Monday, October 16, 2017

What Financial Success Looks Like

I started looking after these folks more than 10 years ago (I have been helping families manage their wealth and risk since 2000), they came to me with a little under $500,000 in non-registered and registered investments. They were a working couple with 3 kids and RESP's. They had their company benefit life insurance plan, they owned their home (likely valued then at about $350,000 to $400,000) with a reasonable mortgage.

They were not aggressive investors (stewards of what wealth they currently had and wanted to grow), but wanted, as most do, to have a comfortable retirement and some tax efficient method of leaving their kids some of their estate.

We (my team at the time at an independent investment company) set up a Wealth Forecast that included a Whole Life Insurance plan for their estate goals and to offer some diversification away from their investment portfolio strategy. Their retirement goals could ultimately be funded by their investments.

A couple of years into our relationship, along came the financial crisis.

I don't have all the history from this early time in our relationship (because the bank that ultimately bought the investment company we were with, made the assumption that they were the bank's client as opposed to my clients and would not release their history and files to me when I moved our business away from the bank), but I would suggest that they probably saw the value of their investment portfolio slip by about 15% in 2008 and were able to get it back to even by somewhere into early 2010.

When we moved back to an independent investment company in 2012 (from that bank) we started their investing history (from scratch) all over again. We were able to keep their history when we began the High Rock Private Client division in 2015, which looks like what you see here (about a 5 year history):

After fees, the average annual rate of return has been 7.78% over the last 5 years (Return on Investment from the above chart uses the net of fees IRR method).

You can see that there has been some volatility (mid 2014), but for the most part, we have been able to keep the growth (in green) to a relatively smooth up-slope. This is because we manage risk first and foremost.

We have the 4 year return per unit of risk chart for this client (because we don't yet have the 5 year monthly benchmark comparison data yet), but generally, you can see that we have been able to maximize return, relative to the risk that we have taken in this 60% equity, 40% fixed income, globally balanced portfolio: 

Under the Actual HR PC heading in the top table (and circled in green) is the compound annual average 4 year return (absolute return), the risk factor derived from the volatility of the investments (not circled) and the return per unit of risk, which is the compound return divided by the risk factor (also circled in green). By comparison a benchmark of 30% SP/TSX index, 30% ACWI ETF (global equity benchmark) and 40% XBB ETF (Canadian bond index) (circled in red) has both a lower absolute return, a higher risk factor and ultimately a lower return per unit of risk.

So, that is how we manage risk to get that smooth upward sloping level of compounding growth (back to the green in the monthly equity growth graph) for our client in this specific case, but also for our clients in general. 

Most importantly, this is how it relates back to the Wealth Forecast and the growth of their investable assets (yellow, grey and orange) that they will have to fund their retirement goals. 

And of course, the life insurance (blue) will provide tax free transfer of wealth to their beneficiaries.

Sweet success, without taking on extra risk. Good on these folks!

There is an alternative to what the banks and big investment advice firms are offering and we at High Rock are offering low cost, more fiduciarily responsible, full-service wealth and portfolio management.

We would love to help you reach your goals too!

Wednesday, October 11, 2017

World Economic Outlook

The International Monetary fund (IMF) and its team of economists have update their projections for the World Economic Outlook and they are looking slightly improved from their previous outlook in July.

For Advanced Economies, expectations are for an improvement to 2.2% GDP growth (from 2016's 1.7%). Slowing slightly for 2018 to 2.0%.

As I have discussed on many occasions before (and as recently as last week in my blog on Volatility), this growth, which includes 2.2% GDP growth for the US in 2017 and 2.3% in 2018, is in line with the 10 year average. It, however, is hard to see this very average growth as a proponent for well above average equity price to earnings ratios some 20% or more above their 10 year averages.

Clearly all that is potentially positive is more than built in to current equity pricing (including US tax reform).

So, what would be the rationale or incentive for putting cash to work now in global and especially US equity markets? It would appear, with all the good news built in, that there is significantly more downside risk.

Here is what the IMF thinks about the potential downside:

"Risks to the baseline are broadly balanced in the short term but skewed to the downside in the medium term. Short-term growth could increase further, as stronger confidence and favorable market conditions unleash pent-up demand, but setbacks are possible. With high policy uncertainty, missteps -which the baseline assumes will be avoided- or other shocks could materialize, taking a toll on market confidence and asset valuations, and tightening monetary conditions".

If risks are skewed to the downside in the medium term, it suggests to me that buying equities at current prices would require a much larger risk premium than what currently exists.

As we manage risk, first and foremost, in our High Rock models, we need to take this situation into all of our decision making. Specifically because we manage our and our clients money for the long-term (based on the goals identified in our respective Wealth Forecasts). In essence this is our definition of disciplined investing: not chasing returns for short-term growth, but making tactical, short-term decisions that will lead to long-term sustainability in the growth of our portfolios. If that means patiently waiting for opportunities to evolve, then that is what we shall do. We will not force investments into our models for the sake of having investments.

If current prices and valuations do not make sense (i.e. there is not enough risk premium built into pricing), then we will not put our or our clients money at risk. 

We have a fiduciary responsibility to protect our clients (which I have written about on many occasions) and this means that we have to be ultra careful that we are totally prudent with our investing strategy.

We need to look well beyond the current economic, political and investing climate to determine how risk plays into the management of portfolio strategies. So that is what we do.

Monday, October 9, 2017

Conflict Of Interest

"...when the stakes are high and the choices are difficult, people will go out to hire experts to help them. The problem with this argument is that it can be hard to find a true expert who does not have a conflict of interest. It is illogical to think that someone who is not sophisticated enough to choose a good portfolio for her retirement saving will somehow be sophisticated about searching for a financial advisor, mortgage broker or real estate agent. Many people have made money selling magic potions and Ponzi schemes, but few have gotten rich selling the advice, "Don't buy that stuff." "

Richard H. Thaler was (today) awarded the Nobel Prize for Economics.

"The Nobel committee, announcing the award in Stockholm, said that he was a pioneer in applying psychology to economic behavior and in shedding light on how people make economic decisions, some times rejecting rationality." (NY Times)

"Professor Thaler said on Monday that the basic premise of his theories was that, "In order to do good economics you have to keep in mind that people are human."" (NY Times)

One of the most basic of human behavior's in the world of investing is the "recency effect", whereby we tend to project what has been going on in the recent past to our expectations of what we think is likely to go on into the future.

It took a long time for investors, rattled by the financial crisis,  to get back to investing in equity markets, many only recently. But now, after 9 years of positive equity markets...

CNN Money's Fear & Greed Index is pushing its upper limit.

If my/our job (at High Rock) was to keep you fully invested at all times by telling you to stay invested (in order to be paid my commissions), then I would truly have a conflict of interest, especially when I am in the 8% of the Fear and Greed index who is actually fearful.

I guess I will never get rich being a contrarian (according to Professor Thaler), but hopefully, at some point, I/ we will be appreciated for looking out for our and our clients best interests!

Happy Thanksgiving!

Friday, October 6, 2017


Back in 2015, one of my/our themes for the year was that central banks loathed volatility because it eroded confidence. As we discussed in our High Rock weekly webinar on Tuesday, all the liquidity that has been added to the global financial system over the last 9 years:

Has very gradually reduced the level of volatility in the S&P 500 (gold line = VIX, volatility index) and other global stock markets:

This liquidity is going to start gradually being withdrawn from the system beginning this month as the US Federal Reserve starts to wind down its bloated balance sheet by not re-investing in the maturing bonds that are currently part of it.

In other words, the white line in the chart above will start to fall. What remains to be seen is what this means for volatility (the gold line). We suspect that it will start to push the gold line higher, i.e. greater levels of volatility.

The liquidity generated from 9 years of extraordinary (easy) monetary policy has found its way into global stock markets, artificially pushing prices to levels that are significantly above what the economic fundamentals have been confirming: relatively modest growth in the vicinity of 2% annually (pink line is the 12 month moving average which smooths out the quarter to quarter changes):

Stocks (on a global basis: All Country World Index, ACWI ETF) have returned a little over 5 1/2% since March of 2008 (Compound Annual Growth Rate):

So  equity markets have been performing at a rate of more than 2X economic growth annually over the last decade.

Clearly, the fundamentals are lagging the stock market: 

And Expected Earnings (12 months forward), relative to stock prices) anticipate some additional 20% improvement (over and above the 10 year average):

So, at some point either the fundamentals will have to catch up to stock prices or stock prices will have to fall to be more in line with the fundamentals.

Hope now resides with the Trump Administration and tax reform and cuts to help drive the fundamentals. You can all make your own decisions on what this might ultimately mean (if it is accomplished or not). We will certainly be monitoring it closely.

With declining financial market liquidity, the stock markets will become more susceptible to economic and / or political shocks. We think that this ultimately defines the current investing market (risk is high) and is limiting investment opportunities at the moment.

And as you all may know, we (at High Rock) are not gamblers, we are managers of risk (first and foremost), so we are prepared to wait for opportunities to evolve (as higher levels of volatility create them) and remain prudently cautious (in the short term). With the knowledge that opportunities will develop (as they always have and always do) to allow us to continue to generate longer-term, strong, risk-adjusted returns:

It is also my duty to tell you that historic returns do not guarantee future returns. However, we, at High Rock, work very hard to get the best risk adjusted returns possible for ourselves and our clients (because we invest in the exact same assets as our clients and back this up with an independent Investment Review Committee quarterly report, which our clients will be receiving shortly with their quarterly summaries).

Thursday, September 28, 2017

Morneau Tax Policy Intended To Force Small Business Owners To Take On Greater Risk.

As managers of risk, we are a little concerned with an article in The Globe And Mail, where (with a new explanation) Fin Min Morneau outlined a reason for his new tax policy:

"Speaking to The Globe And Mail's editorial board Wednesday, the minister presented an entirely new argument in defence of the controversial tax package." 

"Mr. Morneau said the ultimate goal of the changes is to correct an unintended aspect of the tax system that fails to encourage small-business owners to reinvest their corporate savings back into their companies."

Mr Morneau said that "We're actually giving the people incentive to sit the dead money on their balance sheet and invest it in something else", he said. "We've created a big gaping hole for tax planning and at the same time a decreased likelihood that people are going to invest in their business. That's what we are getting at here."

I would suggest, first and foremost, that small business owners know exactly how much they need to invest in their businesses for the growth that they wish to achieve and need not be coerced to invest (risk) more by the government.

Secondly, as a business owner builds her / his business, their security for the future depends on not having all of their "eggs in one basket" (i.e. "investing in something else"). In other words, financial success (and the ability to survive economic slowdowns) depends on the ability to have asset diversity (to be able to ride out the economic storm) and continue to operate without adding leverage or reducing their work force. That is lesson one in the management of risk.

This would be especially true as small-business owners approach their ultimate retirement, when it is even more essential to have a broad diversity of investments to carry them through the balance of their lives. They should not have to wait until they have sold their businesses to be able to build a comprehensive investment strategy.

Small-business owners take enough risk throughout their careers, they have made their contribution to the economic growth of this country. They deserve some respect for this, not derision for being somewhat and rightfully safety conscious.

Saturday, September 23, 2017

ETF Popularity, Complacency = Bigger Risk

Each week, like the proverbial broken record, we tell our clients (and any one else who cares to listen) on our weekly client webinar that the changing dynamics brought on by extraordinary monetary policy and liquidity by central banks since the financial crisis have made the old balanced portfolio correlations between equity and fixed income significantly less stable.

In other words, if you are using that "old-school" buy and hold methodology you have way more risk than you likely should have and are vulnerable to permanent portfolio damage if you (or your advisor) do not take the time to assess it.

At High Rock we manage risk first and foremost, so we have a full understanding of exactly what risk our clients (and we ourselves) have.

We often rail against the complacency factor: Canadian investors with global equity exposure have watched (if they pay attention) their portfolio values erode as the Canadian $ strengthened by over 10% (that is where the volatility has been). Did your advisor point out that risk to you?

There are greater risks out there: Asset prices have decoupled from their underlying fundamentals because central bank liquidity has put a temporary floor under them.

Corrections in market prices have not been significant as a result.

However, this liquidity is going to disappear (as central banks unwind their extraordinary monetary policies (the US Federal Reserve will start in October) and asset prices and the gap between them and the fundamentals will revert.

The big question is will the lagging fundamentals (like economic growth and inflation) catch up to extended asset prices or will prices fall to more realistic levels?

The big risk is the latter (obviously) and we all need to be prepared for that. If you are not, you could be in for a nasty surprise.

At High Rock, we are prepared. We are underweight expensive equity assets and over-weight cash. We are positioned to protect our clients. We do not use bond ETF's. They are expensive and don't allow us the flexibility necessary to adjust the average duration of our bond maturities. We are tactical: looking for real opportunity as opposed to owning over-priced assets.

Our (Paul and my) voices (blogs) do not get enormous exposure, likely a couple of hundred views per blog or thereabouts. And our profession is not journalism. So our message is not necessarily as far-reaching as some.

But when great voices on this topic echo our sentiment, it is always reassuring: so I would recommend having a peak at this conversation between a great market economist, Dr. Mohamed El-Erian and

In words way more eloquent than mine, Dr. El-Erian suggests that "there is a difference between the investment journey and the destination". 

The investment journey being the day to day, week to week, month to month, year to year swings in portfolio value. The destination, of course, is your long term goal. Sometimes it may seem that the journey may not be taking a direct route to the destination, but you have to keep your eye on the target and let the capable managers worry about the day to day, etc. journey.

That is what we do: protect ourselves and our clients from risk that may impact the ultimate destination. Do you know for certain that your advisor is doing the same (especially if you are loaded up, like the rest of the mostly unsuspecting investing public on ETF's)?

Be aware of your risk. We can help.

Thursday, September 21, 2017

According To US Fed, Best Economic Growth Is Behind Us:

These are the forecasts released after yesterdays Federal Reserve (FOMC) meeting. 2% GDP growth is not conducive to corporate earnings growth of 20% (which is currently built into stock prices). 

Something has to give.

And now, interest rate adjustments aside, the US Federal reserve will be starting to reduce its balance sheet by $10B per month (beginning in October) and gradually increasing that amount.

What happens to the $10B (and eventually more)? 

It is removed from the financial system. The US Federal Reserve will not be buying $10B of additional securities (each month) that they have been previously buying, so the financial markets have to take up the slack and buy those additional securities themselves. 

Where will the $10B come from? 

The most expensive assets will be sold to make room. If you own expensive assets, it is likely that their prices will start falling.

If economic growth is only going to be 2% and stock prices have built in a 20% premium (above the current expected earnings), I would argue that the 20% premium in stock prices might indeed make them expensive assets and therefore vulnerable to selling.

This is one of the reasons that we have taken a cautious position in owning over-priced equity assets in our portfolios. Tactical and disciplined investing.

Bianca and I were visiting with one of our older clients yesterday (yes, we make house calls!). She had recently moved into a lovely assisted living community because of some health issues and while she was thrilled with her new living environment and the additional care, she was, quite reasonably so, concerned about the additional costs.

We had redone her Wealth Forecast to allow for all the changes and were able to show her that there was going to be little impact on her long-term net worth (she was thrilled for her ultimate beneficiaries). Tailored, flexible Wealth Management.

"But what about the stock market?" she asked, "it doesn't look too healthy" (I'm glad she keeps an eye on things). We showed her that at the moment, her total exposure to equity markets was approximately 8% and that we had plenty of income being generated by bonds, preferred shares and cash equivalent, no MER, High Interest Savings Funds (CDIC insured) to provide her with safety and all that she might need into the future.

Folks, stocks are expensive and vulnerable and I would suggest by what the Fed is telling us we should not be complacent.