happy to sell my shares at $30. As Yogi Berra said, "It's never over till it's over".
  • You can still get sand-bagged by the unexpected no matter how good your due diligence. My MBA-style due diligence before purchase in 2010 was as good as I could make it, yet I still missed the one key factor that has been a severe drag on WFI's business performance (in addition to housing starts), namely the huge drop in natural gas prices and relative loss of attractiveness of ground source heat pumps for heating/cooling as a result of fracking. I'm still not sure whether WFI management didn't realize themselves the importance (incompetence), or just didn't want to tell shareholders (untruthful), but they sure didn't talk or write about it. On-going paranoia about what could go wrong seems to be a necessary attitude to maintain when investing in individual stocks.
  • A follow-on is that Socially-responsible environmentally-friendly companies are not necessarily the best-run. Managers missed the boat on natural gas prices and they have been increasing their pay much faster than performance would justify too.

Thursday, 8 May 2014

Sustainability and Executive Pay in S&P 500 Companies compared to Canadian Large Caps

Pensions and Investments reports on a study by GMI Ratings research firm that found the majority (58%) of S&P 500 linked executive pay to performance on sustainability (aka environmental social and governance) factors. That's perhaps impressive news at first glance, but the link seemed quite weak in most cases according to the article.

It's interesting to compare results with what I found on my other blog when I compiled the numbers for large Canadian companies in various sectors:

... which in total is 34 out of 68, or exactly 50%. It's not far off, though a bit behind, the US results.

Tuesday, 6 May 2014

Book Review: Stocks for the Long Run (5th ed) by Jeremy Siegel

SfLR is a classic, a book that every self-directed investor should read. Primarily history, but with a good dose of explanation, and primarily about the USA, it's the best overview of the equity side of investing one can find. It's a book about stocks in the broad collective sense, not about individual stocks or analysis thereof. Anything you wanted to know about stocks (see the table of contents in the Amazon preview of SFLR) and were wanting to ask and get a succinct intuitive (non-academic, non-mathematical) answer, this is the book.

The mere fact the book is now in its 5th edition twenty years on from initial publication is testament to its enduring well-earned popularity. Author Siegel has not rested on reputation, the main update being an account of the 2008 financial crisis and its aftermath in the first 70 pages.

It's hard to say these are criticisms, but here is what I would like to see expanded (I'll gladly take another 100 pages despite the book being already almost a brick at 400 pages):

  • Central thesis past vs future? - The fact in the following quote accounts for the fame, and the title, of the book "... stocks, in contrast to bonds or bills, have never delivered to investors a negative real return over periods lasting 17 years or more" (going back to 1802 up to 2012 in the USA). OK, so how about the future? What are the chances this streak will continue and what are the factors to support the expectation? Is it just that the USA is lucky, as the-world-is-random folk believe? Siegel does address this crucial question to some degree - yes, since i) emerging markets country investors will buy up the assets of the boomer generation as they sell to finance retirement, ii) prosperity comes from productivity growth in the USA, which will continue. This is not totally convincing. How have stocks done around the world? The experience of other countries is not examined to any degree (Canada itself gets a couple of insignificant mentions), especially those where stock investors lost everything. Others like Elroy Dimson, Paul Marsh and Mike Staunton in Triumph of the Optimists and in their annual Credit Suisse Global Investment Returns Yearbooks have taken a much more extensive long term look. Siegel really considers only volatility risk since that is all that has transpired in the USA. It would be helpful for him to consider other long run equity risk, such as William Bernstein does in Deep Risk (which I discussed here). 
  • Investing strategies beyond cap-weight and fundamental weight? - As his own dissection of the Dow Jones Industrials and S&P 500 stock indices makes clear, cap-weight indices and the funds that implement them are strategies themselves, with significant inefficiencies, despite being miles better than actively managed mutual funds. There are better alternatives but he covers only one - fundamental weighting. Siegel describes small size, value and momentum factors but neglects low volatility and then misses the chance to tie all that together by describing the current state of the art indices/strategies being developed in places like the EDHEC Risk Institute in Smart Beta 2.0, such as maximum diversification, efficient maximum Sharpe, maximum decorrelation, minimum portfolio volatility, risk parity etc.
Nevertheless, it's hard to knock Siegel too hard for the tremendously useful contribution this book makes to investing knowledge. 

There's plenty of footnoting for further reading of sources. There are lots of charts and tables. The lengthy 17 page index is excellent. The writing is clear and jargon-free for the ordinary investor though it helps to have basic knowledge of investing. It's a book one can return to again and again. It gave me plenty of blog post ideas.

Rating: 4.5 out of 5 stars.

Disclosure: The publisher provided me with a copy of the 5th edition for review.

Wednesday, 23 April 2014

Good new, bad news: Living even longer than previously expected

Back in February a Canadian Institute of Actuaries press release told us that as a result of compiling data specifically on Canadians (previously, they had always apparently relied on US data), they discovered that we can all expect to live a couple of years longer. If a man gets to 65, he can expect to live another 22.1 years, vs the older US-based estimate of 19.8 years. Women go up from 22.1 to 24.4 years. Good news - we get to live longer. Bad news - we have to find the money to pay for it, as do our pension plans, which apparently take anywhere from a 1% to to 7% under-funding hit. It also means we'll be getting lower monthly income henceforth when purchasing annuities. Fortunately, it seems from the detailed report on the CIA website that the revised estimates are in accord with the assumptions used in the C/QPP so their long term funding sustainability is not being put in question.

Thursday, 17 April 2014

How long in advance to buy air tickets: USA data

Interesting post on CheapAir.com on the best time to buy a US domestic air ticket - but warns answer is different for international flights. Need this stuff for Canada! Their advice - check early and often.

Wednesday, 16 April 2014

Why my core Canadian equity ETFs deviate from the norm

Some years back I switched my core Canadian equity holdings from the norm - the ETF with the largest net assets by far, the iShares S&P / TSX 60 Index ETF (XIU), which is built on the traditional cap-weight principle - to a combination of two non-cap weight ETFs in equal amounts:
  • Invesco PowerShares FTSE RAFI Canadian Fund (PXC)
  • BMO Low Volatility Canadian Equity ETF (ZLB)
Here's why such a move was the right thing for me (I'm now semi-retired in my early 60s).

1) Better long term returns - Both the RAFI fundamental indexing strategy and the low volatility have been shown by plenty of research to reliably outperform, by 1 to 2% per year, cap-weight over long periods, like 10 years minimum but more surely over 15 years. Given that my selected ETFs have higher MERs by about 0.3 to 0.4% vs XIU and probably extra trading costs, I'm expecting to outperform anywhere from about 0.5 to 1.5% net per year over the long haul. Over 15 years, an extra 1%, such as 4% vs 3% annual compound growth, means an extra 15% more in end value. I'll take that thanks.

But achieving that expectation depends on several other factors and circumstances.

2) Sticking to the strategy - One big danger is getting nervous or impatient in deviating from the norm, being different from everyone else. That's a danger especially when the inevitable lag in performance of PXC and ZLB vs XIU happens and it is tempting to sell out and switch back to XIU. We dumb money retail investors are notorious for switching funds at the wrong time and earning less than the funds we invest in. Though one never knows for sure, I believe the odds of avoiding the premature abandonment of ZLB and PXC are on my side for these reasons:

a) Real after-inflation, after-tax positive return, not the TSX Composite, is my benchmark. My measure of success is going to be on absolute gain or loss terms, not one of keeping up with the XIU Joneses. I am my own investment boss, unlike professional portfolio managers, who get judged compared to the equity market index and so have a marked tendency to need to perform accordingly. It is quite serious stuff for institutional asset managers, as one can detect reading the extreme efforts to build investment strategies that do not deviate too far from the index but still outperform, such as those being developed at EDHEC Risk Institute in papers like Smart Beta 2.0.

b) Expectations, knowledge and experience. I have now been actively investing on my own since 1997, and doing plenty of reading and writing, like this blog and my other blog http://howtoinvestonline.blogspot.com/. I've lived through both the tech bubble cum crash and the credit crisis and its aftermath. I've experienced the sickening sinking feeling. I think I know what can happen. I know it can take 15 years for my strategy to pay off.

Despite being semi-retired, my time horizon is not zero, or even a few years. Though I am consuming my capital saved over my life to date, I expect, and plan, to live many more years. My time horizon is a continuum. Some of my money will only get used in twenty five years if I'm only of average life expectancy. And if I'm wrong and die sooner, then it doesn't matter.  Shrouds have no pockets as the old expression goes. Dying cannot hurt you financially.

c) Properly diversified portfolio. I think I've built a portfolio structure with various types of assets that will be resilient to inevitable future shocks, unless the world descends into nuclear war or a global pandemic wipes out half the global population, in which case it won't matter anyway. I also own lots of resiliency enhancing non-equity assets like ordinary bonds and real return bonds. In addition, the Canadian equity ETFs above have some other features that are beneficial.

Part of my "portfolio" is the fact that my income stream to live off is not wholly dependent on withdrawals from my investments accounts. Sources like CPP and part-time income allow me to fund a good chunk of my essential spending and I can reduce withdrawals somewhat without major lifestyle constriction. Having observed that equity dividend income is in fact quite stable at an aggregate level, even through the worst of times like the recent credit crunch crash, I figure that withdrawing the 2 to 2.5% distribution yield (ZLB's is currently 2.1%, PXC's is 2.6%) will allow me to avoid selling shares at market bottoms and thus largely counter sequence of returns risk. Plus I have a near-term cash cushion for my year-ahead spending that lets me avoid any withdrawals during frequent market corrections aka short-term volatility.

Features of PXC and ZLB
1) PXC essence is a Value tilt while ZLB is a Small Cap and Low Vol tilt. PXC's fundamental strategy relies a lot on a heavier emphasis on out of favour "Value" stocks, while ZLB is accidentally focussed on Smaller Cap stocks (amongst albeit the larger cap end of the TSX) and explicitly selected and weighted by low beta (which more or less corresponds to low volatility and has been found in research to behave the same way). The different essence means that ZLB and PXC will be less correlated with each other (according to InvestSpy.com's calculator over the past year, the correlation between the two is only 0.43) and provide a diversification benefit. Both ETFs have so far been more correlated with XIU than each other. Looking inside the ETFs, that is not such a surprise. No less than 58 of XIU's 60 holdings are held within PXC, accounting for almost 85% of its assets. In contrast, the overlap in holdings between ZLB and PXC makes up only 20% of PXC's total weight in assets.

Of course when a big crisis hits again, their correlations will rise (see this table from William Coaker for an instructive look at how correlations changed in the USA under the various market environments since 1970), so it is other asset classes / holdings, like real return bonds and cash that will provide the un-correlation, but in the meantime of relative market calm, it is worthwhile benefit.

There's a bit of a psychological bonus to ZLB and PXC being so different. At times one will follow along XIU better while the other lags, or vice versa. So far, PXC seems to have tracked XIU better than ZLB, which has powered ahead of both, as the chart below shows. To the extent even I cannot resist comparing with the TSX, I can comfort myself that I am not as much different as all that.


2) ZLB is considerably less volatile. It is no surprise that an ETF whose holdings are selected for low volatility should be less volatile overall. The InvestSpy tool shows that ZLB's past year volatility (standard deviation) of daily prices is only 8.0% vs XIU's 10.2% and PXC's 10.1%. Anything that reduces volatility is especially beneficial for me in the early stages of semi-retirement, where withdrawals at the time of severe downside (historical worst-case figures on this post) can permanently damage a portfolio, the so-called sequence of returns risk. ZLB's maximum downside drawdown should be less than XIU's (as Cass Business School found in table 2 of this paper for this type of fund strategy) though PXC might do worse (table 1 of this paper).

3) PXC and ZLB inherently and automatically incorporate the Value and Small Cap factor tilts. Most investors beyond the beginning stage recognize the accepted reality of outperformance from Volatility, Value and Small cap factor tilts. It's finance mainstream accepted truth. But there's a practical problem for individual investors wanting to take advantage. Using cap-weight ETFs to tilt and capture such benefits requires buying a multiple funds and figuring how much of each to buy. There's no finance theory about how much of each to hold. I have not seen anything more than arbitrary suggested funds and percentages. Do I buy a separate small cap fund only, or a small cap value fund and large cap value fund and should the allocation be 5% or 10% etc? Multiply that by many countries and geographies (Canada, USA, developed market, emerging market) and pretty soon you have a dog's breakfast of funds that is an increasingly costly nightmare to rebalance. Add in multiple account types (TFSA, RRIF, LRIF, LIRA and taxable) and the brain starts to hurt. I like the practical the convenience of two funds only that cover the field. The fewer ETFs I have to own across my multiple accounts, the better.

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