Wednesday 5 December 2012

Readings on the History of the Financial Crisis 2007-2009

Worth reading:  summary of the "how it happened" of the financial crisis 2007-2009 - Getting up to Speed on the Financial Crisis: A One‐Weekend‐Reader’s Guide by Gary Gorton and Andrew Metrick

  • "... changes  in  credit  supply  (bank  loans)  are  a  strong  predictor  of  financial  crises, particularly  when  these  changes  are  accelerating... "
  • "Credit booms seem to often coincide with house price increases."
  • "House  price  run‐ups  prior  to  crises  are  common."
  • "... the financial crisis of 2007‐2009 was not special, but follows a pattern of build‐ups of fragility that is typical."
  • "... banks cut back on credit supply, although the demand for credit also
    " and the availability of credit is how the real economy was harmed - companies reduced expenditures and cut employees
  • "The  financial  crisis  of  2007‐2009  was  perhaps  the  most  important  economic  event  since  the  Great Depression."
  • "The  crisis  was  exacerbated  by  panics  in  the  banking  system,  where various  types  of  short‐term  debt suddenly became subject to runs.  This, also, was a typical part of historical crises.  The novelty here was in the location  of  runs,  which  took  place  mostly  in  the  newly  evolving “shadow  banking”  system, including  money‐market  mutual  funds, commercial  paper,  securitized  bonds,  and  repurchase agreements.  This  new  source  of  systemic  vulnerability  came  as  a  surprise  to policymakers and economists ..."
The report summarizes the mechanisms through which the relatively tiny (in global financial system terms) rising defaults in sub-prime mortgages set off a chain of contagion that almost brought down the global financial system and the dire real economy consequences we are still living with. The good and the faultless get side-swiped along with the bad and the guilty.

This kind of report is a salutary dispassionate counterpoint to ones like The Big Banks' Big Secret from the Canadian Centre for Policy Alternatives, which paints the Canadian government's intervention in providing liquidity, primarily through CMHC buying bank-owned mortgages, as a reprehensible and un-necessary bank bailout. Canada's actions were so minor in a global scale that it does not even figure as one of the 13 key countries in the IMF's Chapter III. Market Interventions during the Financial Crisis: How Effective and How to Disengage? referenced in the Gorton paper. Canada's actions were exactly in line with those of all the other countries, however. Canada, and Canadian banks, didn't cause the crisis but everyone has suffered, and could have suffered a lot more without intervention.

Thursday 29 November 2012

Hooray! MER Cuts on US Powershares RAFI ETFs

IndexUniverse posted details today of US-based Invesco Powershares cuts on several RAFI fundamental index ETFs. The cuts in MERs are quite significant - almost half. The reductions in MER vary from 0.30% to 0.36% e.g. for PowerShares FTSE RAFI Emerging Markets Portfolio (NYSEArca: PXH), which goes from 0.85% MER to 0.49%. This is excellent news since the difference will go straight to the bottom line and boost investor returns, mine included, as these ETFs are a core part of my holdings.

Tuesday 27 November 2012

Good-ish News: TFSA Limit Rising to $5500 in 2013

Caught this item on Investment Executive saying the government has raised the TFSA annual contribution limit for 2013 to $5500, up from the $5000 it has been for each year since TFSAs started in 2009 (here's the official press announcement). It's only good-ish news since it isn't an increase in real terms, only compensation for past inflation. As the Department of Finance backgrounder shows, we've been behind inflation through 2012 and now the rounding method will push the limit slightly ahead of inflation for a year, perhaps two. Of course, if you didn't use the $5000 limit from any previous year it has carried over and accumulated but the new annual amount only applies going forward, not also backwards to previous years (see the CRA TFSA info page). Roll on January 1st when the 2013 contribution can be made, I'll be doing it.

Monday 26 November 2012

Whosh! It's a bird, it's a plane? No, it's Mark Carney coming to save the UK

Let's hope his short-lived Superman imitation as Governor of the Bank of Canada works in the UK, where this blogger happens to spend a lot of time. The commercial bank and Bank of England problems in the UK are far worse, still, than any he had to face in Canada. Certainly the Conservative governments in both countries seem to believe Carney is the greatest thing since sliced monetary stimulus - see the BBC clip of the minister announcing his appointment and the CBC article.

Let's also hope the Canadian government got a few first-round draft picks and other future considerations for the sports superstar of central banking who is, after all, the first ever Bank of Canada Governor not to have served out his term (see Wikipedia links to the others in Carney's Wikipedia profile which, amazingly, someone has already updated with today's news). Raiding requires compensation. They could send Prince William and Kate over perhaps?

One never knows what goes on in the back rooms and boardrooms of government so judging his effectiveness is difficult (his one tangible accomplishment as Governor that I could dig up seems to have been to inject liquidity into the banking system during the financial crisis by buying good short-term bank assets, instead of the less effective US method of buying the toxic assets; other stuff like keeping interest rates low everyone is doing and he was not in the least responsible for the solid position of Canada's banks or of the government's finances that enabled Canada to weather the storm much better than other countries) but for all our sakes, I wish him luck and that he really proves in practise at last that the high regard all seem to have of him is justified.

Shame on W.H. Stuart & Associates - Providing Painful Financial Education

It sure didn't take long for the inadequacies of the current investor protection system to be displayed in cruel fashion after our last post contrasting the arguments of the financial advisor group Advocis with investor gadfly (and I mean that admiringly) Ken Kivenko. Advocis thinks everything is just fine with the system today.

The impartial Ombudsman for Banking Services and Investments investigated the case of the Irons (who have allowed themselves to be identified on this CBC news video), an elderly couple whose financial "advisor" put their money into dubious high-risk investments when their true risk tolerance was clearly low. Inevitably the investments went bad and the couple lost a lot of money they could not afford to lose. The OBSI found the mutual fund company the "advisor" worked for to be negligent and ordered the company to pay compensation. The company W.H. Stuart and Associates has stepped forward, looked the regulator and the victims in the face, and told everyone to shove off, it's not paying.

Meanwhile, on its website it continues to spin its line "W. H. Stuart & Associates is a family owned independent Mutual Fund Dealer & Insurance Agency committed to providing you, the Canadian investor, regardless of your investment amount, with the knowledge to make the right financial investment and retirement decisions to achieve security and peace of mind". Of course, those nit pickers amongst us might note that the sentence does not actually specify whose security and peace of mind the decisions aim to achieve. It could be yours or theirs! 

Elsewhere the Stuart website says "We wanted to build a company where the education of clients about financial matters came first and foremost". In a cruelly ironic way, the Irons have received quite an education. In this month where financial literacy is being promoted as the solution for Canadians maybe there's a lesson from the Irons' experience. Should we be expecting people to acquire engineering literacy to know if the new car they are buying is safe to drive, or medical literacy to decide whether their doctor is giving good treatment advice? (Though it is a bit of a stretch to say that the Irons should not have had the common sense to question why their "guaranteed like a GIC" ill-fated investment would pay them 20% at a time when interest rates were only around 5%) Till fiduciary duty comes into play, the only financial literacy that matters is the ability to figure out who you can trust and who knows what they're doing.

I guess the industry knows that unfortunately, as watchdogs go, the OBSI can only bark and recommend compensation but not bite and order it.

Meanwhile, there is silence from the Mutual Fund Dealers Association of Canada, which Stuart identifies as its strategic partner and which bills itself as having "... a mandate to enhance investor protection and strengthen public confidence in the Canadian mutual fund industry".

In this case, there is also silence from Advocis but we cannot blame them since it seems none of the people nor the firm itself are members of Advocis.

Monday 12 November 2012

Debating Fiduciary Duty - Kivenko vs Pollock of Advocis

Ken Kivenko debates Greg Pollock (CEO of Advocis, an association representing financial advisors) in this BNN video.The intriguing verbal tussle follows on the consultation launched by the Canadian Securities Administrators on the possibility of imposing fiduciary duty as the standard of care for all financial advisors and dealers (see CSA paper here). The video is well worth watching as a gentle introduction to the subject. I think Ken comes off as an effective advocate i.e. wins this debate hands down not only because what he says is true but he expresses it well too. He has also just been named to the Ontario Securities Commission Investor Advisory Panel so maybe can help further such progressive ideas there.

The exacting and somewhat cynically inclined lot over on the Financial Webring are also debating the merits and possible practical consequences of fiduciary duty. One post by Dan Hallett, who runs what looks to me like a financial advisory firm that has already decided to operate with a fiduciary philosophy, posts a comment that includes this great line: "Either it's [i.e. the financial industry] got to give up the sorts of titles and marketing that imply fiduciary advice or embrace the standard with all of the benefits and obligations that involves."

That's the point. It's too complicated. People think they are getting unbiased advice but it rarely is. The financial consequences of biased advice - 20 or more years of a much poorer retirement - are too severe.

... oh, and another bit of info

The Chartered Financial Analyst Institute does an annual survey of its charterholders about ethics in various countries. People with the CFA designation almost all work in the business, so this is an insider's view. But look anyway below in the latest available 2010 Canadian survey report at where the relative and absolute opinion lies regarding the ethical behaviour rating of financial advisers to private individuals - barely above half way and lower than anyone than hedge fund managers and sell side analysts. There also some damning quotes e.g. "In my career the thing that stands out the most is that most advisers are not out for the client’s best interest; instead they are out for their own interests ahead of the client." a Portfolio Manager/Investment Consultant in Canada.

Sadly, little seems to have changed compared to the situation when I posted about the same survey in 2008.

Tuesday 30 October 2012

(In)efficient markets, indices and investors - Martellini explains - brilliant!

Highly recommended: Lionel Martellini's Inefficient Benchmarks in Efficient Markets at the EDHEC Research Institute. Martellini is precise and brief in his explanation of a couple of the slipperiest and most important ideas in finance and investing. Quotes: 
  • " ... cap-weighted indices are inefficient benchmarks, regardless of whether or not markets are efficient (keeping in mind that they probably are efficient, at least to a first-order approximation)... " i.e. the implication is that indices like the S&P 500 and the S&P/TSX 60 aren't very good
  • " ... When the word “efficient” is used in reference to a market, as in the efficient market hypothesis (EMH) formulated by Eugene Fama in 1970, it suggests that at any given time, prices in the market fully reflect all available information on all stocks in the market. ... " and "... there is a consensus regarding the fact that markets can still be regarded as somewhat efficient ... " i.e. it's not impossible but it's hard to outperform the market, considering fees and costs
  • " ... even if markets are efficient, at least up to a first order approximation, investors can still be holding highly inefficient portfolios. The word “efficient”, now applied to a portfolio as opposed to a market, means that the portfolio performance can be improved without any increase in risk through an improvement in the portfolio diversification ..." i.e. it isn't a great idea to invest only in Royal Bank shares even if the price is correct
  • " ... empirical evidence also suggests that the average investor holds a severely inefficient portfolio. In other words, the finding here is that the portfolio held by the average investor, which by definition is a cap-weighted index, tends to be poorly diversified. This result is hardly a new finding, ..." i.e. buying SPY (S&P 500 tracker ETF) or even VTI (Vanguard Total US Market ETF) or XIC (S&P/TSX Total Market ETF) is NOT the ideal thing to do.
  • "... various alternative weighting schemes have been proposed to improve upon cap-weighting (see Amenc et al. (2011), Arnott, Hsu and Moore (2005), Choueifaty and Coignard (2008), Maillard, Roncalli and Teiletche (2008) to name but a few), and it is now commonly accepted that moving away from cap-weighting tends to enhance diversification and increase risk-adjusted performance over long horizons. ..." i.e. consider dumping SPY and XIC. I think the best practical answer is an empirical matter - if another non-cap-weighted (like equal-weighted, or fundamental weighted) index ETF exists for the asset class with reasonable costs that do not eat up the performance gain (e.g. perhaps PRF, EWI, RSP, PXC, CRQ;

Sunday 28 October 2012

Socially Responsible Funds: Who's Got it Right - RBC or iShares?

Here's an interesting situation. Compare the standard iShares Socially Responsible Canadian equity fund XEN with RBC Asset Management's version RBC302. XEN is passive and has an MER 0.55% while RBC302 adds a layer of active stock picking after applying the same Jantzi social screen as XEN and it sports a much higher MER of 2.1% (on series A, non-advisor class).

RBC302's annualized 5-year return of -0.12% (per Morningstar), including the all-important adjustment for fees, beats XEN's -1.12% (per the Globe Watchlist) by a whopping 1% per year!! and the benchmark cap-weight market fund iShares XIU's -0.83% (also from Globe WatchList) by 0.71%! Of course, the data might not be strictly comparable coming as it does from different sources - why the heck can't the data providers give us ETFs and mutual funds together since most investors want to compare the two?! That's right, an actively managed high-MER mutual fund has beaten the index by a good margin, even after fees.

What explains the difference?
1) RBC has been good at excluding a number of stocks that have been losers. RBC's final investment decision-making step, after the initial screening for the Jantzi social criteria, is to pick stocks with "... above-average financial fundamentals while considering broader factors, such as economic trends, interest rates and the outlook for profits, valuations and stock prices". We only have the top 25 stocks to look at, since RBC doesn't reveal the whole portfolio, but the holdings differences between RBC302 and XEN are significant. 8 stocks are different. The spreadsheet shows in red, which stocks do not appear in the top 25 of the other. Of the 8 in XEN, but not in RBC302, six have significantly negative annualized 5-year total returns.
2) RBC seems to be fairly good at picking winners. As for the stocks in RBC302 that have replaced those losers, 5 out of 8 are 5-year positive and the positives are stronger than the negative. It's interesting that RBC302 is much less concentrated than XEN. It's top 25 only add up to 56.8% of assets vs 82.2% for XEN. RBC is no closet indexer with this fund!

Is "socially responsible" inclusion partly in the eye of the beholder?
Not a single one of the red stocks in the top 25 holdings of RBC302 appears anywhere in XEN, not in the top 25 of XEN, nor within the 61 total holdings of the XEN. Yet all of these stocks are large enough to appear in cap-weight benchmark XIU. What is going on? XEN is strictly a Jantzi index tracker so those stocks must have been screened out as unacceptable according to socially responsible criteria. How the heck does RBC get to put them back in? Unfortunately, the Jantzi index composition and its exact methodology are not disclosed so we cannot go back to the true source to figure this out. It would be ironic if RBC has been beating the virtuous socially responsible index by cheating!

Thanks to Ken Kivenko for the pointer to the RBC Jantzi funds.

Wednesday 24 October 2012

Sustainable Investing: Is It OK to Destroy the Economy if You Reduce Greenhouse Gas?

It sure is confusing to do the right thing. My most recent foray into looking at what is often called Socially Responsible Investing (SRI), or investing based on Environmental Social and Governance (ESG) factors, started with a recent news item in the Financial Post.  

Group of 49 ethical funds call for greener oilsands made the interesting statement that "... the current approach to development, particularly the management of the environmental and social impacts, threatens the long-term viability of the oilsands as an investment". That's interesting, I said to myself, at last an analysis that takes the viewpoint of the investor who wants to do right but also to understand the long term investment issues. Alas, the future investment risk analysis consists only of a couple of sentences about aboriginal lawsuits and market access restrictions due to potential low-carbon fuel standards laws in the USA. When I tracked down the original stuff from Ceres (why don't mainstream news sites provide a link directly to original sources anyways?), the entire content of the press release and document issued by lobby group Ceres is occupied with micro-management - telling the industry what it should do and what its goals should be. Such blatant lobbying with only the slightest veneer of investment content does more to discredit their effort than gain investor support.

The trickster feel to the Ceres release was exacerbated by the reference to investors with "$2 trillion under management" and "investments in Alberta's oilsands", which disingenuously fails to say exactly what stake those 49 funds have. Presumably if the oil sands producers are doing a bad ESG job, the ethical funds won't be invested, will they?

And if the companies are doing a good job, why do they need Ceres to tell them how to operate at such a micro level? Isn't it curious that the Jantzi Social Index Fund from iShares (TSX symbol: XEN) which buys into "... companies that reflect a higher standard of environmental and social performance", includes among its holdings several notable oil sands companies like Suncor, Imperial Oil and Nexen. Another holier-than-legally-required list, the Newsweek 2012 Green Companies Global Rankings, has Suncor in its list too, as well as another oil sands major Shell (see Wikipedia's oil sands article for others).

The disappointment over the oil sands article turned to real cognitive dissonance distress (hey, I paid for my university education so I get to use those lovely buzzwords) when I looked more closely at the Newsweek list. How the heck do all those major world banks get on the list - RBS, Lloyds, Barclays, Citigroup, Morgan Stanley, Goldman Sachs - those fine upstanding institutions whose follies almost tore apart the world's financial system in 2008 and whose miserable economic consequences continue to this day? Is it ok if banks destroy the economy as long as they recycle, have a small carbon footprint, hire lots of women and minorities and get involved in their local communities?

It's not that it is necessarily misguided to expect more than obeying the law as the desirable mode of operation from companies. Indeed, a few years ago in the Financial Times, Rob Arnott wrote an eloquent piece called Why poor moral ethics prove costly on the necessity for moral ethics (doing what is right) instead of just legal ethics (doing what is allowed).

My objective as an investor is to consider companies holistically. No company is perfect in every way and some things matter more than others. The range of ESG issues shown in the chart image below from index provider MSCI must be considered as a whole. ESG is not enough either. I cannot afford to invest in dud companies that lose money and go out of business no matter what their ESG score may be. A financial and business rating needs to be integrated with the ESG.

What I'd want is some combination of the ESG ratings that determine the holdings of ETFs like XEN in Canada or KLD, DSI, NASI and EAPS in the USA (see these ETFs' details on the ETFdb screen for SRI funds) plus an active index methodology like the RAFI Fundamental ETFs CRQ or PXC in Canada or PRF, PXF, PDN and the like in the USA. They could be called "Fundamental Virtue" ETFs.

Tuesday 2 October 2012

Kivenko Tells How to Check Out Fund Advisors

Want to avoid an Earl Jones nightmare in your life? Do you know whether the person who wants to sell you mutual funds is on the up-and-up? Ken Kivenko of gives us the details on how exactly to check out mutual fund salespeople (technically, dealing representatives, self-termed as advisors) in Checking Registration and Disciplinary History. Unfortunately, the dogs-breakfast regulatory system in Canada means that it takes three pages of single-spaced explanation on how to do this and even then it is not foolproof, but hopefully readers will believe it is worth the effort.

There is another solution of course - be a DIY investor. Then you can wrestle with the question of whether you should entrust yourself to invest your own money.

Wednesday 26 September 2012

Picking Out Actively Managed Funds that Predictably Outperform

There is an oft-repeated rule of thumb that past performance is no guide to future performance, that picking funds with recent above-average results usually leads to disappointment because their future performance tends to under-perform and revert to the mean. It certainly seems to be true in Canada (e.g. Richard Deaves in the book What Kind of Investor Are You? says there is no historical evidence of persistence in either under- or out-performance). Is that situation necessarily inevitable and immutable?

Along comes Super Fund Performance, a report from the Australian superannuation industry, to say "yes, it is possible to identify with considerable confidence which funds will continue to out- or under-perform". The key differentiator: whether the funds are retail for-profit offerings or not-for-profit (sponsored by public sector, corporate or industry). Not-for-profit has been winning, and by a huge amount - an average of 2% per year for the past 15 years!

Below is a fascinating chart from the study. Especially interesting is that the not-for-profits always did better than the retail for-profit funds. It looks like a sure-fire way for Australians to narrow down retirement fund selection. Too bad the not-for-profit option doesn't exist in Canada and it doesn't look like pension reform via the government's PRPP proposal will change that soon.....

Why the out-performance?
  • lower fees/costs - the report doesn't state the difference but a quick search in one comparison website, the Canstar Superannuation Star Ratings, shows MER ranges from about 0.4% at the very low end to 2.5% at the extreme high end. The big not-for-profit funds look to be in the 0.6-0.8% Total Expense Ratio range according to another comparison site, Selecting Super.
  • economies of scale, but only among the not-for-profit funds; retail funds don't get any more efficient with size, which the report says is due to governance factors - "... either economies of scale are not available to retail funds, or the benefits are not passed on to members". 
  • embedded advice - the for-profit riposte is that their members get financial planning advice much more than clients of the not-for-profits, about twice as often according to Canstar. Investor Daily reporter Wouter Klijin says the not-for-profits are increasingly gearing up to provide advice, which he says will increase their costs and possibly/probably lessen their out-performance down the road. A big question is, of course, how useful the advice is, whether it is merely sales or client-interest-first, depending on the source. From which type of outfit would I want "advice"? That's a pretty easy call I'd say. 
Why Does Mutual Fund Performance not Persist? by Wolfgang Bessler, David Blake, Peter Lückoff and Ian Tonks provides another take on persistence using US data -
  • Winner funds keep winning if, a) the fund investment manager stays on and b) there is NOT high fund inflow
  • Losers start doing a lot better if, a) the investment fund manager is sacked and, b) there is a high fund outflow
The problem for the investor is of course, that what works on average may not happen for the specific fund selected. 

Wednesday 12 September 2012

Equity Risk Premium and Likely Future Returns: Elroy Dimson's History Lesson

Highly recommended: Rethinking the Equity Risk Premium, Elroy Dimson's free (registration required) audio and slide presentation that says investors should expect no more than 3-3.5% annual real returns from equities over the riskless rate aka government bonds, which currently is more or less 0!

Noted academic and equity researcher Elroy Dimson (best-known as co-author along with Mike Staunton and Paul Marsh of the yearly investor treat called the Credit Suisse Global Investment Returns Yearbook, 2012 edition here) has been at it again, producing well-explained, substantial commentary on a supremely relevant topic - how much return have investors achieved around the world and what should one expect from equities in future?

Other notable points in the presentation:
  • the equity risk premium has not been constant over time, or from country to country, though equities have substantially outperformed bonds over the past 112 years in every single one of the 19 countries for which they have data (slide 19)
  • over the very long run (100 years or so) currency shifts between countries have barely mattered to equity returns for an international investor (using the USA investor as the example) ... though it has mattered a lot over short periods (slide 17 c. 21 minutes along)
  • most (or all, in some countries) of long-term real equity return comes from reinvested dividends (slides 20 and 222)
There's more fascinating and potentially useful stuff on such topics as - do higher or lower GDP growth countries give better equity returns, do weak or strong currency countries give better equity returns, do high or low dividend markets foretell better equity returns? Here's one of Dimson's slides that reinforces the idea that "valuation matters", at least in the form of dividend yield (as this post on my other blog showed, the current Canadian yield around 3% is around the the historical average):

There's also a background paper with the same title (likely to be heavy reading; though I haven't yet read it, I'd bet it's worthwhile), also free from the CFA Institute.

Tuesday 14 August 2012

WaterFurnace Renewable Energy 2Q2012: Worrying Sales Slide

WaterFurnace (TSX: WFI) has just released its second quarter 2012 financial report. The news is not good.
  • Big slide in sales - Sales dropped a big 16.5% vs the same quarter a year ago. Management is now lamenting dropping consumer confidence and belatedly recognizing the competition from low natural gas. Worst news is that CEO's Huntington's claim that WFI is stronger than its competitors and gaining market share looks dubious. LSB Industries reported recently too and its sales drop on the comparable climate control side of the business was only 12.5%.
  • Inventory climbing - Inventory is rising fairly dramatically - from 33.5% of sales in 2Q2011 to 41.1% in 2Q2012. Why are managers downplaying this by saying that inventory remains at "historical levels"? The factors behind the sales slowdown aren't likely to reverse soon.
  • Warranty costs rising - Warranty provisions continue to rise, even as sales decline. Using note 13, net additional accruals for honoring warranty claims rose from 4.3% of sales in the first six months of 2011 to 5.5% in 2012. The biggest portion comes from increasing claim rates not new units covered following sales. As I discussed in my last post about WFI in April, this cannot continue forever without consequences. If the provisions are correct, future cash flow will suffer when claim repairs or replacements occur. If so, the dividend could be in danger. If the provisions are too high, earnings will shoot up when the liability is reversed.
  • Dividend payout looks unsustainably high - Aside from the warranty cost question, the current dividend payout at $0.96 per year looks way too close to the trailing 12-month earnings per share of $1.07 i.e. 90% payout. If sales remain soft and below 2011 in the next few quarters, the ratio will exceed 100%. That 5.8% dividend yield is not sustainable.
  • Manager compensation rising out of line - Both salaries and stock allocation to managers rose considerably (10+%). That doesn't fit very well with relative or absolute business performance, nor with WFI's stock price, which has dropped 22% in the past year.
The only hopeful news was the announcement of the joint venture with a Chinese partner to sell its products into China. However, whether that initiative produces renewed sales growth will only be seen in a year or more. And success is not at all certain.

Revised Stock Valuation - Using much more pessimistic assumptions than in the initial assessment of 2010 (see post here) - earnings fall to $0.85 EPS, dividend cut in half, no growth for six years, followed by 3% growth thereafter, with a required return of 5% - WFI is worth around $23. With no growth at all, dividing the 0.85 EPS by the 0.05 required return gives a value of $17, just above where it trades today. FWIW, one broker tracking WFI, Canaccord Adams, has a target price of $24. According to Thomson Reuters, two un-named brokers have 12 month price targets of $21.90 and $23.90. One rates WFI a Hold, the other a Strong Buy.

Though it doesn't look as though there is a high chance of further big price declines, the last quarter's drop in sales was a surprise - even it seems to management - so it will be interesting to see what happens after the ex-dividend date of August 20th. Some investors might stick around to collect the dividend and then head for the exit. For the moment, I'm holding on.

Monday 13 August 2012

When a Broker Goes Bankrupt Your Securities May Not be Yours to Take

The latest article by Independent Investor What if your investment dealer went bust gave me a fright. Probably like many others, I have gone along believing that since my holdings with my discount broker are segregated and in effect held in trust, I would get my securities back automatically and promptly. Oops, bad assumption, as Independent Investor explains: "... the assets of all customers generally fall into a single, common pool, and the rights of the customers become financial claims to be dealt with uniformly by the trustee. In other words, customer assets that are fully paid for and fully segregated are not separately and directly returned to those customers."

It is true that the Canadian Investor Protection Fund is there to step up and make up any deficiency up to $1 million per customer per dealer but a problem remains - how long will this take? Going through courts and insolvency proceedings is likely to take "some time" as they say. Meantime, what are people who need access to the holdings e.g. for retirement income, supposed to do?

An obvious tactic to deal with this danger would seem to be to split assets amongst several brokers. Another tactic, admittedly harder and more constantly complicated to carry out, is to assess and monitor the solidity of the broker, which for most Canadians, is a subsidiary of one of the big six banks. I look forward to what Independent Investor has to say in his promised follow-up article on who is most at risk and on possible preventative steps to minimize the risk.

Tuesday 26 June 2012

CEO Compensation: Jarislowsky Opines, Algoma Central Delivers

It's reassuring that it isn't just me complaining that CEO compensation is way too high these days. Billionaire investor Stephen Jarislowsky recently appeared in this BNN clip saying he doesn't believe it is either wise or necessary to pay CEOs amounts that have gotten totally out of line. Amusingly, or scarily, he admits that he, a highly experienced and sophisticated investor, has a great deal of trouble figuring out the extremely complex pay schemes found in most big publicly traded corporations. He blames the historical out-of-line rise in CEO pay as being due to two factors: the public disclosure of pay, which made CEOs ask for what others were getting and the arrival on the scene of the compensation consultants, who have created all the insanely complex pay structures that magically produce higher pay whatever the company results or stock performance (I think there is probably a rule of thumb that the more opaque a CEO pay plan is, the more likely the shareholder will get taken advantage of). 

Whether pay gets reduced, both in relative and absolute terms, by shareholder "say on pay" or Boards putting the hammer down, it needs to happen. Another BNN clip with Globe and Mail reporter Janet McFarland and Fair Canada (as in, fair to investors) executive director Ermanno Pascutto, talks about the small advances in Say on Pay votes in Canada, which as ever in the hands-off Canadian regulatory landscape is voluntary here in contrast to the mandatory regime in the USA.

One company that caught my eye through this Globe and Mail article as being more on the right track than many others is Algoma Central (TSX: ALC). The description of it as old style with no stock option plan for the CEO, which is what Jarislowsky recommends, made me look up the latest Management Information Circular on to see the pay structure. Indeed, the CEO pay scheme is actually understandable, only a base salary plus an annual cash bonus scheme, half of which gets deferred and paid out only after three years. There are no options, no benchmark peers that automatically drag up pay, no golden parachutes and the pension accrual formula is the same as for other employees (CEO Wight is grandfathered in a very generous DB plan of 2.25% per year while new executives (after the Jan 2010 closure of the DB plan to new employees) go into the DC plan that all employees apparently receive). There is a new twist to the bonus plan for next year - half the cash bonus, instead of merely being deferred for three years, is notionally invested in common shares that vest in three years and are paid out based on the value of the shares then. In other words, unlike options, which have no risk to the CEO, there is downside risk - if the shares go down, the CEO loses that amount of the bonus, just like a real shareholder would. Sounds good to me. The only part of the pay that looks dubious is that the CEO Greg Wight's base pay, on which bonuses are based, rose at more than double the inflation rate in both 2010 (+6.6% over 2009) and 2011 (+5.5%).

Of course, sensible pay doesn't guarantee good stock performance. ALC's stock return has languished in the last five years, doing worse than the overall TSX. As the Globe article says, it might be a buyout value play since it looks quite under-valued (a P/E of 6.3 and a P/B around 1, profitable every year for the last 5 - see TMX here). The controlling ownership structure and the consequent lack of liquidity and analyst coverage seem to be getting in the way of value recognition.

Wednesday 13 June 2012

Labour-Sponsored Rip-off

The union labour movement likes to think of and to portray itself as fighting for the common man, for fair dealing, for social justice, for honesty in business and so on. At times it does, witness its support of an expanded Canada Pension Plan.

Why on earth then would it continue to allow its name to be besmirched with one of the unmitigated disasters of investing for the common retail investor, the horribly exploitative abomination known as the Labour-Sponsored Investment Fund (LSIF), also called the Labour-Sponsored Venture Capital Corporation?

The history of LSIFs according to Wikipedia had a naively noble origin - fledgling companies need capital to thrive and grow, so the labour movement pushed the government to give generous tax breaks to average joe retail investors putting money into funds that would invest in these companies. It would stimulate the economy and create jobs. Professional managers in the funds would research and figure out which were the best small companies to choose. So the theory went.

The reality is that putting money into any old small company doesn't work. Many, indeed, most companies don't survive and grow, they unfortunately wither and die. And when the incentive structure is such that the fund managers make a lot more money a lot more easily from collecting high fees than on choosing future star companies, which is hard to do at the best of times, while the managers have none of their own money at stake, putting money into any old company with a cool story is the easy way out. The recipe was set for LSIFs to fund weak companies and provide little or no lasting job creation in the real economy while uniformly losing money for investors and allowing financial managers to systematically strip money through exorbitant fees (like 5, 6, 7, 8% annually).

The proof is in the pudding, and it has been for a long time. Go to Morningstar Canada and pull up a table of current LSIFs. There are seven with a positive 10-year return out of 82 funds, not bad you might say since they outnumber the six with a 10-year loss. It's not so good, however, when we remember that many long term losers disappear through being bought and merged into other funds. Two examples are the Capital Alliance Ventures Inc and Canadian Medical Discoveries Fund, both of which started back in the 1990s and have ended up folded into the GrowthWorks Canadian fund (I traced the history of these funds in this post last year). Here's a telling chart from Morningstar that shows the downward slump of CMDF and of the overall Retail Venture Capital Index compared to the BMO Small Cap index.

The CMDF is now in dire straits. Thanks to Ken Kivenko sending on the news published here and here in the Financial Post, we learn that CMDF is essentially insolvent. Fundholders are caught between the proverbial rock of not being allowed to withdraw funds and the hard place of being asked to approve CMDF taking on a loan merely to pay the managers' fees. It's inevitable that fund investors will lose big time, sooner or later. Yet the show is allowed by government (by the feds and some provinces continuing to offer a tax credit) and regulators to go on.

Why for example, has the Canadian Federation of Labour, the labour sponsor of the GrowthWorks Canadian Fund, not intervened through its majority (it nominates 8 of 12 directors) control of the Fund's Board, to say enough is enough, it's time to liquidate and wind up the fund before all the investors' money is sucked out of it? I'd like to see how differently labour Directors like Joseph Maloney and Edward Power, both of the International Brotherhood of Boilermakers, Iron Ship Builders, Blacksmiths, Forgers and Helpers and both on the Board since 2006, would react if they had more than their share ownership of exactly zero. (None of the labour directors have a big stake in Fund shares.) Of course, if the fund were wound up, messers Maloney and Cole would not collect the $16,000 or so in director fees they got last year.

Though the Canadian Federation of Labour doesn't take a fee from the GrowthWorks fund, in some cases the union itself does collect an on-going trailer fee. For example, the Canadian Police Association and the Association of Canadian Financial Officers are co-sponsors of the Covington Fund II. They collect an annual fee of 0.16% of the fund's net asset value, which turns out to be a tidy $480,000 based on the Fund's $300 million NAV (as of February 2012, per the Semi-Annual Report filed on All that for lending their name. Of all labour groups, one would think that police and financial officers would recognize and not want to take part in a rip-off scheme.

Disclosure: I am not neutral on this topic since I owned shares of both CAVI and CMDF and lost most of my investment before I managed to sell out a few years ago.

Saturday 2 June 2012

Book Review: Purple Chips by John Schwinghamer

Purple chips is author Schwinghamer's invented term to describe the best of the blue chip stocks. In his definition found on the book's website, purple chips are large companies with a market cap minimum of $1 billion which have an unblemished track record of seven years growing earnings per share (EPS).

The book lays out Schwinghamer's method for long term trading in the purple chips, i.e. his method for picking when to buy and when to sell. The method is designed, in his analogy, to hit singles and doubles, not to try for the home run. The method appeals to common sense since it is based on two factors - first, the idea that in the long term the stock price is determined by EPS (what Warren Buffett said thusly: "If a business does well, the stock eventually follows"); second, the fact that markets go through periods of optimism when investors are willing to pay more for earnings (reflected by rising P/E multiples across the board), or the opposite pessimism. For a particular stock there may also be company-specific good or bad news that causes the market's willingness to pay more or less for earnings, which he calls valuation resets. He thus establishes a reasonable trading range for any purple stock. The signal to buy is when the price goes above the upper bound and to sell below the lower bound. All this is summarized graphically on a chart which overlays EPS and stock price, such as the image below taken from the book.

That is the gist of his method, though there are more rules, which he explains, to fine tune the buying and selling decisions as well as for building a portfolio of such stocks (such as not exceeding 15% invested in any sector, or 3% in a non-dividend paying stock). Schwinghamer's system is unique but he takes the trouble to show how its conclusions about stock value are the same as a traditional fundamental financial and ratio analysis would come up with.

Schwinghamer's book is graced with clear direct informal writing including helpful analogies, with progressive and well-organized exposition from a very low assumed knowledge base to the somewhat intricate level of his unique system and with numerous charts and real stock examples (a whole chapter is devoted to several case studies that walk through valuation resets and buy/sell decisions, as well as profits thereby attained).

Though the method is clear, I believe there are a few big challenges for an individual investor wanting to try applying it:
  • extreme discipline and patience, which he admits himself might be the toughest task, since it may be necessary to wait for years before the price of a stock becomes favorable (e.g. in his Abbott Labs case study); part of the challenge is to constantly track quarterly results for all the candidate stocks and market moves
  • data availability and manipulation - he uses his Bloomberg professional terminal to quickly pull up and chart the trailing 12-month EPS for seven years against stock price; try to do that with Yahoo Finance, Google Finance, ADVFN, GlobeInvestor, your discount broker's version of stock research tools, or any other free online website.
The actual mechanics of the method are a bit complicated and subject to some judgement, especially the business of valuation resets and setting the exact location of the high-low price points. The author's explanation in an email response to my query was "The placement of the projected EPS line does influence the buy/sell targets. Keep in mind that this methodology has two objectives: 1) to lead you to invest in companies that have great earnings profiles and 2) to give you a high probability of buying low and selling high." i.e. it is approximate, not exact. Schwinghamer also warns that his method does not pretend to guarantee profitable trading every time on every stock. It is meant to work on average over multiple stocks and trades. Probably it would become easier after some time working with the method.

Those who might be interested in the method but are looking for an easy way to follow it can check the book's website where the Top Picks tab shows both the top 25 US and top 10 Canadian picks with current High or Low price assessment. With free membership registration, all 233 US and 41 Canadian Purple Chips are available.

The method is intriguing and makes a lot of sense and the book does a fine job explaining the method. Any investor considering buying individual company stocks, and especially those who believe in fundamental analysis, can benefit from reading the book and checking out the stocks named in the website. As I discovered on my other blog looking at the stocks in the Purple Chip list, there is considerable overlap with holdings in low volatility ETFs and a fair degree of overlap with stocks arising from various methods that seek out worthwhile companies.

My rating: Excellent book, 4 out of 5 stars.

Monday 14 May 2012

Swapping in the Invesco PowerShares Canadian Fundamental Equity ETF

For the last few years, the iShares Canadian Fundamental Index Fund (TSX symbol: CRQ) has been my core Canadian equity holding. It is also the ETF used in the portfolio contest at the bottom of this blog, which pits the Fundamental indexing approach against the traditional cap-weighted index approach. Just as as I replaced some time ago the cap-weighted fund XIU with a lower cost equivalent ETF HXT, now it is time to replace CRQ with a new lower fee ETF.

The new CRQ-equivalent was launched with too-little (since I missed it at the time) fanfare in January (press release here) by the Canadian arm of Invesco PowerShares, which offers a number of similar RAFI funds in the USA, such as PRF, PRFZ, PDN, PXH and PXF. The new Canadian equity ETF is the PowerShares FTSE RAFI Canadian Fundamental Index ETF (TSX: PXC).

PXC's big attraction is an MER of only 0.45% vs 0.71% for CRQ. There will be a little extra cost for PXC's trading and annual rebalancing that will only be known in a year but it should in the area of CRQ's 0.6% since it follows the identical index and trading rules as CRQ. That 0.2% lower fee will be money in my pocket - $20 extra for every $10,000 invested each and every year, which will compound and add up over the long term.

As I started to look more closely at PXC to assess its potential for my portfolio, it became apparent that I am not the only one who has been in the dark. Trading volumes are minuscule. Some days there have been no trades at all and on many days there have been less than a hundred shares traded. That has caused some misleading pricing reporting for PXC on mainstream sites like Google Finance, TMX Money and Morningstar, which all use Toronto Stock Exchange public data.

The public data makes it look as though PXC is doing a very poor job tracking its index and its Net Asset Value (NAV, the value of the underlying portfolio holdings within PXC). Look at this Morningstar chart of PXC's closing price vs that of CRQ. The lines don't overlap at all though they should track almost perfectly given that the two ETFs track exactly the same index with its holdings and weightings.
PXC also seems to be far off having its market price reflect its NAV per this Morningstar chart.

Meanwhile CRQ has been tracking its NAV very closely.

Making the situation even more puzzling is data published on the Invesco website in this table.

If we look closely at the data for May 4th, a day in which there is a large spread between PXC's price and NAV, we see that Google, Morningstar and TMX all report a closing price of $20.01. Invesco's table reports the price as $19.43, purportedly based on TSE data. The NAV was $19.45. It took a phone call to Invesco to clear up the discrepancy. According to Invesco, the reason is that most of the trading for PXC has actually been taking place on alternative exchanges like Alpha and the price there, which Invesco has been reporting, much more closely matches the NAV since it is much more current.

The important thing for the investor is that the bid-ask live quote for PXC at any point will be close to NAV. In that regard, I have minimal fear of paying a big premium over NAV for PXC. Unfortunately there is no way of actually verifying that since in Canada, unlike the USA where it is apparently required by regulation, the intra-day live NAV value is not available on any website. Yesterday, when I spoke to Invesco rep Chris, he checked and relayed to me that while the NAV at that moment was $19.00 the market bid price was $19.00 (what the bidder was offering to buy shares at) and the ask was $19.03. That's a very reasonable spread premium of only 0.16% for an investor placing a market order to buy. So the ETF pricing mechanism that keeps ETF prices and NAVs very close is not failing for PXC. Invesco says that there are six market makers for PXC, with the primary one being National Bank.

In short, PXC checks out ok. The 0.2% lower annual expense is worth the switch. Claymore or new owner BlackRock/iShares should have pre-emptively lowered CRQ's too-high fees. I am replacing CRQ with PXC in my test portfolio as well as my own holdings.

Monday 30 April 2012

Disappointing News on Banking Ombudsman

Today, the Financial Post features an article about federal Finance Minister Jim Flaherty saying that he "will not force the country’s banks to resolve client disputes through the Ombudsman for Banking Services and Investments (OBSI) and is set to unveil new rules and regulations that will allow financial institutions to hire their own mediators to sort out disputes with clients."

Royal Bank and TD have used private mediation services for the last few years since opting out of OBSI. The world may not be falling dramatically apart because of this but it is and will be worse as made clear in the comparison table of OBSI vs TD and Royal's private mediator ADR Chambers, published today as it happens by Fair Canada. Harm by small individual abuses is harm nevertheless.  Blessing and encouraging the expansion of private dispute resolution will further tilt the scales in favour of the banks over consumers. As the hoary expression goes, "he who pays the piper calls the tune".

Sunday 22 April 2012

UFile Giveaway Winners

The draw has been done. Congratulations to these three winners of the giveaway: IG, Aidan and Be'en. Please contact me via the "email me" link in the right hand sidebar and I will send you the code to enter to use UFile for free.

Wednesday 18 April 2012

WaterFurnace Renewable Energy(WFI): 2011 YE Dilemma

Last month WFI published its annual report of 2011 results. For investors, the report along with the conference call (available on CNW), the annual information form (AIF) and the information circular paint a positive picture on some fronts offset by negatives on others and overall stagnation.

Competition from Natural Gas
When I made my original assessment of WFI 18 months ago, I concluded that the main constraint on the company's renewed growth was US housing starts and that when the US housing market recovered, sales and earnings growth would begin again. Not so certain, it now appears. The success of fracking and the resulting now plentiful natural gas supplies causing low gas prices are providing another big restraint on potential home geothermal heat pump installations. Consumers do the math and conclude that natural gas is cheaper, as the annual information form concedes: " ... very low natural gas prices will put competitive pressure on geothermal heat pumps if availability and low gas prices persist." That's probably why WFI said in the conference call that the residential market was down 9% in 2011.

That something else besides housing starts is affecting WFI's residential sales is seen in the fact that US starts did rise steadily through 2011, a condition about which management said the following in the Q1 report: "Housing starts are forecasted to be 600,000 by the end of 2011, despite the overhang of foreclosures and tighter bank lending practices. The residential replacement market will continue to be the single greatest opportunity for geothermal heat pump installations for the next several years. As residential new construction revives, then this will present a significant upside opportunity for the business." Housing starts reached 700,000 in December yet WFI experienced falling residential sales. The latest AIF still doesn't include natural gas prices amongst risk factors.

The discussion of the economics in the Wikipedia geothermal heat pump article tells us that the economies of scale on capital costs benefit commercial large buildings much more than residential, making systems more cost effective for commercial buildings, which is most likely why WFI's sales in that segment continue to grow.

WFI management says it is also looking more to international markets for growth - in the UK, China and South Korea - and also in the commercial sector. Maybe, but possible success is in the future and not evident now. The Hyper Engineering acquisition of 2011 in Australia is having no discernible effect except that shares issued for the purchase helped dilute earnings per share by 1 cent to $1.14.

Not-so-good Numbers in Financial Statements
Several 2011 numbers aren't good for investors, though not disastrously so.
1) Executive and employee compensation was way up - What justifies executive compensation rising 31% and employee salaries and benefits 13% (while employee headcount dropped from over 300 to 287) in 2011 given that company earnings and sales stagnated and the stock price dropped dramatically? The $1.7 million or so excess increase over what a 3% inflation rise would have been represents $0.14 cents less in earnings per share. Has the Board (whose rise in fees was only 2.6%) been paying attention? It is a dilemma to invest in a virtuous green company only to have management and employees grab an increasing share of the profits.
2) Warranty claim provisions rising faster than sales - Note 12 in the financial statements records another whopping increase (27%) in provisions for warranty claims, a big chunk of which is due to an increase in claim rates, as opposed to more units under warranty from higher sales. How this jives with an assumption stated earlier in the annual report that unit failure rates will remain the same as in the past is not explained ( I sent the company an email asking for an explanation and have not received a reply). Warranties have become a significant part of balance sheet liabilities and of cash flows (as a non-cash item added back). In the future if the reserves are correct or too low, when warranties are honoured/paid out, the warranty cash flow will reverse and become a drag on cash flow. There will be much less leeway to keep up dividends. If the reserves have been too high, earnings will get juiced by one-time upward adjustments. It is getting harder to understand how profitable WFI actually is.

In short, WFI has become much less attractive than before with its current sales geography and product mix, perhaps not to the point of selling, but management needs to deliver on expansion to new regions of the world and/or through new products.

Monday 16 April 2012

UFile Tax Software Giveaway

Here's an opportunity for all the last minute tax filers to use UFile, one of the packages I rated highly recommended in my annual review last week. UFile has been one of the best packages ever since I started doing assessments several years ago.

Dr Tax, the makers of UFile, have supplied me with three codes for the online web version of UFile to give away to blog readers. With the code you can prepare your taxes for free, a value of $15.95 for an individual return, or $24.95 for a family (spouse and dependents).

This is how the giveaway works:
  • To enter submit a comment on this post below - though you don't have to, I'd be interested in your comments on tax prep software; use a unique name (Anonymous won't suffice!) so I can distinguish people
  • One entry per person please
  • Entries close Friday, April 20th midnight EST
  • I'll do a random draw of three (3) names from amongst the entries after the deadline
  • Winners will be announced on the blog and asked to contact me via email with their own email address so I can reply with the code to enter in the UFile software (your email will not be used for any other purpose than to contact you as a winner)
Best of luck and remember to file by the deadline of April 30th. UFile, like the other NETFILE certified packages, lets you do it online quickly and conveniently.

Thursday 12 April 2012

Review and Ratings of Canadian Online Tax Software: 2011 Taxes Edition

Tax time again! For the 6th year running, these are my ratings and assessments of the best and the worst of the online tax preparation programs available to Canadian taxpayers for 2011 tax returns. As before, I've gone through all the packages certified by the Canada Revenue Agency for electronic submission of a return through NETFILE. The same ratings method has been used but the results are a bit different. Some packages are better, some just the same as last year, one is sadly worse and there's one new entrant.

Ratings Method: total score out of 45 max points on 5 factors
  1. Privacy and security (10 points) - How well does the online tax prep company protect your data and your privacy? What do they promise and what evidence is there of their capability to deliver? As I said last year, it is unfortunately still the case that this is the most uncertain area of the ratings - my numbers could be fairly wide of the mark - since it is hard to get much tangible proof of the reality vs the promises made, even compared to the minimal promises as are publicly made on the websites. Only one company (Acetax) actually claims to have been audited by an external party. CRA does not do anything, as they woefully admit in the disclaimer on the webpage with the list of packages, to check up on the companies and how they handle our data, which I think is shocking and unacceptable, given that a lot of people likely believe that NetFile certification somehow gives assurance of security protection.
  2. Flow, readability and layout (10 points) - How does the appearance and the flow of the program guide the taxpayer through all the steps, ensuring that everything is entered correctly in the right places? Is it easy to go back and forth, to review results and check one's work or make changes? The programs vary enormously on this factor, from simple on-screen versions of the paper forms, which merely do the arithmetic correctly and transfer amounts (or are supposed to!) between forms, to sophisticated interview processes akin to interaction with an accountant, asking questions to uncover all income and deductions and credits.
  3. Help (10 points) - How much access to explanations about tax rules is provided and how well placed is it? One of my on-going pet peeve test items is the infamous T1135 Foreign Income Verification Statement which a taxpayer with foreign property over $100,000 in cost must fill in, sign and send in to CRA. Does the program tell you, ideally at the point when you have to tick that box, that it is not required for foreign holdings within registered accounts like RRSPs? Some do not say so and others do not say that the T1135, if required, cannot be done online and that it must be submitted by mail on paper. Failure to send in a T1135 can be very painful.
  4. Responsiveness (5 points) - How fast is the online application at saving data and refreshing the screen? slow = frustration! Some of the programs are a lot more reliably responsive, an important factor if you are in the final throes of meeting the April 30th deadline.
  5. Accuracy (10 points) - How good a job does the program do at calculating your taxes and helping you legally pay the least amount? For those who think that NetFile certification means the programs will all come up with the same answer (as I believed myself before starting to look at all these packages a few years ago), it is time to recognize the reality. As I commented two years ago, CRA's certification only means the program is correctly including all the revenues. the programs differ enormously in their ability to automatically detect and claim all deductions and credits to which you are entitled. As a result, in my own case with all the packages my total income on line 150 was identical but balance owing on line 485 showed different amounts, anywhere from a few dollars to a few thousand dollars apart. In the cases where I had thousands less to pay this was the result of incorrect eligibility for deductions that the programs did not prevent. It is only because I used them all that I got to learn what should be the correct result. Some are much better than others at preventing incorrect input but it is always worth the time to use a couple of the programs to enter your data and compare the results. They all allow you to see the bottom line in much detail, if not actually to print or submit the completed return. The very best package (TaxChopper) at using deductions and credits for an individual and/or shared amongst family members is almost like having a skilled accountant doing your taxes - it is essentially an expert system for income tax. Three examples tested the packages' ability to optimize using age amounts and pension splitting, tuition and education transfers, foreign tax credits with inter-provincial residence thrown in for the trickiest rule. In no case did any other package beat TaxChopper - it always found deductions, transfers and credits to use and end up with the lowest taxes to pay. The difference was about $250 on a total refund of around $6000 for the fictional test family. Optimization can be very worthwhile.


Highly Recommended
#1 TaxChopper - 40 points - a repeat winner
"A tax expert system – Delivers on the biggest refund / lowest tax to pay promise. Best value for money."

#2 UFile - 38 points
"Polished, easy to use and handles all but the more sophisticated tax reduction optimizations"

#3 H&R Block - 35 points
"Technically, it's UFile but it has a few less desirable privacy features"

#4 TurboTax - 33 points
"Guidance every step of the way with plenty of questions, reminders and some useful suggestions for future tax planning"

#5 EasyCTAX - 30 points
"Biggest improvement since last year's “beta version”. Now a credible product."

#6 AceTax - 29 points
"Just fine for those who need minimal help and are familiar with tax forms"

#7 (tie) WebTax4U - 26 points
"For those who know where things go and are familiar with tax forms"

#7 (tie) EachTax - 26 points
"Looks like the forms; for those who know what forms to use. Much improved responsiveness."

#9 Taxnic - 24 points
"OK package if you know what forms to fill and credits to claim. What CRA would give us if they created a NetFile package – no error checking or optimization, just the forms and correct transfer of amounts from box to box and form to form."

Merely OK
#10 MBOTax - 20 points
"It's like working with the paper forms except amounts get transferred automatically and arithmetic is done correctly."

#11 eTaxCanada - 19 points
"New interface a step backwards. Works ok if you know what you are doing and which forms to use"

Not Recommended
#12 - FileTaxOnline - 13 points
"Not recommended – too many weaknesses, some fatal"

#13 5DollarTax - 3 points
"Crude, half-finished effort, not worth using."

#14 FASTnEASYTax - not rated
New this year. Doesn't support rental or self-employment income, or returns for Quebec, Yukon, Nunvaut, NWT

Monday 26 March 2012

Sobering Views of Future US Stock Returns

Those thinking "phew! thank goodness stock markets have returned to normal and happy days are with us again" may want to read John Hussman's A False Sense of Security on the Hussman Funds website and James Montier's What Goes Up Must Come Down on Both articles just published in March 2012 make a compelling argument that US stocks are richly valued since corporate earnings are artificially (government stimulus) and unusually high, distorting the P/E ratio and prospective returns.

Hussman's bottom line: "... we project total returns for the S&P 500 of just over 4% annually over the coming decade"

Montier's: forecast annual real total return for the S&P 500 over the next seven years of only 0.4% (see Exhibit 2 in his article)

That is woefully weak compared to the long term historical annual average of 6.2% for US stock returns documented in Dimson, Staunton, and Marsh's Credit Suisse Global Investment Returns Yearbook 2012.

Tuesday 20 March 2012

Fundamental vs Cap-Weight Portfolio: Still Neck and Neck after 20 Months

No Clear Winner Yet - Last time I reported on the contest in August 2011, the cap-weight portfolio had jumped into an inconclusive lead. The contest between portfolios made up of either fundamentally-weighted or cap-weighted ETFs continues without a clear winner. The portfolios, shown in detail in the Google Docs spreadsheet at the bottom of this blog page, have been updated with all distributions up to and including February 2012. The $85 separating the two portfolios' values is a miniscule 0.07% difference. Three of the fundamental ETFs are in the lead against their cap-weight rivals while four of the cap-weighted ETFs are ahead, but by lesser amounts.

Every Asset Class is Up - Our contest start date of June 2010 must have been a good time to get into the market since every ETF is above its initial start value. The portfolio as a whole has gained 16%, a very satisfactory result for less than two years in the market.

No Rebalancing Yet Required - None of the ETFs has deviated beyond the limit (more than 25% away from its target allocation e.g. a 4% holding can go up to 5% or down to 3% before our rule kicks in) we set for forced rebalancing. That has been the case since the start. Both portfolios are quite maintenance-free. There is cash building up however, and come the June anniversary date, it will be time to invest that cash into the ETFs that lag their target the most.

Lack of Automatic Reinvestment Warps the Comparisons - One of the difficulties with making head to head fundamental vs cap-weight comparisons between ETFs within an asset class is that the cash distributions do not get reinvested within the ETF. The market hype of the ETF providers use total return calculations which assume that the distributions do get reinvested when received. Our growing cash pile includes an important part of the ETFs' returns but the cash doesn't show in the current market value of the ETF shares that we use to do the Red vs Green who-is-ahead comparison. Since the ETFs do not distribute the same amount of cash, the total returns can be a fair amount out of whack with the Red vs Green indicator on my spreadsheet e.g. PXF distributed USD$404.82 in 2011 while its counterpart VEU paid out USD$644.80; VEU is much further ahead at the moment than the $124 showing in the spreadsheet. The truest comparison of my test is at the total portfolio level.

The best direct head to head matchup is between Canadian equity ETFs CRQ and HXT since in those cases, the dividends do get reinvested. In HXT's case, the construction of the ETF itself as a total return swap ensures that HXT's value reflects reinvested distributions. In CRQ's case, Claymore's free DRIP program buys new shares for the investor so all but a few dollars each quarter gets reinvested. Right now CRQ, despite its much higher MER, is winning the race by 2.6%.

Wednesday 7 March 2012

Luck or skill? Ray Dalio of Bridgewater

Do investors like Warren Buffett succeed through luck or skill? The statistical argument is that such success cannot be distinguished from luck so therefore we cannot believe in skill. Yet ... when we encounter successful people in more tangible pursuits like sports or music, we don't say they are just lucky.

The other day I came across Principles, the exposition of what uber-rich investor Ray Dalio believes and lives by. Dalio is the founder of Bridgewater Associates, the world's biggest hedge fund according to Wikipedia. (Interestingly, Bridgewater manages some of our pension money as one of the Canada Pension Plan Investment Board's private investment partners). Principles isn't flowery imaginative writing - just plain, matter-of-fact, direct statement - but what it says rings true. It also isn't about investing principles he follows - that may come later he says. Though meant primarily as a management bible and indoctrination tool for new employees at Bridgewater, there is much value for self-reflection on what it takes to be successful e.g. "everyone has weaknesses. The main difference between unsuccessful and
successful people is that unsuccessful people don’t find and address them, and successful people do".

Dalio evidently (e.g. see John Cassidy's Mastering the Machine in the New Yorker of last July) lives by his principles with a ruthless and implacable discipline. It's the same as in any other human endeavour. To become highly successful, let alone the best, requires enormous unstinting effort.

Interesting is his take on ability since most people including me believe that talent must be there too. His reply is "... if you are motivated, you can succeed even if you don’t have the abilities (i.e., talents and skills) because you can get the help from others". In investing terms, that could mean using an advisor but then Dalio's principle 187 kicks in - "Have good controls so that you are not exposed to the dishonesty of others and trust is never an issue. A higher percentage of the population than you might imagine will cheat if given an opportunity, and most people who are given the choice of being “fair” with you and taking more for themselves will choose taking more for themselves." Or it could mean a person should take the passive index ETF route where talent and ability aren't required at all.

Dalio unintentionally provides support for the argument that there really is investing ability. First, as he says in principle 31,"People who have repeatedly and successfully accomplished the thing in question and have great explanations when probed are most believable. Those with one of those two qualities are somewhat believable; people with neither are least believable". The phenomenal success of Bridgewater is a hefty track record and this book is a pretty good explanation.

Second, in footnote 38 on page 21 he says "Luck—both good and bad—is a reality. But it is not a reason for an excuse. In life, we have a large number of choices, and luck can play a dominant role in the outcomes of our choices. But if you have a large enough sample size—if you have large number of decisions (if you are playing a lot of poker hands, for example)—over time, luck will cancel out and skill will have a dominant role in determining outcomes. A superior decision-maker will produce superior outcomes". Investing is very much an activity where there really is luck or true uncertainty at play so one cannot expect always to be correct, no matter how much data one collects and analyzes. Now, it is true that the world's biggest hedge fund may have got there merely by gathering assets and snowing all those giant pension funds about actual investment performance but there is some direct performance evidence cited in Wikipedia.

As the ancient Greek Aeschylus said "Call no man happy till he is dead". Dalio's investing prowess is only as far away as the next market shift that he has not anticipated which runs contrary to his investments. He does claim not to be too concentrated and is aware of the danger per principle 197 "make sure that the probability of the unacceptable (i.e., the risk of ruin) is nil ... knowing what you don’t know is at least as valuable as knowing" and principle 195 "Constantly worry about what you are missing. Even if you acknowledge you are a “dumb shit” and are following the principles and are designing around your weaknesses, understand that you still might be missing things". The New Yorker article also says he deliberately does not make any concentrated bets to avoid the possibility of being wiped out.

A blowup by Bridgewater / Dalio would no doubt make the skeptics happy, strangely including blogger Pension Pulse. I prefer to think investing is like sports - champions do exist because they are better than everyone else at the time but they all have their day.

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