Active vs. Passive Investing?

This is an ongoing argument that is yet to be resolved:

(and I thought that on the heels of yesterday's blog that this might be an appropriate topic to follow)

• Many academics will argue that the additional trading costs of trying to "out-perform" an benchmark index (and the potential for misses) tilt the case in favour of the Passive argument.
• How then do the passive managers justify their fees?
• Technically, passive portfolio managers should be able to match the benchmark index, before fees and taxes.
• This is referred to as the "Beta", or the expected return.
• Ongoing re-balancing (perhaps quarterly), whereby "over-weight" assets (that have out-performed) are paired back to the strategic allocation weight (taking profit on a portion) and using the cash generated to buy additional "under-weight" (under-performing assets).
• This will add additional potential to return, over time as different assets will out-perform and under-perform over the course of the economic cycle.
• The additional return, above the benchmark return, is referred to as "Alpha".
• An active portfolio manager's goal is to increase "Alpha" with a more active trading regimen, trying to find anomalies in certain assets that have (in their opinion) given them additional value.
• This is how a more active portfolio manager can justify a higher fee.
• In some cases (especially with active "hedge funds") there may be an additional "performance fee".
• It comes down to the argument of "efficiency" in markets: does a market immediately price in all the relevant information or is their a behavioural aspect that makes markets create "inefficiencies" that build anomalies in to a market?
• Further, can a good active manager seek out and take advantage of these anomalies before the rest of market participants discover it?

(click on this chart to enlarge)

Tomorrow I will look into this topic using the arguments presented by "Behavioural Finance"

The views expressed are those of the author, Scott Tomenson, a Raymond James Financial Advisor, and not necessarily those of Raymond James Ltd. It is provided as a general source of information only and should not be considered to be personal investment advice or a solicitation to buy or sell securities. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor's circumstances and risk tolerance before making any investment decision. The information contained in this blog was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. Raymond James Ltd. is a member of the Canadian Investor Protection Fund

When Boring Is Good!

I have, in past blogs, talked about the best way to counter volatility in a portfolio by being balanced and diversified.

Why is volatility in a portfolio a bad thing, when higher degrees of risk can offer higher rates of return?

The more a portfolio's value goes down in times of financial market volatility, the longer it takes to recover:

(you will definitely have to click on this chart to blow it up)

• This is a study of a number of model portfolios with various levels of balance and diversity over an 11 year period.
• a 30-70 portfolio has 30% fixed income (various bonds and preferred shares) and 70% equity (exposure across various geographical regions: US, Canada and International markets).
• With Return on the vertical axis and Risk (standard deviation) along the horizontal axis, as might be expected, the 30-70 portfolio has the lowest annual average return and the least amount of risk.
• As is generally expected, as we move out the risk spectrum (higher degrees of risk) by taking on a greater % of equity and a lower % of fixed income, historically, on average, the portfolio models have produced a greater return.
• However, as we get to the 70-30 portfolio, we can see that the "curve" has flattened and become slightly inverted.
• This is the impact of the volatility caused by the 2008 financial crisis where the portfolio with the most risk has taken a greater deal of time to recover.
• The portfolio that has performed the best, relative to the risk taken (what we refer to as "Risk-Adjuted Returns) is the most "efficient" portfolio.
• This is not a portfolio that out-performs in times when equity markets are charging ahead, but it is also a portfolio that will have more limited downside when volatility is high.
• This is when Boring Is Good!

The views expressed are those of the author, Scott Tomenson, a Raymond James Financial Advisor, and not necessarily those of Raymond James Ltd. It is provided as a general source of information only and should not be considered to be personal investment advice or a solicitation to buy or sell securities. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor's circumstances and risk tolerance before making any investment decision. The information contained in this blog was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. Raymond James Ltd. is a member of the Canadian Investor Protection Fund

As Goes Oil....

• oil prices have "stabilized" after testing support at just below $45.
• The down-trend is still intact, but there is some price "exploration" happening between $50 to $55.
• It will take some significant buying to change the trend, but for the moment, there is some consolidation of price expectations.

So Goes the $C

• As is frequently the case, in the short-run, the $US/$C relationship tends to trade with some synchronization.
• In similar fashion, the $C has stabilized at or about 1.25 (or 0.80 $US)
• As the US is Canada's largest trading partner, this is the most important relationship and certainly a key focus for the Bank of Canada.
• This afternoon Deputy Governor Wlikins will speak and this may give some clues to BOC thinking going forward.

Interestingly, the C$ continues to improve vs. the Euro:

• Travelling this summer?
• Perhaps it is time to visit Europe!!

The views expressed are those of the author, Scott Tomenson, a Raymond James Financial Advisor, and not necessarily those of Raymond James Ltd. It is provided as a general source of information only and should not be considered to be personal investment advice or a solicitation to buy or sell securities. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor's circumstances and risk tolerance before making any investment decision. The information contained in this blog was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. Raymond James Ltd. is a member of the Canadian Investor Protection Fund

What Is The Yield Curve Telling Us Now?

Friday's Employment Data in both Canada and the US were both quite positive (although one month's data never tells the whole story because it is subject to revisions), but the bond market adjusted and the yield curves can tell us a great deal about future expectations:

US and Canada:

• the difference between US and Canadian interest rates at a specific maturity date is called the "spread".
• The Spread tells us that investors in bonds (in this case, US Government Bonds) want a higher yield over a Government of Canada Bond for a similar maturity date because they expect a higher rate of inflation (brought on be stronger economic growth) in the future.
• No surprises here! Expectations of a stronger US economy and a less strong Canadian economy.

The US Yield Curve:

• after Fridays employment data, the US curve moved significantly higher beyond the 3 year point, signalling an eventual return to higher yields, but the nearer end of the curve is signalling that change (higher interest rate expectations from the FED) is still some way off.

The Canadian Yield Curve:

• after the BOC cut the bank rate in late January, the front end of the Canadian Curve inverted slightly, suggesting the potential for a short, shallow recession. 
• Following Friday's employment data, the curve has flattened in the front end , suggesting that while slowing of economic growth will still likely happen in the near-term, it may not be recessionary.
• Longer-term (and more importantly), the slope of the curve remains positive, which signals an eventual return to growth.

There is always new and revised data continuously being presented to the market on a daily basis. As the bond markets digest this data, the yield curves will adjust, giving us key insight as to what expectations are being built in to current economic thinking.

The views expressed are those of the author, Scott Tomenson, a Raymond James Financial Advisor, and not necessarily those of Raymond James Ltd. It is provided as a general source of information only and should not be considered to be personal investment advice or a solicitation to buy or sell securities. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor's circumstances and risk tolerance before making any investment decision. The information contained in this blog was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. Raymond James Ltd. is a member of the Canadian Investor Protection Fund

The Things That We Say!

So I was googling (is that a verb in the new parlance?) to see where my blog came up on the list under my name and I came accross this from April 2010:

An article from the Financial Post Variable mortgages (almost) always win Whether They're Taking On New Mortgages Or Renewing Ones They've Held For Years, Homeowners End Up Asking Themselves The Same Question: Should They Lock In Their Mortgage Or Should They Let It Float With A Variable Rate. Here, Toronto-Based Wealth Manager Scott Tomenson Makes The Case For Variable Rates:

ARE VARIABLE MORTGAGES AS GOOD AS THEY LOOK? 

Q: My fiancé and I have just bought our first home and we are going in circles about what is the best mortgage for us before we close. We currently have a locked-in fixed rate with a bank of 3.98%, which we prefer to the uncertainty of taking a variable mortgage. But would we be better off with a variable-rate mortgage, especially if we saved money during periods when rate are low and use that to make payments on principal? Will that offset costs when our payments are higher than our current fixed rate? Getting Dizzy, Ontario 

A: Historically, as far as interest rates are concerned, it is better to float your mortgage interest rate (i. e., choose a variable rate mortgage). This is a result of the "yield curve." The "normal" yield curve is positively sloped, with interest rates lower for short-term maturities (one to two years) and higher for longer-term maturities (five to 30 years). When the economy strengthens, the Bank of Canada will raise short-term interest rates (they only have control over short-term rates) and the base for variable-rate mortgages (usually the prime rate) is moved higher. This action signals a period of "tightening" of monetary policy to cool the economy and reduces inflationary pressures. The vehicles that determine longer-term interest rates -- bonds -- tend to move according to inflationary expectations: If bond investors anticipate inflation (because of economic growth), they demand higher returns (interest rates) as protection from inflation. When the Bank of Canada is perceived as "fighting" inflation by raising short term interest rates, long-term rates have a tendency, in most cases, to remain stable or improve, because long-term bond investors are content that inflation will not grow. In essence, while short-term interest rates may go up, they do so only until the Bank of Canada has slowed the economy enough to curb anticipated inflation. Then, as economic growth slows, the bank starts to lower them. The yield curve will flatten (with higher short-term interest rates) for a time, but when the economy slows, short-term rates will go back down and the yield curve returns to its "normal" positive slope. Over this time, variable-rate mortgages will move up to being approximately equal to locked-in five-or 10-year rates, but that's followed by a period when they return to lower levels. More often than not, over this time, it is less costly to have held the variable rate debt. Exceptions to this situation would be times of hyper-inflation (like in the 1980s) when short-term interest rates went to extreme levels. If you had a variable mortgage at prime minus over the past few years, as I did, it's been a great ride. I kept my payments level and the low interest rates allowed to me to pay off massive amounts of principal. True, the economy is strengthening and short term rates will go up a bit over the next couple of years, but I don't think it will be dramatic. The case for variable-rate mortgages remains strong. 

That was in 2010!! I was wrong: interest rates did not "go up a bit over the next couple of years".

But I was so right on the case for variable rates!!

Next blog: what is the yield curve telling us now! Stay tuned!

The views expressed are those of the author, Scott Tomenson, a Raymond James Financial Advisor, and not necessarily those of Raymond James Ltd. It is provided as a general source of information only and should not be considered to be personal investment advice or a solicitation to buy or sell securities. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor's circumstances and risk tolerance before making any investment decision. The information contained in this blog was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. Raymond James Ltd. is a member of the Canadian Investor Protection Fund

Canadian Household Debt:

McKinsey and Company  released a study on global debt yesterday called: Debt and (not much) deleveraging.

more at http://www.mckinsey.com/insights/economic_studies/debt_and_not_much_deleveraging

One of the more  interesting parts of the report is that:

 "Household Debt Is Reaching New Peaks"

• Of developed nations: Australia, Canada, Denmark, Sweden and The Netherlands have actually seen their household debt to income ratios rise (since the peak of the crisis in 2008). The US, Ireland, Spain and the UK have been "deleveraging".

We have all seen this chart before, but it is telling!

• most recent data put the Canadian Household Debt to Income ratio approx 162%
• and still climbing.
• lower interest rates do not add much incentive to pay this down.

However!

• buried in the McKinsey report was another interesting statistic: Canadian Debt Servicing Ratio is one of the lowest in the world at 8%.
• Debt Servicing is defined as Interest plus Principle payments / Household Income.
• In other words, Canadians have less to pay vs. their incomes.
• By comparison, Australia's debt servicing ratio comes in at 26%, one of the highest in the world.
• Should allow a little breathing room, until the costs of borrowing start to rise.
• With the BOC lowering rates, this is not likely to be a significant factor in the near term.
• The message is clear though, taking on more debt is not going to be helpful for economic recovery.

It is not just about debt to income:

• In December, Moneysense put out an article that looked at Canadian Income and Net Worth (Assets - Debt) levels
• more at ; http://www.moneysense.ca/planning/the-all-canadian-wealth-test-2015-charts
• Key data show that in Canada (data from Dec. 2013) show that Real Estate assets were 60% of the average household's total assets.
• Debt against total assets was 22%.
• Average Net Worth was approx. $442,000.
• Trouble is: that 60% of your assets (or 76% of your total net worth) in one asset class is not very good diversification and the housing market looks over-valued and due for a correction.

The views expressed are those of the author, Scott Tomenson, a Raymond James Financial Advisor, and not necessarily those of Raymond James Ltd. It is provided as a general source of information only and should not be considered to be personal investment advice or a solicitation to buy or sell securities. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor's circumstances and risk tolerance before making any investment decision. The information contained in this blog was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. Raymond James Ltd. is a member of the Canadian Investor Protection Fund.

Provocative Copper!

One of my readers suggested that charts were only going to draw "nerds" and that I should have more "provocative" pics!

What a challenge when you want to discuss the important relevance of copper to the global economy!

Copper has been and continues to be viewed as a leading indicator of the health of the global economy:

(nerds: click on the chart to enlarge)

• since reaching a peak price of approx $4.65 in 2011, copper prices have been in decline, hitting a low of $2.42 at the end of January this year.
• It has rallied back to $2.60 since then.
• It is worth keeping an eye on to see if this "bounce" should materialize into something more.

The views expressed are those of the author, Scott Tomenson, a Raymond James Financial Advisor, and not necessarily those of Raymond James Ltd. It is provided as a general source of information only and should not be considered to be personal investment advice or a solicitation to buy or sell securities. Investors considering any investment should consult with their Investment Advisor to ensure that it is suitable for the investor's circumstances and risk tolerance before making any investment decision. The information contained in this blog was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. Raymond James Ltd. is a member of the Canadian Investor Protection Fund.