PWLCapital

In today’s environment of low interest rates, investors are looking outside of fixed income to find yield.  In my  discussion with Jason McIntyre of CFRA we talk about yield, risk and how your own capital may be recycled back to you and described as yield.

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There are many components to the area of estate planning. The major ones that come to mind include the preparation of your last will and testament and ensuring adequate life insurance is in place to meet your needs. But what about all those other areas:

• An inventory of your assets, liabilities, sources of income, insurance policies, etc. etc.
• End of life directives for your attorney for personal care
• Discussion of your wishes for your funeral with your executors, who are responsible for the arrangements (Prearrangement of your funeral)
• Direction on how family treasures are to be distributed

I was reminded recently of the importance of some of these areas. A long-term client, for whom I handled his tax planning (although not his investments), passed away just before Christmas at the age of 91. He had a very successful business career and was very well-respected in his industry, maintaining contact with many of his co-workers. He and his wife, who predeceased him, had no children, and his surviving brother is in the U.K. A number of years ago, he asked me to be his co-executor, along with his lawyer.

He was very conscientious in documenting how he wanted his estate distributed and what plans were to be implemented – down to where he wants his ashes scattered, and the company to use to clean out his apartment. When news came of his death, our decisions regarding his funeral were easy – one call to the funeral home with which he had contracted and things fell readily into place. We were able to focus our efforts on providing a means for at least 60 of his friends and business colleagues to celebrate his life.

He also kept a list of all of his assets up to date, and we reviewed it each year. This included his bank accounts, insurance policies, investment accounts, etc. Because I have prepared his tax return for the past number of years, I could readily identify what pension plans had to be notified of his death. Names and addresses of his beneficiaries, who are in various locations around the world, were also documented and kept up to date.

The result has been a relatively smooth process to get the ball rolling for the gathering in and distribution of his estate assets, while providing what we hope was a good send off.

We don’t like to think about our death, but it is inevitable. Often we have our wills prepared, review our insurance and think we have completed our estate plan. But what about all those other areas? Have you defined your wishes? Have you discussed them with family members (an often difficult but very important communication)? Have you made any formal pre-arrangements?

When our clients come in for their annual review meeting, this topic will be on the agenda. Is it on yours?  

Truth be told, I’m not much of a gambler, but the allure of the bright lights, ringing bells, and the possibility of winning it big tugs at my better judgment. I’m particular fond of the game roulette. I normally place single “inside bets,” meaning that I would try to select the exact number of the pocket that the ball will land in (out of 38 numbers…at least in the American version). By doing this, I effectively have a 1 in 38 chance of choosing the correct number and winning the game (not the best odds, I assure you).

A 1999 study by John Bogle showed similar odds of success. He compared the returns of 355 U.S. equity mutual funds over the past 30 years and found that only 9 funds managed to outperform the market by at least 1% (he considered these to be “true winners”). This would imply that as an investor in 1970, you would have had a 1 in 39 chance of selecting one of the winning mutual funds – slightly worse than your odds at selecting the exact number on a single bet in the game of roulette.

Just as selecting the exact number in roulette isn’t a prudent investment strategy, neither is attempting to select an outperforming fund manager in advance. The odds are not in your favour, so why bother playing? Instead, it may be more appropriate to invest your retirement savings in low-cost, passively managed ETFs and mutual funds, and leave the gambling for your next trip to the casino.
 

Markets have come through a turbulent year, marked by an earthquake and tsunami in Japan, uprisings in the Arab world and European debt concerns. Despite all these events, there were some bright spots that mitigated the difficult equity market performances. Here’s a review of the major asset class results for 2011.

Fixed Income: Canadian DEX Short Term Bond Index = 4.7%, Canadian DEX Bond Universe = +9.7

• With continued decline in government and long-term bond yields, bond performances were strong again in 2011 (when bond yields go down, prices go up). US 10 Year Treasury bonds ended the year yielding an all-time low 1.88%.

Other Income: S&P/TSX Canadian REITs Index = +23.5%, Barclays Capital High Yield Bond Index = +7.6% in CAD

• The Real Estate Income Trust and Power Utilities markets both had strong years, seeing increased demand for high yielding income investments. The High Yield Bond market in the US saw a more normal year, with upside from yield compression (see above) offsetting downside from increased credit risk due to turbulent markets.

Canadian Equity: S&P/TSX Capped Composite = -8.7%

• With reduced demand from China for Canadian commodities and difficulties among Canada’s largest insurance companies.

US Equity: S&P500 Index = +4.5% in CAD

• Despite the debt ceiling negotiations and election preparations, the US economy continues to exceed expectations. Jobs are being created, albeit slowly, and economic growth is slow, but better than predicted. The biggest contributors to the US market performance were the Health Care (+12.3%) and Consumer Staples (+13.9%) sectors. Value stocks and Small Cap stocks both underperformed while the rise in the USD contributed a 2.5% currency premium to Canadian investors.

International Equity: MSCI EAFE Index = -9.66% in CAD, MSCI Emerging Market Index = -16.25% in CAD

• The earthquake in Japan early in the year and the concerns over the European periphery country’s ability to pay their debts weighed heavily on international markets. The major Emerging market countries (China, India) also had difficult years as their respective central banks tried to restrain inflationary growth by increasing interest rates and reducing liquidity.

PWL Market Stats, as at December 31, 2011

As always, don’t hesitate to contact us if you’d like to discuss.

Best regards and Happy New Year!
Tony & Peter

Assessing a fund manager’s skill is a difficult task – most of the time, advisors would simply pick a benchmark index and compare its returns (and perhaps its standard deviation) to that of their fund. For example, if we wanted to compare the 5-year performance of the DFA Canadian Core Equity Fund Class F (a fund we have used with many of our PWL clients in the past 5 years) to an appropriate benchmark index, we may choose the MSCI Canada Investable Market Index and compile the following information: 

At first glance, it would appear DFA had generated significant “alpha” over this time frame – they were able to beat their index, and with a lower standard deviation. Good enough explanation for our clients, right?

Wrong.

DFA is a Canadian fund company that consistently tilts their portfolios toward smaller companies (with smaller market capitalization than bigger companies) and value companies (with higher book-to-market ratios than “growth” companies). Their past outperformance could simply be due to taking on more small cap and value risk than the index, and not alpha at all. This would make intuitive sense, because as advisors, we do not expect DFA to generate alpha at all – we expect them to provide our clients with efficient and low-cost access to 3 of the risk factors that have historically been shown to compensate investors over a long-term investment horizon:

1. The Market Factor
   
2. The Size Factor
   
3. The Value Factor

So how can we tell if DFA (or any other manager for that matter) has done their job?

This question leads us to the Fama-French 3-Factor Model:

where:

The model can be used (among other things) to more accurately assess the true nature of a fund manager’s performance (whether it is good or bad). Determining the equation inputs for a Canadian equity fund is another matter. Unfortunately for Canadians, there is no easily accessible database where you can obtain the monthly return data necessary to run a 3-factor regression analysis (unlike in the U.S., where Ken French’s online data library is available to the public). Instead, I’ve created a “makeshift” Canadian version of the database that seems to work fairly well for this exercise – I’ve made notes below for the source of the monthly returns: 

After running a 3-factor regression analysis with the above data and monthly returns for the DFA Canadian Core Equity Fund Class F (minus the monthly Canadian One-Month T-Bill returns), we get the following results: 

 all show t-statistics greater than 2, indicating a high level of significance in the results. I find it easier to illustrate the main results of the small cap and value factors in a chart:

The chart above is divided into four quadrants, relative to the market portfolio. The further to the right and up a fund plots (the more small cap and value tilt it has), the higher the expected return of the fund (and the higher the risk). The opposite is also true. We are now ready to plug in the data (I’ve included it again below for convenience) and calculate a more appropriate benchmark return for the DFA Canadian Core Equity Fund Class F (DFA256).

Comparing this result (+1.92%) to the 5-year annualized return of the DFA Canadian Core Equity Fund Class F (+1.93%) appears to make more sense now. DFA did not in fact add alpha – they merely did what they said they were going to do – consistently tilt their portfolios in such a way to capture the small cap and value factors (which happened to be positive over this 5-year period, but could have just as easily been negative). There will be periods when the small cap and value factors will be negative, and it is even more important at that time to not cast aside fund managers like DFA, whose returns will be expected to lag the broad market indices.

In this week’s Science of Investing, Cameron and host Jason McIntyre discuss 2 studies, and also the buyout of Claymore ETFs by Blackrock. 

The first study looks at the correlation of IQ and how much one invests in stocks, and the second looks at the success of investing in IPOs.

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In this week’s Science of Investing, Cameron and host Jason McIntyre discuss The January Effect, what it means, and whether it really exists.  

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Excess expected return from small cap and value stocks has long been documented. What has been debated at length is what is the reason for these effects.

In this week’s Science of Investing, Cameron and host Jason McIntyre discuss a new study that looks at the level of distress that a company is under, and whether that distress explains the excess returns. 

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In this interview, Jason McIntyre of CFRA’s Business at Night and I discuss the ‘value factor’. As part of our ongoing series ‘the science of investing’ we talk about the very important research done by Eugene Fama and Ken French on how markets produce returns for investors, and how to make use of this information in your portfolio.

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Lately, the media has been painting a critical picture of Exchange Traded Funds (ETFs). Most of the criticisms apply to a small subset of ‘synthetic’ ETFs, which represent only 16% of the ETF market. Unfortunately, most of these articles fail to make the distinction between ‘synthetic’ and ‘physical’ ETFs. At PWL, we only use physical ETFs in the portfolios we manage.

In Raymond’s latest Economic Pulse, he explains the difference and how PWL’s due diligence protects our portfolios.

Enjoy the read!

Tony & Peter