Category: Articles

Uniquely Canadian

Around the world, particularly since the bottom of the stock market crash of 2008 (which occurred in February 2009), growth stocks have lead the recovery – but not in Canada. Global value stocks have traditionally produced greater gains during good quarters and bigger declines through bad quarters but Canada is different in this regard than the rest of the world. In this we are uniquely Canadian.

Growth indices include stocks with higher price-to-book ratios and faster than expected earnings growth rates. The value index includes stocks with lower price-to-book ratios and slower earnings growth rates. A quick glance at the three main sectors for Canada versus the U.S. and EAFE markets show exactly why our market marches to a different beat:

Canada – Financial Services (36.5%), Energy (19.4%) and Materials (11.7%)
U.S. – Information Technology (24.7%) Financial Services (17.4%) and Health Care (13.8%)
EAFE – Financial Services (23.6%), Industrials (14.6%) and Consumer Discretionary (12.6%)
Not only does Canada have one of the most concentrated stock markets in the world, it is also highly value stock orientated. Unfortunately for the past 10 years that has been a very bad combination.

By looking at the cumulative total return chart to the right (all values in U.S. dollar terms) investors might conclude that for the past 20 years Canadian value stocks (especially) and growth stocks would have been the place to be. And they would be absolutely correct except this timeframe can be divided into two distinct periods; before the 2008 market crash and after. As the data to the left shows, over the last 20 years we were world-beaters; after February 2009 (the market bottom of the crash) not so much. The U.S. stock market has absolutely dominated the rest of the world and growth stocks (everywhere but Canada) have ruled the roost.

Growth has normally been the better strategy in this bull market which could be coming to an end in the not too distant future. Bull markets have been greatly supported by the stimulative policies of the world’s central banks, which increased the money supply and kept interest rates at historically low levels for nearly a decade.

Value stocks do their job for the most part (everywhere but Canada) as a defensive play during the last cycle of rising interest rates. This time around, inflationary pressure, brought about by rising rates as demand for workers increases could force the central banks to be more aggressive. In Canada, we simply do not have many growth stocks so value stocks lead the way over most market cycles and distort the Canadian stock market relative to most other countries.

Despite the runaway success of growth stocks globally over recent years the reality of rising interest rates could mean a comeback for value stocks beginning this year as investors flock to defensive investments. During the last period of sustained interest rate increases Canadian value stocks have reeled off 10 straight quarters of outperformance. And for a country like Canada where value stocks are king and historically outperform the rest of the world, we might just be able to break the back of the sustained period of weak relative performance and once again become the world-beaters we used to be. In that way being uniquely Canadian may work in our favour once again.

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 Downside of Market Timing – Missing Out!

Trying to avoid a bear market can come at a very steep price: missing out on further gains if you get it wrong. Market timing can be a costly mistake since correctly timing the market is virtually impossible. The potential mistakes are just as severe whether you are trying to time the market to sell high or buy low. Because of this, investors who are troubled by the current state of the stock market may want to take a long term view and hold tight.

A bear market is typically defined as a 20% drop from a market peak, or twice as severe as the threshold for a correction which is just a 10% decline. The last year of a rally is sometimes referred to as a “melt-up” or a move higher that is driven by investors being fearful of missing out on past gains. The final years of a bull market are usually the best years of the economic cycle and staging an early exit from stocks to avoid a coming downturn can be a damaging long term mistake. In particular, equities tend to see steep gains in the 12 months before the start of a bear market. Double digit gains have historically been seen in the year leading up to a bear market, as the gains in the last year of a bull market make for a much more pronounced rally than is seen earlier in the cycle. There have been nine significant market corrections since 1970 (using the Canadian stock market as the reference, see the dates of the market peak on the left). The chart to the right shows the asset class returns late in a bull market for various periods prior to the various security types reaching their apex.

The penultimate year of a bull market has seen a 31.3% gain for Canadian stocks on average, which on its own would more than compensate for the pending market correction. More importantly this level of return confirms the fact that typically Canadian stocks are very much late cycle stocks and their performance dwarfs what is achieved elsewhere. For example, U.S. stocks “only” averaged 16.1% in the year before the stock market correction occurred, while bonds eked out 7.3% over the same time span. Comparatively, in the year before that and the two years before the peaks (meaning the period that is between 24 and 36 months before the start of the bear market), U.S. stocks were clearly the better overall investment. This sounds very familiar to what has been occurring over the much of this economic cycle. Should this 40-plus year pattern continue and if the current market uptrend is winding itself closer to a market correction or a bear market, it is possible that Canadian stocks could make up much of their relative underperformance versus U.S. stocks over the past few years.

Certainly, the concerns that stock markets could be looking at weak future results, if not necessarily a bear market, have been growing. However, stocks are not seen as overly expensive right now and the first quarter earnings season has been strong, although the market’s reaction to them suggests investors have not been impressed. The final stages of a bull market can be lucrative for investors and an early exit can be detrimental to an investor’s long term results. Current economic data supports the case for continued economic recovery and further stock market gains. Despite what could happen in the coming years, the best course for most investors is to stay put, getting the benefit of compound growth and not making short term trading decisions.

MARKET DATA

market data imageThis 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.

Closing The Gap

Dividend paying stocks have been very popular with investors in recent years due to weak returns in the bond market. That picture appears to be shifting in Canada for the first time in almost a decade. As the Bank of Canada has slowly tightened monetary policy, bond yields have naturally risen, yet still remain well below the levels seen before the financial crisis. As bond yields rise, investors may cut their exposure to equities. Historically bull markets tend to end once interest rates have risen too much, too fast. The current long-lasting uptrend is beginning to show signs of entering the euphoria stage. If dividend yields drop below bond yields it could be another indication that the high-flying stock market is headed for a correction.

article table

The ‘Yield Gap’ is the difference between the S&P / TSX Stock Index dividend yield and the 10 year Government of Canada bond yield. The yield differential between stocks and bonds has historically been one of the more attractive signals for many investors. It has signaled when equities were good value relative to bonds. However in the last few months that spread is becoming less favorable to equities and is giving many investors pause for thought. Higher bond yields could make stocks look more expensive. Additionally, higher borrowing costs could have an impact on corporate earnings as it becomes more expensive for companies to finance projects. Lower profits could result which would boost the price-to-earnings ratio and raise equity valuation concerns.

Before the 2008 financial crisis the yield on 10 year bonds was markedly higher than equities, before abruptly changing course during the depths of the crisis. In fact, for most of history, dividend yields have stayed below 10 year bond yields. During the 2008 financial crisis bond yields started oscillating around dividend yields for several years but have spent significant time below dividend yields since June 2011, as economic growth recovered and inflation concerns faded. As the chart above and data to the left illustrates, the dividend yield of the S&P / TSX has remained steady at around the 3% mark throughout the post-2008 crisis recovery period as companies have grown their dividends to keep up with increasing share prices.

For the past decade, investors have flocked to the stock market for higher yields as government bond yields have hovered at historic lows. The increase in asset prices can be partly attributed to low yielding debt instruments. Still dividend paying stocks tend to be a poor defense when rates are rising and stocks could be facing yield competition from bonds for the first time since the financial crisis. If and when the S&P / TSX yield falls below bonds it will not necessarily be bad news as most equity investors generally buy stocks for capital appreciation and not for steady income.

At this juncture, the case for stocks still appears to be favourable compared to owning bonds so yield seekers currently invested in stocks do not necessarily need to jump ship yet. As with all market measures, the consequences of the narrowing yield gap are hard to predict. While some risk averse investors might switch to bonds, for most investors dividend yield is simply one factor contributing to the total performance of owning stocks.

MARKET DATA

market data image

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.

Great Expectations?

Asset allocation is one of the most important decisions investors will likely make. There are a number of risk factors related to the type of investments used as well as their mix which makes determining the appropriate capital market assumptions necessary. There are many firms which provide investment assumptions to investors with each making their own risk and return calculations so that clients can evaluate their investment decisions. Of course, these assumptions are not permanent and need to be changed over time.

article table

Empirical evidence has not been favourable to market forecasters. Studies have shown that the vast majority of financial gurus do not do better in their predictions than simply flipping a coin. So, on the face of it, being able to accurately forecast markets 10 years out is extremely difficult. In a world of seemingly random events, all of which could affect assumptions, it is hard to figure out where to turn. Fortunately, in Canada, there is one semi-independent organization that touches upon almost every adult’s life to varying degrees; the Canada Pension Plan (CPP). The CPP operates throughout Canada (except in Quebec, where the Québec Pension Plan serves the same function) to provide pension benefits to Canadians. It is the responsibility of the Chief Actuary of CPP to form the capital markets assumptions used in the modeling that serves as foundation for their strategic asset allocation. So, it makes sense that their primary projections should be the bedrock of the return on investments for most investors. Fortunately, these are updated periodically and publicly available.

The data to the left illustrates the most current forecasted long term nominal returns for capital markets in Canadian dollar terms (i.e. returns before the impact of inflation). The chart to the right shows the historical evolution of those previous projections from the past 8 years. Clearly, the prospects for cash and/or other short term investments has been deteriorating over the years; as has the expectation for bonds since the significant tightening of credit spreads have lowered yields, thereby reducing the potential for future returns. These conditions could be made worse if the yield curve inverts as is broadly expected. Still not all bonds are created equal with government bonds expected to return just 3.0%, corporates 3.5% and high yield instruments 5.25%.

Similarly, assumptions for equities in general have trended lower; falling behind what history would suggest. Interestingly, Canadian stocks are no longer considered the shining light for forecasted performance. Increases in expected earnings growth and corporate profit margins outside of Canada has seen the expected returns for both major foreign and emerging market stocks jump, such that investors should be relatively indifferent as to which markets to invest for the best results. Although, the returns investors do actually receive will be ultimately determined by the crucial impact of dividends and buybacks going forward. Of course, most investors are not looking to just match the market but exceed it. Unfortunately, that then becomes a question of determining those that have the necessary skills to add value. However, that is a question for another day.

MARKET DATA

market data image

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 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.

transcend-december

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.

transcend-december

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.

transcend-december

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.

Market Data

bottom

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.

transcend-december

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.
transcend-october2

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

bottom

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