The Service Factor: Are You Getting What You Pay For?

A new client just came on board and as is the standard case on many occasions, we are amazed at what some advisors will put into client investment portfolios. 

Back in 2000, when I first began my adventure into the world of family wealth management (easily the oldest person in the advisor training class at a large bank), I was amazed by the fact that this was not about how to properly look after client needs and their future, but all about maximizing the level of assets one was expected to "gather" and the revenue that was necessary to be generated to graduate to advisor status.

Back in those days, the easiest way for an advisor to get there was to sell mutual funds with "deferred" sales charges (DSC) that paid a 5% commission up front to the selling advisor as well as a "trailer" fee of 1/2% for as long as the client owned the fund.

The client was not charged a fee for the fund up front, but there were enormous penalties for the client if they wanted to sell the fund before a certain period (usually about 7 years). The mutual fund management fees (MER), usually in the vicinity of about  2-3%, were hidden or embedded in the return of the mutual fund (and were not tax deductible). The unsuspecting client, on average, always wondered why they were never able to make any headway in growing their portfolio.

The mutual funds made tons of money, the advisors (sales force) and the institutions that they worked for made tons of money, but the client? Not so much. So many were taking their cut, that there was not much left.

I witnessed so many advisors parking clients in these DSC mutual funds, grabbing their commissions and moving on, pretty much abandoning their clients as they searched for the next batch of assets to "gather". I was dumbfounded. I was so naive. I was under the impression that I was supposed to be helping people build wealth, not robbing them of it.

As a "trainee", I was also required to get my license to sell life insurance. Why? Something called "seg funds". I had pretty much forgotten about these things, until one (a big one) showed up in our new client's portfolio (with an MER of something in the vicinity of 3.75%!).

To refresh myself on what these were all about I went to an internet search engine and came across a number of  interesting sites, one of which is called Get Smarter About Money.ca, which is sponsored by the Ontario Securities Commission and worth a visit.

"Segregated (or seg) funds are an investment product sold by life insurance companies. They are individual insurance contracts that invest in one or more underlying assets, such as a mutual fund".

"Unlike mutual funds, segregated funds provide a guarantee to protect part of the money you invest (75% to 100%). Even if the underlying fund loses money, you are guaranteed to get back some or all of your principal investment. But (very big but, here!) you have to hold your investment for a certain length of time (usually 10 years) to benefit from the guarantee. And (get ready...) you pay an additional fee for this protection". And it is not tax deductible.

Big fees and  big commissions for the advisor, the advisors institution, the insurance company and the mutual fund company. Guess why these funds rarely make any reasonable return for the end buyer?

If you need principal protection, you or your advisor has likely chosen the wrong manager/fund for your money.

In a study commissioned by provincial securities commissions  across Canada in 2015, it was suggested that advisors recommending mutual funds to clients were "clearly motivated" by the presence of trailer fees.

Obviously a conflict of interest and clearly not putting the client first.

Friends, the investing world is full of those who wish to take advantage of those that are in need of help (and commissions and revenue generation are at the heart of it). It is so important to know what you are paying for (the service) and what your advice giver is receiving in return. If they can't be transparent with you and offer up a lot of talk that does not get to the point, a warning flag should be raised.

We (at High Rock) are setting the bar higher with our Voluntary Code Of Conduct, transparent low fee structure, attention to personal service (when was the last time you talked to the guy who's name is on the wealth management practice that you deal with?) and legal fiduciary responsibility to our clients. It is because we passionately believe that we can do better for them and that is what they deserve.

Stock and Bond Prices Falling Is Tough On A Traditional 60/40 Balanced Portfolio

Bond yields are rising (prices are falling), but balanced portfolios are not getting any relief from the growth part of a traditionally balanced (and fully invested) portfolio as previously over-valued stocks encounter the reality of the investing cycle: stock prices are falling at the same time.

As we suggested on our Weekly High Rock Video, the addition of non-correlated assets in a portfolio (Canadian High yield Bonds, for example) become an important part of containing the volatility. Defensive assets like cash (or short-term cash equivalent assets) are also helpful. 

Non-correlated (see the table above) means that assets like Canadian High Yield (C$HY) bonds do not necessarily trade in line with interest rate sensitive assets like government (C$ 5yr) or investment grade (Corp IG) bonds. In other words (as highlighted in yellow),  prices in these assets move independently, based on the quality and ability of the issuer company to pay interest and principle on the debt.

Owning these C$HY assets, however, demands deep levels of research on each of the respective companies to understand their ability to repay their obligations and the underlying security pledged against the bonds. Only a seasoned portfolio manager with plenty of experience is going to be able to offer this. It is one of those features that makes High Rock's value proposition different and better. We have one of, if not the best C$HY portfolio manager in the country. Scotiabank trusts High Rock to manage a C$HY fund (AHY.un) for their clients (and does all the due diligence necessary to ensure that we are keeping to our mandate to do so) and there is a seven year track record to show for it. As I mentioned in my blog last week, C$HY has had better risk adjusted returns than the S&P 500 over the last 5 years.

Having more than normal cash or cash equivalent assets in our collective portfolios by being tactically underweight equity (less than 60% in a 60/40 equity/bond balance) is an other way that we have been able to provide a more defensive strategy.

Tactical portfolio management and non-correlated assets: helpful strategies when the 60/40 balance is not working for you.

And as always, past performance is never a guarantee of future returns, but as you regular readers know, at High Rock we work darn hard to get our clients the best possible risk-adjusted returns.

Bank Of Canada Forecasting?

You Decide

There is no doubt that the Bank of Canada has some really smart folks putting together all the data and making their best efforts to get a sense of what may be coming at us in regards to the Canadian economy (i.e. is that light at the end of the tunnel sunshine or a train heading our way!).

In their Monetary Policy Report released yesterday, here is the snapshot:

Numbers in parentheses are from the previous report, which means that for Q1, 2018 they have revised expected growth lower by 1/2% to 2.2% from a previously estimated 2.7%.

Likely a good enough reason for not raising interest rates yesterday. Q2 doesn't look so good either. That being said, they must be expecting some pretty good growth in the second half of 2018 (although they are not giving us more detail) because the total 2018 growth is revised up to 2.1% (from 1.8%), which as a matter of fact, matches the IMF's forecast for Canada (see our High Rock Weekly Video for more on that).

For fun (I know, you are all thinking, Scott, get a life, how is this fun!), have a look at the previous 2 year's April forecasts to get a sense of how these folks have done with their work:

April 2016:

Two years ago, the thoughts on 2018 GDP growth were the same as they are now.

April 2017:

But last year, they revised them lower. Likely because of better than expected 2017 growth and the interest rate increases that followed.

Second to the BOC's forecasting abilities, we can also glean that past interest rate increases have definitely put the brakes on Canada's economy (perhaps among other things as well).

As always, we are more interested in looking behind the headline data to see what risks the BOC is concerned with:

1) Weaker Canadian investment and exports: in other words, does increasing competitiveness from US tax reform lure Canadian firms across the border and weaken the prospects for growth?

2) Sharp tightening of global financial conditions: rising interest rates, especially in the US would impact Canadian bond yields and increase debt servicing factors on a highly leveraged household.

3) A pronounced decline in house prices in over-heated markets: which would dampen residential investment and consumption.

What are the bond markets telling us?

2 year bond yields are close to their highest levels in many years (a function of the BOC's actual and expected interest rate increases).

Longer-term bond yields have moved higher, but at a slower pace than the 2 year.

And the spread between 2 year yields and 30 year yields has narrowed to about a 1/2 % differential. When this relationship narrows to 0 (we call it a flat yield curve), it usually signals a recession will follow shortly thereafter.

Another couple of 1/4% increases by the BOC will hasten a recession. Another reason why the BOC is reluctant at the moment.

Confidence in the economy is paramount to economic growth. In all likelihood, the BOC wants to forecast enough growth to keep businesses and consumers participating, but the risks are out there (high and rising) and the bond markets are telling us that.

We (at High Rock) continue to position our collective portfolios with all that is necessary to protect them from the inherent risks that we see building behind the scenes, so that we can all sleep a little better.

Best Return vs Risk Over The Last 5 Years?

Canadian High Yield Bonds

Stock markets receive most of the media attention when it comes to retail investing. The retail investing public has been long conditioned to believing that owning shares in a company is the best way to invest. 

What many don't necessarily realize is that owning those shares has a lot more risk involved than what they may be lead to believe.

In the chart above, the S&P 500 (SPX) returned almost 14% annually over the last 5 years (compound, absolute return). However, if you consider the potential for a downside move in that index (by 1 standard deviation from the mean), it is in fact the riskiest of the asset classes in the above chart (over that 5 year time period) by a factor of about 10. In essence, that is telling us that in a one year time frame, most of the potential for return could  possibly be wiped out by a significant market correction like what occurred in February and March of this year. Therefore the return per unit of risk taken is 1.38 (return/risk). The SP/TSX had a 5 year return per unit of risk taken of 0.90.

This is what we mean when we discuss "risk-adjusted" returns, which looks not only at the absolute return, but also the relative return to the amount of risk that you take.

By comparison, the Canadian High Yield bond index (C$HY), with a compound annual average return (over 5 years) of  5.36%, has a much safer risk profile and as a result a return per unit of risk taken of 1.43. A better risk-adjusted return than the S&P 500.

In the capital structure of a corporation, bondholders get preference to stock (common shares) holders in the event of a liquidation:

You can add that to the list of positive attributes for high yield bonds.

One more reason to own them : Canadian High Yield bonds have 0 correlation to interest rates (none, nada, zilch!).

When government bond prices are falling because interest rates are rising, that is not going to impact Canadian High Yield bonds. That is what we mean by non-correlated assets. Stocks and bonds may go up and down, but that has little impact on how Canadian High Yield bonds perform. That means they are company specific and as long as we are doing our research on the companies that we own, we should be able to manage that risk.

This is some of the added value that our High Rock expertise in Canadian High Yield bonds allows us to bring to the table for our Private Clients.

Our balanced portfolios have much broader diversification.

And that is how we are able to achieve our strong risk-adjusted returns.

As you know, past performance is not a guarantee of future returns (anybody who tells you otherwise will be seriously offside with the regulators). However, at High Rock we work darn hard to get our clients the best possible risk-adjusted returns.

High Rock Private Client Turns 3!

We started this journey because Paul could not get reasonable prices on bonds that he wanted in his personal portfolio from his investment advisor. They were the same bonds that he owned in the fund that he (High Rock) managed  for Scotiabank, so he knew their value. But as is the case with banks and investment dealers, everyone who touches securities on their way to your personal portfolio takes their commission and the price keeps going up. That is just the way it is in the retail investment industry. As I have suggested in the past, through my own experience, at the banks, the client takes a backseat to the shareholder.

At the same time, I found myself in a position where I was in disagreement with the direction we were heading with the client service factor at my then wealth management practice. There was a strong influence from the world of Robo-advice: focus on building assets under management and minimizing attention to client service. 

So Paul and I put our heads together and came up with a solution for creating a platform for clients that was different and better.

So few investors have a really good understanding of what goes on behind the scenes at the financial institutions that they have come to trust, but if they did take a closer look, they might think again. The Small Investor Protection Association has done their research and what they have found is disturbing.

Read more: An open letter to Canada’s leaders

Nonetheless, we have created a wealth and portfolio management solution that is like no other:

üFiduciary Duty above and beyond      

üInterests truly aligned – we manage our own money exactly the same as client money

üGroundbreaking formation of Independent Review Committee (IRC)

üManage fund for Scotiabank

üCore competency in the complex, opaque bond market

üComplete Fee Transparency

üTruly Independent – 100% employee-owned

üExperienced Large-scale Risk Managers - $13 billion

üHighest Education in the business – CFA, CIM, and CFP

üCommunication – Blogs, Weekly Webinar, Quarterly reports and Semi-Annual reviews

üRegistered with the Ontario Securities Commission, not IIROC which is a self-regulatory body owned by the Banks

We must be doing something right because we have been able to more than triple the size of our business over the course of the last three years. Many clients have followed me from my previous practice and many have joined from referral's from existing clients.

We write blogs, we have weekly videos, we send out detailed quarterly reports and portfolio summaries, we try to have at least semi-annual meetings with our clients, so our communication level remains high.

Most importantly, we actually care about each and every one of our clients, individually. You don't get that with big bank or big advisory practices. At the same time, you have all the protection that you would have with a big bank.

So thank you to our clients for putting your trust in us, we do not take it lightly.

Investor Confidence: Where Are We?

Investing is about the future. 

The simple rationale for investing is that, over-time, you absolutely need to grow the value of your money at or better a rate of return than the increases that will occur in your cost of living. 

Ultimately, when you no longer have employment income, you will have to then depend upon your savings and /or pension plans to provide you with the means with which to enjoy a comfortable lifestyle.

We invest in companies (buying their stocks and bonds) in an effort to give us a future cash flow, dividend income, interest income and also the potential for capital appreciation. This requires a leap of faith, to a degree, that the financial system will continue to provide these (as it has for the most part through history) positive returns.

Through a good portion of 2008 and early 2009, investors (especially investors in the the stock market) lost confidence in the global financial system to provide the growth they were looking and hoping for.

The very extraordinary actions of the world's major central banks helped, over time, to restore some level of confidence that the global financial system would not collapse.

Needless to say, for some, confidence was gradually restored and from 2009 until the end January of this year (with a few minor relapses), confidence had been growing steadily.

The Trump era brought on further confidence (for many) in so far as that what he intended would be economically beneficial: deregulation, tax cuts and infrastructure spending. There were some, however, who were somewhat concerned about his foreign policy initiatives.

Nonetheless, the expected increase in corporate earnings was taken very positively. So much so that stock prices reached levels on a price to earnings basis (in January) that were close to all time highs. Some might suggest that we moved into an area of "over" confidence.

Confidence took a hit in February and March as political rhetoric flared over trade tariffs and protectionism (among other things) and subsequently, stock prices have returned to levels that are more in line with the last 5 year averages (green dotted line in chart below). Still expensive relative to 10 year averages (blue dotted line in chart below):

The investment community is mixed on its outlook from here:

A poll released by Wells Fargo / Gallup in late March claimed that investor confidence was at 17 year high. However, Eurozone investor confidence, according to a report this morning has fallen in April, which was apparently unexpected.

By and large, most participants in the stock market want stock prices to rise, because the majority of participants are owners of stocks. The likelihood of getting any truly honest feedback on this front may be limited to the bias that participants carry with them.

Of course there are also the contrarians, who see high levels of investor confidence as a reason to be bearish. Most likely they are positioned according to their respective views / bias as well.

Earnings expectations for the S&P 500 companies are expected to grow at a rate of 18.4% through 2018. This of course is largely based on the tax cuts and deregulation being put into place by the Trump administration.

This is a fairly lofty expectation that, if not met, may also take a tole on confidence. So we will have to look for possible revisions as the year progresses.

At High Rock we remain cautious (which is our bias). We know that stock markets always over-shoot both to the upside and the downside because of the emotional element that plays into trading / investing. That is why we are currently carrying more cash in client accounts which we can put to work when markets offer the opportunity to make purchases with better value.

When markets are making lower highs, it suggests that there is less buying strength (and better sellers) when prices rise. If markets start making lower lows (and break through buying support), it will show us that confidence is slipping and will likely encourage more selling.

When everyone else is selling, that, historically, has turned out to be the best time to be buying (especially over the longer term). So we will be patient and let the market and confidence levels determine appropriate buying points upon which we will wisely invest our and our clients excess cash.

Cash, $US And Non-Correlated Assets In Portfolios Helped To Mitigate Volatility in Q1

The benchmark by which we measure our and our client's portfolio performance, a fully invested, balanced and globally diversified mix of the All Country World Index (ACWI), the S&P/TSX and the Canadian Bond Index, finished the first quarter of 2018 with a negative return of about -3/4% (data provide by Bloomberg monthly TRA, Total Return Analysis).

The severe increase in stock market volatility (chart above) and the inability of bond holdings to provide adequate coverage for the losses on stocks and equity ETF's were the main proponents of this negative return for "balanced" portfolios.

As Canadian investors our portfolios are consolidated and reported in Canadian dollars ($C), some of the sting of owning assets denominated in $US would have been reduced by the strength of the $US vs. the $C over the quarter by close to 3%.

This improved the global portion of the portfolio (ACWI) from a negative return of about -0.5% ($US terms) to a positive return of close to 2.5% ($C terms). Mitigating the loss on the benchmark portfolio by close to 1%.

At High Rock, we have advocated for sometime that equity markets were expensive, so we have had underweight (relative to being fully invested) exposure to equity markets, especially the US. However, we continue to hold $US denominated money market assets, so our portfolios were able to not only avoid a good deal of the stock market meltdown, but still benefit from the stronger $US / weaker $C.

We have also advocated that, from a defensive stance, owning non-correlated assets (High Yield bonds and / or certain types of Preferred Shares) can help mitigate some of the volatility in times when the old-style stock / bond correlations are not providing the protection that they have historically (when interest rates were higher).

Needless to say, our style of portfolio management with its more tactical approach was fully tested over the first quarter of 2018 and considerably beat the benchmark (after fees and costs). Depending on your asset allocation structure, most portfolios finished in positive territory.

While we will always be more focused on longer-term returns and the ultimate attainment of our client's future goals, it is nevertheless heartwarming to see that our focus on our first priority of risk mitigation and protecting client capital passed another major test, the second since we began our High Rock Private Client Division a little over three years ago.

And as you all should know, historical performance is no guarantee of future returns, but as you also know, at High Rock we work darn hard to get the best possible risk-adjusted returns as we possibly can.