Whew! I was pretty sure that holding a portfolio of uncorrelated assets would be just as worthwhile in retirement when withdrawals are being made as it is in the build-up phase before retirement but now I've found someone has crunched the numbers to demonstrate the fact. And the results are impressive.
Retirees are much more concerned to avoid downside risk, the risk of loss that cannot be recovered when poor returns occur, especially several years in a row of negative returns, such as happened in stock markets from 2001 to 2003. The opportunity to make up for losses by working harder or longer is not available to retirees. Capital preservation comes before everything. That fear is the reason many retirees stick to safe bonds, GICs, money-market funds. Unfortunately, such investments have low rates of return too.
In The Benefits of Low Correlation, Craig Isralesen shows that a balanced diversified portfolio is an attractive alternative. He calculates the results from the point of view of a US retiree withdrawing 5% a year (and adjusted upwards by 3% a year for inflation) from a hypothetical portfolio consisting of equal weights in seven different asset classes: large cap US equity, small cap US equity, non-US equity, intermediate term US bonds, cash (T-bills), REIT and commodities. He uses actual return data from 1970 to 2006. He works out the portfolio return and volatility but also shows - and this is the key part for a retiree - how much and how often the portfolio would go down, considering that the withdrawals were also taking place. What is particularly interesting and instructive (after all, he is a university prof) is that he starts with a portfolio of only two assets (the US equities) does all the calculations and then adds another one till the full seven are included. The progressive benefit of downside risk reduction, portfolio stability and return enhancement (or reduction, when a lower return asset like cash is added) comes out very clearly.
It is not the actual numbers he calculates that are important - a real portfolio would have transaction costs and tracking error and the future will not be exactly like the past. Plus a 4% withdrawal rate would reduce even further the risk of a reduction in the portfolio's value in any year, enhancing its sustainability. It is the effect and the magnitude of the effect of diversification through uncorrelated assets that is worth noting.
Here is part of Israelsen's conclusion:
"There are several quantifiable benefits of lowering the correlation of a retirement-withdrawal-mode portfolio's component assets. First, there is a dramatic reduction in the volatility of the portfolio's performance (i.e., lower standard deviation of return). Second, there is a significant reduction in the worst-case portfolio loss, or maximum drawdown. Third, the likelihood (or frequency) of loss is minimized. Fourth, performance does not suffer if sufficient diversification is achieved."
As a mini example of the benefits touted by this study, in my own portfolio, shown at the bottom of the blog, the huge rise in commodities and emerging markets has partially offset the fall in US and European equities, providing stability in the past year.
The lesson I draw is that a diversified portfolio is a viable alternative for a retiree, close to the safety of cash but with much higher returns. Happily, passive index mutual funds or ETFs provide a practical way of implementing such a portfolio. Finding new uncorrelated assets to put into the portfolio, such as inflation-indexed bonds (RRBs in Canada TIPS in the US), which Israelsen did not consider, will have similar benefits of further risk reduction or return enhancement, or both.
Saturday, 31 May 2008
Wednesday, 28 May 2008
Everybody's Talking Globalization and Oil Prices but Inflation is the Real Worry
Judging by the number of media that have reported the story, and the comments on the CBC website, a report by Jeff Rubin and Benjamin Tal, Will Soaring Transport Costs Reverse Globalization?, has revealed the hatred of globalization many people seem to harbour.
What they should really be worried about is the rising specter of inflation, which will do everyone a lot more harm. The same CIBC World Markets report contains a prediction that 2009 will see much higher inflation. Already, a BBC report says world economies are being hit by higher oil prices. Who cares where the steel in your toaster comes from if it costs 15% more along with everything else you buy and your job gets downsized in a slowdown? CIBC notes that Canadian inflation has only been kept at bay so far by the rise in our dollar.
Perhaps oil costs will cause a slowdown or even a partial reversal in the growth of world trade (aka globalization) but it won't be more than temporary. The transport industry will adjust - e.g. in the short term by slower steaming (see this study of optimal ship speeds and oil consumption) and in the long term by building ever larger containerships (not faster ones as this website shows) that lower unit costs or by adopting nuclear power (see this serious assessment by a US government body) as Sir George Thomson predicted more than 50 years ago in his remarkable book (so many of his predictions, based on physical laws - he was a nuclear prize winning physicist - are spot on) The Foreseeable Future "I think that we may expect shipping to go nuclear about the time that the natural oil gives out."
What they should really be worried about is the rising specter of inflation, which will do everyone a lot more harm. The same CIBC World Markets report contains a prediction that 2009 will see much higher inflation. Already, a BBC report says world economies are being hit by higher oil prices. Who cares where the steel in your toaster comes from if it costs 15% more along with everything else you buy and your job gets downsized in a slowdown? CIBC notes that Canadian inflation has only been kept at bay so far by the rise in our dollar.
Perhaps oil costs will cause a slowdown or even a partial reversal in the growth of world trade (aka globalization) but it won't be more than temporary. The transport industry will adjust - e.g. in the short term by slower steaming (see this study of optimal ship speeds and oil consumption) and in the long term by building ever larger containerships (not faster ones as this website shows) that lower unit costs or by adopting nuclear power (see this serious assessment by a US government body) as Sir George Thomson predicted more than 50 years ago in his remarkable book (so many of his predictions, based on physical laws - he was a nuclear prize winning physicist - are spot on) The Foreseeable Future "I think that we may expect shipping to go nuclear about the time that the natural oil gives out."
Tuesday, 27 May 2008
Faster Electronic Payments in the UK ... Possibly
An article on the BBC website Faster Bank Transfers Underway lets us know of the start-up today of a worthwhile service that allows people to make same-day transfers from their own bank account to someone else's bank account. The existing electronic payment service (called BACS) saw the money disappear from the sending account and then show up three days later at the recipient's account.
The drawback is that not all the banks are starting up at the same time (see this previous BBC article How Fast is Faster Payment Plan?) and some are phasing in the amount that can be transferred, starting with small amounts now and upping it later to the eventual maximum of £10,000. This is apparently to avoid the "Terminal 5 Effect" (thank you British Airways for enriching our language with a delightful new phrase that denotes big bang cutover disasters). Instead of Terminal 5, we have the equivalent of a gradual shift from driving on the left to driving on the right - motorcycles the first week, trucks and buses the following week, cars the third week and so on. It will likely be mid-2009 before we can count on the new service.
The launch is so low-key that Lloyds TSB, one of the first banks supposedly offering the service today, makes no mention of it on its website, or even in the payments function inside an account.
Nice try APACS (the UK payments association), which has a checker to verify if your sort code is able to receive one-day payments. We' ll rate this 5 out of 10 for now. Why could the existing same-day transfer service called CHAPS not have been made free and expanded to everyone? Does it have to do with another hoary but true axiom of the IT world that describes the difficulty of modifying an operating application, "God could not have created the world in seven days if He had had an installed base"?
The drawback is that not all the banks are starting up at the same time (see this previous BBC article How Fast is Faster Payment Plan?) and some are phasing in the amount that can be transferred, starting with small amounts now and upping it later to the eventual maximum of £10,000. This is apparently to avoid the "Terminal 5 Effect" (thank you British Airways for enriching our language with a delightful new phrase that denotes big bang cutover disasters). Instead of Terminal 5, we have the equivalent of a gradual shift from driving on the left to driving on the right - motorcycles the first week, trucks and buses the following week, cars the third week and so on. It will likely be mid-2009 before we can count on the new service.
The launch is so low-key that Lloyds TSB, one of the first banks supposedly offering the service today, makes no mention of it on its website, or even in the payments function inside an account.
Nice try APACS (the UK payments association), which has a checker to verify if your sort code is able to receive one-day payments. We' ll rate this 5 out of 10 for now. Why could the existing same-day transfer service called CHAPS not have been made free and expanded to everyone? Does it have to do with another hoary but true axiom of the IT world that describes the difficulty of modifying an operating application, "God could not have created the world in seven days if He had had an installed base"?
Sunday, 25 May 2008
Two HighQuality Web / Blog Sites
Here are two sites worth bookmarking:
- CXO Advisory Group - run by Steve LeCompte, former US Navy man with a physics degree, this site reviews research studies and draws out the investing implications. Good for a chuckle is his Guru Grades, where he tracks the accuracy of forecasts by various stock gurus, showing that some do ok and some are worse than the proverbial dartboard.
- InvestmentGuide.co.uk - a very thorough primer for the UK investor, covers just about everything you could want to know; no eye candy illustrations (and almost no ads either), just well-organized with lots of intra-linking and well-written text for the person willing to read; use it as a reference or read it from end to end.
Saturday, 24 May 2008
Lessons of a Failed Endowment
An acquaintance here in the UK recently received the annual statement for a Life with Profits Endowment policy. An endowment is a kind of investment whose purpose is to provide a target lump sum a specified number of years in future, when it matures. Most often, as in this case, it is meant to pay off an interest-only mortgage when the mortgage ends. The word "Life" means that there is also a life insurance policy that pays off the lump sum if the person dies before the policy matures. The "with Profits" bit refers to the method of crediting the profits generated by the underlying investments in stocks and bonds (the details of which are hidden and unknown to the investor). The profits are dribbled out in the form of so-called bonuses to smooth out returns from year to year. The proceeds are normally free of further tax in the hands of the investor since the life insurance company has already paid taxes. Endowments were often touted as "tax-free" investments when all that really meant is that they were tax-prepaid. For a longer explanation, read this page at InvestmentGuide.co.UK.
In this case, the endowment was to generate £24,000 over the twenty years, starting in 1992 and maturing in 2012. My acquaintance would pay £49 a month during the twenty years. That's about a 6.5% rate of return. It would actually be a little more since the insurance component costs something and not all goes into the investment component, but the insurance cost is minor - less than 10% of the premium.
"RED ALERT: HIGH RISK OF SHORTFALL" read the top of the statement in big bold (though not red) letters. You're not kidding! The plan as of May 2008 was worth £13,162. That's about 4% return per year. The statement also provides low/medium/high projections of possible value at maturity in 2012 were £16,400, £17,500 and £18,600 using 4%, 6%, 8% growth rates. Hmm, wonder which one to count on? High risk of shortfall? Is this the British fondness of under-statement?
To put this abysmal rate of return since 1992 in perspective, consider that the FTSE 100 index has risen about 5.3% a year since 1992 (see EconStats for the numbers). That's not even counting the 3% or so per year in dividends distributed by those companies, which would give an annual return of 8.3%. In that context, the 6.5% per year that would have been required to produce £24,000 seems quite achievable, even if lower yielding bonds were added to the mix.
I suspect that fees and expenses ate away the returns as much or more as Standard Life's investment incompetence. Whatever the cause, the result is awful, especially since the person is still locked in and cannot cash out, or even suspend payments, without paying severe penalties that would be worse than simply sticking with it for another four years. Caveat emptor indeed!
The lessons I draw from this:
In this case, the endowment was to generate £24,000 over the twenty years, starting in 1992 and maturing in 2012. My acquaintance would pay £49 a month during the twenty years. That's about a 6.5% rate of return. It would actually be a little more since the insurance component costs something and not all goes into the investment component, but the insurance cost is minor - less than 10% of the premium.
"RED ALERT: HIGH RISK OF SHORTFALL" read the top of the statement in big bold (though not red) letters. You're not kidding! The plan as of May 2008 was worth £13,162. That's about 4% return per year. The statement also provides low/medium/high projections of possible value at maturity in 2012 were £16,400, £17,500 and £18,600 using 4%, 6%, 8% growth rates. Hmm, wonder which one to count on? High risk of shortfall? Is this the British fondness of under-statement?
To put this abysmal rate of return since 1992 in perspective, consider that the FTSE 100 index has risen about 5.3% a year since 1992 (see EconStats for the numbers). That's not even counting the 3% or so per year in dividends distributed by those companies, which would give an annual return of 8.3%. In that context, the 6.5% per year that would have been required to produce £24,000 seems quite achievable, even if lower yielding bonds were added to the mix.
I suspect that fees and expenses ate away the returns as much or more as Standard Life's investment incompetence. Whatever the cause, the result is awful, especially since the person is still locked in and cannot cash out, or even suspend payments, without paying severe penalties that would be worse than simply sticking with it for another four years. Caveat emptor indeed!
The lessons I draw from this:
- don't invest in something merely for tax savings or a tax-free payoff
- fees and expenses are a critical investment evaluation factor, the lower the better
- passive index-type investments will more often do better for the average person than any type of active fund management, even when the approach of the fund company is conservative - the fund performance is just under a lower bar
- a complicated product like an endowment should be subject to much skeptical scrutiny - e.g. why is an endowment better than simply buying term life insurance separately and getting a repayment mortgage? If you cannot understand what you are buying, there is a significant chance you will be taken advantage of - see ThisIsMoney article amongst many, on how mis-selling of endowments caused enormous criticism and compensation for some has come about.
Wednesday, 21 May 2008
US Tax Gotchas for Canadian Snowbirds
Came across this write-up by frequent Financial Webring and 50Plus.com forum contributor Keith Cowan on some little-known dangers for Canadian snowbirds who spend anything more than 122 days a year on a regular basis in the USA. It is about unintentionally getting caught up in the US income tax net. Yikes!
Monday, 19 May 2008
Ins and Outs of Mortgage Investment Corporations
A reader brings up an interesting question:
"I'm interested in investing in real estate, but the market is pretty volatile right now and I don't want to put a large lump some of money into real estate at this point but still would like to 'play' the market. What do you think about mortgage investment corporations like ACIC? I found their website (http://www.acicinvestor.ca)? Could you do a review of ACIC or products like this?"
I must admit to not knowing about MICs before now, so I am approaching this cautiously and don't pretend to have a final answer or a blanket answer that applies to every MIC. A due diligence process is very much in order.
What is a Mortgage Investment Corporation? (good place to start, huh?)
A MIC is a corporate structure recognized in Canada's Income Tax Act (thus the use of MIC as a proper noun) that enables small investors to pool funds and invest in (i.e. act as a lender of) mortgages. The Act allows the MIC itself to be exempt from income tax as long as it passes along all its income to the investors, in whose hands it is, of course, taxed.
A picture is worth a thousand words (perhaps more, the way I write). Here is a good summary of the flow of various funds into and out of a MIC from one of these outfits Magenta Mortgage Corporation.
Just below the diagram on the Magenta explanatory webpage is a succinct summary of the Income Tax rules about what a MIC can and cannot do. Or you can try deciphering the ITA section 130.1 yourself. Here is Magenta's summary:
(btw, to me the availability on a company's website of clear and complete information is a good sign, though by no means a final answer)
MICs go back to the 1970s, that alone being a favourable point. If their format/structure itself were bad, they should have disappeared, right?
MICs are thus a legitimate investment vehicle, though naturally that doesn't mean every MIC will be successful and a good place to invest money.
The Prospectus and Audited Financial Statements
MICs are securities and as such, are bound by the securities regulator in its home province to send a prospectus to all potential investors. The Prospectus details everything about the MIC and is essential reading. Most of the MIC websites are coy and require you to give them your name and contact info before giving you a copy (no doubt so they can do some selling). One exception is Westboro, whose very readable Prospectus is on this Documents page.
The audited financial statements tell you how the company is succeeding, how much profit it is making, how big and diversified is its lending, how much leverage it is using, percent of loans in arrears and so on. It's necessary and highly useful reading to understand a potential investment.
Each to Its Niche
Within the tax rules, MICs vary quite a lot in the types of loans and borrowers they focus on. Among the possibilities: first mortgages, second mortgages, multi-unit residential buildings, construction loans, individuals or companies, commercial properties (up to the limit), people the banks won't lend to like poor credits, bankrupts, self-employed, undeclared income
Rates of Return
This is the big carrot, naturally. The historical rates claimed went from a minimum of 8% a year up to c. 12%! That's impressive! This is cold, hard cash either paid out, either monthly, quarterly or semi-annually, as a cheque / deposit into your bank account or reinvested. That's pretty darn good considering that these cash distributions have been steady for years. For instance, check out Cove MIC's table of its returns , which averaged 10.53% since 1999.
What are the Risks?
Check out the sensible questions that the OSC suggests you ask in this information page on the Westboro site.
Fraud - less likely since a MIC must produce audited financial statements every year. Check out the financial statements and see if the MIC is subject to any lawsuits.
Losing MIC Status - failing to keep within the Income Tax Act rules would cause the MIC to have its income taxed before being distributed to shareholders and would lower returns considerably
Manager (In)competence - the success of the MIC depends to a critical degree on the experience, expertise, judgement and good faith of the managers. Do they know the business, do they know their market and do they have a record of success? Can and will they find a steady flow of new mortgages to keep the income flowing in? Think of it as a job interview.
Leveraging - the rules allow the MIC to borrow money but some do more than others. The spread between the lower rate of the MIC's borrowing and the lending will boost the ability to generate shareholder returns but it also increases risk. The audited financial statements will show how much the MIC has borrowed. The prospectus will say if the MIC has a policy to cap what it will borrow. Many of the MICs are fairly short term lenders - 24 months or so - which reduces interest rate risk and should allow the MIC to continually readjust its lending rate to match increases or decreases in general interest rates and keep the spread between its lending and its bank borrowing rates constant.
Default on Mortgages - mortgage borrowers may not pay back what they owe; all the MICs claim to be very careful about who they lend to but some are explicitly in a niche where the banks don't tread or in second mortgages. The MIC gets a higher interest rate but that is associated with the higher risk. At least one MIC - Cooper Pacific - has two funds, one that lends out first mortgages with an 8% return and another with second mortgages with a 12% return. "You takes your picks and you takes your chances."
Market Downturn / Geographical concentration - some MICs, the smaller ones, are concentrated in very limited markets, like Westboro in Ottawa or Edgeworth in northern Alberta. Ottawa is a stable market but what happens to Edgeworth if the oil industry cools off considerably, as it has done in the past? A general economic recession would everywhere increase the number of borrowers having difficulty to repay.
Liquidity (Can't sell) - the basic method to get your money back is not a sale in some market since MICs are not (with one exception, I found) publicly quoted companies but for the MIC to redeem the shares; the restrictions vary by MIC, whether funds can be sold / withdrawn immediately, or with 30/60/90 days notice; for smaller MICs, the Income Tax Act restriction that each MIC must have at least 20 shareholders might come into play;
A Partial List of MICs - there seem to be a lot of these around
Taxes and Which Account to Hold the MIC Investment
A registered account such as an RRSP or a RRIF is the natural place for a MIC investment since it will generate all its income only as interest (and not as dividends, despite some use of the word dividends to describe the cash distributed; and don't be fooled when they are called preferred shares - the dividends are interest for tax purposes), which is taxed at the highest rate. I don't know for sure but I would hope and expect that a MIC could also reside within a LIRA or an LRIF but that would need checking out.
Some MICs want or allow you to hold the MIC investment withing your own self-directed RRSP. Others want you to set up an RRSP with a connected financial services provider.
Minimum Investment Amount
This may be the key practical point that blocks the average investor from getting into a MIC. The lowest minimum investment I found was $5,000 at ACIC and that only for a non-registered account. There is the publicly traded Quest Capital whose shares sell for about $2.05-$2.10, so you can get in for less ... but is it a good MIC?
The MIC's Place in a Portfolio
A MIC is fixed income. But unlike a bond, the value of your principal stays the same. If you invest $10,000, that's what you get back when you redeem shares and cash out. Bond value will fluctuate with interest rates, which affects their return. The MICs return is only the interest. As for other asset classes, like real estate investment trusts (REITs), various types of equities, real return bonds (RRBs) and short term cash (i.e. things like T-bills and GICs), the MIC is most like latter - little or no variation in principal value or in returns. There is more risk however, due to the nature of the mortgage investment.
I would suspect there is little correlation of returns with any other asset class, which means that MICs offer the happy prospect of adding true diversification to a portfolio by either reducing overall variability or increasing returns, or a bit of both.
Being ever the compromiser, I would therefore tend to replace some of my cash-type holdings and some of my corporate bonds, perhaps up to 10% of my overall portfolio.
For others like retired folks who want a steady, high income stream and don't mind the tax rate, MICs may be a good vehicle.
As far as ACIC goes, I cannot offer an opinion since I didn't feel like giving them my name and details just to have a look at their prospectus and financial statements and get into their guts a bit more.
MICs are definitely worth consideration and will get a close look when I do my portfolio review shortly.
Thanks for the great question.
"I'm interested in investing in real estate, but the market is pretty volatile right now and I don't want to put a large lump some of money into real estate at this point but still would like to 'play' the market. What do you think about mortgage investment corporations like ACIC? I found their website (http://www.acicinvestor.ca)? Could you do a review of ACIC or products like this?"
I must admit to not knowing about MICs before now, so I am approaching this cautiously and don't pretend to have a final answer or a blanket answer that applies to every MIC. A due diligence process is very much in order.
What is a Mortgage Investment Corporation? (good place to start, huh?)
A MIC is a corporate structure recognized in Canada's Income Tax Act (thus the use of MIC as a proper noun) that enables small investors to pool funds and invest in (i.e. act as a lender of) mortgages. The Act allows the MIC itself to be exempt from income tax as long as it passes along all its income to the investors, in whose hands it is, of course, taxed.
A picture is worth a thousand words (perhaps more, the way I write). Here is a good summary of the flow of various funds into and out of a MIC from one of these outfits Magenta Mortgage Corporation.
Just below the diagram on the Magenta explanatory webpage is a succinct summary of the Income Tax rules about what a MIC can and cannot do. Or you can try deciphering the ITA section 130.1 yourself. Here is Magenta's summary:
(btw, to me the availability on a company's website of clear and complete information is a good sign, though by no means a final answer)
MICs go back to the 1970s, that alone being a favourable point. If their format/structure itself were bad, they should have disappeared, right?
MICs are thus a legitimate investment vehicle, though naturally that doesn't mean every MIC will be successful and a good place to invest money.
The Prospectus and Audited Financial Statements
MICs are securities and as such, are bound by the securities regulator in its home province to send a prospectus to all potential investors. The Prospectus details everything about the MIC and is essential reading. Most of the MIC websites are coy and require you to give them your name and contact info before giving you a copy (no doubt so they can do some selling). One exception is Westboro, whose very readable Prospectus is on this Documents page.
The audited financial statements tell you how the company is succeeding, how much profit it is making, how big and diversified is its lending, how much leverage it is using, percent of loans in arrears and so on. It's necessary and highly useful reading to understand a potential investment.
Each to Its Niche
Within the tax rules, MICs vary quite a lot in the types of loans and borrowers they focus on. Among the possibilities: first mortgages, second mortgages, multi-unit residential buildings, construction loans, individuals or companies, commercial properties (up to the limit), people the banks won't lend to like poor credits, bankrupts, self-employed, undeclared income
Rates of Return
This is the big carrot, naturally. The historical rates claimed went from a minimum of 8% a year up to c. 12%! That's impressive! This is cold, hard cash either paid out, either monthly, quarterly or semi-annually, as a cheque / deposit into your bank account or reinvested. That's pretty darn good considering that these cash distributions have been steady for years. For instance, check out Cove MIC's table of its returns , which averaged 10.53% since 1999.
What are the Risks?
Check out the sensible questions that the OSC suggests you ask in this information page on the Westboro site.
Fraud - less likely since a MIC must produce audited financial statements every year. Check out the financial statements and see if the MIC is subject to any lawsuits.
Losing MIC Status - failing to keep within the Income Tax Act rules would cause the MIC to have its income taxed before being distributed to shareholders and would lower returns considerably
Manager (In)competence - the success of the MIC depends to a critical degree on the experience, expertise, judgement and good faith of the managers. Do they know the business, do they know their market and do they have a record of success? Can and will they find a steady flow of new mortgages to keep the income flowing in? Think of it as a job interview.
Leveraging - the rules allow the MIC to borrow money but some do more than others. The spread between the lower rate of the MIC's borrowing and the lending will boost the ability to generate shareholder returns but it also increases risk. The audited financial statements will show how much the MIC has borrowed. The prospectus will say if the MIC has a policy to cap what it will borrow. Many of the MICs are fairly short term lenders - 24 months or so - which reduces interest rate risk and should allow the MIC to continually readjust its lending rate to match increases or decreases in general interest rates and keep the spread between its lending and its bank borrowing rates constant.
Default on Mortgages - mortgage borrowers may not pay back what they owe; all the MICs claim to be very careful about who they lend to but some are explicitly in a niche where the banks don't tread or in second mortgages. The MIC gets a higher interest rate but that is associated with the higher risk. At least one MIC - Cooper Pacific - has two funds, one that lends out first mortgages with an 8% return and another with second mortgages with a 12% return. "You takes your picks and you takes your chances."
Market Downturn / Geographical concentration - some MICs, the smaller ones, are concentrated in very limited markets, like Westboro in Ottawa or Edgeworth in northern Alberta. Ottawa is a stable market but what happens to Edgeworth if the oil industry cools off considerably, as it has done in the past? A general economic recession would everywhere increase the number of borrowers having difficulty to repay.
Liquidity (Can't sell) - the basic method to get your money back is not a sale in some market since MICs are not (with one exception, I found) publicly quoted companies but for the MIC to redeem the shares; the restrictions vary by MIC, whether funds can be sold / withdrawn immediately, or with 30/60/90 days notice; for smaller MICs, the Income Tax Act restriction that each MIC must have at least 20 shareholders might come into play;
A Partial List of MICs - there seem to be a lot of these around
- All Canadian Investment Corp (ACIC) - lends mostly in western Canada on multi-unit residential and commercial mortgages; min $5k investment / $20 k in RRSP (2% fee if redeemed in less than 2 yrs)
- CareVest Capital Inc. - lends in Ontario and western Canada; residential and commercial mortgages; founded 1994; $400 million in assets; 4000 investors
- Cooper Pacific Mortgage Investment Corporation - western Canada; founded 1994; 1000 investors; interim mortgage and construction finance; min $25k; monthly dividends
- Cove Mortgage Investment Corporation - BC; founded 1976; $42 million in assets
- Dominion Properties - Edmonton;
- Edgeworth Mortgage Investment Corporation - northern Alberta; recently founded
- First Island - BC and Alberta mortgages only; founded 1973; $155 million in assets
- Magenta Mortgage Corporation - Ottawa and eastern Ontario, 14 years in operation
- Sun Country MIC - western Canada; founded 2001
- TGL Mortgage Investment Corporation - Alberta; "high yield" mortgages
- Quest Capital Corp - unusually, a public company quoted on the TSX (symbol QC)
- Westboro Mortgage Investment Corporation - Ottawa; founded 2006; min $100k investment; aim to have $3m under investment by 2008; interesting discussion of their clientele and niche under How is it all possible
Taxes and Which Account to Hold the MIC Investment
A registered account such as an RRSP or a RRIF is the natural place for a MIC investment since it will generate all its income only as interest (and not as dividends, despite some use of the word dividends to describe the cash distributed; and don't be fooled when they are called preferred shares - the dividends are interest for tax purposes), which is taxed at the highest rate. I don't know for sure but I would hope and expect that a MIC could also reside within a LIRA or an LRIF but that would need checking out.
Some MICs want or allow you to hold the MIC investment withing your own self-directed RRSP. Others want you to set up an RRSP with a connected financial services provider.
Minimum Investment Amount
This may be the key practical point that blocks the average investor from getting into a MIC. The lowest minimum investment I found was $5,000 at ACIC and that only for a non-registered account. There is the publicly traded Quest Capital whose shares sell for about $2.05-$2.10, so you can get in for less ... but is it a good MIC?
The MIC's Place in a Portfolio
A MIC is fixed income. But unlike a bond, the value of your principal stays the same. If you invest $10,000, that's what you get back when you redeem shares and cash out. Bond value will fluctuate with interest rates, which affects their return. The MICs return is only the interest. As for other asset classes, like real estate investment trusts (REITs), various types of equities, real return bonds (RRBs) and short term cash (i.e. things like T-bills and GICs), the MIC is most like latter - little or no variation in principal value or in returns. There is more risk however, due to the nature of the mortgage investment.
I would suspect there is little correlation of returns with any other asset class, which means that MICs offer the happy prospect of adding true diversification to a portfolio by either reducing overall variability or increasing returns, or a bit of both.
Being ever the compromiser, I would therefore tend to replace some of my cash-type holdings and some of my corporate bonds, perhaps up to 10% of my overall portfolio.
For others like retired folks who want a steady, high income stream and don't mind the tax rate, MICs may be a good vehicle.
As far as ACIC goes, I cannot offer an opinion since I didn't feel like giving them my name and details just to have a look at their prospectus and financial statements and get into their guts a bit more.
MICs are definitely worth consideration and will get a close look when I do my portfolio review shortly.
Thanks for the great question.
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