Month: June 2016

New pay-for-performance funds to offer investors something different

A new pay-for-performance structure has been introduced for pooled funds in Canada – and it’s putting a wealth management firm’s money where its mouth is. Provisus Wealth Management, which has been in business in Canada for over a decade, has launched a sister company named Transcend, which will offer a first-of-its kind performance structure.

“The operative word is new, because what we’ve done doesn’t currently exist in Canada,” says Chris Ambridge, CEO of Provisus and Transcend. “We decided that with the advent of the ETFs and the robo structure, people are looking for real value for the money they pay, so we decided to give them something entirely different.”

Transcend has driven down the costs of their pool funds to their operating costs, charging only 25 basis points to clients in order to cover the administration, trading and legal requirements of the funds.

“For us to earn money, what we have to do is drive value-adding performance, or beat the benchmark that we’ve assigned,” says Ambridge. “Every fund has a pre-set industry standard benchmark and what we will do is – clients get the performance they get up to the benchmark, so no fees will be charged. But once we outperform the benchmark, we will take a 20% performance fee on the value add that we deliver.”

He adds that with pending CM2 regulation in store for mutual fund fee structures clients will start looking to more transparent options as they realize just what they’re paying for.

“Bringing these funds to these fee levels has clearly been at the back of our minds with CRM2, because as clients for the first time in a lot of instances truly start to see what they’re paying, and see what they’re actually getting in terms of performance, we suspect there’s going to be a lot of people questioning what they’re in, and trying to determine if change is necessary,” he says.

He adds that Transcend’s service model will provide lower net worth clients with the same level of service as higher net worth investors – an important feature as robo advisor models become more prevalent among investors.”There’s always in every instance, a portfolio manager who will discuss over the telephone with the client their goals and aspirations, risk tolerance, profile, and produce for them a customized investment policy statement for that client and their money types,” he says.

“It’s exactly the same functionality, service and support that we give to our much wealthier clients so they’re taking that high-net worth solution and giving it to everybody.”

 

by Penelope Graham

16 Jun 2016

 

Link: http://www.wealthprofessional.ca/news/etfs/new-payforperformance-funds-to-offer-investors-something-different-208942.aspx

The Real Cost of ETFs – Not just the MER

Most investors know that passive Exchange Traded Funds (ETFs) are low cost investment vehicles, correct? Well, almost right! Passive ETFs are designed to track a benchmark index or market at a low cost. ETFs may be relatively cheap from a Management Expense Ratio (MER) perspective but the costs don’t stop there. Putting aside the negative impact of brokerage costs to buy and sell and potential custodian or registration fees, ETFs in the majority of instances still underperform their underlying benchmark.

In a perfect world ETFs would precisely return the same performance of their benchmarks but this is not realistic. Therefore investors should determine if they are getting what they are paying for by tracking the difference between an ETF’s performance and the benchmark’s performance. The resulting Tracking Difference is seldom zero and usually trails its benchmark. It is easy to find as ETFs are required to file a Management Report of Fund Performance (MRFP) twice a year on the SEDAR.ca website.

Of course fees are almost always the cause of performance lags and are the single best indicator of future Tracking Difference. That is why ETF issuers keep trying to offer the lowest fees. However other factors could impair returns such as the trading and rebalancing costs which occur when ETFs realign themselves as indices adjust their holdings, sampling issues that occur when it is impractical to hold every security in the index and there is a cash drag between when the ETF receives dividend and interest payments and when it then distributes them to shareholders.

In Canada there are more than 425 ETFs but the largest 100 by assets represent over 83% of all the invested assets. These Top 100 ETFs as of May 31, 2016 provide an excellent sample of the extent of any lag in performance relative to the benchmark. By gathering both the MER and the Tracking Difference (based upon 3 years of information ending December 2015) we are able to see how much of the underperformance is attributed to these costs. The chart above and the table on the left show this analysis on a pro-rata weighting basis for the Top 100 ETFs and their major asset subcategories. Interestingly, the average MER across the entire 100 ETFs is 0.31% (individual MERs ranged from 0.03% to 0.91%) and this remains very consistent across all the asset classes despite the fact that the number of individual ETFs per category varies dramatically with 2 Money Market ETFs, 33 Bond ETFs and 65 Equity ETFs. The other surprising item about this data is that while Money Market and Bonds had very little additional underperformance that was not directly attributed to fees, this was not the case for Equities. Equities, on average, significantly underperformed their benchmark by 0.73% per year, which flowed through to the entire sample underperformance (0.61%) since equities are such a large part of the Top 100 ETF group. This cost/weakness is much more than most investors know about or expect.

The aim of a Passive ETF is to mirror its benchmark so they are not designed to outperform.  As such, Tracking Difference is one of the most important ETF statistics to consider. Without an understanding of Tracking Difference, investors could be virtually guaranteeing themselves underperformance.

MARKET DATA

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.
While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Q1 2016

MARKET COMMENTARY

The past quarter was another lesson in the benefits of long term investing as the markets were particularly volatile in the course of reflecting the January recessionary scare, to the grudging acceptance that returns might be limited by slower growth, to a flat out bull market surge at the end of the quarter. This turmoil has caused confusion but also created bargains and opportunities. Markets are caught in a tug of war between stubbornly slow growth and central bank stimulus.

The plunge in commodity prices, particularly in oil and gas, has caused a great deal of concern on Bay Street and as well as for Main Street. While the drop in oil prices is hurting a lot of businesses, improvements in non-energy based activities is more upbeat. The federal government is committed o further stimulating the economy, but welcome though it may be, it appears to becoming less necessary as improving employment and a stronger U.S. trading partner are starting to exert themselves.

The U.S. economy has been solid for the most part. While there has been strength in the labour and lending markets, a lack of business spending is slowing growth. Inflation rose in January from a year earlier, after 13 consecutive months with rises below 1%, owing to a slide in energy prices. U.S. households are benefiting from a tightening jobs market that is starting to push up ages. As is always the case, U.S. consumers will lead the way in supporting global growth.

At this point, international economies do not look that much different from most of 2015. Europe continues to be steady with the business climate showing surprising improvement. The European Central Bank unleashed another round of unprecedented stimulus, pushing interest rates below zero. Japan is not rushing toward more fiscal stimulus, but they too are laying the groundwork for additional easing if necessary after cutting its deposit rate to minus 0.1%,. The outlook for emerging markets is clouded by China’s diminishing growth and high debt, worsening demographics, as well as maturing emerging market economies are subduing any possible rapid expansion.

Central bankers have managed to steer the world economy clear of a recession but government bond yields are exceptionally low. With most advanced economies still experiencing anemic recoveries from the 2008 financial crisis, central banks have been forced to move from conventional monetary policy to a range of unconventional policies. Some have already implemented negative interest rates to try and force safety conscious investors to seek real returns.

The horrendous start for the equity markets in 2016 shows that investors are still very skittish. This pervasive pessimism and skepticism however were quickly overturned by the U.S. Federal Reserve’s dovish stance on interest rates; a dramatic softening of the U.S. dollar; and a sharp recovery in the commodity markets triggered a rebound in stocks. The Canadian stock market gained 4.5%, one of the best performing markets in the world. The U.S. stock market declined 5.4% (all returns in Canadian dollar terms), but all of this loss was due to the decline in the U.S. currency, which fell 6.7% in the quarter. International stocks dropped 9.6%, while Emerging Market stocks only declined 1.4% and were the best performing stock markets in their base currency terms. Canadian bonds continued to eke out positive returns, appreciating 1.4%.

The year began with the view that stable growth would be a very good thing given the nasty combination of events that could envelope the world. Investors were awash in angst, showing little faith the markets and instead worrying about hard landings, currency devaluation and risks around every corner. The first quarter is essentially a microcosm of what to expect to play out in markets over the next little while. These are not desperate times as slow and lackluster baby steps forward are expected to be the norm.

Christopher Ambridge, CFA

CANADIAN EQUITIES

2015 After a disappointing year 2015 where the Canadian market fared as the worst among its peers, the TSX like other global markets started 2016 in the red amid concerns over China’s GDP growth, further deterioration in commodity prices and geopolitical tensions. On January 20th it hit a two and a half year low, dragged down by broad based losses in different sectors but notably in oil and commodities as prices in these sectors tested levels not seen in more than a decade. From an abysmal start, followed by intense volatility until mid quarter, the index managed to rebound more than 12% from its January low. It ended the quarter with a 4.5% gain on a total return basis, making it one of the best performing global markets year to date.

The economy surprised by expanding at an annual rate of 1.5% in January which was better than expected analysts’ expectations. But jobs unexpectedly went into reverse in January with 6,000 jobs losses and another 2,000 in February before blowing all forecasts with more than 40,000 jobs gain in March.

Canada’s growth outlook for the months ahead has received warnings signs from many analysts and institutions such as the Bank of Canada and the International Monetary Fund (IMF). A few months ago the IMF revised its GDP growth expectations for 2016 to under 2% and trimmed 2017 GDP growth from 2.4% to 2.1%. Many positive developments in the economy have occurred since then, notably the revival of manufacturing and exports. In January manufacturing sales rose 2.3% to more than 53 billion dollars, an all time high, while exports also hit a record high in January. The depreciation of the Lonnie was the main reason for the increased competitiveness and there has been a shift of the economy away from energy and commodities and towards manufacturing and exports. Likewise the Bank of Canada acknowledged in a recent report that the economy is improving, although it is still facing downside risks. It is a well known that the TSX’s performance is highly correlated with oil prices. That correlation is at a long term high even though energy’s weight in the index has decreased. The index’s earnings excluding energy is very strong and once oil prices revert to normal levels, the index will likely reclaim it’s spot among the leaders in global markets.

Ari Abokou, MBA, CIM, FCSI

FIXED INCOME

In the first quarter of 2016 the Canadian FTSE TMX Universe Bond Index gained 1.4% and the Bank of Canada’s target for the overnight rate remained unchanged at 1/2 of one percent. Over the course of 2015 Canada’s central bank lowered its target for the overnight rate by 1/4 of one percentage point on two occasions; first in January and again in July. In the U.S., the Federal Reserve maintained its benchmark interest rate target range of 1/4 to 1/2 of one percent after having raised rates in December for the first time in seven years.

As 2016 began, global financial markets were in the midst of a steep correction, commodity prices were plunging and concerns were being raised about growing risks of a world recession. Since then the Bank of Canada believes that some of the pressure facing the country’s economy has eased and the central bank is taking a wait and see approach to the federal government’s multibillion dollar fiscal stimulus. The market has steadily lowered the odds of a further rate cut as the combination of firmer oil prices, much-improved nonresource exports and the growing expectation that the U.S. central bank will most likely raise rates this year have all contributed to a change in sentiment. The possibility of a rate cut in Canada remains though as GDP growth is still well below potential, unemployment had been moving higher at the end of 2015 and the currency’s recovery has been removed as an obstacle for a rate cut.

The central bank’s recent Monetary Policy Report noted three important changes to the bank’s outlook. Expectations for global economic growth for 2016 and 2017 have been reduced, the energy sector has reduced its investment intentions despite the significant rebound in oil prices and the Canadian dollar has rallied from its lows. A further recent change was the introduction of the recent federal budget. The report noted that “We can’t be entirely certain about the full effects of the budget on the economy, as some will depend on how households react over time. But Governing Council judged that the budget actions will more than offset the negatives from the other three changes….The net effect is that our projected growth profile is generally higher than it was in January.” The report concluded that “In sum, recent economic data have been encouraging on balance, but also quite variable. The global economy retains the capacity to disappoint further, the complex adjustment to lower terms of trade will restrain Canada’s growth over much of our forecast horizon, and households’ reactions to the government’s fiscal measures will bear close monitoring. We have not yet seen concrete evidence of higher investment and strong firm creation.”

Peter Webster, CFA

U.S. EQUITIES

The Standard & Poor’s 500 index climbed 1.3% in U.S. dollar terms over the first quarter of 2016 but in Canadian dollar terms the index lost 4.9% as the Loonie recovered in the early months of the year. While the U.S. market was little changed over the quarter in U.S. dollar terms, the near flat return belied a volatile period as stocks fell dramatically over the half of the quarter and more than recouped those losses by the end of the quarter. In March the bull market in the U.S. celebrated its seventh birthday and while it has been a long run, the longest post war bull market lasted for nearly 10 years, until March 2000,

Modest economic growth continues to be seen in the U.S. but the economy is sending mixed signals according to the recent Beige Book report from the Federal Reserve. The Beige Book, more formally called the Summary of Commentary on Current Economic Conditions, is a report published in advance of meetings of the central bank’s Federal Open Market Committee and includes anecdotal information of current economic conditions. The April 2016 Beige Book noted that, “Reports from the twelve Federal Reserve Districts suggest that national economic activity continued to expand in late February and March, though the pace of growth varied across Districts. Most Districts said that economic growth was in the modest to moderate range and that contacts expected growth would remain in that range going forward.” Overall the anecdotal evidence suggested that consumer spending is weakening but wage growth is picking up and business spending is increasing in most districts.

Federal Reserve Chair Janet Yellen indicated that the Fed still envisions only a gradual pace of interest rate increases in light of global pressures that could affect the U.S. economy. She said risks to the U.S. appear limited but cautioned that that assessment is subject to “considerable uncertainty.” The U.S. central bank is monitoring a global economic slump which has hurt some U.S. companies and key sectors such as manufacturing. In particular she is concerned about China, noting widespread uncertainty over how well Beijing will manage a delicate slowdown in the coming years. She said that because foreign economic growth seems to have weakened this year, the Fed will “proceed cautiously” in raising rates. Yellen noted that the U.S. job market and housing recovery have lifted the economy close to full health despite the risks that remain. She also noted that the economy has also benefited from low long-term interest rates. Those rates have been held down by money flowing into U.S. bonds from investors who have now scaled back their expectations for the number of Fed rate hikes this year. Longer term, U.S. worker productivity will need to begin increasing in order to boost the outlook for the U.S. economy.

Peter Webster, CFA

INTERNATIONAL EQUITIES

The first quarter of 2016 was a roller coaster ride for international stocks. The first few weeks of the year were littered with large swathes of losses as negative sentiment smothered global stock markets. Then just as suddenly in mid-February, stocks made an epic about face, rebounding at a rate not seen in ninety years. This was not a reckless rally; it has been a very cautious comeback. While skepticism has not disappeared, the number of positive and negative economic surprises is slowly shifting in favour of further upward momentum.

Europe needs to make their economies and labour markets more competitive, rein in profligate spending and fix their banks. Reform efforts need to be stepped up, particularly to encourage banks to lend out money instead of hoarding it. Unemployment has somewhat improved but is still too high. The inflation rate is minus 0.2%, nowhere near the 2% target rate. The European Central Bank has enacted a series of stimulus measures, such as cutting interest rates to minus 0.4% and pumping newly printed money into the markets in an attempt to expand credit to companies. However, the ECB cannot do it alone so consumer spending will likely be key if the
Eurozone’s growth is to regain momentum.

In England the outlook for financial markets has deteriorated due to the risks surrounding the possible termination of membership in the European Union. The upcoming referendum is the most significant risk to financial stability and economic growth currently facing the U.K. The possible negative spill over effect on Europe is immense and once again highlights the overwhelming impact politics plays on economics.

Japan’s economy is at risk of falling into recession once again as volatile financial markets and sluggish emerging market growth threatened to derail a fragile recovery. Its manufacturing activity contracted at the fastest pace in more than three years as exports shrank. Household spending has slumped due to lower average income. The Japanese central bank has for years tried to bring the economy to life but none of the measures seem to work. Even larger stimulus could be in store to jolt the country out of its malaise.

Bull markets reigned from Brazil to Russia as the U.S. central bank indicated that it was going to slow down the speed of interest rate increases, fueling optimism that capital inflows would improve. At the same time a bounce in oil prices and a shift in sentiment on commodities in China lifted all markets but a rough ride for emerging markets is still ahead.

Global shares rebounded from the January plunge and embarked upon a bullish tear. Despite the international stock market’s 12% recovery since the February 11th low, most markets produced losses over the full quarter. Across all international developed market the declines were fairly uniform. European stocks dropped 3.2% (all returns in U.S. dollar terms); Asian stock fell 2.9% for an average loss around the globe of 2.9%. Emerging markets were the only respite from the pain, as they gained 5.4%. Most of the weakness stems from poor corporate earnings as most global company profits remain 15% below the record highs reached in 2007.

There is ample opportunity for investor’s sentiment to improve. In a lot of instances sentiment turns unjustifiably negative, followed by surprising surges in stock markets. Of course the embedded skepticism about this glacial recovery is well founded. The emphasis going forward is on investors, companies and consumers who need to put their money to use, to expand or buy things and ultimately stimulate growth.

Christopher Ambridge, CFA

Q2 2016

MARKET COMMENTARY

Uncertainty has always been the main source of angst for investors and there has been no shortage of that lately.  The last few months have been a frenzy of dire predictions and hyperventilated commentary which has caused significant swings in the financial markets.  However, at the end of the day, all the information available was absorbed and investors carried on.  Perhaps global growth will take a short term hit but after some reflection and clarification, the anxiety will likely be subdued and the world will keep spinning.

Global demand continues to grow at a moderate rate despite many over hyped warnings. In reality, the most important issues of the day do not emanate from Europe: the potential fallout from China relying heavily on debt to fund infrastructure and economic expansion could lead to a financial crisis; weak business investment from companies spending less could slow earnings growth; and a slowdown in the U.S. economy that looks to be running out of steam and adding fewer new jobs, will have widespread repercussions.

The perceived worries following the U.K.’s vote to quit the European Union are fading and global growth is chugging along. Of course, the vote to quit the Eurozone roiled markets, torpedoed the pound and spurred a surge in demand for safe haven assets for a few days. But after the shock subsided, stock markets rebounded and in the U.S. they hit new all-time highs. Now we need to get down to the business of looking forward as the damage to global growth from Brexit should be limited.

Europe, on the other hand, needs to address many legitimate grievances and start to move in the right direction.  It needs to manage a surge in refugees, Greece’s debt problems and the future of the shared currency.  It cannot keep pretending that it is business as usual.  It will be a long and tortuous journey but the risk of doing nothing is potentially even more dangerous.  The good news is that growth is accelerating and has pushed the 19 country bloc to the level it was just before the recession of 2008.  While unemployment is still 3% higher than 8 years ago, it is also on the right path.

Canada’s economy has reversed its trajectory from the two consecutive monthly declines earlier in the year, although the second quarter is still expected to be weak.  The Alberta wildfires will likely sink the second quarter growth rate but a rebound is anticipated in the third quarter.  The Bank of Canada will likely hold key its interest rate steady into 2017. The struggling manufacturing sector is surprisingly upbeat but the fallout from the U.K. uncertainty could lead to some surprises.

Despite the initial carnage after the Brexit vote, the second quarter was generally a good one for most investors. Canada was the second best performing market gaining 5.1% in the quarter and 9.8% year-to-date. Most of these gains were propelled by commodities as they surged 13% (all returns in C$ terms), spurred by a 25% gain in oil prices after a 6.2% rally in the first quarter. Canadian bonds increased 2.6%; U.S. stocks gained 2.8%; Asian stocks appreciated 1.1%, while emerging market stocks were flat. And while in the long run the Brexit turmoil will likely be just a blip, it did contribute to European stocks falling 3.9%.

Certainly more signs of economic weakness could unbalance investors but prolonged low rates and lackadaisical non-recession growth will continue to propel the markets upward.  For now the real future of the markets and global economies are in the hands of the politicians.  While the Brexit vote did not really produce financial carnage, it is an important reminder to expect the unexpected and prepare accordingly.

CANADIAN EQUITIES

Stock market anxiety resurfaced after the Brexit vote which resulted in massive losses for global markets. The TSX in particular dropped more than 3% in the two days after the vote before bouncing back at quarter end. That bout of volatility and the adverse impact of the wildfire in Alberta would appear to have worked against the TSX. However the wildfire along with other geopolitical unrest triggered a decrease in daily oil production which ultimately propelled the price of oil to more than US$50 a barrel for the first time since mid 2015. Additionally the fresh nine month high in mining stocks helped the TSX break through the resistance level of 14,000 points. The result of all this activity was the TSX ending the quarter with a 5.1% gain, making it one of the best performing global markets in the world year to date.

A sector breakdown shows that Materials and Energy continued their impressive run that started in the middle of the first quarter. The Materials sector has been the natural beneficiary of negative interest rates, now common throughout some major economies in the world, including Japan and Germany. It led the pack on the TSX with a 26% gain followed by Energy with a gain of about 10%. Utilities were the third best performer during the quarter with a 6% gain, driven by asset value appreciation amid the subdued interest rate environment. On the flip side the index was dragged down by Health Care which posted a 7.5% loss as investors continue to be cautious due to the drug price scandal that began a few months ago. Information Technology also lagged the index with a 5.6% loss. Although the financial services sector was a modest detractor on the TSX with 0.2% loss, the sector is still striving to find some stabilization.

The Canadian economy, unlike its stock exchange, shows some fragility amid a see-saw growth pattern. The first quarter posted annualized GDP growth of 2.4% which is slower than the 2.9% pace economists expected. Though decent, there are few reasons to believe that such a pace will be maintained over the next few quarters as the February and March GDP readings were weak. The aftermath of the wildfire in Alberta will also likely cut a few percentage points from next quarter’s GDP.

FIXED INCOME

The Canadian FTSE TMX Universe Bond Index gained 2.6% in the second quarter of 2016.  Year to date the index is well into positive territory with a 4.0% gain. The Bank of Canada continues to maintain its target for the overnight rate at 1/2 of one percent. Over the course of 2015, Canada’s central bank lowered its target for the overnight rate by 1/4 of one percentage point on two occasions; first in January and again in July. In the U.S., the Federal Reserve maintained its benchmark interest rate target range of 1/4 to 1/2 of one percent after having raised rates in December.

Canada’s central bank governor, Stephen Poloz, is finding it a challenge to determine the current state of the economy as data has been volatile. Following a speech to the Canadian Economic Association in June he noted that “Views in the market, about what policies might do, change virtually every week so our job is to continue to do our analysis to see our way through that volatility and focus on getting the trends right.” Senior Deputy Governor Carolyn Wilkins confirmed at a recent Monetary Policy Report press conference that the bank’s, “discussions focused on how we should look through the choppiness in recent data to see the underlying trends, and what these trends mean for the inflation outlook. Among other factors, the fires in Northern Alberta, which have been costly for many, represent a sharp, but temporary, hit to the economy. We expect to see GDP fall by 1% at annual rates in the second quarter, and then grow by 3.5% in the third quarter as oil production resumes, rebuilding around Fort McMurray begins and the new Canada Child Benefit lifts consumption.”

Despite volatile energy prices there are positive signs in other sectors. Thanks to the slow but steady growth in the U.S. economy and a lower Canadian dollar, exports outside of the energy sector have recovered to levels close to their pre-recession peak. Nevertheless exports are another example of volatile data. After two months of declines, Canada’s exports rose 1.5% in April while imports increased more slowly at 0.9%. Together they narrowed the country’s trade deficit to $2.9 billion from a $3.2 billion shortfall in March, which is a positive trend for Canada.

The Bank of Canada is projecting that inflation will average 2% in 2017 as the economy recovers.  However, wage pressures have been subdued relative to historical experience so inflation may remain on the low side. A low inflation environment constrains the bank’s ability to raise rates and the current low interest rate environment is a concern to the bank as it is seen as a driver of high household debt levels and overly high home prices in the Vancouver and Toronto markets.

U.S. EQUITIES

The Standard & Poor’s 500 index rose 2.5% in U.S. dollar terms over the second quarter of 2015 and in Canadian dollar terms the index was up 2.7%. For the year to date the benchmark is up 3.8% but fell 2.2% in Canadian dollars as our currency recovered some of the ground it had lost to the U.S. dollar in the first quarter.  While weak in Canadian terms recently, the U.S. index continued to be positive as investors continued to ride one of the longest bull markets since the 1940s. The S&P 500 index has more than tripled since bottoming out in March 2009.

In February, when the S&P 500 index had fallen more than 10% since the beginning of the year, concerns were growing that the U.S. economy was slipping into a recession. Those fears have since subsided as consumer spending, which accounts for more than two thirds of U.S. economic activity, increased to $11,373 billion in the first quarter of 2016; an all-time high. Economists, impressed by the vitality of American consumers, expect the economy to grow at least twice as fast in the second quarter as the 1.1% pace we saw in the first quarter. The rough start to the year had prompted economists to initially lower their estimates for economic growth; however the average forecast now calls for better than 2% economic growth this year.

Economists were surprised by the strong employment increase in June as U.S. employers added 287,000 workers. The good jobs number is easing concerns that the labour market is in a slump. The unemployment rate did edge up from 4.7% to 4.9% but that was largely because more Americans resumed looking for work. The employment number stood in sharp contrast to May when only 38,000 people were hired, the smallest number in five years.  At the time expectations were for 164,000 new hires.

While fear is increasingly evident it is actually a foundation for the bull market as stock prices perpetually climb a wall of worry. From a global perspective, the U.S. economy appears to be a relatively safe haven and there are signs of improvement. Recovering commodity prices confirm that the deflationary undertone dominating investor mindsets in the last couple of years seems to be finally easing and there are increasing reports that suggest earnings performance may begin to improve over the balance of the year. The second half of the year is also looking better due to renewed strength in housing and auto sales, and thanks to the most recent jobs report, consumer confidence is near a post-crisis high.  After weakening earlier in the year, the outlook for the U.S. economy now appears to be reasonably good.

INTERNATIONAL EQUITIES

After the past quarter, the world appears very messy once again. However, the reaction out of the U.K. and Europe was entirely unpredictable and not all that bad, everything considered. The world did not stop spinning; sure the financial markets went through a period of volatility, which could lead to a slowdown in global growth, but let’s wait and see before charging into the next so-called “event-of-the-decade.”

The world has been focused for months on the debate about the U.K. remaining in the Eurozone. While the outcome was not as expected, it does come with a sense of relief. While it was long, hard and tedious to endure, the unfortunate part is that this is not the end of “Brexhaustion”. Negotiations that will lead to some kind of new relationship between the U.K. and Europe will begin.

The British financial markets had functioned smoothly despite the pound hitting a 30 year low and the absolute drubbing U.K. stocks initial experienced following the vote. But the markets rebounded somewhat and are content to take a wait and see attitude given the lack of hard evidence about the actual impact. However, the British exit out of the Eurozone is likely to act as a significant drag on the British economy and to a lesser extent on the Eurozone’s economy as well. European officials are in no hurry to implement any changes, as the process could take years to unwind and how it will end, nobody knows. The Eurozone’s economic growth continues to remain frustratingly low, with monetary policy becoming less and less capable of keeping the region afloat. It is probably time to pass on the baton to fiscal policy, but that is in the hands of the politicians and the private sector. Unfortunately, they are likely not in the mood to significantly increase spending at this juncture.

Japan’s recovery is apparently faltering again after the economy returned to growth in the first quarter. Industrial production is declining more than forecast as a drop in exports hit most of the country’s manufacturing sector. The Bank of Japan is flooding the economy with cash in the hope that doing so will prompt companies and households to start spending more. Still after sending interest rates into negative territory and unleashing a massive stimulus program, more will likely need to be done. Australia has also added its name to the list of troubled economies and is likely facing a prolonged period of political and economic instability.

After the U.K. exit vote’s initial panic selling spree that erased $3 trillion from global markets, the markets collectively began reversing their knee jerk reaction. Barring a severe global recession, large stock market declines generally undo themselves within three or four months. Even so, international stock markets on aggregate were barely down on the quarter, declining 1.2% (all returns in U.S. dollar terms). European stocks, as would be expected, were the biggest losers falling 4.2%. Asian stocks actually increased 0.8%, while emerging market stocks slipped marginally, declining 0.3%.

Looking past the initial disruption and current uncertainty, the true impact of the Brexit kafuffle will vary widely depending on proximity. The U.K. will suffer the most; Europe will likely stumble, but outside of that the rest of the world will carry on. Not many pundits are predicting a recurrence of 2008 all over again, so it is reasonable to expect that the financial markets will not seize up. Even as events in Europe unfold, the markets have settled down and the world will muddle through as always.

Q3 2016

MARKET COMMENTARY

The tranquil summer that investors were enjoying came to an abrupt end towards the latter part of the quarter as negative events triggered a brief wake up call and volatility crept back into the picture. While short term news may twist the market’s tail, it will be the major fundamental factors that truly change the course of the markets, namely corporate earnings and low interest rates. Fortunately, there has been some good news on both fronts.

Corporate earnings and cash flow are stabilizing and perhaps even rising as the earnings dip appears to be over. In the second quarter earnings were expected to decline however, excluding energy companies, year-over-year earnings were actually positive. The cash generated by corporations has allowed them to not only pay attractive dividends but also to buy back large quantities of their own shares which has strengthened the market. Interest rates have bottomed after falling since the beginning of the year. Even if there are some short term rate increases, the world’s central banks expect relatively low rates to prevail for years. And when interest rates are lower, earnings are worth more and share prices tend to rise.

The Canadian economy shriveled in the second quarter to its worst performance in seven years. This contraction compared with growth at an annual pace of 2.5% in the first quarter. The drop in the economy came as exports of goods and services fell dramatically. The jobless rate rose to 7.2% as the collapse in oil and gas prices caused significant job losses. While it was not pretty, growth is expected to pick up in the third quarter, due to the federal government’s new Canada child benefit program and a boost in infrastructure spending.

The U.S. and Canadian economies have parted ways of late, with the U.S. economy’s superior relative performance remaining quite strong despite operating below its long term historical patterns. Despite some wage pressures, inflation has been kept in check. It has often been said that expansions do not die of old age; they typically die of economic excess and aggressive monetary tightening. Accordingly, there are at least a couple of years of growth before trouble starts to brew.

The world’s economy remains fragile and uneven. Certainly politics and geopolitics are not helping, with the final stretch of a contentious U.S. presidential election dominating the headlines. In the U.K., the consequences of the Brexit vote have yet to be felt; Italy is facing its own defining referendum; and in Germany, the governing party suffered a humiliating local election defeat. Japan’s experiment with negative rates has been ineffective and possibly counterproductive. China is wrestling with widening economic imbalances and stresses in its financial system that could stall its growth.

The third quarter was very rewarding for investors with equity volatility and bond yields near historic lows. The question now is whether there is enough conviction to push markets even higher. The Canadian stock market gained 5.5% in the quarter and is up 15.8% for the year, the second best return across developed markets, rising on the back of earnings that are expected to surge 33% from a year ago. The U.S. stock market returned 4.7% (all returns in Canadian dollar terms) for the quarter; with international markets doing even better by climbing 8.4%. Emerging Markets led the way with a 10.3% gain. Canadian bonds produced the weakest returns eking out only a 1.2% gain for the quarter while climbing 5.3% for the year.

It is important to remember that is not about where markets are now, but what the markets are anticipating, that will expand and extend the current cycle. There will always be sudden air pockets in optimism but they are infrequent and have usually proved both temporary and quickly reversible.

CANADIAN EQUITIES

The Canadian economy has been growing at its slowest pace in 60 years. In addition to the uncertainties in the global economy, many domestic factors have not gone in the country’s favour over the last few months; first the collapse of energy prices last year, then the wildfires which added to the disruption, and then there was an unprecedented decline in exports during the second quarter. Yet the Canadian stock market held its ground thanks to gold in particular which surged more than 75% year to date. Over the quarter the TSX posted a decent 5.5% total return. Although it lagged many other global peers in the quarter, it outperformed most other markets on a year to date basis with a 15.8% total return.

The TSX has been notably resilient as it stayed in positive territory for three consecutive months and corroborated the view that the Canadian market has been the place to be after years of underperformance vis-a-vis its global peers. One particular trend that has emerged within the Canadian stock universe is the return to positive gains for the small and mid cap segments of the market. Over the last five years, these segments, especially the small cap, have lagged their larger capitalized counterparts. This trend was reversed as small cap stocks have returned almost twice the performance relative to the TSX benchmark year to date.

On the economic front, the third quarter started weakly. During the first half of the year, Gross Domestic Product (GDP) saw its worst drop since 2009 as it was hit by oil production disruptions in Alberta as well as setbacks in exports. The weak employment numbers at the beginning of the quarter raised concerns for many analysts as the nation lost over 31,000 jobs in July versus the 10,000 in gains that they had predicted. But reports over the entire quarter showed that GDP bounced back solidly as it gained 0.5% in July and exports reignited nicely to narrow the previous months’ deficit.

For the remainder of the year the economic momentum is expected to continue, given that the Federal government has rolled out an enhanced child benefit plan that should increase consumption. Nonetheless the sustainability of a full turnaround in the longer term could be in doubt due to the many economic challenges that may prevail. In the face of lower potential GDP growth over the upcoming quarters, the Bank of Canada has few alternatives other than to adopt a dovish tone until the economy is back at full capacity.

FIXED INCOME

The Canadian FTSE TMX Universe Bond Index gained 1.2% in the third quarter of 2016. Year to date the index is well into positive territory with a 5.3% gain. The Bank of Canada continues to maintain its target for the overnight rate at 1/2 of one percent. Over the course of 2015, Canada’s central bank lowered its target for the overnight rate by 1/4 of one percentage point on two occasions; first in January and again in July. In the U.S., the Federal Reserve maintained its benchmark interest rate target range of 1/4 to 1/2 of one percent.

The Canadian economy looks to have recovered during the third quarter following a second quarter drop of 1.6% in Gross Domestic Product (GDP) due to weak exports and the impact of May’s wildfires in Alberta. More recently, GDP grew by 0.5% for the month of July, largely due to the oil sands sector which gushed 19% as production returned to normal after the wildfires. Canada’s trade deficit in August shrank to its lowest level in eight months on stronger non-Energy exports. Exports rose a healthy 3.4% in July and another 0.6% in August. Canada’s central bank has long projected that exports would rise on the back of the weak Canadian dollar and a recovery of the U.S. economy. U.S. economic growth is now picking up after a first half lull and job gains have remained healthy.

The prospect for an eventual rise in interest rates is heavily dependent on the U.S. With the improving employment numbers, the Federal Reserve now only needs to see inflation approach its 2% target in order to implement a higher rate policy. It has been a slow grind but inflation has been creeping upward, driven by higher food and energy costs. The prospect for an eventual rise in U.S. rates is supporting the American dollar relative to a weak Canadian dollar.

There had been expectations that the Bank of Canada might lower rates to maintain the trade advantage of a weak Loonie but that is now looking less likely as the Canadian currency remains relatively weak. Looking forward Canada could be one of the next countries to raise rates in the next few years which would be well ahead of Europe or Japan where rates aren’t expect to rise until at least 2020.

In this low rate environment, yield hungry investors have been ditching the safety of bonds in a search for returns in risker real estate investment trusts and high dividend yielding stocks. This can be a dangerous game as these investments don’t have the defensive characteristics of high quality bonds. Investors should note that while the bull market in bonds may be over, it does not mean that a bear market in bonds is beginning.

U.S. EQUITIES

The Standard & Poor’s 500 index rose 3.9% in U.S. dollar terms over the third quarter of 2016 and in Canadian dollar terms the index was up 4.7%. For the year to date the benchmark is up 7.8% but in Canadian dollars was only ahead 2.6% as our currency recovered some of the ground it had lost to the U.S. dollar in the first quarter. Investors in the U.S. market continue to ride one of the longest bull markets since the 1940s as the S&P 500 index has more than tripled since bottoming out in March 2009.

U.S. Gross Domestic Product (GDP) expanded at a 1.4% annual rate according to the Commerce Department in its third estimate of second quarter GDP as exports outpaced imports and businesses increased their investments. That was up from the earlier estimate of 1.1% and higher than analysts’ expectations. The revised data showed businesses sank more money into research and development and suggests that the worst of the Energy-led slowdown in business investment might be over. As well, the rebound in exports relative to that of imports was enough to boost GDP by the most since the third quarter of 2014. Nevertheless, the economy has struggled to regain momentum since output started slowing in the last six months of 2015 and the overall growth rate for GDP in the second quarter was below historically normal rates. On the plus side, consumer spending, which makes up more than two-thirds of U.S. economic activity, was robust in the second quarter, rising at a 4.3% annual rate.

Many investors are concerned that the valuation of the U.S. stock market is at or above historical extremes while at the same time the U.S. economy is historically weak. The concerns are that a bear market is imminent because markets are expensive. While expensive valuations may precede a bear market, they are not in themselves the cause. Market declines are generally caused by larger economic effects. The data confirms that considerable slack remains in the U.S. economy. Single family residential building permits are significantly below their long term potential, durable goods orders are scraping along the bottom, and while consumers remain the bedrock of the U.S. economy, consumption as a percentage of income is weak. What the data does suggest is that a recession is not likely for at least another 18 to 24 months. While we are more than seven years into this economic expansion, the U.S. economy is by no means at risk of overheating. The economic landscape today is one of low inflation and considerable slack in housing, autos, and investment

There is also a compelling story for U.S. equities when viewed from a global context. Despite the underwhelming rate of economic growth domestically, the economy is still growing relatively well when compared to most other parts of the developed world. U.S. GDP is expected to grow at or above the 2% range next year, while the Eurozone economy is projected to advance at around 1% and Japan’s GDP is forecast to rise by even less than that. For global investors a bet on the U.S. economy is seen as a good way to invest.

INTERNATIONAL EQUITIES

While international stock markets have done very well lately and seem to be pushing to the forefront of investors’ consciousness, the high hurdle of sustainable economic growth has not been cleared. Political and event risks have intensified and may spread while the macroeconomic environment could also be deteriorating.

The market’s recovery since the 2008 financial crisis has been moving at a snail’s pace. Still, there are quite a few trends that have dominated the landscape and will eventually allow the global economy to scale new heights: interest rates are not going up any time soon; borrowing for both government and consumers continues to grow at a faster pace than the economy; cheap energy means the world’s economy will continue to enjoy the benefits; technology’s impact and velocity for change is accelerating; demographic trends are reshaping the world around us; and Emerging Market growth will eventually overwhelm the poor demographic trends in Western countries. Ultimately concerted and meaningful growth should ensue.

Growing caution seems to be the buzz phrase currently; as the economic outlook and political uncertainty in Europe weigh on investors; as the U.K. gears up to start exit proceedings from the European Union; and as Germany and France are facing elections. Europe’s business activity in September expanded at its weakest rate since the beginning of 2015. While strong export sales saved the Eurozone from stagnation in the second quarter, investments slowed and consumers reduced domestic spending. And with the key driver of growth, declining oil prices, starting to fade, the potential for ramped up support from the European Central Bank could be on the horizon. However, the Bank may have little left in the tank to boost growth after unleashing unprecedented monetary stimulus in recent years.

Japan has been the most daring country in using monetary stimulus to confront deflationary pressures and stagnation, but it now appears to be shifting from the “whatever-it-takes” approach of the past three years. It is taking a more long-term view of re-inflating Japan’s economy and is focusing on controlling interest rates more effectively across the entire yield curve. How successful this approach will be given the fact that the government already owns more than a third of outstanding government bonds is anyone’s guess, especially since little else has worked to stimulate the economy.

China has been supporting its economy since 2008 through record investment spending. As such, its debt levels have skyrocketed. But government support can only go so far as many industries are facing overcapacity issues. At the same time, consumers’ spending power is falling, resulting in a surge of bad loans which is raising concerns of bloated debt levels and housing bubbles. Even so, industrial output and retail sales have handily beat expectations which means third quarter growth is holding up better than expected and will likely remain on target.

International stock markets were the best place to invest during the third quarter. On a whole, international stocks were up 6.5% (all figures in U.S. dollar terms), with Emerging Markets being the pace setter increasing 8.3%. Asian stocks were the next best performing region with gains of 6.7%. European markets were the laggards with a return of 5.0%. This quarter was only the fifth time international stocks have outperformed both the Canadian and U.S. stock market simultaneously in the past 5 years.

Global economic growth should recover somewhat but no miracles can be expected with weakening employment growth and geopolitical issues dominating the headlines. Global trade is also likely to be lackluster in the later portion of the year. It’s important to remember that these sluggish conditions are quite often the best times for stock markets as investors look past the current doldrums and envision much better times ahead.

Q4 2016

MARKET COMMENT

Dramatic twists and turns in politics, economics and finance have turned 2016 on its head. Extreme events have bombarded investors virtually every day of late but thankfully they appear to be isolated occurrences. Still, the potential blight on the global economic and financial markets (i.e. political uncertainty; the steep increases in bond yields; a potential hard landing in China; and trade wars) could be looked upon with trepidation during the next year. This would be a very wrong outlook as a bevy of market stimulating activities are just over the horizon.

Trump’s election as U.S. president sent shock waves through global markets. This surprising turn has introduced a great deal of uncertainty in U.S. fiscal and monetary policy and it is impossible to tell which of Trump’s often wild promises will actually be put into effect. Whether it is the slashing of corporate and personal income taxes, or massive infrastructure spending, or overseas cash repatriation or jobs stimulus, there is considerable uncertainty about the timing, size and composition of any policy initiatives; so as always the future is uncertain. But in all likelihood it will give stocks, another shot in the arm for now anyway.

Take heart, Canada. Despite the U.S. projections for a miserable next four years under a new U.S. president, Trump’s victory could be a big win for Canada which could see its economy stimulated as an offshoot of U.S. activity. Furthermore a Trump presidency could lead to more political openness and less myopic thinking, which will actually allow the U.S. to clean up some of their outstanding problems. These are all good things.

International economies have stabilized and started to rise above the recent multi-year stagnation, however they are now playing a waiting game while the key political players shift seats. Trade tariffs and job repatriation threaten many countries, not just China and Mexico. Europe and the U.K. both do a lot of business with the U.S. and are just starting to see real job growth. Japan has seen a significant downturn in its currency and has been forced to ratchet up measures to combat this pressure. Emerging markets are experiencing massive capital outflows as protectionist trade policies loom.

The consensus is that the 35 year bull market in bonds is over and a bottom in bond yields has been reached. Bonds around the world suffered their biggest two week loss in at least 26 years as the election of Trump sent inflation expectations surging. As well, quantitative easing with massive bond buying by central banks appears to be over which suggests higher yields. However, bond weakness could also partly reflect a strengthening world economy, as the overall global environment has been healing rapidly. Canada has remained relatively immune to the global bond malaise eking out a 1.7% gain for the year on the back of corporate bonds which gained 3.7% for the year, as yields narrowed.

North American stocks surged last year, led by Canada as commodities made a big comeback, advancing 12% after sinking to a quarter century low in January. Canadian stocks appreciated 21.1% for the year, while U.S. stocks gained almost 9% (all figures in Canadian dollar terms). Investors have been rushing into inflation favoured sectors like insurance companies and banks while dumping utilities and real estate investment trusts (REITs). On the other hand higher interest rates and collapsing local currencies have caused capital flows out of Asia which was down 1.9% and Europe which was down 6.6%. Emerging markets were able to break the international weakness by gaining 5.4% for the year.

It is likely that a low growth, low interest rate world is here to stay driven by secular forces. The important thing is to hang in there as jumping to conclusions can be dangerous. Let events play out. However favourable or unfavourable the key market players may be, perhaps the prospect of future prosperity will make the journey more palatable.

CANADIAN EQUITIES

Canadian markets, like other global markets around the world, have easily absorbed the unexpected outcomes of major events during 2016 including the fall of energy and commodities in early 2016, Brexit, as well as the pending change of the political regime in the U.S. Globally these events were initially presumed to be negative and should have put a halt to the 8 year bull market. Although some sell-off activity did occur for a short period, especially in the Brexit case, the trend quickly reversed and global markets have since surged higher.

The Canadian stock market in particular faced an extra hurdle in the Alberta wildfire, but nonetheless as the TSX index closed 2016 at 15,287 points; levels which had not been seen in months. The unanticipated rebound led the Canadian index to a strong 21.1% total return for the year thanks to a strong revival in the Energy and Materials sectors, making it the developed world’s biggest advancer in 2016.

As global economic conditions have strengthened, the Canadian economy has followed suit, although there have been periods of sluggishness such as in the second quarter where GDP unexpectedly dropped 1.3%. Despite the strong 3.5% GDP rebound in the third quarter, GDP for the full year is expected to be moderate, which implies that the adjustment to a full recovery has yet to fully materialize.

The job market continues to remain relatively strong as 214,000 jobs were gained over the past one year period. That represents a 1.2% increase, versus 0.9% a year earlier, putting Canada in line with its long-term average. Unless the rebound in Energy and Materials is maintained there is a risk to a full economic recovery in the upcoming years. However, the world-renowned Canadian banking system, as well as recent government intervention to tighten mortgage rules, should mitigate that risk and prevent a major fallout in the credit market like the one that occurred south of the border a decade ago.

FIXED INCOME

The Canadian FTSE TMX Universe Bond Index lost 3.4% in the fourth quarter of 2016 but was up 1.7% for the year. Over the course of 2016 the Bank of Canada maintained its overnight interest rate at an ultralow 1/2 of one percent, which is where it has been since July of 2015.

The Bank of Canada noted that global economic conditions are improving but at the same time they cut their forecast for the economy. Their December interest rate press release cited, “uncertainty, which has been undermining business confidence and dampening investment in Canada’s major trading partners, remains undiminished. Following the election in the United States, there has been a rapid back-up in global bond yields, partly reflecting market anticipation of fiscal expansion in a U.S. economy that is near full capacity. Canadian yields have risen significantly in this context.”

The prospect of an eventual rise in interest rates is heavily dependent on the U.S. With the outlook for an improving U.S. economy there is a significant chance that we have reached a top in bond prices after 30 years of falling interest rates. It is likely that President-elect Trump will pursue stimulative policies by cutting taxes for both corporations and the wealthy, slashing regulations and reducing the country’s dependence on imports. The flip side, according to the Committee for a Responsible Federal Budget, is that Trump’s plans would raise the national debt by $5.3 trillion over 10 years.

This would be on top of the $9 trillion that the national debt is already projected to rise as determined by the Congressional Budget Office. The increase in debt risks making it more expensive for the United States to borrow. Relatively strong U.S. growth could cause problems for plans to stimulate employment by U.S. manufacturers. Those that export products and services may find themselves priced out of foreign markets.

In this low rate environment, yield hungry investors have been ditching the safety of bonds in a search for returns in risker real estate investment trusts and high dividend yielding stocks. This can be dangerous as these investments don’t have the defensive characteristics of high quality bonds. Investors should note that while the bull market in bonds may be over, it does not mean that a bear market in bonds is beginning.

U.S. EQUITIES

The Standard & Poor’s 500 index climbed 3.8% in U.S. dollar terms over the fourth quarter, which was matched in Canadian dollar terms. For 2016 as a whole, the U.S. equity benchmark gained 12.0% in U.S. dollar terms and was up 9.0% in Canadian dollars as the Loonie rebounded over the course of 2016, largely due to an improvement in energy prices.

The surprise win of the White House by Donald Trump was easily the primary driver of the U.S. equity market in the fourth quarter. There are significant implications for the stock market over the next few years but it will take time to determine what the outcomes will be.

The main sources of concern for the U.S. equity market as a result of the new policies longer term are a stronger U.S. dollar and higher government borrowing costs. A strong dollar could undermine the new administration’s efforts to revive export based manufacturing. The president-elect has also promised to spur growth with corporate and personal tax cuts, as well as to use tax credits to fund infrastructure projects. These initiatives could help the economy but would increase the fiscal deficit and likely lead to increasing bond yields. There are already concerns about high debt levels so increasing both the amount of debt and interest rates could push the cost of servicing government debt to challenging levels in the long term.

A big driver for the U.S. stock market for 2017 would be the implementation of a proposed reduction in the corporate tax rate from 26% to 20%. Lower taxes would boost corporate profitability which would improve the chances of keeping the long lasting economic expansion on track to rival the 10 year U.S. record. U.S. based companies with international operations could use the lower tax rates to repatriate cash held overseas and that could be used to fund expansion and for the payment of dividends.

The initial assessment of the stock market seems to be that the developments are broadly positive. The administration is being stocked with individuals who have good understanding of how the economy works and who are able to make reasonable calculations concerning the implications of their shifts. We should expect some big bumps resulting from these big changes but there is a good chance that irrationality will play less of a role than many had feared.

INTERNATIONAL EQUITIES

The global outlook has become slightly more fragile of late, due to the results of the U.S. presidential election and heightened risks in China, Europe and some Emerging Markets. It is yet to be seen whether Trump’s election will change the world, but it has turned the investment landscape on its head. Many parts of the world will be in a “wait and see” mode for some time to come, weighing potential rising inflation against faltering business confidence and general nervousness about the future.

In Europe, growth rebounded at the end of the year based upon domestic demand after a slow summer. Growth may have been artificially inflated by record low interest rates and the European Central Bank’s asset purchase program. However, going forward it appears the key themes will be: higher fiscal spending, extended quantitative easing and regional elections. The potential for political upheaval on both sides of the Atlantic is raising financial stability risk and could trigger sudden capital flows and market volatility. Unemployment has been consistently falling for more than a year while manufacturing output has accelerated to its best pace since the start of 2014, benefiting from a weaker currency and stronger demand. In the U.K. a slowdown in growth remained likely in the near term. Interest rates remain at record lows, despite warnings of higher inflation and slower wage growth.

The outlook for Japan remains cautious as a potential rebound in exports after thirteen straight monthly declines could lead to domestic growth. However, twenty-two consecutive months of decreasing imports threatens Japan’s stilted recover and exacerbates the risks associated with increasing U.S. trade barriers. The Yen skidded to an eight month low which could delay additional reforms which are much needed.

Emerging markets are in better shape than they have been in five years, continuing an upward climb as currencies recover and economic growth accelerates. However, U.S. policy uncertainty and imbalances in the Chinese economy are becoming major sources of risk. China expanded at a steady 6.7%, fueled by stronger government spending as they have clearly chosen to do everything they can to rebalance the economy from an over reliance on government led growth. The rest of Asia is looking at good growth rates going forward as well. Latin America has been dragged down by Brazil over the past two years but they appear to have finally turned the corner.

The topsy-turvy non-North American equity markets continue to struggle this year; particularly after the world’s attention was diverted to analyze the potential implications of a Trump-led fiscal stimulus package and higher U.S. interest rates. That activity was compounded with the U.S. dollar surging to a near 14 year high and the stage was set for currencies to be clobbered and for a massive stock rotation out of defensive stocks into interest rate sensitive stocks, energy (OPEC’s production cutting agreement contributed mightily here) and manufacturing stocks.

Clearly the global outlook had improved, but this partial optimism needs to be counterbalanced by an elevated level of risk. Certainly a note of caution is warranted, however it should be underpinned by slightly greater momentum in the global economy as evident in a range of data since the earlier part of last year.

Your guide to retiring well

June is Seniors’ Month and we think there’s no better time to break down exactly what you need to plan for a financially secure retirement. After years of working hard, don’t leave your golden years to chance.

Here are some things to think about:

1.       Age doesn’t matter

With a topic like retirement, you’d think it would. But the harsh truth is, no matter how old you are now, one day you’ll likely want to retire. What’s the number one thing our clients mention? “I wish I started saving sooner”.

Think of it like this: you are gearing up for the marathon of your life. It requires a certain degree of physical ability, but also a dedicated fitness routine that takes practice, determination and will. Your financial fitness similarly needs a degree of dedication in order to achieve your goals and finish the race. Or, in this case, retire well.

Stretch yourself to meet your goals. Perhaps that means giving up one luxury each month. You’ll see the savings accumulate over the years. See how this family saved nearly $1,500 a year by practicing better grocery shopping habits. That adds up to over $45,000 in savings over 30 years.

2.       Embrace the acronyms

A RRSP and TFSA account, as well as a workplace pension savings plan (if applicable) are the three greatest ways for you to save, rather effortlessly, for your golden years.

RRSP contributions let you reduce your taxable income. Your savings grow tax-free as long as your money stays in the plan and you get to choose how to invest your savings. Learn morehere.

TFSAs are great for letting you save tax free for any goal. You can save up to $5,500 a year and withdraw whenever you want without paying any tax. Learn more here.

Pension plans, group RRSPs and other savings plans can be a convenient way to save because the savings come off your pay rather seamlessly. If your employer matches your contributions, your savings power is instantly doubled. Learn more here.

3.       Think outside the box

Saving for retirement is not as easy today as it once was. It’s not enough to just put aside a portion of your annual salary and expect it to stretch as far as it once did.

If you think your Starbucks latte is expensive today, what do you think it will cost 10, 20 or 30 years from now? The further away you are from your retirement, the more impact inflation will have.

Consult with an experienced advisor and they will help you consider the effect of inflation for your retirement savings.

4.       Consider other sources of income to bring in savings

We get it; it’s really difficult to find the extra money to put away after bills, payments, groceries…etc. Consider using your skills to make some extra money that you can allocate to either a savings account or for your leisure spending.

Think about what you’re good at and look for an avenue that lets you explore it. Working extra will let you augment your income. Broad-spectrum websites like Kijiji or Workopolis are always sharing job postings that serve as opportunities for you to make some extra money; many of them even let you make this extra money from home using professional skills. Even an extra $50 each week means an augmented income of $200 each month, which you can use to spend on leisure or to add to your TFSA for additional savings. The bottom line: if you find saving to be very challenging with your current income, it’s time to think about augmenting it. Get creative!

5.       Considerations for the future

What you should take away from this blog is not to listen to typical widespread notions that 75% of your annual salary is an appropriate retirement savings benchmark. It’s not. This retirement calculator will give you a general idea of just how much of today’s money you’ll need to save up until the year 2048.

The problem with general retirement formulas is that they do not consider societal inflations. They also fail to recognize that every person’s dream retirement is completely different. While your retirement might look like a trip around the world, your neighbour’s retirement may include downsizing and relaxing by the cottage with little spending.

Your best bet? Consult a trustworthy advisor with experience in retirement planning and take the guesswork out of planning for the rest of your life.

Take the first step to planning your golden years today.

The Real Cost of ETFs – Not just the MER

Most investors know that passive Exchange Traded Funds (ETFs) are low cost investment vehicles, correct? Well, almost right! Passive ETFs are designed to track a benchmark index or market at a low cost. ETFs may be relatively cheap from a Management Expense Ratio (MER) perspective but the costs don’t stop there. Putting aside the negative impact of brokerage costs to buy and sell and potential custodian or registration fees, ETFs in the majority of instances still underperform their underlying benchmark.

In a perfect world ETFs would precisely return the same performance of their benchmarks but this is not realistic. Therefore investors should determine if they are getting what they are paying for by tracking the difference between an ETF’s performance and the benchmark’s performance. The resulting Tracking Difference is seldom zero and usually trails its benchmark. It is easy to find as ETFs are required to file a Management Report of Fund Performance (MRFP) twice a year on the SEDAR.ca website.

Of course fees are almost always the cause of performance lags and are the single best indicator of future Tracking Difference. That is why ETF issuers keep trying to offer the lowest fees. However other factors could impair returns such as the trading and rebalancing costs which occur when ETFs realign themselves as indices adjust their holdings, sampling issues that occur when it is impractical to hold every security in the index and there is a cash drag between when the ETF receives dividend and interest payments and when it then distributes them to shareholders.

In Canada there are more than 425 ETFs but the largest 100 by assets represent over 83% of all the invested assets. These Top 100 ETFs as of May 31, 2016 provide an excellent sample of the extent of any lag in performance relative to the benchmark. By gathering both the MER and the Tracking Difference (based upon 3 years of information ending December 2015) we are able to see how much of the underperformance is attributed to these costs. The chart above and the table on the left show this analysis on a pro-rata weighting basis for the Top 100 ETFs and their major asset subcategories. Interestingly, the average MER across the entire 100 ETFs is 0.31% (individual MERs ranged from 0.03% to 0.91%) and this remains very consistent across all the asset classes despite the fact that the number of individual ETFs per category varies dramatically with 2 Money Market ETFs, 33 Bond ETFs and 65 Equity ETFs. The other surprising item about this data is that while Money Market and Bonds had very little additional underperformance that was not directly attributed to fees, this was not the case for Equities. Equities, on average, significantly underperformed their benchmark by 0.73% per year, which flowed through to the entire sample underperformance (0.61%) since equities are such a large part of the Top 100 ETF group. This cost/weakness is much more than most investors know about or expect.

The aim of a Passive ETF is to mirror its benchmark so they are not designed to outperform.  As such, Tracking Difference is one of the most important ETF statistics to consider. Without an understanding of Tracking Difference, investors could be virtually guaranteeing themselves underperformance.

MARKET DATA

 

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Forget Robo-Advisors Think Bionic

Time waits for no one (or service). Change is inevitable for both people as well as business. The wealth management industry is striving for greater efficiency, while an explosion of regulatory adaptation is forcing change, and the wealth transfer from baby boomers to younger generations is about to become a tsunami across the land. The backbone for this transformation is technology, but digitalization will never entirely replace personal relationships.

While clients are evolving; migration to the extreme of complete communication through virtual channels is not really in the cards. A recent survey by Temenos (2016) of high net worth clients from around the world found that: 34% of clients want either digital only or a mix of digital and offline communication; 62% of clients say that the digitization of wealth management services is good overall, but they still want to meet often with an advisor; and 48% of client’s rate cyber risk and hacking as a top concern related to the use of technology, particularly for those older than fifty. Similarly, a new survey by a European firm, GfK (June 15, 2016) shows that just 10% of those surveyed said they would be willing to trust a computer algorithm more than a human to give them financial advice. So the central driver of recruiting or retaining clients will never completely revolve around technology.

At the same time the wealth management industry is starting to embrace technology with the goal of scaling up their own distinct offerings. While robo-advisors might be all the rage, their success is anything but assured. They have shone a light on current deficiencies and highlight the opportunities ahead. A recent report from Business Insider Intelligence (2016), illustrates that 49% of consumers are considering investing some of their assets using a robo-advisor, but less than 1% of the assets that could migrate to technology based platforms by 2020 are from people who currently don’t have any investments. So it is an advisor’s existing clients that are up for grabs, as they are just waiting for a clearly superior solution to motivate them to switch.

Robo-advisors burst onto the scene several years ago in the U.S., based on the premise that automated low fee investing would overtake and jettison traditional financial advisors. Canada joined the parade in 2014 with multiple emissaries joining the mix. After initial success, 2015 saw established financial service firms launch competing offering and more participants are on the way. As this technology arms race expanded, something not completely unexpected occurred, client recruiting has become more challenging, more expensive and slower. In the U.S. growth rates have fallen to just a third of their levels from a year ago. According to one U.K. study and Morningstar estimates, client acquisition costs range from $300 to $1,000 per person. Assuming an average account size of $40,000 with an average Canadian fee of 0.63%, robo-advisors produce revenue of just $252/year. This disconnect can only spell trouble.

So to grow and gain traction, robo-advisors are evolving: they jumped into traditional advertising channels (TV and bus stop signs); they sought out smaller accounts and younger investors; and now they are attempting to coax traditional investment advisors to offer the service to their clients. It is this last point that emphasises that the disruptors themselves are about to be assimilated. They may have just have been the catalyst for the financial advisor community to reinvest itself and infuse itself with new technology; ironically they could turn advisors into bionic men and women.

Established financial service firms are rapidly incorporating many of the enhancements launched by robo-advisors and using their existing brand power to leap frog their newer
competitors. While robo-advisors created a cost efficient solution, the potential cost of mass client acquisition is becoming a major challenge. And unfortunately for them, having too few clients to pay    the bills cannot be overcome by pretty graphics and gimmicks. If the cash is gone, the lights go out.

The long term winners will still be the ones with an innovative solution that attracts and keeps clients. Solving this challenge is more than just putting technology on a website and waiting for clients to roll in. Having an existing presence is vital. Many studies have shown that technology centric human advisors are outpacing their fellow advisors. While technology is never going to replace advisors it can benefit them or make them bionic, combining human advisors with technological enhancements (hopefully only figuratively). After all, the robo-advisors do have one thing right in that technology is the only way forward for wealth managers in a competitive financial landscape; it is just not the be-all and end-all.