Thursday, May 24, 2018

Bank's Post  Big Profits: A Win For Shareholders 
(What About Their Clients?)

When you call your bank advisor, who answers the phone? In all likelihood a computer generated voice that will steer you to multiple options. Why employ a human when the world is moving to technology driven cheaper alternatives. 

Perhaps you prefer email communication? But is it always secure? In my days as a branch manager at a couple of financial institutions, I can recall numerous episodes where client emails and personal financial information were hacked and fraudulent requests made to send money to a supposed distressed traveler, impersonating the client.

Any transfer of money had to be verified directly with the client by phone.

Nonetheless, in order to cut costs and increase margins and earnings, bank financial advice is heading to a more robo-style offering. Even the more expensive human advice givers are being squeezed out and with them, personal service.

If you are big enough (i.e. lots of assets to be invested and therefore more "worthy" of attention) to have one of the "big producer" advisors, getting their attention is going to be more difficult as they bring in more assistants to run interference so that they can handle their increased client load, as smaller advisors are shown the door.

Remember, large advisors (at these financial instituions / banks) are paid a commission that is based on a certain % of the fees that they generate. The % commission that they are paid is based on a "grid" that depends on the total "production" that the advisor has generated over the previous 12 month period.

If, as an advisor, your production does not cut it, your place on the grid may render your commissions received too low to provide you with a reasonable income. You then have to make a decision as to whether this is the right work for you. Or you go and find a way to increase the revenue you are generating.

 If the incentive for an advisor is to grow revenue (to find a good place on the payout "grid"), is that a conflict of interest? Who's needs are being attended to first and foremost? Do the client's needs become secondary to revenue generation?

As a client of a very profitable bank or investment dealer you should want to ask those questions. 

As an independent, employee owned portfolio and wealth management company, we (at High Rock) have committed to put our clients first and our shareholders (us) only benefit because we do a good job for our clients. Of course we earn our fees in the course of looking after our clients, but our incentives are pure and derive from managing our client's wealth using the exact same assets as we purchase for our own portfolios (clients may have different allocations according to their personal strategy).

And we answer our own phones.

Owning shares of Canadian banks may just be better than being clients of them.

Tuesday, May 22, 2018

What Is Successful Investing ?

It probably depends on who you talk to and how they might define success. Some might define it as speculating on Cannabis related stocks in the age of Marijuana legalization (if /when you can catch the ride). Or owning Facebook, Amazon, Apple, NetFlix and Google stock at the right time.

But, really, that is just gambling on the hype (which can be quite inviting and exciting) and is a very short-term, high-risk strategy. Fun when it works, frustrating when reality intrudes and valuations stop looking so terrific (which will happen, eventually). 

With the speed that we all demand for gratification in the age of the internet, we have to be careful that when we invest, the results that we expect and desire are in keeping with a more structured long-term plan (even when you are in your 60's, you have likely 25-30 years still remaining on this planet). At High Rock we call it a Wealth Forecast and it becomes the basis for all of our investing decisions on your behalf. Quite simply, it outlines your goals and your timelines for achieving those goals.

From that point we can determine what average annual return (over multiple years) you need to achieve your goals: be they retirement lifestyle, major purchases or creating a financial legacy for the beneficiaries of your estate.

More importantly and crucially, your plan needs to be monitored, reviewed and updated as life changes occur. We think that this should be done at least semi-annually.

The challenge, as with anything that takes time to accomplish, is sticking to the plan. "Shiny object syndrome" will always prey on your psyche and hindsight is always 20/20. Some financial salesperson is always going to paint "greener grass" on her/his canvas and hype their offering making it all sound so tempting.

Over a year ago we came up with a Voluntary Code of Conduct declaration (duly signed by all of our partners) to ensure that we always put our client's interests ahead of our own. The idea being that financial success is more than just month to month, quarter to quarter or year to year returns, it is the faith and trust put in the plan, the execution of that plan and managing that plan to see it through to meeting your end goals.

Our intent is to do all of this within the context of a low fee environment, a higher level of service (than most of our large financial institution competition) and a legal fiduciary responsibility that is not offered by large financial institutions: our provincial securities license holds us to a higher standard than IIROC licensed advisors.

So often we see the portfolios of new clients joining us with investments (with such unsuitable risk) that if we were to have bought them into our client portfolios, we would lose our license. 

So the key to long-term investment success is to look long and hard "under the hood" to find the wealth management team that will make you (and not the assets that provide them with their commission's) their priority.

Tuesday, May 15, 2018

Volatility And Portfolio Performance:
It Matters!

A conversation that I often have with clients when we review their portfolio performance comes down to a discussion as to how well their friends have done relative to their own portfolio performance: "they got 10% and I only got 6%". True. "What happens when markets (usually meaning stock markets) go down ?" 

First and foremost, of course, is what annual average return are we trying to achieve that we have built in to your Wealth Forecast? So how much risk do you need / want to take, to get that return? Why take more risk than is absolutely necessary?

If your portfolio has less risk (less potential for volatility), it won't go up as much (as your friend's portfolio), but it won't go down as much either:

A Tale Of Two Portfolio's:

Which portfolio would you rather have?

Both have the same annual average return of 4.00%.


What is actually more important (in this simplified example) is the annual average compound return: if you started Year 1  with $500,000, Portfolio 1 ended Year 5 with $607,137. Portfolio 2 ended with $600,564. Personally, I would rather have Portfolio 1 (would you not all agree?).

The key is the potential swings in year to year returns. The ability to reduce volatility (hopefully limiting or avoiding negative returns), over time, is important. You may give up a few basis points to your friends in the good markets, but in all likelihood they are going to give up more (than you) in difficult markets. Especially if they have a fully invested, balanced portfolio without any tactical advantages.

That is how we do it at High Rock. Although past performance is not a guarantee of future returns, we work darn hard to ensure that we get the best risk-adjusted returns for our clients.

 Over time, that is what pays off!

Wednesday, May 9, 2018

Global Stocks: Where To Next?

One of the benchmark indices we use to measure global equity market stock performance against our (High Rock)  blended portfolio performance is the All Country World Index (ACWI). The ACWI, if you recall, is an index with  over 2400 constituent companies domiciled in 24 developed countries and 23 developing countries. A good representation of the global stock market. Using the ACWI ETF as a proxy for this index, since the beginning of February this index (chart above) has continued to face periods of higher trading volume selling every time it attempts to move higher and selling follows. 

US stocks make up over 50% of the ACWI.

A similar pattern has evolved with the S&P 500 ETF (SPY):

Trading volume has diminished as the trading range has become more established. In the US, the trading range continues to be prolonged as the markets wait for a multitude of issues to bring more clarity to financial market traders:
(not necessarily in order of priority) 
1) Geo-political developments: North Korea summit, Middle East posturing, global trade and US protectionist developments.

2) Economic growth, Inflation and interest rates: The US Federal Reserve is expected to continue raising US rates and tightening monetary policy, but there are building concerns as to how well the US economy will be able to withstand that pressure. A higher $US and higher oil prices will likely add question marks to the global growth scenario. Record levels of debt (especially $US denominated debt in emerging economies as well as rising US government deficits) on a global scale will make debt servicing more expensive for governments, businesses and households.

3) The debt build-up has been positive for the global economy over the last year or so, but if the economy should stagger under the debt burden, it becomes a potential powder keg as borrowers struggle with debt repayment issues.

If  and when investor's begin to lose confidence, buying support may not hold if selling volumes increase pushing equity prices through the support line. The fact that record amounts of margin (stock investors who have borrowed to buy stocks and equity ETF's) may be called if and when stock prices decline (investors are called to increase the amount of cash put up to borrow stocks), assets need to be sold to raise cash and a snowball effect can occur, as it did in 2000 and again in 2008.

As portfolio managers, we need to constantly weigh the risks inherent in owning any asset class and apportion a percentage weight to owning that asset class in a balanced portfolio. Portfolios need to be re-balanced regularly in order to ensure that assets classes are appropriately risk-weighted. We believed that those risks were high at the end of December and even higher when the market peaked in January and I wrote a blog asking the timely question: Should You Be Worried? An advisor, who is not a portfolio manager, took me to task for that. We are always worried. It is our job to be worried so that our clients don't have to be. They have much better things to do with their time. Proper balancing and re-balancing are a necessity. Just sitting on a balanced portfolio is the big mistake.

Stock prices may go up. That is great for a portfolio with 60% equity ownership (or any equity ownership, for that matter). They may also go down. We think that if they go down, they will go down pretty hard. So we will continue to take proportionate risk. We work for our fee.

Saturday, May 5, 2018

Bonds Part 3: What Does The Yield Curve Tell Us ?

About 90% of the time (or more), the yield curve is positively sloped, which means that short-dated bond yields and other interest rates (i.e. floating or variable  rate loans) are lower than longer-dated bond yields (or 5 year mortgage lending rates, which are priced as a function of 5 year bond yields).

For borrowers, this means that prime (now 3.45%) will be lower than a 5 year fixed mortgage rate (somewhere near 5.5%  now) about 90% of the time. If your cash flow can handle changing (variable) interest payments, it is likely going to be better (less costly) to have that kind of borrowing structure over longer periods of time. Talk to your Certified Financial Planning professional (or High Rock's) to see if that is best for you.

You can also see why Canadian banks continually have record earnings. They are able to borrow at the overnight rate (currently at 1.25%) and lend at prime or higher and take out a nice 2.2% (or more) profit. They get even more when their depositors get 0% on chequing and about 1/4% on savings accounts and they lend that money at prime in the short-term or 5.5% for a 5 year mortgage. The banks love a positive sloping yield curve.

What about the other 10% of the time?

When the Bank of Canada (or any central bank for that matter) is fighting inflation, usually the economy is strong and can withstand higher interest rates. As we mentioned in part 2's discussion, as the BOC raises short-term rates (inflation fighting) long-term bond investors demand less inflation premium and yields rise less quickly at the longer end of the spectrum. When the BOC raises rates one or two times too many (it is not an exact science) as happened back in 2007, the yield curve became flat: short-maturity yields moved high enough to become even  with longer-term yields (more or less). 

Historically, this usually precedes a recession: the economy can't handle the higher interest rates any more (usually at the end or peak in the economic cycle) and begins to slow, unemployment rises, inflation also slows and the BOC now takes off the "inflation fighting" hat and puts on the "defender of the economy" hat and starts to drop interest rates: the yield curve returns to a more positive slope.

As an investor, what do you do? It is not where the yield curve is at in any moment in time, it is where is the yield curve going that becomes important:

We call this a "yield curve shift" (and this is where it all gets truly exciting, so stay with me)!!


Let's start in late 2013, early 2014, we had a very positive (normal) yield curve. However, the events of 2015, a precipitous fall in the price of oil, had a major negative impact on the Canadian economy. The BOC cut rates (red arrow left) by a total of 1/2%. The 30 year bond yield fell by close to 1% (red arrow right). If bond prices are rising as yields fall, wouldn't you rather be invested where prices are rising faster (i.e. longer duration)? Absolutely. 

Fast forward to 2017, we are over the oil crisis thing and the economy is growing and the BOC is back wearing the inflation fighting hat and raises interest rates three times each by 1/4% (3/4%, gold arrow left side). What happened to the 30 year bond (gold arrow right side)? Yields up, prices down, but not nearly as dramatically as the shorter term part of the yield curve. If you have to own bonds (as we do in a balanced portfolio), wouldn't we rather have less portfolio impact with longer duration? Absolutely.

What is next? It depends. If the BOC continues to fight inflationary expectations (like the US Federal Reserve) all those households  with record amounts of debt and variable rate loans are going to be digging a lot deeper to service their debt at 1/4% or even 1/2% higher rates (blue arrow, left side). Not good for an economy being driven mostly by the consumer. That would likely create a flat (red line) or at least flatter yield curve. What duration would you like to have in that case? Looks to me like I would want longer duration (blue arrow, right side).

When we (at High Rock) make investing decisions (with our combined sixty plus years of bond trading experience) for our fixed income model, we make determinations on what our average duration (on the yield curve) should be for the bonds that we collectively own. We will buy and sell different maturities to make those adjustments. We may want to own a higher weight of 30 year bonds now, but we do not necessarily need to own them for all 30 years until maturity. If at some point we decide that we see a shift in the yield curve coming where it is better to have a shorter average duration of our bond holdings, we can sell some or all of them back into the secondary market to do so. Tough to replicate what we do with an ETF, so we own the actual bonds and our clients don't need to pay an MER on top of our fee. Real portfolio management at a reduced cost. What could be better?

There you go! Wasn't that thrilling? Fun for me, anyway! I did simplify things a bit, but feel free to get in touch with any questions:

Thursday, May 3, 2018

Bonds Part 2: Interest Rates, The Bank of Canada and Bond Yields

Remember: Bond Markets Lead All Financial Markets.

In other words, the bond market already knows the Bank of Canada's mandate (which they are very transparent about) is to "preserve the value of money by keeping inflation low, stable and predictable". The BOC's acceptable range for inflation is 1-3%, with a target in the middle of 2%. If economic indicators are showing increasing inflationary pressures (usually on the back of a strengthening economy) bond market participants will have already anticipated what the Bank of Canada will do next: raise the interest rate that Canadian banks borrow and lend to each other at, called the "overnight rate". This rate influences where banks lend to their clients: the prime rate and any other adjustable rates (which are usually a function of the prime rate).

So the bond market has already built this in to its pricing and for bond market participants, these rate increases are expected and  bond yields adjust well in advance of any action by the BOC. All of the various bond yields plotted on a graph with the Yield To Maturity on the vertical axis and the Term To Maturity (3 month T-bills to 30 year bonds) on the horizontal gives us what we mysterious bond types in bond jargon refer to as the Yield Curve:

If you recall yesterdays exciting discussion around the 10 year bond which jumped from a yield to maturity of 2% at issue to a current yield of 2.38% and a price discount of $3.65 because bond investors became a little more concerned about future inflation (highlighted above): the yield curve shifted higher.

This is where it gets really crazy (so hold on to your hats!): Last June, The BOC decided to go from inflation stimulator (easy monetary policy following the oil price crash) to inflation fighter and has raised rates on three occasions (3/4%) since last July.

Here is what happened to the yield curve:

Wild eh?! Note that the 3 month, 10 year and 30 year yields (red arrows) have all moved differently. The shortest maturities closest to the "overnight" rate have moved exactly 3/4%, following the BOC. The 10 year has moved almost a full 1% and the 30 year less than 1/2%. Remember that the BOC is still expected to continue to fight inflation with another one or two 1/4% rate increases (gold arrow). Clearly this is already anticipated in the 10 year yield and way out at the 30 year end of the spectrum, the expectation of inflation getting out of control is not a worry: bond investors are comforted by the inflation fighting stance of the BOC, so they are demanding less inflation premium to buy those bonds.

Question 1: if you have to have the safety of Government of Canada bonds in your portfolio (always part of good balance), where on the yield curve might you wish to own them (us bond folk refer to the maturity spectrum as "duration")? 

So what duration is best? Short or long?

Remember, prices go down as the yields go up.

Question 2: If mortgage rates are a function of bond yields, where is the best place to borrow? Short (floating) or long (fixed)?

Stay tuned! (so very exciting!)

Wednesday, May 2, 2018

Do You Find Bonds A Bit Confusing?

At the end of our  High Rock Weekly Video, I prompt our viewers to send feedback and ask questions, because if one person has a question (and they are always all good questions), it is highly likely that others have the same one. Yesterday I received an excellent question and decided to include it and hopefully some answers that will help anyone else who may have similar desire for knowledge! (warning: this may take more than 1 blog)

"Hi, Good stuff as always.

And I have always been a bit confused by the bond market. Maybe a bond market primer would be of interest as a blog post.

My understanding is that as bond prices rise, yields fall. So rising interest rates mean bond prices are falling. But is that a net gain? If you are buying cheaper bonds but getting lower returns, are you ahead? And then there’s the correlation to equity values. As equities drop, people retreat to the security of bonds? Prices go up but yields come down? Is that a strictly defensive posture? And any bonds you hold, I assume are unaffected. You’ve bought at one price with a fixed yield.

Governments raise interest rates to cool fast-growing economies. 

But the economy seems to be stumbling along at an unspectacular growth rate, despite high stock prices. Is it an anomaly?

I suspect I’m not the only one who finds bonds a bit confusing. "

In case you did not already know, I was a bond trader from the mid 1980's until 1999. Paul has been trading them (and still does) since 1990. So we know our stuff!

If you have  a balanced 60% equity and 40% fixed income you likely have been told that, at least in historical perspective, when stocks go down in price, there will be an offsetting increase in the price of the bonds that you own that will, at least partially, protect your portfolio until stock prices start to rise again. In 2008-2009 for example (obviously an extreme circumstance), stock markets dropped close to 60%, but a 60/40 balanced portfolio dropped about 20% over the same time period. This negative correlation between stocks and bonds was able to reduce the volatility and allow a much quicker period of portfolio recovery: a little over a year for the balanced portfolio compared to multiple years for the stock portfolio.

Back in December, I wrote a blog called "Myth Busting Of The Bonds In Your Portfolio", which I highly recommend having a look at as it does cover some of the basics:

Remember that bonds are issued at $100 per bond at a fixed interest rate for a specified maturity. Usually (and we shall focus on Government of Canada bonds, not to be confused with Canada Savings bonds, as they are the safest) they are issued for a term of 2 years, 5 years, 10 years or 30 years.

For example, recently the Government  of Canada auctioned a 10 year bond (which will mature in June of  2028) with a coupon of 2% (interest paid semi-annually). At the time, the buyers were prepared to pay $100 for this particular bond. If they hold it until it matures, they will get their $100 back, plus  2% annual interest paid to them ($2, $1 paid every 6 months). 

What are the risks?

1) Will the issuer be a able to pay interest and repay the principal (safety)? In this case, that is not a concern (Canada has a AAA rating, the highest).

2) What is the current and expected rate of inflation (increase in cost of living) and will this reduce the value of the bond in the future. If inflation is going to grow at an annual rate of 2% and the bond is going to pay you 2%, then you are going to have a "real" return of 0. But, perhaps that is worth the safety of the bond (compared to other, more risky assets in your portfolio) and provides the desired balance and it is better than sitting in cash which pays 0%.

Nonetheless, fast forward to now and in the secondary market (where bonds are actively trading as buyers and sellers re-position their bond holdings for a myriad of reasons) that particular bond is trading at a price of $96.65 ($3.65 lower than the issue price). The Yield to Maturity (at this discounted price) is now 2.38%. Although the coupon or semi-annual interest rate paid to you is still 2%, the actual return of holding the bond to maturity means that you get an additional $3.65 when the principal of $100 is repaid (if you were to by the bond at the discounted price today).

That means that bond investors are now demanding a better return (to purchase the bond) than at the time the bond was issued (i.e. inflation expectations are rising). If you are a seller, you will take a capital loss (but you will have accrued some interest since you bought the bond, so it reduces the loss slightly. Whatever interest has accrued is paid to you buy the buyer).

If you own that bond in your portfolio, it will be marked to market every day, showing the daily change in the trading price. So, at the moment, your portfolio will show a capital loss on the bond (if you purchased it when it was issued). 

However, until you actually sell that bond, you have an "unrealized" capital loss. If you sell the bond, you have a "realized" capital loss. If you hold the bond to its full maturity, despite all the daily changes in price between now and then, you will break even on the price and have earned the $2 per year in income. So while the day to day swings in price affect the total value of your portfolio on any given day. If you hold the bond until maturity, those daily swings in price don't matter. Unless you sell the bond.

So why do people sell bonds in the secondary market?

1) They fear higher inflation and expect to buy that bond back at a lower price (deeper discount) and higher yield to maturity in the future.

2) They need to raise cash (perhaps to buy cheaper assets: stocks, bonds or other) and this is the most advantageous asset to sell (see number 1).

3) If, as in number 1, inflation is rising, what will be the Bank of Canada's response (i.e. will the Bank of Canada increase its interest rate)?

To be continued!! (I hope the suspense will bring y'all back!!)