Category: Articles

The Times Are Changing

As the old ways melt away it is time to establish your place and thrive in the new world. Pretty much everything affecting the process of providing financial advice is changing: regulations, products, technologies and business models. Advisors should not ask themselves “how will I operate going forward?”, but “how can I position myself to excel in the future?” There is no way to have absolute clarity about how things will evolve, but there are several big picture items that advisors can begin to prepare to deal with.

Just Learn to Love Technology

Obviously technology is changing our world, but the tech revolution should not paralyze advisors. With new fintech firms popping up daily or the latest “shattering” announcement that yet more robo advisors are being unleashed on the country, the proper response is likely to let out another yawn. The hype seldom lives up to the promise.

Seldom does a new technology or app rock the world on day one, but over time and with gradual improvements and adoption, the future starts creeping into the now. So take a deep breath and accept that this part of your job going forward will be changing. This means the sooner advisors adapt, the sooner they will be able to differentiate themselves from their competition. If an advisor does not have the necessary skills to leap the divide, outsource to someone who does. With the fast pace of change in the industry, what were once core competencies may soon be reduced to run of-the-mill functions. Get in front of the curve, while the getting is still possible.

Invent a New Value Proposition

Truth be told there are a lot of advisors who can do what you do. In the past, it was all about selling products, now it is about portfolios and financial plans. Technology creep will continually intrude upon the service advisors offer, so much so that it will be the unique elements of human interaction that will allow advisors to shine.

Rudimentary onboarding processes are in need of a major upgrade. The softer side of the client interaction will have to dominate going forward by creating customized solutions for each client that extends well belong asset mix and fund selection. Client behavior is greatly influenced by the daily bombardment of news, opinions and whimsy, allowing fear and doubt to adversely affect their portfolios results. Given that most clients have limited understanding of the investment world, advisors are presented with a great opportunity to teach clients how to behave as good, long-term investors for years to come.

Refine the Client Experience

Many advisors are their own business and it is their technical strengths that allow them to prosper. When they add great customer service, clients feel pampered. But will this be enough going forward? Increased disclosure is upending the status quo, particularly with fees where compression and cannibalization are gouging profits.

So maybe it is time to evolve and incorporate alternative fee structures that respond to client preferences and rationalize the way advisors and wealth managers get paid for their services, such as “success” based fees i.e. fees directly tied to client results . Whether it be performance, tax savings or simply a shoulder to cry on (after all a lot of psychiatrists get paid quite a lot for doing little more), aligning fees to a specific service or outcome will set you apart. Clients want options and to feel connected. Advisors need to tailor their services to create a human connection that the “robots” and giant players cannot reproduce.

Not every client wants the same thing so having a suite of solutions that are different or tailored to deliver the most robust results is paramount. In many ways it will come down to evolve or perish. So take time from your busy day; turn off the computer and stare into the future. Change is coming for you!

The financial planning industry is coming under increasing scrutiny these days. On the regulatory front, the Ontario government has announced plans to develop legislation that would regulate financial planners in Ontario. Under the proposed framework financial planners would be required to meet specified proficiency requirements. Additionally, the government indicated that it will take steps to reduce consumer confusion created by the wide variety of titles used in the financial services industry by restricting the use of titles related to financial planning.

While a start, there are calls from some consumer groups to more clearly separate product sales from advice. What people really need to get from a planner is an answer to the question, am I on track? Planners should focus on getting to know their clients and helping them to simplify, declutter and remove their financial anxiety. Investment managers are qualified to keep clients up to date on portfolio returns but returns are only part of the picture. How many people, irrespective of income or net worth, genuinely know if they are on track to achieving their goals? This is where financial planning specialists can really help. Advising on products and investments is not financial planning. Investment advice should follow a properly developed financial plan. Financial planners should help clients to understand that financial products and investments are tools that only need to be used if required. Proper financial planners should only use products to help implement certain strategies. With that approach consumers will finally come to understand what proper financial planning really is and how they can benefit.

The investment industry’s main focus has traditionally been to gather assets and build assets under management (AUM). Historically financial advisers have been money managers. This model has been in place for decades although there has been a shift from transactional fees to fee based accounts. When advisers meet and swap notes, one of the first questions asked is, “how much do you have in AUM?”. There certainly is a client need for some basic services at low, and perhaps subsidized, prices but at the higher end, professionals should adhere to certain standards such as providing disclosures concerning their relationship with clients. If the consumer wants to be transactional in their relationship this should also be clear to them. The legal profession receives fees for service and they have nothing to sell other than advice. Could the financial planning industry survive without product? Until the value is seen as being for advice and strategy, advisers will continue to sell products.

Regardless of the business model, financial professionals of all types need to be clear on who their optimal client is, what their client experience will be, how they are structured to support this experience and how they manage to do it profitability. They need to answer the key strategic questions around why they exist in financial services, regardless of which regulatory structure they operate under. As the financial industry continues to evolve, more advisers are likely to view themselves as financial planning professionals and not product distribution outlets.

What clients should look for in a Financial Planner :

  • They have studied financial planning to a high level,
  • They are keeping current with the latest trends in the industry,
  • They will tell you what you need to hear, not what you want to hear,
  • They will not receive financial remuneration for any products they recommend and, most important of all,
  • They will act in your best interests at all times.

 

Enshrining the term ‘financial planner’ is a step in the right direction. In most jurisdictions these days anyone can call themselves a financial planner, whether they are licenced or not. In conjunction with the proposed Ontario legislation the media and public will need to be educated to understand that there are qualified and ethical financial planners, many of whom are CFPs, in the financial industry. There are many compelling reasons to seek financial planning advice, not only as a oneoff, but ongoing, however few people do. If the planning industry doesn’t change, then the interest of ordinary people utilizing the industry’s services won’t change either. People will handle life’s financial challenges the way they have always done it for the most part, without financial planners. There are many very good financial planners and there is great advice provided to clients but it needs to be complimented by a product sale or by building up assets to enable the adviser to be remunerated. Going forward, consumers need to be better educated about the need to stay on track with a plan and be willing to pay for it. There needs to be a clear separation of advice from product if the financial planning industry is to become a true profession. While it may be a long way off it seems likely that this overdue separation is coming.

The fiduciary standard is getting a lot of attention in the United States once again as the Department of Labour’s rule requiring advisors to act in the best interests of their clients was denied by an appeals court. The most interesting aspect of the debate on these standards is not whether a fiduciary standard will ever be applied, but the increase in public awareness for this issue. As more retail investors become aware of the different standards, it is important for you to be prepared to answer the inevitable question: Are you a fiduciary?

Many investors assume financial advisers have a duty to act in their best interests yet that is not necessarily true. The requirement in Ontario, for example, is to act “fairly, honestly and in good faith” which is known as the duty-of-care model.

The fiduciary standard is much stricter than the “suitability standard” that applies to brokers, insurance agents, and other financial professionals. The suitability standard only requires that as long as an investment objective meets a client’s needs and objectives, it is appropriate to recommend to clients. A Fiduciary duty is a commitment put the clients’ best interest first.

Canadian regulators have been reluctant to move to an industry-wide fiduciary standard partly because some of the new standards being proposed in other countries have been in place in Canada for some time. The existing duties and obligations imposed on investment professionals, together with the rules developed through the CRM project, provide investors with significant safeguards in their financial dealings with registered investment professionals. As it stands, the only Canadian financial professionals who are under fiduciary obligations to act in the best interests of clients are those registered as portfolio managers with discretionary authority over their clients’ accounts.

This lack of uniformity can create a fundamental misunderstanding between the expectations of investors regarding the duty that is owed to them by their financial advisors. If nothing else, the fiduciary duty debate has increased public awareness. Now, more than ever, prospects are questioning not only the qualifications of advisors, but also how they are compensated as well as their philosophy on how they run their practice. A prospect wants to know if you are truly serving their needs or are you pushing products.

Fiduciaries are different from other financial advisors structurally, philosophically and legally. Due to the extensive requirements it takes to become a Portfolio Manager (including qualifications and experience) it is unrealistic for most advisors to get registered as such. So the reality is that most advisors cannot say they are bound by fiduciary standards. Yet there is a way to address this which would give your clients peace of mind. Advisors who outsource portfolio management and compliance responsibilities to a discretionary Portfolio Manager like Provisus can assure their clients that they are being cared for by money managers with a fiduciary responsibility to act in their best intrest.

 

Canadian securities regulations place different standards of care upon financial advisors depending on how they act on behalf of their clients. Currently there is no single standard that applies to all advisors. Advisors fall under these two registration categories on the Canadian Securities Administrator’s national registry search:

  • Dealing Representative – This category includes virtually all InvestmentéFinancial Advisors. Regulations only require them to ensure that investments they recommend are suitable for their clients.
  • Advising Representative – Held to a fiduciary standard.

 

Established in 1979, the Beutel Goodman Private Client Group extends the concept of value-oriented investing to individuals, estates, trusts, private holding companies and foundations. Through active portfolio management, and by drawing upon the collective strengths and resources of the overall firm, it is uniquely positioned to achieve personal investment objectives. It has customized the value principles of the firm to meet the needs of its private clients, recognizing that each client has individual financial needs, investment parameters and service expectations. Today, the Beutel Goodman Private Client Group manages assets of $1.0 billion and benefits from being affiliated with one of Canada’s largest and most successful pension fund managers with over $35 billion in assets under management.

In terms of International equities, Beutel has noted that global equity markets rallied strongly in 2017 and reached multi-year highs across many countries. Surprisingly synchronized global economic growth was the key reason behind the strong market movements. While no major economies are expected to grow at a particularly fast speed, all of them continue to show positive signs of improving growth momentum. In the U.S., the much anticipated tax reform seems within reach and may further strengthen business and investment confidence.

Throughout 2017, valuations have moved up as markets climbed to new records. Beutel’s valuation discipline and investment process prompted them to trim or exit positions as they achieved strong returns and reached their upside potential. In the meantime, they are finding great opportunities and have added a good number of high quality businesses into the portfolio. 2017 certainly saw market enthusiasm in some new technology areas such as artificial intelligence, self-driving/electric vehicles and cryptocurrencies, to name a few. The frenzy in those areas also led to a market rotation out of some strong, wellestablished (but “boring”) businesses and offered opportunities to invest into those highly cashgenerative operations at unusually low valuations.

Stock Sectors After Rate Hikes

Last year the Bank of Canada (BOC) implemented its first interest rate hike since 2010 and many investors reached for their crystal balls to try and forecast the future. While rising rates tend to signal stronger economic conditions and inflationary pressures, they can also have a meaningful impact on stock market sector returns. Changing the overnight interest rate, which is the cost that depository institutions pay to borrow money, is how the BOC attempts to control inflation. When the BOC increases the overnight rate, it does not directly affect the stock market but it does have a ripple effect that can rock the market. However some sectors benefit from interest rate hikes and others do not.

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A review of equity performance following previous BOC tightening cycles over the past 20 years shows that in five of the past six periods of hiking overnight interest rates; October 1997, November 1999, May 2002, October 2004 and June 2010 (July 2017 excluded), there was some deviation from normal results which provided excellent opportunities but there are grounds for concern. The conventional way of thinking is that cyclical sectors like Industrials, Materials, Energy, Information Technology and Financials do well in a rising interest rate environment. A healthy economy has more investment activity, increased profit margins for financial entities, improved employment and a healthy housing market; all of which allow consumers to splurge. Meanwhile, defensive sectors like Utilities, Telecom, Consumer Staples and Healthcare (which tend to be proxies for bonds and do poorly as interest rates climb) generally show weaker results when the world’s central banks take away the cookie jar.

At times Canada dances to a different beat and over the past 20 years our stocks have for the most part have done the opposite of what economic theory would forecast. Perhaps it is a weak Canadian dollar, the near term glut in crude oil or weak commodity prices, but whatever the cause, the unexpected has occurred. The chart on the right shows the net difference between the average annual calendar returns for the 10 Canadian stock sectors since 1998 relative to the average 12 month return for the same sectors after the BOC implemented its first rate hike. The data to the left shows the individual averages for both occurrences.

These performance numbers do not include the impact of dividends. These five sectors: Energy; Consumer Staples; Financials; Telecom and Utilities, have outperformed their long term averages after interest rates started rising, leaving the other five; Materials, Consumer Discretionary, Health Care, Industrials and Information Technology lagging. The degree of variance in some cases is quite glaring and the reverse of what was expectedValue stocks tend to outperform by falling less during bear markets and growth stocks tend to outperform in the bullish phase. Of course, there are many permutations that push and pull markets. Being right all the time is next to impossible but shifting a portfolio’s exposure between sectors can go a long way to minimizing the damage when financial gravity reasserts itself.

 

While a rising interest rate environment may not be detrimental to equity market returns in general, historically there have been clear winners and losers. Canadian investors who invest in our very unique stock market have been doing things differently for quite some time as conventional wisdom (at least with regard to domestic rate hikes) is thrown out the window. Perhaps rather than focusing on our own situation, many Canadians may be overly fixated on what is happening elsewhere; say to the south of us perhaps

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

WILL NEW DISCLOSURE RULES LEAD ADVISORS TO ABANDON SEGREGATED FUNDS

It is easy to understand why Segregated Funds are a favourite investment vehicle for many financial planners. They have a great market-ing gimmick, a rosy benefits story making them an easy sell, the payout to advisors is great, and currently they do not fall under transpar-ency rules like mutual funds with the Customer Relation-ship Model (CRM). Strate-gic Insight data shows that Seg Fund assets increased from $110.7 billion to $116.8 billion between June 2016 and June 2017. If we look at these products ob-jectively they do have some theoretically appealing fea-tures for certain clients, but many clients would be bet-ter served in other invest-ment vehicles. Now that the Canadian Council of Insur-ance Regulators (CCIR) is recommending greater transparency will Seg fund growth continue to be as robust as it has in the past?

This new disclosure frame-work seeks to ensure con-sumers are informed of not only the performance of their segregated funds, but also all of the details of what they cost. As well that disclosure provides a better understanding of this prod-uct. Are you ready for this discussion? Segregated funds are con-sidered to be like mutual funds with an insurance policy wrapper that give investors the following ben-efits:

  • Downside risk protec-tion. Guarantee of capi-tal after ten years and resetting privileges to lock in growth
  • Protection of assets from creditors
  • Guarantee of capital at death
  • Probate protection

All these benefits are priced into Seg funds and with a greater focus on costs through the pro-posed disclosure rules clients are going to want answers. The Manage-ment Expense Ratios (MERs) of Seg Funds tend to be higher than mutual funds to cover the cost of the insurance fea-tures. The fund filter on Globeinvestor.com shows that the management ex-pense ratio for the 20 most widely available Canadian Equity Seg Funds range from 2.57 per cent to 3.25 per cent. MERs for the 20 largest Canadian equity mutual funds run from 2.05 per cent to 2.39 per cent. In order to deter-mine if the benefits are worth the extra cost let’s examine these features.The Canadian Council of Insurance Regulators recom-mends changes to Seg Fund disclosure rules to bring that information more closely in line with the information clients receive about their mutual fund investments. Specifically, the CCIR outlines a list of information that must be part of the Seg Fund investors’ annual statements, including:

  • all charges for the year, in dollar amounts, with the management expense ratio (MER) broken out to show management fees, distribution costs and insurance costs explicitly;
  • all remuneration paid during the year for the provision of services in connection with the contract; changes in the net asset value of the contract in dollar amount;
  • redemption value; and
  • total personal rate of return, net of charges, calculated using the money weighted method for the last year, three years, five years, ten years and since issue; among various other items.

 

Downside Risk Protection

Salespeople tell clients that Seg Funds are safer than mutual funds because they guarantee a certain amount of its principal to its investors, typically ranging between 75 and 100%, as long as they hold it for a determined period, usually ten years. If the fund value rises, some segregated funds also let you “reset” the guaranteed amount to this higher value (which also resets the length of time that you must hold the fund). This is an investment that has all the upside of mutual funds and no downside because your capital is guaranteed so why wouldn’t everyone buy these funds?

While they are appealing to an investor’s peace of mind, the first problem is that you have to lock your money in because if you cash out before the maturity date, the guarantee won’t apply.

The second issue is that since stock markets have historically risen over the long term, the likelihood of actually needing the guarantee to get your original capital back after 10 years is small. In fact, since 1900, the only two short-lived periods when the S&P 500 was negative over 10 years were the periods ending in the late 1930s following the Great Depression and those ending in 2009 at the lows of the subprime mortgage crisis. So 98% of the time, 10 year returns were positive for U.S. stocks. For Canadian stock markets, since 1960, more than 90% of the time the TSX has returned over 6% over 10 years. And in no 10-year period have TSX returns been negative. Consultants William M. Mercer found there’s a 2% likelihood of losing money in the stock market over ten years.

Protection of Assets From Creditors

Creditor protection is a key benefit for business owners in particular but has also served as a selling feature for individuals as well. The first issue with this is that there is a way to achieve creditor protection without paying a higher fee for your investments. Instead of structuring a business as a sole proprietor or a partnership, small business owners can incorporate or may already be incorporated. Seg funds are based on the market value of a portfolio and as it gets larger, the costs of managing a portfolio for a small corporation (which are mostly fixed), may be more cost effective than the additional cost within the Seg fund for this protection. If a business is big enough that it faces the chance of large losses, or if it is risky enough that there is concern with solvency, then incorporation may be more suitable.

Here is where the proposed disclosure requirements come into play. The more knowledgeable the consumer of Seg Funds is on this point, the more likely creditor protection will not be available. Seg Funds may not be able to provide creditor protection where it can be proved that the purchaser was in financial difficulty ahead of the purchase. Fraudulent conveyance, dependant relief claims, property claims in marriage breakdown as well as CRA claims are instances where creditor protection may be impacted so the feature is not as enticing as it is laid out to be.

Guarantee of Capital at Death
This is a benefit that makes a lot of sense for using Seg Funds…if you think you are about to die and you also think the markets are about to crash.

Probate Fees
Seg Funds have an addi-tional cost to the client of roughly 1% per year which they pay each year they are locked into the product. Probate fees charge a one-time fee of about 1-2%. As such, there is limited value in this feature.

Conclusion
What an investor ends up with in segregated funds is a portfolio with higher than normal fees, marginal per-formance and features they may not really need. There’s a cost for peace of mind but has that cost be-come too high for Seg Funds? As exchange-traded funds and Pay-for-Performance pooled funds gain ground, Segregated Funds must hold their own if they want to carve out a place among the solutions offered to increasingly cost-sensitive investors. Mar-ket trends in the coming years indicate money management costs will be a greater focus. If you currently sell Segregated Funds, it is time to pre-pare for the inevitable disclosure requirements. It may also be time to re-evaluate your options and entertain alternative solutions.

The new disclosure initiative has the potential to create a scenario where creditor protection may be lost and a court can rule that you had set up the Seg Fund to avoid your debts. There are circumstances where the creditor protection may not apply:

  • The Seg Fund must be purchased in good faith. The creditor protection feature could be challenged if the investor purchases the fund knowing that they may eventually face financial difficulties. This falls under fraudulent conveyances provincial legislation.
  • Seg Funds may not provide creditor protection from the Canada Revenue Agency if income tax liabilities are outstanding in a non-bankruptcy situation.
  • Claims under Family Law may take precedence over creditor protection in a court of law to provide for a dependent.

Shifting Importance

Eventually this bull market will break its long winning streak but that does not mean you should be abandoning everything and running for the hills. What it does mean is that you should consider shifting your portfolio’s emphasis. Not all stocks react equally during good and bad times so the secret is to rearrange the deck chairs to ensure smoother sailing.

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History never repeats itself exactly but similarities do exist, particularly in the timing of economic events or cycles. These recurring ups and downs in economic activity (or market/business cycles) are made up of several years of peaks, recessions, troughs and eventually a recovery phase. The peak is when business activity has reached its maximum level followed by a slowdown or recession during which business activity reaches its lowest level. The final phase or recovery is when the economy again expands towards maximum output. The movements of the markets are closely linked to the business cycle. Stocks, bonds and commodity prices are heavily influenced by investors’ expectations of the future. Each financial market tends to peak and bottom at different points in the business cycle. An expanding economy is generally favourable for the stock market; a weak economy for bond prices; and an inflationary economy for commodities. The overall stock market tends to lead the general economy with stocks going up before the economy peaks and falling before a recession begins. However, the stock market is made up of companies from many sectors which rotate in and out of favour during the phases of the business cycle. The image below shows a typical market cycle and indicates which sectors tend to outperform the broader market at particular times.

Economic recoveries are often led by consumer spending so the retail sector is considered a leader of the broader stock market. It is usually one of the earliest sectors to peak and also to bottom. The same holds for the banking, housing and construction industries which are heavily influenced by interest rates. As interest rates are cut, demand in these sectors grows, as does their stock price.

The table to the left shows the performance of each sector during and after the tech bubble burst in 2000 and the financial meltdown in 2008. The first column has sector performance during these bear phases and the second is the initial recovery phase. The inverse relationship in this case is striking. Those sectors which performed the worst in the falling market tend to increase the most when the market rebounds. Conversely those that had done well during a falling market returned a relatively flat performance when the market recovered. There is a pattern to these rotations which investors can exploit. The industrial and manufacturing sectors usually follow the movement of retail and construction. As inventories become depleted, demand for more manufacturing and industrial output increases. Because the economic environment and news is often bad at this point, investors tend to be cautious and initially invest in companies with good earnings and cash reserves. As the bull market grows, investors tend to place money into relatively speculative stocks such as technology companies. In the later stages of expansion, when interest rates are rising, the capital goods, basic materials, and energy industries tend to thrive as they expand capacity and bid for increasingly scarce resources.

Value stocks tend to outperform by falling less during bear markets and growth stocks tend to outperform in the bullish phase. Of course, there are many permutations that push and pull markets. Being right all the time is next to impossible but shifting a portfolio’s exposure between sectors can go a long way to minimizing the damage when financial gravity reasserts itself.

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

The two sides of January

Most investors have heard of the January Effect which is the observation that January has historically been one of the best months to be invested in stocks. However there is another January Effect which states that, “as goes January, so goes the year”. While January has produced positive performance 66% of the time between 1968 and 2017 for the S&P/TSX Stock Index, it has also produced negative performance one-third of the time.

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What is striking is that in years when January had a positive return, those returns were well above average relative to the returns in other months of the positive January years. For example, of the 33 Januarys with positive performance, the S&P/TSX was up an average of 4.3%. The next best performing month in those years, as can be seen in the table to the left, was December which returned half that amount at 2.1%. Conversely, when January had negative returns, -3.5% on average; the remainder of the months of the down January years produced better returns. Although in total only 7 months had positive returns, they were more than enough to lift the overall years performance into positive territory but still well behind the 50 year average market performance and still further behind the years where stocks came roaring out of the gate in January.The chart below depicts the average annual cumulative returns for months that had positive Januarys and negative Januarys net of the S&P/TSX average annual return for the period. While the relative performance between good and bad months of January time periods did narrow over the course of the year, it clearly shows that the opening month of the year often sets the pace and influences the remaining months of the year. We then looked at how these markets performed for the full year. In those years where January was positive the S&P/TSX (including dividends) returned 12.6% versus an average of 10.7% for all 50 years reviewed; a 17.8% improvement. On the other hand, negative Januarys underperformed the market as a whole by -39.3%. These numbers confirm that “as goes January, so goes the year”, translating into above or below average annual performance in those years.

The most widely accepted explanation for the January Effect is tax-loss selling. The tax circumstances of taxable investors are often more important than a security’s fundamental valuation, as such investors will sell whatever securities are required at the end of the calendar year to establish capital losses for income tax purposes and then repurchase the shares after a prescribed waiting period. As the waiting period most often expires early in the next year, the repurchase orders flood the market in January, hence creating abnormal returns in the month. In addition to tax issues, researchers have also suggested other reasons for the January effect. One is “window-dressing”, as portfolio managers unload their embarrassing stocks at year-end so that they don’t appear on their annual report, and then redeploy the proceeds in January. Another reason, which we may see more of in 2018, is short sellers covering their successful short positions early in the next year so they usually do not have to pay taxes on the gains until April of the following year.

Whatever the explanation, predicting the future is impossible (even if it is only one month’s prospects), but it is good to know the end result is just a question of how large the annual gain will be on average. Because it is clear that investors should not be out of the market if January is a good or bad month because the returns over the rest of the year are just a question of magnitude. Of course one must always bear in mind that past performance does not mean this trend will continue. It will be interesting to see how it plays out in 2018.

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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

VANISHED – CANADIAN STOCK VOLATILITY

Investors had taken most of the summer off as the S&P/TSX stock index drifted aimlessly, trading between 15,500 in May and 15,000 at the end of August, but since then it has undergone a steep 7.5% increase. Of course for those investors who closely follow the market, it seemed to be moving in all kinds of directions, falling for a week, rallying for two and jumping about like a chicken on a hot tin roof the rest of the time.

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If investors were to glance at volatility measures however, they would come away yawning. The socalled “fear gauge” has been nothing but a sea of tranquility. The best level of fear gauge for the Canadian stock market is the Montreal Exchange’s Implied Volatility Index VIXc (or MVX prior to October 2010) which measures the implied volatility of the iShares CDN S&P/TSX 60 Fund (XIU). VIXc is a good proxy of investor sentiment for the Canadian equity market: the higher the Index, the higher the risk of market turmoil. A rising Index therefore reflects the heightened fears of investors for the coming month. A high VIXc is not necessarily bearish for stocks, as it measures the fear of volatility both to the upside as well as the downside. The highest VIXc readings will occur when investors anticipate large moves in either direction. Only when investors anticipate neither significant downside risk nor significant upside, will the VIXc be low.

The chart below shows the VIXc values as well as the S&P/TSX Stock Index. Currently the VIXc is trading around 8.2 which is very low and confirms that the market is not anticipating any dramatic swing in volatility for the foreseeable future. Low levels of implied volatility are often good periods to enter the market as the risks are relatively low. Equity markets tend to disconnect from their underlying values in periods of high volatility as investors scramble quickly to trade those shares that are coming in or going out of favour. On the other hand, a peak in volatility in down markets can be a useful indicator as it closely precedes a market bottom. Think of 2008 when the VIXc spiked to 88 nine days before the market bottomed, in 2011 the VIXc spiked to 37 the day before the market bottomed and in 2015 the VIXc spiked to the 33 which was the day the market bottomed. Following the years the Canadian stock market experienced significant declines, the VIXc shone the light on the pending major stock market recovery.
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Another factor to consider when assessing the timing of a move to equities is the current cash on hand. Not only are retail investors switching from cash and bonds into equities, but hedge funds and institutional managers have been moving this way for some time. Back in 2009 hedge funds and experienced investment managers were well ahead of the retail crowd in buying up equities early in the rally, as they covered short positions and began accumulating long positions. The amount of cash on the sidelines currently has the potential to drive forward a long term equity rally. While it is difficult to say when a rally will begin, savvy investors may want to use this period of low volatility to add to equity levels.

Market Data

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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

Range Bound No More

After every major bull market, stocks typically become range bound and experience a sideways pattern with many optimistic and pessimistic periods before exiting 15 to 30 years later at about where it began. This has occurred in the U.S. five distinct times since 1870: 1870 to 1900 (lasting 30 years); 1902 to 1927 (25 years); 1935 to 1950 (15 years); 1965 to 1980 (15 years) and of course the most recent starting in 2000. Although Canadian stock market history does not extend back quite so far the pattern is very much the same, which should be expected since we march to the same drummer. Ultimately, the advancing economic recovery results in enough earnings growth that stocks that once seemed expensive are now bargains, and triggers a new bull market when stocks break through the upper constraints of the range.

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Back in 2008, following a robust record high equity bull market, investors were feeling optimistic. Not surprisingly the flows into equities were significant. This was when the current sideways market began with a bull market peak of 15,073 in June 2008 for the S&P/TSX index. Seven years later in April 2015, the market was barely higher at 15,451. The market continued to oscillate for the next two years, unable to climb above 15,500. However, this began to change over the last two months.

History is a reasonable guide for what might occur next and it has suggested a new bull market is fully established once the range is broken. Only those perceptive enough to see though the market “noise” will be rewarded by the time the new upward trend is well entrenched. And it appears the markets have now finally broken out of this range by firmly establishing new highs.

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As is evident in the chart to the right and in the table to the left, the equity market’s gyrations over the last 10 years have produced little tangible gains unless investors were astute enough to tactically determine the right time to buy and sell stocks. History suggests that investors with a long term horizon will achieve better returns in equities (probably 6% to 9% annualized) than in most other investments.

Investors have been pulling money out of equities and adopting bonds as the “must have” alternative, which was part of a broader trend that has been going on since the middle of the last decade. The financial crisis of 2008 made investors increasingly more risk averse and drove them to higher yielding investments as a way to maximize their returns in an era where longer term gains from the prices of stocks alone had proven elusive. With a record 21% of the workforce now aged over 55 and growing quickly, the asset mix of the general population is structurally biased towards instruments that generate an income stream as concerns over retirement percolate. This had put more pressure on stock valuations and dampened the desire for riskier assets.

Following extended periods of weakness, history shows that the future should be quite bright. After all of the worst performing 10 year periods since 1926, the following 10 year average returns were close to 11% and the lowest of those subsequent returns was still over 7%. Logic would dictate that investors should take profits in those asset classes that had performed the best, which in Canada were bonds and real estate, and seek returns in the weakest asset class, which has been equities. In the midst of the current equity rally, ten year government bonds are yielding less than 2% so a potential annualized return of 7% in equities over the next 10 years would be very attractive.

Market Data

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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

Retirement Income on Steroids

Short term interest rates are near 60 year lows which makes it hard for fixed income investors to earn a decent income. Couple this with the fact that the average investor has an aversion to investing in long term bonds because of the belief that higher interest rates are on the horizon and it becomes nearly impossible to earn much more than money market rates. So what are the options for clients looking for good yields while being able to take advantage of higher returns in the future?

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With over $300 billion in assets, Guaranteed Investment Certificates (GICs) account for a huge share of fixed income sales in Canada. This is due to the advantages that many investors feel GICs offer over bonds: a predictable and guaranteed income stream, the principal value won’t decline and no fees mean every penny earned is theirs to keep. For these benefits clients are subjected to returns that can be low and, after inflation, the returns are actually negative. This is not a great situation as people are living longer. Sometimes the safety investors are seeking becomes just another form of risk.

After GICs, bonds are the next popular vehicle in adding returns to an investor’s portfolio as they have very different characteristics but do offer distinct advantages. Interest rate changes affect bond values so that as rates fall, bond prices increase and as rates rise, prices fall. However, if held to maturity bonds repay the full principal. Another essential difference is liquidity. Bonds can be bought or sold at any time with price determined by each bond’s individual characteristics and current market conditions. While bond returns are impacted by the cost of purchasing and managing the portfolio, this can be offset by the higher returns bonds can achieve. They offer the distinct possibility of higher yields and capital gains.

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Taking it one step further and incorporating other types of fixed income vehicles into the mix can be quite rewarding for conservative investors. For example, constructing an optimized High Yield Fixed Income portfolio consisting 15% of a 10 year Corporate Bond Ladder, 7.5% REITs, 20% High Yield Bonds, 15% High Yield ETFs, 20% Mortgages and 22.5% Fixed Income Hedge Funds leads to a very attractive alternative. Certainly the degree of risk investors assume with this type of portfolio are higher, but so is the potential for greater returns. The real question is, is it worth it?

Given current low interest rates this may be a good time to consider these strategies. Current 5 year GIC rates (based upon the average rates of the Schedule A chartered banks) are 1.6%. Using bonds with a similar term structure (represented by 50% FTSE Short-Bond Index and 50% FTSE Mid-Bond Index) shows how an all bond portfolio would perform. While the returns for the outlined High Yield Fixed Income portfolio is clearly superior. As the chart above shows, over the past 10 years the one year rolling performance of these two portfolios consistently produce higher returns when compared to 5 year GICs (outperforming 83.3% and 88.1% of the time, respectively). The data to the left shows these advantages both on a quarterly and annual basis; while doing so with very low correlation to GICs of 0.22 and -0.24 respectively.

With today’s very low yields and increasing interest rates, investor returns on GICs after inflation, fees and taxes are minimal. So unless investors are comfortable with only safe harbour investments and unconcerned with the less than stellar returns going forward, the only realistic solution is to explore other options. The decision to be safe is making many investors less safe and creating a whole new level of risk, running out of money. With this situation bearing down on many investors, the proposed High Yield Fixed Income structure is a solution that plays it safe, but still generates meaningful returns.

Market Data

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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

Playing it Safe is Risky

The law of unintended consequences is defined as the actions of people (especially governments) that will usually have an unanticipated impact. In fact, the harder we try to achieve something quite often the exact opposite occurs. In the investment world it is very hard to foresee outcomes beforehand, so the final results can sometimes be surprising.

Some of the greatest investing blunders of all time came from the consequences of unforeseen events. Since one of the primary objectives of investing is to grow your wealth, unintended outcomes are very dangerous to investors’ future wellbeing. While the traditional culprits for potential disaster are “get-rich-quick” schemes or penny stocks, a historically safe harbour is slowly entering the lexicon of potential problems for many investors; bonds.

Traditionally, bonds have been seen as safe, low risk investments and the principal means of preserving wealth. They are also viewed as being an excellent way to diversify your portfolio. While this is normally true over the long run, there are distinct periods where bonds have been simply ineffective at building wealth. Considering today’s very low yields and increasing interest rates, investors’ returns on bonds after inflation, fees and taxes, are minimal. So, unless investors are comfortable with only the safe harbour feature of bonds and unconcerned with the less than stellar return opportunities going forward (or you have more money than you need), the only realistic solution is to hold a higher weighting in equities.

For the vast majority of investors, a balanced approach to asset allocation is normal. Historically, as clients age and approach retirement, they become more conservative and seek safety. Traditionally, this has meant more bonds and fewer equities. This is exactly the wrong approach for efficient portfolio growth or to even maintain the purchasing power of assets given inflation. However, this way of thinking is completely opposite to most aging clients’ mindsets of protecting what they have achieved over their lifetime. So a battle is brewing between the markets and peace of mind and unfortunately the markets are always right.

Retirees or near-retirees are scared to death of losing the value of their assets so they have in the past shifted the majority of their assets into GICs and bonds for “safety”. Of course, for the first few years of retirement this works fine. However, with the steady onslaught of inflation, fees and taxes they are slowly dwindling their nest egg. With people living longer and spending more years in retirement the probability of running out of money increases. The decision to become safer has made them less safe and has created a whole new level of risk; running out of money.

There is no such thing as taking no risk. There is only the choice of which risks to take and when to take them. The risk from owning bonds shows up later in your investment life, while the risk of owning equities can show up earlier. Without assuming risk, meagre results are all that is left to investors. In fact, there is a famous quote from Benjamin Franklin that summarizes this nicely: “those who give up return for security deserve neither return nor security.”

While bonds in the near future are not likely to be wealth builders, they are however necessary. The question is: how much? They do dampen volatility during downturns and are an excellent source of liquidity. Also, since investing often comes down to an emotional decision rather than an analytical one, bonds can act as a form of insurance against panicking when things turn ugly in the markets.

With this situation bearing down on all investors, we have created an entirely new fixed income investment structure that benefits from the strengths of bonds (risk reduction) and the benefits of equities (potential for higher returns). The Provisus Multi-Strategy High Yield Fixed Income Fund is designed to target the risk of short term bonds, but generate greater performance. It attempts to provide an attractive cash yield and stable returns, while investing in a broad range of non-equity assets: corporate bonds, convertible bonds, preferred shares, income trusts, REITs, mortgages, secured real estate backed lending, infrastructure products and alternative investment strategies.

It keeps fees client-friendly using the Pay-for-Performance™ model with a fixed annual management fee of 0.25% (which is less than the pro-rata average MER for all the fixed income ETFs in Canada, 0.28%) plus a performance fee only if the fund outperforms a pre-set benchmark (50% FTSE Short Bond Index and 50% FTSE Mid Bond Index). This fee philosophy provides a very strong incentive for the fund to achieve positive results for clients. In this day and age, it may be one of the few solutions available that plays it safe but still generates meaningful returns.

Crisis Are Buying Opportunity

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While it is sad to say, there is always some sort of crisis cropping up around the world and more often than not they can lead to fear as investors become overly pessimistic. Such crises inevitably lead to panic selling and selling into a panic is always a bad idea. In fact, the panic lows in the wake of a crisis are far more often than not a good buying opportunity.

The growing concerns about North Korean’s nuclear threat and terrorist attacks in Europe have caused many investors to try and gauge the risks to the stock market. While every event is different and no one knows which crisis will escalate and which ones will fizzle, stock markets have generally sloughed them off and recouped initial losses. The Canadian stock market has proven remarkably resilient, so doing nothing is almost always the best investment strategy during a geopolitical crisis.

The clear conclusion that can be drawn from the most momentous geopolitical crises of the last 47 years is that stock markets strongly rebound from their post-crisis panic lows, so much so that within six months they are actually higher than where they stood before that crisis erupted. And one year after the event, markets have gained on average 10.1% from the market lows. The average percent decline in the S&P/TSX Canadian Stock index following major international geopolitical crises from 1970 to 2017 was -4.9% for the 17 crises listed to the left. Obviously the list of crises can be debated, but even going further back in time, the pattern of sell-off and recovery holds during such crises as the Fall of France 1940; Attack on Pearl Harbor, 1941; Outbreak of Korean War, 1950; Cuban Missile Crisis, 1962; and the Kennedy assassination, 1963.  Canada has had its share of domestic crises as well: Munsinger Affair – Canada’s first national political sex scandal, 1960; Airbus Affair – PM Mulroney was implicated in a kickback scheme, 1995; and the Sponsorship Scandal – a major misuse of funds by the Liberal governments of the 1990s, yet none of these had a major impact internationally.

Of course, the Canadian stock market did not quickly recover in all 17 cases. However, even in those that did not, the market still rallied meaningfully from the lows. As the chart to the right illustrates, major crises can be disconcerting but they do not spell the end for markets or investment strategies. It seems clear that staying invested through volatile episodes can help keep portfolios on track to achieve long term goals.

Perhaps the most valuable lesson from this analysis is that business cycles have far more influence on the market’s reaction than periods of crisis. The crises that took place during healthy economies are more the exception than the rule. The conflicts that have triggered the biggest declines tend to be associated with economic weakness, something that is not on the horizon at the moment.

The bottom line is that history tells us that the stock market tends to be resilient to crises. So even if a military conflict with North Korea does erupt, investors should not compound the crisis by doing something ill-advised with their portfolio. As always, patience is often rewarded.

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