The Bank Of Canada Wants Us All To Pay More Attention To Its Message(s)

And I think, as stewards of your family's wealth, that it is a pretty good idea.

In a speech yesterday in Victoria, BOC Governor Poloz explained that they are making significant efforts to become more transparent to all of us. This transparency is intended to build trust. That is a message in itself: trust in the institution to do the right thing.

As a natural skeptic, I am always reluctant to respect institutions, especially when in my experience they often have an ulterior motive.

Banks and financial institutions want you to be their clients (usually through their "advice" channels), but will always put their shareholders first.

As for the Bank of Canada: as participants in the Canadian economy, we are de facto shareholders because we live in the land of the $C (nicknamed "the loonie", which is never a handle that sits right with me). The BOC's mandate is to provide stability to the purchasing power that we as Canadians rely on to maintain our lifestyle. So we all have a vested interest in what it is that they are up to and why.

"And as we announced earlier this month, we are changing how we communicate about financial stability issues."

"Let me make one last point about connecting with the general public. Yes, we want people to understand our views on the economy and its prospects. But it is equally important that we get out across the country and listen to people. These two-way conversations help fill in the gaps that economic statistics leave behind".

As financial market participants, we and by extension, you (who are High Rock Private Clients) need to be aware of what is going on in the minds of the folks who are at the helm of steering the Canadian economy.

"Financial market participants trade securities based on their understanding of the economic outlook and the Bank's monetary policy. The Bank controls only one interest rate-the overnight rate- so its policy actions are transmitted to the economy through financial markets. This means that market expectations for monetary policy and the economy are embedded in market prices and interest rates. As a result, fluctuations in financial markets provide very useful signals about the future- they summarize the views of a multitude of market participants."

Financial market participants are really anyone who borrows and / or saves / invests, which is a great number of Canadian households.

"There is always a degree of uncertainty when using economic models, but these days there is a litany of things that we simply do not know. These include the degree to which uncertainty about trade policy is holding back business investment, how new guidelines for mortgage lending are affecting the housing market, and how sensitive the economy is to higher interest rates given the accumulation of debt."

"With all these uncertainties, setting monetary policy is a matter of risk management."

How many blogs or weekly videos or client conversations have you all had to listen to me or Paul go on about managing risk being our first priority. 

Friends, most of what we see in the portfolios of prospective clients are way, way over exposed to risk that they and their current advisor have little understanding of.

The Bank of Canada's message is loud and clear: pay attention to the risk that is out there (as they are doing). Prepare your household asset and investment ownership and any debt / leverage that you are carrying and consider the high levels of uncertainty prevalent in not only the Canadian economy, but the global economy as well.

Need help? 

scott@highrockcapital.ca

Clients Must Come First

I think it has been a while since I have been up on my soapbox, but here you go:

If you have not seen this latest from the Globe and Mail's Rob Carrick, take note: 

Here is the link: 

https://www.theglobeandmail.com/investing/personal-finance/article-well-never-see-an-investment-industry-where-clients-must-come-first/

"The dream of creating a standard of transparent, client-focused service in the investment industry died Thursday".

"Regulators bailed on two reforms that would have made a huge difference for both investors and the investment industry to change a business model in which too many bad actors are allowed to prosper".

1) "The Canadian Securities Administrators announced that embedded commissions will be banned only for on-line brokerage firms selling mutual funds"

That means that when you buy a mutual fund from your "Advisor", she/he can still be paid a trailer fee by the mutual fund company. That is a very significant conflict of interest in which recent studies have identified that advisors tend to sell the funds that pay them the most (pretty easy to figure that out).

Certainly not putting the client first.

2) "Regulators also torched any hope that investors will be protected by a requirement that advisors operate under a "best interest" standard, which was the preferred way of saying a fiduciary duty to put the client first".

I would argue that even a "best interest" standard is not a legal fiduciary duty. As it stands, as long as you are considered "suitable" at the time of purchase, that is the only obligation that an advisor has to you. Once you own it, the obligation is transferred to the buyer, you, to determine future suitability. If the investment goes south, the advisor is off the hook.

It does appear that the worst of the mutual fund offerings, the Deferred Sales Charge (DSC) option, where as a buyer you are fooled into believing that you are not paying any commission (as long as you hold on to it for a certain time period) and the advisor got something like a 5% commission up front and a trailing commission as well, has been eliminated. 

All of you out there who have ever been unknowingly sold these funds should be appalled that your advisor stooped so low as to put you into these things. It is nothing but an advisor money grab and is shame-full. There is a reason that this practice will be outlawed.

Makes you want to think about the quality of the person who did it and the institutions that promoted and allowed it in the first place.

As Mr. Carrick has stated, clearly: the regulators have failed to put clients first. The institutions win.

But you do have a choice. You can choose to make the switch to the new breed (see SIPA Sentinel June 2017 p8)  of portfolio management offerings that will put the client first: provide you with total fee transparency, legal fiduciary duty, full service and all the safety and security of the CIPF that you would get at a bank or large investment firm.

Why would you not?

If you believe that your advisor is generally a good person, ask him or her about the level of responsibility that they give to you and whether you come first. See what they have to say. Perhaps use High Rock's offering as a guide post. Ask the tough questions. How can you lose?

Will they honour what High Rock does: a signed code of conduct, guaranteeing that your interests come first.

The investment industry will not protect you enough, so your advisor under their regulations doesn't have to either.

Not only do we have to (our licensing to be discretionary portfolio managers is dependent upon it), but we want to.

Trying To Make Some Sense Of It All

Next week I am apparently going to be a guest host on BNN Bloomberg's "The Street" and thought it might be worthwhile to put a few coherent thoughts together in order to not make a complete fool of myself. Some of their guests are quite brilliant.

 What better place to do that than on an uninterrupted (and slightly delayed) flight from Calgary to Vancouver, where I had been visiting with some clients and prospective clients and discussing with them the current state of the global economy, financial markets and the precarious world of trying to find the best way to manage wealth in spite of it all. Sorry Vancouver clients and prospective clients, but this may be a bit of a preview of what you might have to endure during our meetings over the next few days.

The U.S. economy is strong: unemployment is low (and may inch even lower) and the consumer appears to be bouncing back from a sluggish Q1 (according to today's retail sales data). Inflation is creeping higher and the U.S. Federal reserve is ready to keep raising short-term interest rates (see Paul's blog from yesterday).

The second quarter for the U.S. economy looks pretty good. However, the second quarter is coming to an end in a couple of weeks and it will all soon be ancient history. Our job is to look out somewhat further to try and get a handle on what is coming over the next couple of years and how this might all impact our and our client portfolios (and what we need to do to continue to get the best possible risk-adjusted returns to keep them moving forward to their long-term goals).

What we do know is that we are late into the economic cycle, (perhaps akin to being in the bottom of the 10th inning in baseball parlance) which has been aided along the way, first by aggressive monetary policy easing and subsequently extended, more recently, by a dose of fiscal policy easing. As with all things cyclical, despite how rosy everything may appear on the surface, we know that a recession is going to happen in due course. Exactly when is not clear. Had the "hope" of substantial fiscal easing not materialized with the surprise election of the current U.S. administration, we may already be well into it. We are not there yet, but it is inevitable.

It may come on the end of monetary stimulus and yield curve flattening, it may come on the rising global trade protectionism, or perhaps it will come on the escalation of some geo-political military mis-adventure. But make no mistake, recession will happen. The global debt situation (record levels of debt) as we discussed in our most recent weekly client video may also play a role in making it deeper than we might wish.

That is all part of the normal and natural cycles of the economy ebbing and flowing.

None of it should jeopardize your long-term goals. If you have too much of your portfolio in risky growth assets trying to squeeze too much return into a narrow time frame (immediate gratification), you are gambling. Pure and simple.

It is human nature to see stock markets rising and want that in your portfolio. But you may not need it. If your Wealth Forecast suggests that you need considerably less risk in your portfolio, then why do you want to chase returns that might, in the end, blow up your whole plan?

It is a common discussion that I have with many folks.

The point is that you need to survive the cycle intact. The greater the risk of downtime (actual capital losses) that you expose yourself to, the longer it will take to recover the lost ability to keep the positive compounding working for you and the longer you will end up taking to get to your end goal.

The biggest risk is not being able to get to your end goal. As experts in managing risk, we know that solid long-term results are the result of well-managed risk: appropriate asset allocation and balance (and re-balancing) and reasonable fees.

For each investment we put in our High Rock models, we do hours of assessment on the risk factors in owning that asset. Regression analysis allows us to put a relative risk factor (potential standard deviation from the mean in times of crisis) on each investment so that we can determine what the potential damage might be before we add it to the model or portfolio, so as not to overwhelm our disciplined investing process.

This is intended to stand up through the full economic cycle: good times and bad. 

There are some assets that new clients already have in their portfolios (when we first see their holdings) that astound us. More often than not, those investments have caused them (or have the potential to cause them) a great deal of unnecessary mental anguish that they really don't need to have. Calling into to question, who actually helped these folks get to this point.

So, when we are called into action, we love to bring our expertise in to the equation and get these issues resolved and our new clients on the best path forward. 

Investors Love To Hate Bonds

I have plenty of conversations with lots of different folks from many varied backgrounds. When we get around to my bond trading past, where I received most of my hands-on risk management experience, the word "bonds" tends to generate two basic responses:

1) "I never really understood bonds"

2) "My advisor hates bonds and we have reduced our allocation"

If you are in camp 1, I highly recommend the three-part blog series that I did at the beginning of last month, starting with Do You Find Bonds A Bit Confusing? 

If you are in camp 2, I suggest that you have your advisor do the same, especially if they think that it is enough for your portfolio to just own a bond ETF (on which you pay an MER) as a substitute for the real item.

AAA government bonds are the safest asset that you can own. They are (despite their relatively light semi-annual interest payment) absolutely paramount for protecting your portfolio from the adverse impacts of stock market volatility.

However, as in the chart above, the cash flow yield of a very safe US government 2 year bond is now significantly better than the dividend yield of the S&P 500 (and way safer), so the reasons for not owning government bonds (i.e. cash flow) are being reduced. 

BBB or better ("investment grade") bonds will give you a little better yield and reasonable safety, but in more difficult economic times will have more potential for volatility (than government bonds).

Of course there is another option in the world of bonds where few advisors have any expertise (but we do) that can give you plenty of yield, diversification and are not in anyway subject to changing interest rates (i.e. zero correlation!). Another blog to assist you with understanding this: Stock and Bond Prices Falling Is Tough On A Traditional 60/40 Balanced Portfolio

All of these should be part of a broadly diverse allocation to bonds. 

More importantly, we need to be able to understand how important it is to be able to forecast shifts in the yield curve and how a strategy that maximizes the use of duration (average length of time to maturity) to allow us to continue to manage our important bond exposure (and limit the potential impact of rising interest rates that advisors fear so much).

Reducing bond allocations (unless you are increasing your cash weighting by the same amount) only increases your risk and exposure to potential volatility.

In my experience, people tend to hate what they don't understand. Well, we know and love bonds. We understand how important they are in a well-balanced and diversified portfolio. They just need to be managed properly. That's what we do. Solid, risk-adjusted, fiduciarily responsible portfolio management. It is way more than just Investment Advice.

And So The Pendulum Swings

In order to find neutral ground, we are going to witness tests of the extremes. The human experience in the age of internet demands a more rapid response time for our need of instant gratification. Unfortunately it leads to errors in judgement when long-term goals are interrupted by short-term desires.

Populist protectionist strategies fall into that category. Whether it is just a negotiating strategy or a misguided belief for economic betterment, the perpetrators will likely not be around for the final results. That means that our children and grandchildren will bear the brunt of the eventual fallout.

Lower productivity, reducing economic potential and higher prices for goods and services will create a new era of stagflation as interest rates are raised to fight inflation in a world where debt levels are concerningly high.

Regardless of the current economic picture, which is in the very late stages of the cycle (low unemployment levels, high consumer confidence), akin to extra innings in a baseball game and appears on the surface to be safe, it is nothing like that: one more "swing and a miss" and the game could be over. The latest on the trade front could be the catalyst.

If you don't remember the 1930's, specifically the words "Smoot-Hawley", have a peak.

Hopefully, it is all just bluster and negotiating tactics, in which case some quick resolution will follow. However, our mantra at High Rock is "hope for the best, prepare for the worst".

Over exposure to cash (or cash "equivalent") and longer dated maturity AAA government bonds are probably the best way to be protected.

Are you protected?