Steadyhand Blog

Meet Alan

Mon, 28 May 2012 15:47:20 PDT

I’m pleased to introduce our newest member to the team, Alan Hamade. Alan is taking on the role of Operations Manager. He has a ton of industry experience, having worked for over 30 years in the business. Most recently, he was the Manager of Securities Services at Qtrade Financial, Canada’s #1 online brokerage for six years running based on the Globe and Mail’s annual survey.

Alan will be taking over some of Colette Madill’s responsibilities. Colette recently left the firm to pursue a more accounting-focused career after obtaining her Certified Management Accountant designation (CMA). Along with overseeing the account opening process and facilitating client trades, he will also be a key resource in helping us evolve our backoffice operations and processes.

I expect that Alan will be a great addition to our team. The firm has experienced a faster pace of growth in recent months and his experience will help ensure that our backoffice continues to hum. If there’s one strike against him, however, it’s his allegiance to the Maple Leafs, which we find puzzling given his local roots. David Toyne, on the other hand, is ecstatic to have another Buds fan on the team.

Get to know our newest employee a little better:

Favorite restaurant: Ichiro (Steveston)
First industry job: Vancouver Stock Exchange, 1980
PC or Mac: PC
Favorite 70’s rock ballad: Two out of Three Ain’t Bad (Meat Loaf)
Asset Mix: 90% equities / 10% bonds
The Bachelorette or Dancing with the Stars: Neither
Most admired athlete: Darryl Sittler
Favorite thing about Vancouver: Stanley Park Seawall
Guilty pleasure: Chocolate

Welcome aboard, Alan.

Mispriced Assets: Learning to Live With a Not-so-free Market

Sat, 26 May 2012 09:38:30 PDT

The Globe and Mail, Report on Business
Published May 26, 2012

By Tom Bradley

‘[T]he market’ is rapidly becoming something of an endangered species. Your mission, should you choose to accept it, is to try and identify any asset of significance that isn’t experiencing huge and artificial distortion to its price by forces that we might term ‘the monetary authorities’ and their huge and daunting printing presses. – Tim Price, Director of Investment, PFP Wealth Management, London

Trust a man named Price to get to the nub of the current valuation quandary. More and more assets (be they financial or real estate) are being priced by something other than long-term valuation. The fluidity of the capital markets is being blocked, plugged and restricted by factors related to government policy and, as is always the case when governments get involved, valuation goes out the window.

Interest rates

Accommodative monetary policy in the U.S. and Europe has been made necessary by fragile, over-leveraged economies and out-of-control government deficits. Nevertheless, near-zero short-term interest rates are reaching well beyond the needy, and rippling (or should I say crashing) through every nook and cranny of the capital markets. Cheaper-than-necessary credit causes severe imbalances – excessive risk-taking, rising debt loads and chronic overbuilding. A case in point is Canada’s red-hot housing market, which is not being driven by a booming economy, but rather depression-like interest rates.

Currency

Countries have historically adjusted to changing economic conditions by turning three dials – interest rates, currency and government policy (spending, taxes, bank reserves). Part of the current distortion is that too many countries don’t have the currency dial on their dashboard and are being forced to manage with the other two.

Europe is a prime example. It operates under one currency despite its cultural and economic diversity. Countries that desperately need to retool their competitiveness, like Greece, are being forced to seek approval on austerity measures, something a free-floating currency would have taken care of unilaterally.

Countries that have pegged their currency to the U.S. dollar are forced to live with America’s monetary policy. China’s economy couldn’t be more different than the United States, but it operates with the same undervalued currency and low interest rates. Perhaps it’s not surprising that it now finds itself with an overbuilt, debt-dependent real estate market.

The hand of government

While interest rates and currencies are the two biggies, a heavier government hand is also distorting markets in other ways. Subsidies, bailouts and loan guarantees all affect the competitive balance. Also, the percentage of companies being run or controlled by government is growing as the developing countries make up a larger part of the world economy. State-owned businesses play a prominent role in the resource and banking sectors particularly. Chinese banks are public companies, but really act as a policy arm of the government.

As investors, we’ve got to be aware when assets are trading away from their long-term valuations (above or below) because of socio-political influences. It may mean being more cautious when buying a company that’s benefiting from the good graces of government policy, and conversely, being more aggressive if it’s been hammered by one-time government actions.

Opportunity

A not-so-free market is worrisome to be sure. As Mr. Price’s comment highlights, we’re in an unusual period when it’s hard to find assets that aren’t being heavily influenced (read: propped up) by monetary policy. As a result, we have to be prepared for more market shocks caused by pricing distortions, as well as the eventual return to a less stimulated environment. Governments are running out of firepower and will have to let their economies sort themselves out on their own. (And, yes, that means mortgage rates will be 6 to 7 per cent again, and utilities will lose their safety premium and trade at 12-13 times earnings).

But all is not lost. There’s money to be made by investors who aren’t locked into tracking the broad indexes and can take advantage of mispricing. There will be policy changes that lead to distress sales (this week, Barclays Bank felt obligated to sell its remaining stake in Blackrock Investments, arguably one of its best assets) and in general, a less manipulated economy will create space for profitable, well-financed companies to play a bigger role.

The best risk control measure in times like this? It’s the same one we always use – Don’t own overpriced assets.

In Your Face ... book

Wed, 23 May 2012 14:31:10 PDT

By Tom Bradley

I find the kerfuffle about the Facebook initial public offering (IPO) interesting. I don’t know if anything nefarious went on behind the scenes, but it seems to me that what played out on this overhyped and highly priced IPO (the $38 issue price equates to over 20x revenue) fell within the range of possible outcomes.

Facebook is impossible to value at this point in its development. It’s already one of the most important web platforms (along with Google, Apple and Amazon) and it certainly has a shot at becoming a highly profitable company (as the others did), but it’s still a bit of a crap shoot. Ultimately the stock price will be determined by how well the company monetizes (makes profits from) its user base. In the meantime, because Facebook’s valuation is so far out of the normal range, the stock will ebb and flow with every new analyst report, privacy abuse and Zuckerberg sighting.

Clearly the company and large shareholders got greedy in pricing and sizing the issue. Employees and other early shareholders sold over $9 billion of stock to the public, while only $6.8 billion was put into the company’s coffers. But should the buyers of Facebook shares, on the IPO or in the market afterwards, be surprised that Wall Street is hyperventilating (it was before the issue, why not after) and media sentiment is swinging like a baby on a Jolly Jumper? Certainly the sophisticated institutional buyers shouldn’t be. They read every page of the prospectus and knew the risks. Individual investors bought through full service advisors, so presumably their Facebook shares were put in the ‘high growth / high risk’ bucket of their portfolios.

I’m not trying to make light of investors’ short-term paper losses, but the result here was well within the realm of possibility. New issues aren’t a one-way street. They don’t all go to massive premiums on the first day of trading. Indeed, the fact that some do, like LinkedIn and Groupon, just reinforces how imprecise the IPO process is.

Video: Global Equity Fund Update

Tue, 22 May 2012 14:42:35 PDT

By Scott Ronalds

Edinburgh Partners’ Craig Armour was in Toronto recently where Tom caught up with him to talk about the Global Fund. Topics of discussion include Europe, the U.S., the emerging markets and Japan.

While the cinematography and sound are admittedly poor, the content is rich.

Download, subscribe via iTunes or RSS, or watch now:

Federal Government Gets a Failing Grade on Transparency

Thu, 17 May 2012 09:44:59 PDT

By Tom Bradley

In this space, we talk a lot about transparency, and we try our best to walk the talk. There was a piece by Barrie McKenna in the Globe and Mail this week about the Federal government’s transparency around financial reporting. The conclusion: If the government was a public company and had to answer to the stock exchange and securities commissions, it would be de-listed. I guess transparency has never been one of Ottawa’s strengths.

Get More Active

Wed, 16 May 2012 08:53:26 PDT

By Scott Ronalds

We don’t spend a lot of money advertising at Steadyhand (at the end of the day, investors pay for it). If we did, you might see something similar to IA Clarington’s latest campaign on Active Mind. But with a Steadyhand spin, of course.

As part of their campaign, IA Clarington highlights Active Share, which is a term coined by a pair of Yale professors (Martijn Cremers and Antti Petajisto). Active Share is a measure of how much a fund differs in composition from its benchmark index. If a Canadian equity fund has an Active Share of 90%, for example, it has very little replication of the S&P/TSX Composite Index. A fund with an Active Share of 20%, on the other hand, is closely mirroring the index.

We’ve been writing about Active Share for a number of years (see Those Damn Academics, Active Management: What are You Paying For? and Active Share). We feel it’s an important concept because in order to beat the index, you have to look different than it. The Yale researchers came to two important conclusions: (1) funds with the highest measures of Active Share consistently outperformed their benchmarks, and (2) smaller funds outperformed larger funds.

In a Clarington video interview with Martijn Cremers, he notes that less than 10% of Canadian equity funds have a high level of Active Share and the bulk of products offered in Canada are simply “closet index” funds. Cremers suggests that one of the reasons for this is that managers have become more benchmark-oriented because investors are quicker to sell if a fund underperforms in the short term. Managers have become too afraid to deviate from the benchmark for a fear of losing assets.

The videos are worth viewing for investors interested in learning more about Active Share. They can be accessed via the Clarington link above.

We periodically calculate the Active Share of our equity funds. Our latest numbers as of March 31, 2012 are:

Equity Fund – 89%
Global Equity Fund – 93%
Small-Cap Equity Fund – 97%

We hope Clarington’s efforts will bring greater awareness to the concept of Active Share and what it means to be a truly active manager. The Yale research suggests that too many Canadian investors are paying too much for what is essentially high cost indexing. We want them to get a better grasp of low fee undexing.

Natural Gas

Mon, 14 May 2012 11:03:26 PDT

By Scott Ronalds

We’re in one of the greatest bear markets of all time. In natural gas, that is. The commodity’s price has fallen from over $10 per thousand cubic feet (Mcf) in July 2008 to about $2.50 today. Last month, it touched $1.90, representing a decline of roughly 85% from peak to trough.

Natural gas is used to heat and cool homes and generate electricity. It is also used in the production of plastics, fabrics and fertilizers, and among other applications, can be used to run vehicles (although until recently it has been more expensive than gasoline). Further, it’s a cleaner fuel than coal, which is more commonly used in generating electricity.

Over the past few years, advancements in drilling techniques – notably hydraulic fracturing (“fracking”) and horizontal drilling – and new discoveries in shale rock formations in areas such as Louisiana, Arkansas, Texas and Pennsylvania, have led to a massive increase in supply. Promising fields are also being developed in B.C., Alberta, Quebec and New Brunswick. Estimates suggest the new fields south of the border could provide enough gas to satisfy U.S. demand for decades. And to think that in the mid 2000’s many experts thought production was in permanent decline.

Add a warm winter to the equation (roughly half of American homes are heated by natural gas), and the continent is currently swimming in the commodity. In fact, there are concerns that storage facilities will soon be full and producers will have to turn off the taps or dump gas.

It seems a shame. Natural gas is a cleaner alternative than many fossil fuels, yet it’s not being used in enough industries to soak up the massive inventories. The commodity sells for much more in Europe and Asia ($8 - $16/Mcf), but it’s not cheap or easy to transport overseas. Advocates of the fuel also see it as a way to fight climate change and reduce dependence on foreign oil.

Why aren’t more industries and businesses using natural gas? For one, it’s expensive to modify machinery, vehicles and service stations. Also, businesses can be tied into long-term contracts for coal or other fuels. And finally, there’s no guarantee it will remain a cheaper alternative to coal and gasoline.

There are radically different views on natural gas in the investment community. Some analysts believe that prices are bound to stay depressed, if not fall much further, because supply will continue to outstrip demand. Others feel that the spread between natural gas and oil prices is unsustainable (oil is currently about 40x more expensive; the historic norm is around 10x) and the commodity is sure to rebound as more industries make the change, more governments implement green incentives, and new facilities and technologies make it easier to export.

As a Steadyhand investor, you want to know what our managers think of natural gas and the role it plays in your portfolio. We break it down by fund below.

Income Fund

With respect to the fund’s income-equities, the manager’s focus (Connor, Clark & Lunn) is on companies that generate steady cash flows and have the financial strength to pay rising dividends. Because of the volatile nature of natural gas prices, direct producers typically don’t fit CC&L’s investment criteria. Natural gas producers do not generate stable income and the manager is not comfortable with the dividend sustainability of many of these businesses. Accordingly, they do not own any direct producers in the fund.

The portfolio does have limited exposure to the commodity through oil & gas service providers such as Enbridge and Gibson Energy. These are midstream businesses, meaning they are involved primarily in storing and transporting energy. Both companies, however, are more focused on oil than natural gas.

Equity Fund

CGOV Asset Management, the manager of the fund, feels that it’s anyone’s guess as to what will happen to natural gas prices in the short term. Gord O’Reilly (the lead manager) believes the magnitude of the price decline has been so great, however, that a reversion to the mean is likely over time, particularly as liquefied natural gas (LNG) export facilities come into production over the next few years (facilities have been approved in Louisiana and Kitimat) and more electric utilities and commercial vehicles convert to natural gas.

Yet, producers aren’t making profits at current prices and Gord feels it’s difficult to find value in the sector beyond CGOV’s two holdings, Birchcliff Energy and Pason Systems. Birchcliff is focused on natural gas exploration and production in Alberta (with some light oil production as well). The manager likes Birchcliff because it has valuable land assets and the ability to rapidly increase reserves. Their light oil production also helps pay the bills. The stock has been the subject of acquisition talk and has bounced around as a result. Pason provides rental oilfield instrumentation systems for oil & gas drilling and service rigs. Although low prices have hurt gas drilling, strong oil drilling activity has helped compensate.

Global Equity Fund

The natural gas landscape outside of North America is much different. The demand/supply equation is more balanced. The closure of nuclear power plants in Japan and Germany has added to demand, while a new wave of LNG coming out of the Asia-Pacific region and the Middle East has contributed to supply. Shale-related supplies are not as plentiful, however, due to inferior geology. Natural gas prices range from the equivalent of $11/Mcf in northwest Europe, to $13 in the Middle East and close to $16 in Japan. The manager of the fund, Edinburgh Partners Limited, believes that gas will play a greater role in the world’s longer-term energy mix, with demand growth concentrated in power generation and the ever-increasing global vehicle fleet.

The fund holds three investments with meaningful exposure to natural gas. Russian-based Gazprom holds the world’s largest natural gas reserves and owns the world’s largest gas transmission network. The company accounts for 15% of global gas output, supplies roughly 25% of Europe’s gas requirements and exports gas to more than 30 countries. ENI is an Italian-based energy conglomerate with a significant natural gas division that produces and sells the fuel throughout Europe and abroad. Petrobras is a Brazilian oil and gas producer and the 5th largest energy company in the world. Although its focus is more on oil, gas is an important division.

Small-Cap Equity Fund

While there are plenty of small-cap resource companies operating in western Canada, few natural gas-focused businesses represent attractive investment opportunities in the manager’s view (Wil Wutherich). Wil feels that stock valuations are expensive at current gas prices. Unless the price of the commodity rises to around $5/Mcf in the near term (Wutherich is skeptical of this happening), he believes that most companies will be hard-pressed to produce compelling profits.

Currently, the fund does not hold any pure natural gas producers. It does, however, own some companies with business divisions that are focused in part on natural gas. Of note, Total Energy Services provides drilling rigs and gas compression equipment to western Canadian producers. As well, Badger Daylighting provides excavation services that are used in the energy field for tank and pipeline cleaning, pipeline trenching, and repair and construction activities. Wutherich has a handful of other gas-related businesses that he knows well and watches closely, but feels they aren’t attractive investments at current prices.

Summary

If you hold a balanced portfolio of our funds (or the Founders Fund), you have modest exposure to natural gas. Our managers’ focus in North America is primarily on natural gas service providers that also serve the oil industry and therefore have a more diverse revenue base. CC&L, CGOV, and Wutherich & Co. are more cautious of direct producers (Birchcliff Energy provides the greatest direct exposure). The landscape is quite different outside North America, where natural gas prices can be 4-6X higher. The Global Equity Fund has holdings in Russia (Gazprom), Italy (ENI) and Brazil (Petrobras), providing you with diversified exposure to a number of international gas markets.

Covered Call ETFs: Are They for You?

Sat, 12 May 2012 10:30:39 PDT

The Globe and Mail, Report on Business
Published May 12, 2012

By Tom Bradley

A long-standing investment strategy is back in vogue. “Covered call writing” is designed to generate income from a stock by selling a call option against it (the right to buy the stock at a set price in the future). While the strategy has been around forever, what’s new is covered call ETFs, which now total over $1.5-billion. The BMO Covered Call Canadian Banks ETF (ZWB) was the second-best selling exchange-traded fund in 2011 and is a sales leader again this year. The Horizons Enhanced Income Equity ETF (HEX) is the other large fund in the category and is growing rapidly.

What are these funds all about? Well, first and foremost, they’re actively managed equity funds. ZWB owns the six major banks, while HEX holds 30 of the largest stocks in Canada. In both cases, the positions are equally weighted (in HEX, RBC is the same size as Silver Wheaton) and don’t change very much. The active part relates to writing call options on each stock. The premiums received from selling these options, along with any dividends, are paid out to the unitholders on a monthly basis. The brilliant thing about these funds is that option premiums are considered capital gains, so the distributions are tax efficient.

As with any product, investors need to understand what they’re getting into when they buy covered call funds. They’re a notch up on the complexity scale, so there’s a greater possibility of them being mis-sold.

No magic

The first thing investors must know is there is no magical source of investment return being created. Long-term fund returns will relate closely to the dividends and capital appreciation from the underlying stocks.

What these funds do is move the deck chairs around, exchanging future capital appreciation for current income (HEX’s estimated annual yield was 10.9 per cent as of March 31). Total returns (distributions and price changes) may or may not reflect the funds’ current yield. Indeed, while the distributions from ZWB and HEX have been healthy so far, their fund prices are well down in sympathy with last year’s market decline.

A one-way street

In the sales material, covered call funds are billed as being well suited to stable markets. That’s because in these periods (let me know when they’re here), the funds receive the option premiums but don’t give up much of the upside.

In declining markets, however, they’ll go down in lockstep with conventional funds, which lessens their ability to generate future income. Also, by definition, the strategy limits the funds’ ability to recover because upside potential is being sold to generate income. In other words, it’s a one-way street. The holder is accepting a gradual deterioration of the market value in return for a healthy income in the early years.

Added value?

In their short history, the total returns of ZWB and HEX (pre-tax) are running slightly behind their conventional counterparts. Going forward, could a sharp fund manager win that race? Personally, I don’t like their chances, because they have a number of factors working against them.

The option market, where the added value needs to come from, have some of the most sophisticated players in the business. The managers of the covered call funds are skilled at what they do, but they don’t have the same freedom as their counterparts and can’t be as valuation sensitive – even when premiums are unattractive, they have to write options.

Also, the strategy demands that managers trade a lot and the cost of trading is high. In its first 10 months of operation, HEX’s trading costs were 1.2 per cent of assets, which exceeded the fund’s management expense ratio of 0.8 per cent (BMO doesn’t disclose ZWB’s cost of trading options). Also, with the growth of these funds and a relatively thin options market in Canada, there will be times when managers have to pay up for liquidity. As one hedge fund manager told me, “The bid/ask spreads are not insignificant.”

The bottom line

These funds are only appropriate for investors who are in need of tax-effective income. They’re not a replacement for a core fixed-income strategy (GICs, bonds or preferred shares), but rather an enhancement. They belong firmly in a portfolio’s equity bucket.

For investors with a longer time horizon, I suggest that they let covered calls slide back into obscurity.

Finding a Better Balance

Thu, 10 May 2012 17:17:26 PDT

By Tom Bradley

In recent presentations, we’ve been discussing a slide that shows the industry diversification of the Founders Fund versus the S&P/TSX Composite Index. We’ve been doing this admittedly ‘apples to oranges’ comparison because it highlights what the portfolios of many Canadians look like (heavy home country bias, lots of financials and resources) compared to our new fund, which has a more balanced representation from around the world.

What jumps out when looking at the bar chart is the three big spikes for the TSX, namely financials, energy and materials. Conversely, there is little exposure to some significant parts of the economy – industrials, consumer, technology and healthcare.

The stocks in the Founders Fund are more evenly balanced across industries. The financials make up the largest weighting (banks and insurers are a large part of the underlying Income Fund), but beyond that, the differences between the fund and index are stark. The industrial and consumer sectors are meaningful weightings, as is technology.

Investors with a focus on Canada (particularly index-oriented investors) are heavily tilted towards two homogeneous sectors of the economy. The Founders Fund, which currently holds more foreign stocks than Canadian, is diversified across a wider array of economic factors.

Job Opportunity: Office Manager

Thu, 10 May 2012 17:02:06 PDT

By Neil Jensen

We are currently seeking candidates for a permanent, part-time or full-time Office Manager. As part of this diverse role, the team member will be involved in many facets of our business, including maintaining the office, managing vendors, coordinating client events and assisting in the preparation of client presentations.

While this is a permanent position, we are somewhat flexible on hours. Our expectation is that the position will be part-time during the summer and full-time in the winter, but we are willing to accommodate a schedule for the right candidate. This is an ideal job for a parent returning to the workforce.

To view the full job description, and to submit a resume, click here.

All interested candidates are asked to submit their resume through the above link. Please do not contact us directly.

Five Years of Undexing

Mon, 07 May 2012 09:46:18 PDT

By Scott Ronalds

In the final installment of our series marking our 5th anniversary, we look at a distinguishing feature of our investment philosophy - undexing.

Our Small-Cap Fund is at the top of its game. Over the past year (ending April 30th) it has gained 13.6% while the market, as measured by the BMO Small Cap Index, has fallen -13.8%. It’s been zigging as the market’s been zagging. Over the past five years the fund has gained 6.2% per year, while the small-cap index and the S&P/TSX Composite Index are up 1.3% and 1.1%, respectively.

What’s more, the fund’s annual returns since inception have been less volatile than those of the market, although it hasn’t been a smooth ride. There have been stretches of time where the fund has significantly underperformed the market. In 2009, for example, the fund was up 14.6%, while the index was up 75.1%. The table below shows the fund’s dispersion of annual returns in comparison to the BMO Small-Cap Index.

	2007*	2008	2009	2010	2011
Small-Cap Fund	24.2%	-29.7%	14.6%	21.9%	12.7%
BMO Small Cap Index	-6.6%	-46.6%	75.1%	38.5%	-14.4%

*Feb 13 - Dec. 31, 2007

The manager’s style (Wil Wutherich) is clearly not benchmark oriented – a distinguishing feature of all our funds and a key tenet of our investment approach. We call it undexing. This approach has rewarded investors so far, and we believe it will generate superior returns over time (see our blog posting on Active Share). But patience is key. Unitholders have had to stomach periods of underperformance.

It will be the same going forward, in that the fund will lag the market over the short- and medium-term at times. Wil’s strategies won’t always be working out and there will be periods when his approach is out-of-favour (e.g., 2009) and unitholders will be cursing us (our Global Fund is currently going through such a stretch).

But we’ve got thick skin. And one of the most important things we can do is to help build some ‘investing calluses’ on our clients’ hands by shedding light on performance and other related issues. It’s what helps make them better investors.

Note: The indicated rates of return are the historical annual total returns including changes in unit value and reinvestment of all dividends or distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Important information about the Steadyhand funds is contained in our simplified prospectus. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

Shades of Gray

Thu, 03 May 2012 12:01:29 PDT

By Scott Ronalds

iShares fixed income turns 50. The global leader in exchange traded funds (ETFs) recently launched their 50th U.S.-based fixed income ETF (iShares offers 22 fixed income ETFs in Canada). Investors can access a wide array of products, including 8 different U.S. government bond funds, 10 municipal funds and 12 credit-based (corporate) funds. Indeed, iShares offers investors more tools than ever to customize their portfolios, as highlighted in a brochure celebrating the milestone.

Is this a good thing? Do investors need access to a 3-7 Year Treasury ETF, a Baa-Ba Rated Corporate ETF, or a Ginnie Mae bond-focused ETF? Professional money managers, perhaps. Average investors, no. Yet, the products are being marketed to average investors. The fixed income world is complicated. Investors need a firm understanding of the yield curve, duration, credit risk, and inflation in order to use these ETFs properly. Otherwise, they’re just different shades of gray.

Broad-based funds such as the iShares Barclays Aggregate Bond ETF can be useful tools to gain diversified exposure to an asset class, but the more slicing and dicing non-sophisticated investors do through the use of specialized products, the greater the risk of cutting themselves.

The once-simple ETF product shelf is quickly turning into a messy closet, not unlike the mutual fund space. Likewise, the graveyard continues to grow. Last week, for example, Horizons announced that it will be terminating five ETFs including the Horizons BetaPro COMEX Long Gold/Short Silver Spread ETF (try saying that five times in a row).

Our advice is to keep it simple. If your portfolio is swelling with products you don’t understand, pluck the gray.

Industry Changes - The Next 5 Years

Mon, 30 Apr 2012 09:21:18 PDT

By Tom Bradley

In the fourth installment of our series marking our 5th anniversary, we look at five industry practices that need to evolve. Desperately.

The wealth management industry has changed a lot since we started Steadyhand five years ago. The banks have strengthened their hold on asset management, low-cost ETFs and high-cost structured products have become more prominent (and numerous) and lower-volatility income products are now the big seller. Some of the changes have been good for client returns, while others were more attuned to company profits.

While our birthday blogs have been mostly about reflecting back, I’m going to look both ways in this post by highlighting five industry practices that have not evolved enough over the last five years and desperately need to in the next five.

1. Reporting

The wealth management industry is great at pitching clients on how a new product or fund is going to enhance returns. Unfortunately, few firms then tell their clients how it worked out. Or what fee and commission they paid? Or for that matter, how the glorious new product fit into the client’s long-term plan.

If financial literacy and investment behavior is going to improve, client reporting has to get better. (Note: I’m quite confident we’ll see improvement here because it can’t get worse.)

2. No advice, no pay

Canada is an expensive place to have your money managed. Investors have failed to benefit from the scale that has resulted from unrelenting industry consolidation. Representatives of the industry will point out that comparisons to other countries are unfair because Canadian mutual fund fees have advice charges built into them, whereas other countries don’t. It’s like comparing apples to oranges, they say.

This is true, but the industry deserves what it gets on the fee issue. It has provided little or no transparency around who is getting paid for what. As a result, capable advisors who earn their annual 1% are being paid the same as their brethren who are doing nothing more than selling product.

What needs to change? Clients who are being charged 1% or more per year (via on-going commissions or trailer fees) for indifferent service and no advice need to be made aware. Compensation must be clearly visible, as opposed to being embedded in the MER (management expense ratio) of a fund or not reported at all. Australia and the U.K. are moving in this direction and it’s time we joined them.

3. One set of rules

In the last five years, the lines continued to blur between products sold by the banks, insurance companies, investment dealers and investment counselors. Certainly it all looks the same to the client. They don’t see much difference between what’s offered and who is regulating their investments. This would be fine, except that the oversight is very uneven. For instance, the level of scrutiny afforded Principal Protected Notes (PPNs) and hedge funds pales in comparison to what a mutual fund goes through. In the bank branches, for instance, there are claims made about PPNs that couldn’t be made anywhere else.

The regulators need to catch up to the product proliferation and make some progress towards regulating wealth management as the one big industry that it is.

4. RRSP transfers

It’s a small thing perhaps, but the industry has got to clean up its act when it comes to transferring registered assets. Firms have proven they can process in-coming money in minutes, but claim to need weeks to transfer it out. When asked why it takes so long, they say it’s “prevailing industry practice”. That may be so, but there are a handful of firms that turnaround transfers in a day or two, while the big players keep the money on their books for 3-4 weeks and leave their departing clients in limbo.

On this one, I’d be happy to get the ball rolling with a proposal for the regulators to consider: I so move that a financial institution’s ‘transfer-out’ time cannot exceed its ‘transfer-in’ time.

5. Less short term

I serve on a couple of institutional investment committees. When managers report to us, I’m amazed how much time is spent reviewing short-term returns, sometimes with pages of detailed attribution. “You had a good quarter because your energy holdings relative to the S&P/TSX Composite Index were overweighted oil and underweighted natural gas.” UGH! It may be useful for day traders, but for long-term investors? Come on.

Even though the most commonly used words in the wealth management industry are ‘long term’, not enough advisors and managers walk the talk. They either focus their communication on near-term stuff (corporate earnings, returns, trading strategies) or even worse, vacillate between short and long-term, depending on what looks better or is more exciting.

Advisors and managers need to ignore the short-term wins (and losses) and stick to longer-term strategies, performance and wealth creation. If they want their clients to be effective investors, they themselves can’t just be disciplined when it’s convenient to do so.

It depends what side of the bed I get up on as to whether I’m optimistic or discouraged about the industry’s direction. But sleeping habits aside, I do think there will be progress on the issues I’ve raised. Some of it will result from new regulation and some will come from client and competitive pressures. I would prefer the latter, but gladly take the former.

Why the Smart Money is Cutting Back on Bonds

Mon, 30 Apr 2012 09:26:23 PDT

The Globe and Mail, Report on Business
Published April 28, 2012

By Tom Bradley

As your buy side correspondent, I make a point of reading a whole stack of investment manager reports each quarter. I particularly focus on managers who think long term (no frequent traders), are prone to non-consensus views and aren’t afraid to act on their conviction. I always read Francis Chou, Eric Sprott, John Thiessen (Vertex) and Geoff MacDonald and Tye Bousada (Edgepoint). From south of the border, Jeremy Grantham and James Montier (GMO), Mason Hawkins (Southeastern Asset Management) and Bill Gross (Pimco) are must-reads.

As usual, this month’s pile brought a wide range of views and strategies. Danny Bubis of Tetrem Capital Management wrote passionately about the opportunity emerging in natural gas. Mr. Chou feels the market’s view of U.S. banks is too negative. “As each year has gone by [post-crisis], the quality of bank earnings has improved, the books have become cleaner, the risks have become lower, and bank management has become far more risk averse.” Meanwhile, Mr. Sprott still hates the banks (“That anyone still takes these [bank stress] tests seriously is somewhat of a mystery to us”), and is focused almost exclusively on precious metals.

Bond caution

The strongest consensus I could find relates to interest rates. There are few managers who aren’t running light on bonds and/or keeping their maturities short (including holding cash) to protect against rising rates. Carl Hoyt at Seymour Investment Management used Warren Buffett’s words to make the point. “Current rates … do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.”

Get real

Speaking of warnings, I’m not the only asset manager sounding the alarm on residential real estate. Mr. Chou reiterated his view that Canadians who need a home should rent, and if they feel compelled to buy, they should use as little debt as possible. The team at Mawer Investment Management advanced the debate by asking, “Why should the average house in Canada sell for 84 per cent more than the average house in the United States over the long run?”

Slow growth

There was plenty of concern about the debt burden in Europe and the U.S. Here, too, there’s a consensus that economic growth will be modest and another ‘Greece-like’ crisis is possible, even probable. Expectations for the U.S., however, were higher than I’ve seen in many years. Larry Lunn and the team at Connor, Clark & Lunn expect the economy to continue its resurgence because, “the labour market is healing, household incomes are growing, business fixed investment is on the rise and there are signs that the housing market has bottomed.”

Go global

It’s not unanimous, but managers who invest around the globe are discovering better value beyond our borders. Mawer made special mention of it and Waratah Advisors, a Toronto-based hedge fund manager, noted that eight of their 10 largest long positions are U.S. stocks. Waratah even provided a Letterman-like Top 10 list of reasons for being bullish on the U.S. Under number seven, entitled Time Heals, they made the point that, “Since the start of the housing crisis … we’ve had five more years of innovation and productivity growth. The only thing that’s been more consistent than the negative headlines since 2008 is the earnings growth achieved by American companies.”

Risk doesn’t equal volatility

The most insightful commentary I’ve read so far was from Southeastern Asset Management, the manager of the Longleaf funds. They began a treatise on risk reduction by saying, “Since 2008, investors have become increasingly paralyzed by trying to avoid risk as defined by stock price volatility. But short-term market fluctuations tell nothing about long-term investment outcome or business worth, which is determined by assets and free cash flow generation.” They went on to say, “For long-term investors … risk is not volatility but the probability that they may not get their capital back and earn an adequate return.”

I enjoy catching up on what the best and brightest on the buy side are saying. I always find some new ideas, understand better where capital is being allocated and consensus is forming, and am often bluntly reminded of what’s really important long term.

Canadian Real Estate - More Reasons for Caution

Wed, 25 Apr 2012 08:43:14 PDT

By Tom Bradley

Last Sunday, while flying to the hottest housing market in Canada (Toronto), my airplane reading surfaced a couple more statistics about Canadian housing, both of which point towards caution.

In their quarterly report, Mawer Investment Management noted that an average home costs 84% more in Canada than the U.S. ($372,762 versus $203,100). Yikes, we complain about paying more on J. Crew’s Canadian website, but 84%?

Also in the briefcase was The Economist Magazine’s quarterly house price survey. In all the years I’ve been following the survey, I’ve never seen Canada featured so prominently. We were at the top of the list for 1-year price change (+7%) and near the top in terms of The Economist’s valuation measures. On price-to-income, our market is shown to be 32% overvalued and on price-to-rents, it’s 76% overvalued. Overall, the survey suggests that Canada’s housing market is 54% overvalued, only slightly behind Singapore, Hong Kong and Belgium. On the same measure, the U.S. market is 19% undervalued.

Also in The Economist was an analysis of Toronto prices over the last 5 years compared to Shanghai, London and New York. Toronto was up 32% in Canadian dollar terms, but 93% when adjusted for exchange rates. On the adjusted basis, Shanghai was up almost 150%, while the other two were down. What this shows is that Toronto has not only got more expensive for the people who live there, but has increased at triple the rate for foreign buyers.

The Economist’s numbers are rough measures of value, and like some others I discussed in my Globe column a few weeks ago (Real Estate as an Investment? Look Elsewhere) – RBC’s affordability index, home ownership ratio, mortgage rates – each can be explained, and maybe even justified. And each may or may not be representative of a particular local market. But what worries me is that there are so many valuation measures that are at extremes and they all point to lower prices in the future.

As my friend Francis Chou said in a recent report, “If there is a choice, it is better to rent rather than buy a house.”

5 Means 7

Mon, 23 Apr 2012 09:46:39 PDT

By Scott Ronalds

In the third installment of our series marking our 5th anniversary, we look at the concept of rewarding client loyalty with lower fees.

At the end of this month we’ll be rewarding our earliest clients with an additional fee rebate, as our first tenure discounts come into play. Clients who hold our funds for 5 years receive an additional 7% reduction on their total fees. This discount is in addition to any rebates they receive based on the size of their accounts with Steadyhand. The tenure discount will apply every year until investors hit their 10th anniversary as a client, at which time their fee rebate will be upped to 14%.

We offer both the loyalty and asset size discount in recognition that:

The costs of servicing our long-standing clients are typically less than our newer clients, as they require less up-front assistance in setting up their accounts and establishing a portfolio of funds. They also have become familiar with and know what to expect from our reporting and communications. And they buy into our investment philosophy, meaning they stick to their strategic asset mix (SAM) and don’t trade too much.
Large accounts do not cost us any more to administer than smaller accounts.
Lower fees lead to higher returns.

While our base fees are amongst the lowest in the business, we recognize they are not the lowest. For long-standing clients who entrust sizeable assets with us, however, our fees are pretty much untouchable.

As far as we know, we’re the only investment firm in the country that rewards clients for their loyalty. Although, perhaps the Deferred Sales Charge (DSC) could be considered a loyalty program of sorts. Under this plan, which is offered by fund companies that charge back-end sales commissions, the fee that investors are charged to exit a fund is reduced each year, usually over a period of seven years, until it reaches 0%. A different definition of loyalty, I guess.

Surprisingly, client loyalty is poorly rewarded in many industries. Consider the telecom and cable businesses. Providers offer sweet deals to attract new customers, but as an existing client, forget it. You get the rack rate, even if you’re renewing a contract.

At Steadyhand, the ‘Client Since’ field on our statements actually means something, in dollars and sense.

Fun with Google Analytics

Thu, 19 Apr 2012 16:42:39 PDT

By Scott Ronalds

A theme in our blog postings this month is to bring readers inside the tent. Many clients express an interest in how we run our business, so we’re bringing it to life.

In the second article of our five-part series (Five Sources of Tension), we noted that our website is one of our greatest sources of constant tension, as we aim to keep it fresh and engaging, yet clean and simple. In this follow-up posting, we look at one of the tools we use to monitor engagement and interest in our site, Google Analytics.

The program enables us to track our website with precision – it shows where visitors are coming from, which pages they viewed, how long they stayed on the site, which web browser they used (Internet Explorer, Safari, Firefox, etc.), which type of mobile device they used, what they ate for lunch, etc. We can see when a particular blog or article hits a nerve, which reports are being read (or not read), and when traffic to the client portal spikes. The analytics can get pretty granular. In fact, it’s a little creepy.

One of the cool features is the geographic tracking. It shows the countries, regions and cities that generate the most web traffic. While we generate the bulk of our traffic in the domestic market, we get visits from around the world (although we only offer our funds in five provinces). Yesterday, for instance, we had visitors from Australia, the Dominican Republic, France, Mauritius, Mexico and Malaysia, among other countries. Perhaps we’re raising some eyebrows abroad, or maybe our clients are just exotic travelers.

I was looking at our U.S. traffic yesterday for the month of April and noticed a particularly engaged visitor from South Carolina. They were on the site for nearly 30 minutes and visited 15 pages. Further digging showed they were a returning visitor, and were viewing our site from North Myrtle Beach. They were left-handed and had a dog named Trixy (OK, we can’t confirm this, but Google will probably be able to shortly).

While some of the Google features are more incredible/entertaining than practical, the Analytics help us determine what’s working on the site and what needs improvement. The geographic tracking can also be a signal that we should visit a certain city or region if the interest is there. Step it up, Hawaii.

Podcast: 5-Year Review

Wed, 18 Apr 2012 11:54:59 PDT

By Scott Ronalds

It was a good start to the year for Steadyhand. We welcomed close to 200 new clients to the firm in the first quarter, our assets under management grew by 15%, and our transfer pipeline is healthy. Stocks also had a strong showing, with the Canadian market rising 4% and the U.S. and World markets gaining roughly 10%. The bond market declined as interest rates edged upwards, although losses were modest.

As we mark our fifth anniversary this month we have our first set of 5-year performance numbers, which are the focus of this discussion. It's been a turbulent period in the capital markets, but our clients with balanced portfolios have fared well.

In this podcast, we review the performance of each of our long-term funds in detail, and provide an update on how they're currently positioned.

Download, subscribe via iTunes or RSS, or listen now:

Five Sources of Tension

Mon, 16 Apr 2012 09:32:31 PDT

By Scott Ronalds

In the second installment of our series marking our 5th anniversary, we introduce the greatest sources of constant tension within our business.

We go through our fair share of Advil at Steadyhand. Like any business, we’re faced with strategic decisions that involve internal discussions in which not everyone sees eye to eye. While some choices are easy – the boardroom m&m’s are for clients only – others face more rigorous debate. Below are five issues that have been constant sources of tension within the walls of 1747 West 3rd Avenue.

Advertising

As a relatively young firm, one of our biggest challenges is getting our name out there. Advertising is one way of doing this. There are two problems with advertising, however: (1) it costs a lot of money; and (2) it can send the wrong message to clients (fees are going toward marketing instead of investment management). Also, the effectiveness of traditional advertising (newspapers, magazines, TV) is questionable in an age of social media and changing consumer behavior. When we’ve experimented with online and traditional advertising, the results have been unspectacular.

The topic comes up every year at our annual strategy session, with valid arguments made for and against it. Is it a necessity or just a fallback? With good 5-year numbers now on the books, the discussion continues. The Advil is extra strength.

Website

steadyhand.com is our hub. We put a lot of resources into our site to keep it fresh and informative. To date, we’ve had four different home pages, including versions with a grizzly bear, a series of animated vignettes, and a bold leading statement. The pressure to make changes often arises when business is quiet or web traffic is stagnant. Do we need to make a change to the home page? Add more tools? Prioritize different messages? Produce more videos? How do we convert more prospects into clients?

The challenge is to balance cleanliness and simplicity with new content and ideas. The last thing we want is a generic, uninspiring or overly-busy site. Again, a headache-inducing task at times.

Minimums

Our minimum initial investment is $10,000 per fund (and $1,000 for subsequent transactions). We settled on this figure because it’s roughly the break-even point to manage and administer an account. It puts us in a tier above the banks and traditional fund companies where minimums are typically $500 to $1,000, and below the ‘managed account’ programs where minimums often range from $500,000 to $1 million.

There’s been much discussion internally that our minimums are too low for the type of service, fees and investment managers we offer. The counter-argument is that as a young firm, we want investors to try us out. Even if it involves a smaller initial investment than they are capable of making, the thinking is that the ‘Steadyhand experience’ will win them over. Five years from now, our minimum could be $5,000 or $50,000. Or it could stay where it is. The decision won’t come without tension.

Balanced Fund

We put a lot of thought into our initial fund line-up. We decided on five funds that cover the waterfront. We wanted a tight offering, as one of our goals is to keep things simple. Our early thinking was that a balanced fund was unnecessary because clients can achieve the same result using our underlying funds. Indeed, we have a series of ‘model portfolios’ whereby investors with different objectives, time horizons, and levels of risk tolerance can build a portfolio of our funds suitable for their circumstances. Further, balanced funds can be perceived as expensive, overdiversified mass-market products.

Internal discussion on a balanced fund surfaced a few years ago, however, when advocates of the firm started lobbying us for an all-in-one portfolio – one where asset mix and rebalancing decisions would be made on the clients’ behalf. A key benefit of such a fund is that it can improve returns for investors who aren’t as attentive or interested in monitoring their portfolio. We had many internal discussions on the topic, with thoughtful arguments provided on both sides. The Advil jar is sealed on this one though, as we recently launched the Founders Fund.

The Elevator Pitch

We feel we offer a great value proposition to investors: experienced managers, concentrated portfolios, low fees, transparent reporting, thoughtful & informative communications, co-investment, clear-cut advice, simplicity, a steady hand, and crisp client service. The problem is, what do we lead with? Which one or two points resonate the most with investors? What will someone remember about Steadyhand after first hearing about us?

While the tenets of the firm have remained rock solid, this has been an ongoing topic of discussion and has led to some changes and refinements in our messaging over the years. The bottom line is that we feel they’re all important underlying elements that help make our clients better investors.

Lessons Learned in the Wealth Management Trenches

Sat, 14 Apr 2012 10:08:45 PDT

By Tom Bradley

The Globe and Mail, Report on Business
Published April 14, 2012

We’re celebrating our firm’s fifth birthday this week, which has brought on lots of reflection. Before we started up, I sought counsel from as many people as possible under the theory that if you want money, ask for advice. As it turned out, I got little money and lots of advice. For instance, “Finance the firm as if you won’t win a client for three years.” “No matter how good your offering is, you’ve got to sell it.” And my personal favourite, “Tom, get a real job before people forget who you are.”

I ignored some of the pearls (at my peril), but heeded most of them. What I couldn’t ignore, however, were lessons the markets, competitors and my team taught me over the ensuing five years. So now when entrepreneurial managers come asking for money, I’ve got plenty of advice to offer.

First off, I’d repeat the maxims about financing and selling. No matter what the projections say, it will take longer than anticipated to build a client base. With few exceptions, time is required to build a record and get the message out.

From there I’d start in on what I learned in the wealth management trenches.

This stuff is hard: For your clients, investing is perverse, unpredictable, emotional and often harrowing. You need to fight the natural tendency to make it even more complicated and daunting. Your work with clients has to be explainable and kept as simple as possible.

Living the long-term: While it’s hard for some clients to understand all of what goes into an investment strategy, it’s even harder to sustain that strategy over a long period. Keeping clients on track requires an entire ecosystem – appropriate securities, clear communications, timely feedback, ongoing counselling and compensation that’s aligned with their objectives. You can’t design solutions without thinking about how they’re going to be executed years from now, and in all types of markets. It’s not a better ride if your passengers get off at the wrong stop.

A bias toward change: The investment industry has the attention span of a 4-year-old. Two of its key drivers – compensation (fees and commissions) and past performance (what’s done well recently) – lead to changing strategies and a steady stream of new products. Unfortunately, this hyperactivity kindles clients’ psychological need to take action (especially males). It makes a “stay the course” strategy, which is often the best option, difficult to maintain. In this context, it’s important to communicate what’s being done on the clients’ behalf (research, buys, sells, rebalancing), even if it doesn’t add up to substantial change.

David and Goliath: Over the last 15 years, the big banks and insurers have come to dominate the investment business. Their reach is now so broad that in addition to owning most of the asset managers and brokerage firms, it appears they’ll soon own the stock exchange. The only way to succeed against such competition is to be substantially different and emphasize aspects where you have a clear advantage – personal, custom, patient, nimble, low fee, non-benchmark, small-cap, employee-owned and other elements that scale precludes. I heard Tom Waits say recently, “If both of you know the same things, one of you is unnecessary.” As a David amongst Goliaths, you can’t afford to be unnecessary.

Shifting winds: On that note, it’s important to focus on your sweet spot and not get too locked in on any one competitor. If someone is eating your lunch, just wait a few quarters. It’ll change. Exchange-traded funds (ETFs) were a good example of that for us. We initially viewed them to be our toughest competitor. But ETFs became a less important part of our competitive landscape when the number of funds proliferated, cost and complexity increased, and the need for advice became more apparent. Adapting our strategy to just compete against ETFs, or another firm or product for that matter, would have been a mistake.

Skating to open ice: This brings me to my last piece of advice. When it comes to generating client returns, the investment industry has plenty of what I call structural inefficiencies – short time horizon, over-diversification, high fees, high turnover (staff and stocks), complexity and an overemphasis on macro-economics over valuation. For you and your clients to win, you need to exploit as many of these enduring inefficiencies as you can, and conform to few or none.

Bradley's Brief - Q1 2012

Thu, 12 Apr 2012 09:22:16 PDT

By Scott Ronalds

From our Quarterly Report:

We’re celebrating our fifth birthday this week, so this letter is going to be more about us than usual. Indeed, during the rest of this month, our plans are to share five stories, post a few ‘five’ lists and drink too much 5-year old wine at our team celebration.

Our achievements, however, don’t obscure the fact that we have lots more to do. Our Global Fund needs to perform better, we can do more to improve our client reporting and we want our ‘landscaping’ to be more bountiful. As the team sits down for our annual strategy session tomorrow, we’ll be fleshing out and prioritizing our ‘To Do’ list. The theme of the meeting is building on our strengths, not trying to replicate someone else’s...

Read Tom's full brief and the rest of our report here.

My Toughest Five Months

Tue, 10 Apr 2012 17:06:45 PDT

By Tom Bradley

“If the bear leans on you, hold your ground”

Are these words of advice from an investment guru like Buffett, Watsa or Hager? No, they’re instructions from the trainer of Koda, my big furry friend who appeared with me in the video on our original home page. As it turned out, the trainer’s words would quickly become as relevant as any from Warren, Prem or Bob.

In this, the first of five posts celebrating our 5th birthday, I’m going to reflect back on what was by far the biggest feature of Steadyhand’s history - the stock market meltdown and financial crisis that played out in late 2008 and early 2009. This period was the toughest five months of my career, as well as being the most revealing, humbling, encouraging and ... well, amazing.

With the help of my somewhat-steady words from that period (blogs, Globe and Mail articles, quarterly letters), let me take you back.

September 30th, 2008 (Blog) - S&P/TSX Composite Index Level 11,753

We would encourage our clients to sit steady and stay positioned for the inevitable recovery. For those who have the stomach, we would recommend further purchases of equities and/or some re-balancing towards those funds.

In the two years leading up to October 2008, I had been cautious about the economy and stock market. Indeed, my biggest fan, Aunt Judy, kept telling me I needed to put more positive stuff in my Globe column. Despite my concerns, however, I didn’t see the capital markets unwinding the way they did. The amount of leverage in the financial system and its impact on investor behavior (panic and forced selling) took stocks and interest rates way lower than I would have thought possible.

So when the Canadian market was down 18% in the third quarter (and 22% from its high), I was already moving into buy mode. As I’ve acknowledged since, I was a couple of months and 20% too early on that first step.

October 3rd (Blog) - 10,803

“You want to be greedy when others are fearful and you want to be fearful when others are greedy. In my adult lifetime, I don’t think I’ve seen people as fearful economically as they are right now.”

My first call was premature, but it’s never too early to draw on words of wisdom from the big guy, Warren Buffett. This quote, taken from a Charlie Rose interview, captured the mood at the time. It felt like the world was melting down and there was nowhere to hide.

October 29th (Blog) - 9,502

A [declining market] often leads to the conclusion that investors must revise downward their future return expectations ... but it is totally wrong-headed. From this low base, portfolio returns will be quite attractive. Good markets are built on a foundation of poor earnings reports, low valuations, wide credit spreads and fearful investors. Three years from now I may be back in the mode of talking down return expectations, but that isn’t appropriate right now.

When markets are plummeting and investors are scared, it’s easy to talk to clients about lowering their return expectations going forward. It’s a ready sound bite, but it’s wrong. After severe market declines, it’s time to expect more from the next few years, not less. I say this because markets constantly overreact to changes in fundamentals. A downward adjustment to a company’s short and medium-term outlook should impact the stock price, but Mr. Market invariably overshoots, especially in emotionally charged times.

December 13th (Globe and Mail) - 8,515

The first three years [of future profits] account for roughly 10% of a company’s value.

As the fourth quarter progressed, earnings forecasts were coming down. Clearly profits were going to take a hit over the next year or two. But as noted in this post, a company’s value reflects a stream of future income (dividends and undistributed profits) of which the early years account for only a small portion. Nonetheless, the market was pounding well positioned, solidly financed companies along with their weaker brethren, which meant the valuation being placed on longer-term profits was significantly cheaper.

My message to the battered and bruised is to start preparing for the other side of the valley. It’s time to get back on plan.

It sounds pat, but the fall of 2008 was a time when investors needed to lean on their long-term plans, not abandon them. In periods of crisis (and euphoria), everyone becomes an economist and wants to take action, but beyond some re-balancing, it’s not the time to make wholesale changes. Bigger changes, if necessary, should be saved for less charged times, hopefully after the portfolio has benefited from the ‘up’ volatility that inevitably follows the ‘down’.

January 8th, 2009 (Quarterly letter) - 9,222

As discouraging as 2008 has been, it is important that we now make rational decisions based on the opportunities and risks we face today. Today, valuations on corporate bonds and stocks are compellingly cheap. Today, market sentiment, which measures how positive or negative investors are, is flashing a ‘Buy’ signal – i.e. bearishness is at an extreme. Today, the de-leveraging of the financial sector is well along. Today, there is a mound of cash on the sidelines waiting to be put to work. Today, the investing environment is very conducive to making money.

Everyone was hurting, but as you can see, I was progressively getting more forceful in my guidance. The ducks were all lining up. Valuations on stocks were screamingly cheap and according to Connor, Clark & Lunn, the manager of our Income Fund, we were looking at a “once-in-a-lifetime” opportunity to buy corporate bonds.

We concluded the Quarterly Report with another quote, this time from Shelby Davis.

“You make most of your money in a bear market: you just don’t realize it at the time”

January 13th (Blog) - 8,962

This isn’t the RRSP season to miss.

We came up with this theme to help personalize our communication. We hoped that a reference to familiar behavior (contributing to an RRSP) would plant our message smack in the middle of investors’ decision-making processes.

The reality is, the RRSP season is a depressingly accurate measure of how most (non-Steadyhand) investors behave. In seasons when the market has previously been good, contributions are robust and targeted at stocks. When markets have been tough, investors allocate money to safe investments, or simply don’t contribute.

I couldn’t think of a better year to break that pattern.

January 24th (Globe and Mail) - 8,628

Based on their valuation models [Edinburgh Partners and Boston-based GMO], expected real returns (after inflation) over the next five to seven years have moved into double-digit territory in most equity classes.

Markets were bouncing around (February was worse again), but my conviction was higher. I wasn’t trying to time the market, but I desperately wanted our clients to take advantage of the opportunity. I can honestly say that this was one of the easier calls I’ve had to make (it’s much harder when valuations and economic signals are more ambivalent). I didn’t expect a V-shaped recovery (which it turned out to be), but was confident our clients would make serious money over the next three years if they acted.

February 19th (Blog) - 8,185

The risk today is not buying cheap equities.

In an extensive interview, Sandy Nairn, the CEO of Edinburgh Partners and manager of our Global Equity Fund, made a compelling argument for buying stocks.

April 9th (Quarterly letter) - 9,187

We have been encouraging our clients to take some ‘baby steps’ in re-balancing their portfolios. Baby steps because we recognize how hard buying stocks is in this uncertain time. Personally, I am continuing to re-balance my portfolio in that direction, although my steps are even smaller because I’m near the top of my equity range. I believe the reward/risk balance is again in my favour, and want Lori and my asset mix to reflect that.

After 5 months of hell, I was feeling beaten up and poorer for it, but also wiser and well positioned. In good times we talk effortlessly about taking advantage of the opportunities that come with recessions and crises, knowing all too well that when the time comes, it’s challenging to do. In this remarkable period, we got it ‘approximately right’. The clients that followed our advice came through 2008 and the subsequent years pretty well.

I don’t expect to see another five months like this again in my career, but for periods like it, I’ll endeavour to be better prepared for the downside and hopefully act just as decisively on the upside.

Five

Mon, 09 Apr 2012 08:26:09 PDT

By Scott Ronalds

Steadyhand opened its doors to investors five years ago tomorrow. Since that bright spring day in April 2007, we’ve witnessed a lot – the biggest stock market decline since the Great Depression, a collapse in the U.S. housing market, derivatives gone wild, a global debt crisis, a strong market rebound, record low interest rates, investor paralysis, political revolution ... and more. It’s been an eventful period. And it’s what we live for. Investors need a steady hand on their portfolio now more than ever.

To mark our 5th anniversary, we’re publishing a series of five articles that take you inside our company and industry and touch on some of the principles and happenings that have shaped our business. The first of the series will be posted tomorrow, with a new entry each week. We hope you enjoy this peek inside the tent.

Whose Interests?

Fri, 20 Apr 2012 13:30:53 PDT

By Tom Bradley

The investment banking league tables came out this week and they showed that Scotia Capital was at the top of the equity list. BNS was lead underwriter on $2.4 billion worth of deals in the first quarter. What pushed them to the top was a $1.66 billion stock issue by their employer, Scotiabank.

That’s right. The bank was the lead underwriter on its own issue. Yes, this is a huge conflict of interest. The seller of shares (BNS) was seeking the best price it could get and the investment banker (BNS) was charged with doing independent due diligence on behalf of the buyers. How does that work?

The fact that the regulators (and buyers) allow this practice to go on is beyond me. Why risk the perception of a conflict ... ever. What leg would the bank and regulators have to stand on if one time there were improprieties?

Canadian banks are well run, but they do make missteps from time to time. Indeed, I write this on a day when Canada’s banking leader, RBC, is facing allegations of improper trading in the U.S. and JP Morgan is being fined $20 million for improper conduct with respect to Lehman Brothers. Going back a few years, BNS was caught with their hands in the till on the ABCP debacle (pursuing its own interests over that of its clients).

I get particularly steamed about this because investment banking appears to be the ‘wild west’ compared to how tightly the asset management and mutual fund industries are regulated with regard to conflict of interest.

(Note: I disclose that I am a shareholder of BNS through my ownership in the Steadyhand Income Fund. Also, I have a friend in their equity research department, Lori and I ski with a branch manager on occasion and we recently went to a movie at the Scotiabank Theatre downtown.)

A Contrarian's Radar Says Cheez Whiz Yes, China No

Sun, 01 Apr 2012 16:42:59 PDT

By Tom Bradley

The Globe and Mail, Report on Business
Published March 31, 2012

I’m wired to be a contrarian. That means I tend to be early getting on and off trends. I was worried about the U.S. housing cycle in 2004 and thought the Rolling Stones were over the hill two decades ago (was I wrong?). I’m still calling for Cheez Whiz to make a big comeback (think Mini and VW Beetle).

Putting my tendencies aside, I have two hard and fast rules when it comes to economic and market cycles. First, it’s impossible to time the beginning and end. And second, if the cycle has gone on for a long time and reached extreme levels (i.e. significantly above or below trend), then the retrenchment period will also take time and go to extremes.

These rules are applicable to all kinds of cycles and trends, including some of the current, long-lasting ones like housing (Canada good, U.S. bad), interest rates (31 years and counting), gold and China. As per Rule No. 1, we don’t know whether these have years to run or have already turned.

Let me explain Rule No. 2 by first saying that all sustained up cycles, whether it’s for a product, company, industry or country, are driven by strong fundamentals – favourable supply and demand; technological change; new markets; demographics and prior under-investment. As a cycle gets extended, however, it starts to pick up baggage that serves to magnify the unavoidable downturn when it comes.

For instance, it’s often the case that the integrity of a cycle – what’s behind the sales and growth – deteriorates as it gets extended. The quality of customer is poorer and more leveraged, and their reasons for buying are less about utility and more about chasing the trend. In the investment business, we talk about shares going into weak hands – buyers who aren’t committed long-term holders and who may not know why they own the stock or how it’s valued. As the adage goes, “What the wise man does in the beginning, the fool does in the end.”

Weak hands and unknowing buyers are inevitable with the flow of good news that accompanies an enduring trend. More people hear about it and the media coverage and cocktail conversation is heavily biased to the positive. With time and attention, however, comes complacency. What is a cyclical upswing comes to be regarded as a secular trend, or even paradigm shift. What was an uncertain variable becomes a given. Participants are less prepared for a negative outcome because the risk factors are obscured. As a result, speculators play a bigger role. If leverage is involved, debt ratios go up. And portfolios get tilted heavily toward the prevailing trend (sometimes at the price of prudent diversification).

I’ve written about all of the cycles mentioned above with the exception of China. Its economy has been growing at 10 per cent plus. It has parlayed abundant, cheap labour and a supportive government into manufacturing dominance. And now the rural-to-urban migration is helping fuel the growth of the middle class.

Until recently, all the economic news on China was good. It was characterized as “an unstoppable machine.” But the quality of growth has deteriorated. Wage inflation is starting to eat away at its competitiveness (although there’s still a large cushion) and economic activity is increasingly being fuelled by easy credit and government-supported capital spending. (As an aside, China’s unwillingness to tolerate a slowdown is reminiscent of the Bush/Greenspan era in the U.S.) It’s widely accepted that China’s next leg of growth will come from the consumer, but that transition is not yet happening as government subsidies and incentives continue to be funnelled in the direction of the inefficient state-owned enterprises.

As for complacency, news coverage on China is more balanced than it was a year or two ago, but still almost nobody can bring themselves to consider the possibility of a “hard landing.”

Long cycles die hard. Whether it’s China, housing or Cheez Whiz, the timing of the start and finish is unknowable. The outcome, on the other hand, is more predictable. The warning signs will be obvious in hindsight, stories of extreme hardship and bad behaviour will come out of the woodwork (and be the basis of many books) and the turnaround will take longer than expected.

With that conclusion, can you blame me for being early?

Are Bonds the Safe Haven They Appear?

Tue, 27 Mar 2012 17:22:24 PDT

This was the heading on a slide that Connor, Clark & Lunn showed us this morning during our quarterly review of the Income Fund. The chart (below) shows the path of a Government of Canada 10-year bond yield compared to the commonly-used indicator of inflation in Canada, the Consumer Price Index.

After 31 years of declining rates (and therefore rising bond prices), we are now at a point where bonds yields are at or below the level of inflation. ‘Real’ yields are negative. In other words, investors will be worse off after inflation is taken into account.

This chart reinforces why Connor, Clark & Lunn is being cautious and is positioning the Income Fund for higher interest rates and why we’re recommending that clients be at their minimum holding in bonds.

Tie Breaker

Thu, 22 Mar 2012 12:56:07 PDT

By Tom Bradley

In his column in today’s Financial Post ('Doing all of the Right Things'), Jonathan Chevreau reviews Steadyhand. The article is a book end of sorts, because Jonathan was the first one to write about us in the summer of 2006, just as our business model was being developed, and we’re now within a few weeks of celebrating our 5th anniversary.

I won’t go through the piece in detail, but I do want to clarify the performance comparisons Jonathan uses. He concludes by saying, “it’s pretty much a tie between indexing and undexing”. I think this significantly understates the results our clients have experienced. As we’ve shown in our regular performance assessments – the latest being the Balanced Income Performance Assessment (January 2012) and the Steadyhand versus ETF faceoff (November 2011) – our balanced clients are solidly in the first quartile compared to the clients of other firms, and have achieved returns that are well ahead of comparable ETF portfolios. There will be periods when we’re in another quartile and trail the indexers, but this (almost) 5-year period is not one of them.

Our funds don’t compare easily to the market indices because in most cases they’re not limited to a single asset class. The Income Fund, which has consistently been one of the top funds in its category, holds income-oriented stocks as well as bonds. The Equity Fund is a Canada-centric fund, but also provides our clients with U.S. and foreign equity exposure. As we arrive at the 5-year post, our returns will show that only the Global Equity Fund, which struggled in 2010 and 2011, trails its benchmark. (Note: The fund performance I refer to is after fees, but before any portfolio rebates. The indices have no fees included.)

As the chief investment guy, I don’t feel like we’ve shot the lights out so far. We can do better. But for our first five years, we don’t need to go to a shootout. The scoreboard shows undexing has beat indexing in regulation.

Real Estate as an Investment? Look Elsewhere

Sat, 17 Mar 2012 10:31:19 PDT

The Globe and Mail, Report on Business
Published March 17, 2012

By Tom Bradley

As an active manager of stocks and bonds, we’ve always considered our biggest competitor to be the market indexes. Over time, our clients expect us to beat them. These days, however, we’re facing another formidable foe. It’s called real estate. Investors (young and old) have a significant portion of their net worth invested in their homes, and we’re seeing more of them consider adding an income property to their portfolio.

I wanted to see what we’re up against, so I put residential real estate through my usual research process. Just as I do with stocks and bonds, I looked at houses and condos from the perspective of economic fundamentals, valuation and market sentiment.

Starting with the economics, it would appear the supply side of the equation looks manageable (except maybe condos in Toronto). Housing starts have exceeded household formation for a decade, but the inventory of unsold homes is not excessive. The demand side, however, is less encouraging.

What drives real estate over the long term is income growth (i.e. jobs). As Canada becomes less competitive in the global markets and our governments stop prescribing stimulus, employment trends aren't too exciting. In the meantime, our home ownership rate has gone from 62 per cent 15 years ago to 70 per cent today, slightly above the level attained in the U.S. in 2006.

Still on the demand side, the demographic charts show the segment of the population that’s the strongest net buyer of houses (those aged 25 to 34) is about to start declining, while the pool of potential sellers (over 65) is continuing to increase. The situation is the opposite to what prevailed in the 70’s and 80’s when the early boomers had a huge wave of buyers following behind them.

While supply and demand factors are important, what’s really driving real estate these days is financing. Sellers can charge fancy prices when buyers are plugging 2 to 3 per cent into their mortgage calculators. But here too, the trends are worrisome. Rates have little room to drop (despite Bank of Montreal’s efforts) and consumer debt levels are now equivalent to the U.S. at its worst (we seem intent on pursuing the American way).

Overall, the fundamental trends in favour of housing investment are getting tired, and in some cases reversing.

Moving on to valuation, it’s important to remember that cheap, abundant financing is transitory, while the price paid is forever. On that front, the affordability indexes show that most housing markets in Canada are near their long-term averages. Even with Vancouver included, the RBC Housing Affordability Measures show that on average 42 per cent of pre-tax household income is required to service mortgage payments and pay the taxes and utility bills on a 1,200-square-foot bungalow (two-storey houses are higher, condos lower). As high as that number sounds, it’s just slightly above the long-term average.

But – and there’s a big but – these calculations are based on current mortgage rates. When we return to a time when Bank of Montreal is advertising five-year mortgages at 4.99 per cent instead of 2.99 per cent, the measures will look ugly. In other words, valuations are okay in most markets at artificially low interest rates, but poor in all markets at higher rates.

An analysis wouldn’t be complete without a word on sentiment. In the capital markets, the mood of investors has a significant impact on prices. Real estate is no different. In this regard, I’ll say only that homeowners are definitely not prepared for prices to go down. Real estate has enjoyed a long upward cycle and with 12 good years comes a high degree of complacency.

When I pull together the economic fundamentals, valuation and sentiment, real estate, as an investment, doesn’t look very attractive. The distribution of potential outcomes looks asymmetrical to me – limited upside and plenty of possible downside. But what really screams out at me is how many important factors are at extremes … bad extremes. One or two off-trend numbers can be explained away, but too many are jumping off the charts – price increases, mortgage rates, loan growth, consumer debt and home ownership levels.

To invest in an asset class that is illiquid, has high holding and transaction costs and involves large amounts of leverage, I want a significant margin of safety. Right now, there are more warning signs than guardrails.

Job Opportunity: Mutual Funds Operations

Mon, 12 Mar 2012 09:12:31 PDT

By Neil Jensen

We are currently seeking candidates for a permanent, full-time operations position. As part of the role, the team member will process account applications and trade documents, manage the account transfer process, reconcile daily valuations, and take a leadership role in evolving our backoffice.

To view the full job description, and to submit a resume, click here.

All interested candidates are asked to submit their resume through the above link. Please do not contact us directly.

Can I Join the Club?

Thu, 08 Mar 2012 14:30:19 PST

By Tom Bradley

Early in my career, the banks all looked and behaved alike. They battled for retail market share (cozily) and pursued copycat strategies – for instance, they all bought brokerage firms and trust companies within a few years of each other. At that time, Canada accounted for most of their earnings.

Canadians may still not see much difference in the branches, but over the last decade or so, the banks have differentiated themselves. RBC (Market capitalization - $80 billion) has continued to lead in all areas and has become a large capital markets player in NYC and London, as well as the biggest asset manager. TD ($72 billion) has focused on retail banking and established a significant presence on the east coast of the U.S. BNS ($58 billion) is Canada’s most international bank, with a successful business in South and Central America. BMO ($37 billion) has lagged in most areas, but continues to expand in the U.S. mid-west. And CIBC ($30 billion) has pulled in its horns while it rebuilds after failed excursions outside of its core banking business.

With the Big 5 quite different today, you’d expect that their CEO’s compensation would also vary. Different levels of salary, bonus and stock options. Each rewarded at different times as their bank’s fortunes ebb and flow. Different compensation philosophies at the board level. Well, not so much.

In the table below, I’ve compiled the numbers for the 2011 fiscal year. I’ve included the annualized return of each of the stocks up to December, 2011.

	Firm	Total Compensation	5 YR Total Return
Gord Nixon	RBC	$11.17 Million	2.7%
Ed Clark	TD	$11.38 Million	5.5%
Rick Waugh	BNS	$10.62 Million	3.6%
Bill Downe	BMO	$11.4 Million	0.7%
Gerald McCaughey	CIBC	TBA	-0.8%

This table speaks to what’s wrong with executive compensation. The process goes something like this. The compensation committee of the board looks at what other companies are paying, with the help of consultants, and adjusts their CEO’s compensation a tiny amount to reflect other factors. If TD smokes the other banks and Mr. Clark is rewarded, the other CEO’s are rewarded too. If one of them stumbles, that CEO takes a hit for one year, but generally gets right back in the pack the next year.

I can’t help but finish with a sports analogy. Should Ed Clark, a 50-goal scorer, be paid the same as a good two-way winger on a deep team, a dependable defenseman, a second-line center and a penalty-killing specialist?

Introducing Emmylou

Tue, 06 Mar 2012 13:23:32 PST

By Scott Ronalds

Emmylou is a typical Steadyhand client (notwithstanding her mono-tooth). Like Bruce, we’ll follow her investing journey and provide periodic updates on the decisions and challenges she faces.

Profile

Age: 57
Status: Divorced
Children: 1
Occupation: Pharmaceutical Sales Rep
Residence: Winnipeg
Likes: Cross-country skiing, yoga, Tom Petty, Guinness, travel, The Amazing Race
Dislikes: Asparagus, lyrics to ‘American Woman’, January, Dancing with the Stars
Steadyhand Client Since: February 2012
Investments:

RRSP: $225,000
TFSA: $20,000
Non-registered: $150,000

Emmylou is 57 years old and divorced. She’s been down the road with a couple of potential partners since splitting with her husband 10 years ago, but is not seeing anyone at the moment. She has one daughter, Stacey, who is a 30 year old teacher in Toronto. Emmylou received her nursing degree from the University of Manitoba and was a nurse in Winnipeg and Calgary for 18 years. In her mid-forties, she moved back to Winnipeg and took a job as a sales representative with a large pharmaceutical company. Her dirty little secrets: Despite growing up in the ‘Peg’, she never liked The Guess Who; she religiously watches Curb Your Enthusiasm; and she prefers beer over wine.

Emmylou’s sales career has gone well and she’s able to live comfortably, pay the mortgage, max out on her RRSP contributions, visit her daughter regularly and fund her taste for travel. She owns a townhouse valued at $350,000. As for debt, she has a mortgage of $60,000 and a line-of-credit with a balance of $20,000 (used for home renovations).

Background

Emmylou held all her investments with one of the big banks prior to moving her accounts to Steadyhand this winter. She discovered the company through her son-in-law Paul, a lawyer in Toronto who has an RRSP with Steadyhand. Paul had often heard Emmylou grumble about her lack of understanding about how she’s doing and what she’s paying, so he suggested she contact Steadyhand for a portfolio review.

After spending some time on steadyhand.com and learning about the firm’s approach, she got in touch with us. We reviewed her portfolio and probed her on her investment objectives and risk tolerance. We suggested that while her asset mix was suitable, she should consider consolidating her investments to avoid over-diversification and unnecessary complexity. We also noted that she could reduce her fees. The simplicity aspect of Steadyhand particularly resonated with Emmylou.

Financial Goals

Emmylou enjoys her work, but would like to slow down in 4-5 years. Rather than retiring, however, she would like to work part-time if possible. She has some key financial goals that she would like to achieve by her 65th birthday:

1. Pay off her mortgage and credit line.
2. Grow her portfolio to the $750,000 mark (not including her townhouse).

Aside from the above, Emmylou has a keen interest in history and would like to spend some time exploring Europe and take part in an archaeological dig. She would also like to volunteer at future Olympic Games, after taking in the Vancouver Olympics with a friend.

Portfolio

Emmylou has a pension from her earlier career as a nurse. It will pay her roughly $1,200 per month (indexed to inflation). This source of retirement income, combined with the Canada Pension Plan payments, allows her to be a little more aggressive with her investments. In reviewing her portfolio, Emmylou also contemplated what other factors should impact her decisions: age (at 57 and in good health, she figures she has an investment time horizon of 30-35 years); potential inheritance (not counting on anything substantial); and children (her daughter is financially independent).

She is not comfortable taking on too much equity risk, however, so she decided on a strategic asset mix, in consultation with us, of 55-60% equities / 40-45% fixed income.

Emmlou is a perfect fit for the Founders Fund. It has an investment objective that lines up closely with hers, and she’ll get Tom Bradley’s oversight on asset mix and rebalancing. The current breakdown of the fund is (as of February 29th):

Savings Fund – 5%
Income Fund – 44%
Equity Fund – 24%
Global Equity Fund – 22%
Small-Cap Equity Fund – 5%

The resulting asset mix is roughly 30% bonds, 33% foreign equities, 27% Canadian equities and 10% cash. Emmylou will hold the Founders Fund in each of her accounts. We presented her with an option in which she would hold the underlying funds instead of the Founders Fund in order to structure her accounts in a slightly more tax efficient manner (i.e., the Income Fund would be held in her RRSP), but she opted for the benefits of Tom’s oversight and the simplicity of holding just one fund across all her accounts.

Her investments with Steadyhand totaled just under $400,000 at the end of February. At this level of assets, Emmylou’s annual all-in fee is roughly 1.09%.

We'll keep you posted on Emmylou's investing decisions as life plays out.

Income Gone Wild

Mon, 05 Mar 2012 14:45:43 PST

By Scott Ronalds

Tom’s Globe article on the weekend focused on Income Gone Wild (Dividends Obsession Distracts Investors From Big Picture). He opines that investors’ intense focus on dividends and income is distracting them from what really matters – “total” returns (i.e. capital appreciation, dividends and interest income).

Many investors are looking at yield and income first, without much consideration for the underlying components that drive returns. A product that promises a pay-out or distribution of 8% may sound great, but it’s crucial to look at how it’s generating the distribution and whether it’s sustainable. An 8% distribution doesn’t look so good if your investment falls by 10% and/or is paying you back your capital (return of capital).

Blogger Canadian Capitalist wrote a piece last month that provides a good example of investors’ fascination with yield. He noted that of all the new exchange traded funds (ETFs) launched last year, the BMO Covered Call Canadian Banks ETF attracted the most assets by a wide margin. He suggested that the fund’s initial yield of 10% was a big reason why investors piled money into the fund. Interestingly, the Covered Call ETF’s total return was lower than a plain vanilla ETF that invests in similar underlying investments but pays a lower distribution. The takeaway: higher yield doesn’t always equate to a higher return.

For income-oriented investors, yield should be a consideration when analyzing a potential investment. It shouldn’t, however, be the only consideration.

Dividends Obsession Distracts Investors From Big Picture

Sat, 03 Mar 2012 13:51:11 PST

The Globe and Mail, Report on Business
Published March 3, 2012

By Tom Bradley

Would you rather see your portfolio earn 3 per cent per year and provide monthly distributions of 5 per cent, or earn 5 per cent with irregular payments totalling 2 to 3 per cent?

It may seem like a ridiculous question, but it’s reflective of the choices being made today. The focus on income and dividends is so intense that it’s distracting investors from what they really need, which is attractive “total” returns. Indeed, the pursuit of convenient, tax efficient, GIC-beating yield is getting downright unhealthy.

Why do I say this? First of all, I hear it constantly from investors. “Do you offer a monthly income fund? How big is the distribution? This fund has been a dog, but I don’t want to sell it and lose my 6 per cent.”

I also see this obsession revealed in where dollars are flowing. Income-oriented ETFs have grown many times over in the last few years. There’s been a rash of new products touting high yields and fancy strategies, including the again-popular covered-call writing. Some income-oriented closed-end funds are trading at premiums to their net asset value. And I watch with interest as Kevin O’Leary builds a fund company and media career based on dividends, dividends, dividends.

Income is clearly important, particularly for older investors, so how can it be wrong to focus on it?

To answer that, we need to go back to basics. Interest and dividend payments come from corporations (government bonds excepted). To compensate bondholders and shareholders, businesses need to make a profit. Earning a return on invested capital is what’s important. The dividend policy developed by the board of directors is the easy part.

It’s similar for investors. Building a portfolio that will earn a total return of 5 to 6 per cent (3 to 4 per cent after inflation) from a combination of interest, dividends and capital appreciation is what’s important. Figuring out how to extract a paycheque from the portfolio is a secondary consideration, and not a particularly difficult task.

So, while investors need income to live off of, pursuing investment strategies that focus solely on the tap (current yield) instead of the source of long-term return is, in my view, misguided. This is especially so when the income flow comes with a higher fee or has features that structurally inhibit long-term returns, such as guarantees (guaranteed income funds), caps (principal protected notes) or limited scope (financial services stocks only).

Now, before you sit down to send me a scorching e-mail, let me say that I fully appreciate the merits of dividends. I know they’ve accounted for 50 per cent of the S&P/TSX composite’s return over the last 30 years. They’re a good indicator of a business’s quality and management’s ability to allocate capital. They can grow over time to offset the ravages of inflation. And in the Canadian context, they’re tax efficient. But hear me out.

Declining interest rates has been a constant tailwind for all types of income securities over the last 30 years, and high-dividend stocks, along with bonds, have been great vehicles to ride. Interest rate risk was amply rewarded. But with stocks like Enbridge now trading at over 20 times earnings and government bonds yielding 2 per cent, the wind is shifting.

No longer can income investing be an excuse to not be diversified. A larger portion of investor returns needs to come from other types of risk – corporate bonds, a broad range of stocks (the other 50 per cent of the stock market return), and perhaps some illiquid investments and alternative approaches (arbitrage, short selling, derivative strategies).

If you’re in the twilight of your investing career, withdrawing 5 to 6 per cent of your portfolio each year while earning a secure, sleep-easy return of 3 to 4 per cent makes sense. For longer-term investors, however, it’s important to build a portfolio that can generate profits well in excess of inflation. One that takes advantage of all the opportunities that are out there, including dividend-paying and heaven forbid, non-dividend paying. And most importantly, a portfolio that clearly focuses on the source of wealth creation, not what’s flowing from the tap.

U.S. Housing - Risk or Opportunity?

Wed, 29 Feb 2012 15:54:05 PST

By Tom Bradley

I still see a number of strategists and portfolio managers citing the U.S. housing market as a risk for 2012. I don’t get it. The slump is almost six years old. Housing starts are down to an unsustainably low level of 600,000 per year. The U.S. economy is well along in sorting things out. And guess what, the market is well aware of the excess inventory and houses yet to be foreclosed.

I think the U.S. housing market will be one of the pleasant surprises for the stock market in 2012 or 2013. Housing starts and prices will begin to rise well before the excess inventory is sopped up. And investor sentiment towards this big economic engine will improve even before that happens.

In his 2011 letter to investors, Warren Buffett put his perspective on the U.S. housing market.

"Housing will come back – you can be sure of that. Over time, the number of housing units necessarily matches the number of households (after allowing for a normal level of vacancies). For a period of years prior to 2008, however, America added more housing units than households. Inevitably, we ended up with far too many units and the bubble popped with a violence that shook the entire economy."

He went on to say,

"That devastating supply/demand equation is now reversed. … At our current annual pace of 600,000 housing starts – considerably less than the number of new households being formed – buyers and renters are sopping up what’s left of the old oversupply. (This process will run its course at different rates around the country; the supply-demand situation varies widely by locale.)"

I’m not worried about U.S. residential real estate being a negative factor for the stock market. As I said at the other end of this cycle in a June, 2006 blog, “I'm inclined to think the consensus will be wrong on this one. It almost always is wrong at major turning points when a trend has been going on for a long time.”

Performance Assessment: More Drum Banging

Mon, 27 Feb 2012 08:49:18 PST

By Scott Ronalds

We’ve been banging the drum on the issue of performance assessment for good reason. Most investors don’t know how their portfolio has performed, and most firms don’t want to tell them.

This reality was expanded upon in a recent article by Larry Swedroe on CBS’s Money Watch site. He cites a study in which the researchers compared investors’ actual returns to how they thought they fared. It concluded the following:

Investors frequently overrated themselves (only 30% considered themselves to be merely average), and overestimated their portfolio performance by over 11% per year.
Investors seemed unable to admit to poor performance. Only 5% of the sample believed they had negative returns, while the actual number of investors in the red was 25%.
On average, investors underperformed their relevant benchmarks.

While this is just one study, we frequently come across situations where investors think they have performed better (or worse) than their actual results indicate. This can lead to poor investment decisions. And it’s why we show investors their actual returns on their account statements and will continue to make noise on the issue of performance assessment.

Manager Profile: Brian Eby (CC&L)

Fri, 24 Feb 2012 13:56:38 PST

By Scott Ronalds

Morningstar published an article today on Brian Eby, the head of fixed income at Connor, Clark & Lunn. CC&L is the manager of our Income Fund and Savings Fund.

Along with highlighting Brian’s background and experience, the piece sheds some light on the team that manages the Income Fund and its current positioning.

To read the profile, click here.

Longleaf versus Fairfax

Thu, 23 Feb 2012 08:55:51 PST

By Tom Bradley

For years I’ve been reading reports published by Southeastern Asset Management. The firm manages the Longleaf mutual funds and is chaired by legendary value investor, Mason Hawkins.

The year-end report is interesting for a couple of reasons, the first being the conviction behind Mr. Hawkins and Chief Investment Officer Staley Cates’ view that stocks will beat bonds. “Never in our investing careers has the prospective return on corporate ownership so surpassed the return on long-term lending. Never has the risk of permanent capital loss from long-term lending been so great. Oft-discussed macro fears and the accompanying market volatility have driven investors from equities into the supposed security of U.S. government bonds and other highly rated sovereign and corporate debt.”

They go on to say, “… surprising to some, equities are even more attractive vis-à-vis bonds today than at the end of 2008, the worst economic downturn and bear market in our lifetime. Because of the large and unprecedented spreads between “safe” lending and business ownership yields …, we believe it is almost certain investors will begin swapping low or no return debt instruments for the much higher returns that high quality equities offer.”

If that isn’t enough, the report is also intriguing because the largest holding in the Longleaf Small-Cap Fund is Toronto-based Fairfax Financial. In reviewing the thesis behind the position, Prem Watsa, Fairfax’s CEO is described as “a uniquely capable investor” and someone they have a high regard for. While that should be no surprise (to Canadians at least), it’s interesting because Mr. Watsa’s view on equities couldn’t be more different than Southeastern’s.

In an article in the Globe and Mail last week, Mr. Watsa is quoted as saying, “We don’t feel comfortable with our common stock position without it being fully hedged. We think for the long term, 10 years, stocks will be very, very good. But the next few years we have to be very careful.” He added, “We have stocks in our portfolio that we like a lot, but in the next few years we’re worried about China and Europe, these are big markets, and housing has still got a lot of problems in the U.S.” At December 31st, 2011, Fairfax’s equities were 105% hedged, which means the company is essentially shorting the stock market.

Two revered value investors, neither of whom is shy about expressing their views, both publicly and through their portfolios. Right now, they’re as strident as I’ve ever seen them … in the opposite direction. It’s surprising, but that’s what makes a market. For every buyer, there’s a seller. Investors have different objectives and time frames. Some factor macro themes into their strategies and others focus on bottom-up fundamentals.

My view these days is closer to Mr Hawkins’. Equity valuations look attractive to me, particularly when compared to bonds. Mr. Watsa’s macro concerns, however, are the reasons we’re recommending our clients hold some cash in reserve (see page 3 of our Q4 Report).

Introducing the Founders Fund

Thu, 01 Mar 2012 10:21:40 PST

By Tom Bradley

Steadyhand Increases its Fund Lineup by 20%!

Yes, we’re introducing a new addition to our lineup - the Founders Fund. The fund is a balanced mix of our income and equity funds (it is a fund of funds) that best reflects my views on market fundamentals, valuation and ultimately asset mix. The fund’s target asset mix is 60% equities and 40% fixed income.

Our clients, and advocates of the firm, have been asking for a vehicle that captures all of what we do – the ‘undexing’ approach to fund management and professional oversight on asset allocation and rebalancing. We’ve been slow to react, rightly or wrongly, because the words balanced fund have always made me cringe. Balanced funds carry with them perceptions of mass market, over-diversification and steep fees (the balanced category of mutual funds is one of the most overpriced). But the fact is, a balanced fund that has a clear investment approach, an experienced manager, charges a low fee and is not pinned down to a rigid mandate makes good sense. As we grow, there are an increasing number of Steadyhand clients who fit the profile of the Founders Fund.

One of the key features of the fund is that I will be making tactical shifts based on my long-standing approach to asset allocation, which I call ‘Approximately Right’. A majority of the time, I’ll run the Founders Fund at or close to its Strategic Asset Mix, or SAM, which is an educated guess as to what will be the best asset mix for the fund holders over the long term. Unless there are extremes in the market, I’ll stick close to it and let our fund managers do their thing. When inordinate opportunities or risks arise, however, I will act. Conceivably, the fixed income portion could be as low as 25% and as high as 60%, while the equity portion may range from 40% to 75%.

The video below provides further info on how the fund is currently positioned and who it may (and may not) be appropriate for. You can also visit the Founders Fund page on our website for further details on the fund.

Download, subscribe via iTunes or RSS, or watch now:

Presentation Summary: Where to From Here?

Mon, 20 Feb 2012 15:16:24 PST

By Scott Ronalds

We wrapped up our cross-country client presentations this month after visiting five cities and braving mother nature in all her winter glory.

If you weren’t able to attend one of our sessions, we’ve produced a summary of the event that hits on the key themes and topics of discussion.

If you have any questions about the presentation, we encourage you to call us at 1-888-888-3147.

Lose Those RRSP Blues: The Benefits of Saving are Certain

Sat, 18 Feb 2012 12:47:08 PST

The Globe and Mail, Report on Business
Published February 18, 2012

By Tom Bradley

The RRSP season ain’t what it used to be. In the 1980s and ’90s when investing was fun, it was a focal point on the investment calendar. You couldn’t open the newspaper or walk a block without seeing an advertisement. Banks stayed open late to accommodate last-minute contributions and all firms brought in extra staff to deal with the February rush.

Investing hasn’t been as much fun in recent years and the RRSP season is now more of a necessary evil. But January and February are still when most investors spend time thinking about their portfolio and making decisions on where to put their money. So whether it’s fun or unpleasant, here are a few things to consider when going through the RRSP ritual.

Wrong question

The most commonly asked question during RRSP season is, what should I buy? Certainly, the question needs to be asked, but it should be down the list. The first is, what do I need? In the context of your long-term plan, where is your overall portfolio underinvested? A new investment has to make sense in the context of what you already own (RRSPs and other financial assets).

Last year, there was a wide dispersion of returns. Bonds were strong, U.S. stocks were up, but Canadian and international stocks were down significantly. Small cap and emerging markets were particularly hard hit.

Coming out of 2011, your portfolio may now be over-invested in asset classes that have done well (bonds for instance) and under long-term targets in others. Registered retirement savings plan and tax-free savings account (TFSA) contributions are an effective way to redress any imbalances.

Look inside first

After narrowing down what you’re looking for, you need to be proactive in your search. I say that because RRSP season is a time when investment companies barrage you with hot, new products. The latest and greatest are on full display. Unfortunately, too many portfolios are littered with prior years’ RRSP solutions – technology (1998 or 1999), agriculture (2008), gold (2010) and silver (2011) – and don’t have a clear direction.

So while the spotlight is on the new and exciting, your first stop is to look for the old and boring in your existing portfolio. You’ve previously made choices as to how you want your money managed and know what you’re getting (people, philosophy, long-term performance). Unless a change is required, allocating more capital to existing strategies and funds makes a lot of sense. If a manager or fund has performed poorly in recent periods, all the better. You can lower your average cost.

Gap attack

I write often about the behavioural challenges that investors face. These obstacles are best illustrated by the Behaviour Gap – a rather depressing statistic that shows the degree to which investors’ returns lag behind returns of the funds they invest in. The gap, which is significant, exists for many reasons, but the primary ones are too much trading and a propensity to chase last year’s winners. In Canada, the RRSP noise (subdued as it is) and end-of-February deadline don’t help matters.

But there are some things you can do to narrow the gap. The first is to contribute every year, no matter how good or bad it feels. Don’t blink because of what’s going on in the markets. If you look back, you’ll undoubtedly find that the “feel bad” contributions were actually the best timed. The benefits of saving are certain, while market timing is anything but. Just do it.

Second, make decisions in the context of an overall portfolio strategy. You shouldn’t be buying what’s hot – unless it’s what the portfolio needs.

And third, take advantage of the longer time horizon and locked-in nature of your RRSP. You don’t need to worry about selling when markets are down. Indeed, when the gloom gets heavy, you can use it to build your portfolio at more attractive prices. So in today’s environment where most investors are pursuing the impossible dream – growth with no downside – you can embrace the uncertainty and volatility. It will give you exactly what you need – capital growth with bumps along the way.

Video: Gord O'Reilly Discusses the Equity Fund

Thu, 23 Feb 2012 10:01:11 PST

By Scott Ronalds

We recently stopped by CGOV's office to talk with Gord O'Reilly (the lead manager) about the Equity Fund. We discussed a number of topics, including CGOV's definition of core vs. opportunistic holdings, their strategy with respect to dividends, and what surprised them most in 2011.

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Invest Like a Champion Today

Thu, 09 Feb 2012 11:15:55 PST

By Scott Ronalds

Warren Buffett’s perspectives on investing are worth their weight in gold (or better yet, stocks). Invest in things you understand. Wait for the right pitch. Don’t follow the herd. Buy things you’d be comfortable holding forever.

In a recent article in Fortune magazine, Buffett lays out his views on what he considers the three major categories of investment possibilities: fixed income (currency-based investments), assets that will never produce anything (gold), and productive assets (businesses, farms, real estate).

Not surprisingly, Warren thinks that the third category is the place to be: “I believe that over any extended period of time this category of investing [ownership of businesses] will prove to be the runaway winner among the three we've examined. More important, it will be by far the safest.”

He notes, “The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.”

Consider Buffett’s views on gold. “Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be about $9.6 trillion. Call this cube pile A. Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”

There are lots of other unique perspectives in the article, which is an adaptation of his upcoming shareholder letter. Buffett fans may also be interested in watching a 12 minute segment that aired on CBS’s ‘Person to Person’ last night, in which he takes Charlie Rose and Lara Logan through his private office in Omaha.

For Money Managers, Small Can be Beautiful

Mon, 06 Feb 2012 09:09:57 PST

The Globe and Mail, Report on Business
Published February 4, 2012

By Tom Bradley

Boyd Erman wrote an article before Christmas titled “Squeeze Is On For Smaller Investment Firms.” When I saw the headline, I shuddered a little. Was he going to talk about firms that don’t have billions of dollars under management? Was he going to burst my bubble?

Well, after a couple of sentences I realized the article was about the “sell” side of the Street in these treacherous markets – the investment dealers that research, sell, trade and underwrite securities. Phew.

But what about the asset managers? How does the size challenge reveal itself on the buy side?

Let me say off the top that it’s not nearly as scary. Certainly, the smaller independent firms would like to have more scale in areas such as sales and marketing, compliance, processing and administration. But there are some significant differences that make the buy side a friendlier place for the small fry.

First and foremost, asset management is not a capital-intensive business. Investment firms that manage money for clients need enough capital to fund operations and satisfy regulatory requirements, but a large capital base is nothing more than a drag on profit margins.

As for what drives money management – investment research – the playing field was leveled in 2000 when Regulation FD came into effect in the U.S. Reg FD prevents the selective disclosure of nonpublic information. In other words, an analyst from a mega-firm can’t (or shouldn’t) hear something from a CFO that hasn’t already been disclosed to the public. Today, when corporations do their quarterly conference calls, small managers can listen in just like the big players.

But more importantly, the buy side is less threatened by large firm domination because it’s an anti-scale business – the bigger a manager gets, the more difficult it is perform. While this adage has generally proven out, each area of the business is affected differently.

In general, our relatively illiquid Canadian market is a challenge for large firms. Equity managers with a few billion dollars to invest are forced to concentrate on the largest 80 to 100 stocks.

Size is less of a constraint outside of Canada. The U.S. and overseas markets offer a broad array of companies to invest in. Indeed, it’s possible to be too small for international investing, as a minimum commitment is necessary to deal with the number of offerings, longer travel distances and different regulatory regimes. It can be done with a small, experienced team, but a global footprint helps overcome these hurdles.

A manager also needs critical mass for bonds. Canada’s corporate market is still relatively illiquid, but if managers are too small, they won’t see bond offerings until all the big guys have been filled (or have passed). Also, the market is getting more complex, which requires a serious research effort. Early in my career, small investment counsellors were stock pickers. If bonds were needed to balance out a client’s portfolio, the admin assistant phoned a broker and bought some Government of Canada bonds. Not so today.

Clearly, in some asset categories, having horsepower is an advantage, but there are tradeoffs. More people in more locations means the decision-making process is prone to slippage and compromise. Bigger engine, but clunkier transmission.

I can’t finish this comparison without mentioning fees. This is an area where the buy side has a greater ability to differentiate. On the sell side, trading commissions and underwriting fees are pretty standard across all dealers, but asset management fees can range from a few basis points for indexing to a 2-and-20 arrangement (2 per cent base plus 20 per cent of the return) for more specialized categories such as hedge funds. Small buy side firms that deliver a unique product can charge more and, as a result, be profitable on fewer assets.

Now don’t get me wrong, it’s no treat operating in the shadows of the big players. The banks and insurers are marketing machines and have plenty of advertising dollars to throw around. The large foreign firms have seemingly unlimited resources. But in the asset management business, their challenges are just as tough as the small firms’ – they have to manage their anti-scale.

Bruce: RRSP & TFSA Contributions

Wed, 01 Feb 2012 17:22:30 PST

We last spoke with Bruce in September, when he acted on our counsel to trim his weighting in bonds and add to equities.

Bruce and Courtney’s portfolio rose roughly 2% in 2011 (its aggregate value at year-end was approx. $346,500). While Bruce isn’t popping any champagne, he realizes that their portfolio fared quite well considering its bias towards equities (which had a weak year).

At the end of December, their asset mix was:

Savings Fund – 10%
Income Fund – 26%
Equity Fund – 26%
Global Equity Fund – 22%
Small-Cap Equity Fund – 16%

The couple contributed $10,000 each to their RSP accounts this week. They want to keep on track with their strategic asset mix (SAM), so they didn’t add anything to the Small-Cap Fund (which had drifted higher, from 12% to 16% of their portfolio). They each invested $5,000 in the Equity Fund, $2,500 in the Global Equity Fund and $2,500 in the Income Fund. They had a tough time adding to the Global Fund given the mess in Europe, but they realize its place in their portfolio. They also understand that valuations for global stocks look attractive.

Bruce and his wife also contributed $10,000 each to their Tax-free Savings Accounts (TFSAs). They didn’t get around to adding to their TFSAs in 2011, so they had extra contribution room this year (reminder: you can contribute $5,000 per year to a TFSA. Unused contribution room carries forward). They used the Savings Fund in their joint investment account as the source of funds for the contributions.

The contributions slightly increased the Equity Fund’s overall weight in their portfolio to 27%, while the weight of the Small-Cap Fund was reduced to 15%. Bruce and Courtney’s bond weighting remains at the low end of their SAM range, following our advice that stocks currently represent better value. The couple continues to hold roughly 10% of their portfolio in the Savings Fund. As a reminder, the purpose of this cash is two-fold: 1) as a source of funds for a vacation property; and 2) as a source of dry powder if the market experiences a notable decline.

With their investments front of mind, Bruce and Courtney took care of one last piece of housekeeping – they RSVP’d for our Annual Client Presentation. They’re interested in hearing Steadyhand’s assessment of the markets. And they really like our cookies.

Balanced Income Portfolio: A Performance Assessment

Thu, 26 Jan 2012 16:22:48 PST

By Scott Ronalds

Last week we published a report on how to assess your portfolio’s performance (How is Your Portfolio Doing?).

Today we’re releasing a supplementary report that uses the framework to assess the performance of the Steadyhand Balanced Income Portfolio, which is a hypothetical model portfolio (comprised of our funds) used by a large number of our clients.

Assessing performance can be an arduous and confusing task. Not anymore.

Here's to the Geeks

Wed, 25 Jan 2012 15:44:19 PST

By Scott Ronalds

I’ve read a few interesting books lately on some of the top technology visionaries of our time. They include Paul Allen (Microsoft), Larry Page & Sergey Brin (Google) and Steve Jobs (Apple). The books were all good reads (Idea Man, In the Plex, and Steve Jobs), although the Microsoft and Google tomes are a little too technical at times for those like me who know little about programming.

One thing jumped out at me about all of these trailblazers – they are/were extremely passionate about what they do. They’re geeks. They have an eccentric devotion to programming/creating/designing and are so engaged in their trade that nothing else matters to them. They don’t let traditional barriers get in their way, aren’t afraid of failure, and don’t compromise on what they believe in. Along the way, they’ve built some exceptionally cool stuff and changed the way we work and play. And there’s only more to come.

Google and Apple have been successful at developing software and products that are hugely complex at the back-end, yet simple and intuitive for the end user. This is a tremendous accomplishment. It’s something the wealth management industry should try to emulate every day.

Investing has its complexities at the back-end. Financial analysis is akin to the engineering that goes behind search algorithms or touch screen interfaces. Unlike Google and Apple, however, the industry does a poor job of making the user experience simple and efficient. There is no shortage of resources at the back-end (equity analysts, portfolio managers, etc.), but few firms put much thought or effort into making the customer experience simple and understandable.

Investing remains a complex activity to many people because the industry wants it to be perceived that way. It shouldn’t be. Investors don’t need hundreds of choices, undecipherable reporting and non-stop economic forecasts. They need a few sensible fund options, a clear investment approach, and plain-English reporting.

Allen, Page, Brin and Jobs threw out the old blueprint. They brought innovative thinking, fearlessness, simplicity, and a focus on the user experience to the table, with a touch of craziness. We could all use a little more geek in us.

Your Portfolio Performance Needs a Regular Check-up

Sat, 21 Jan 2012 11:25:38 PST

The Globe and Mail, Report on Business
Published January 21, 2012

By Tom Bradley

A meeting I had with a prospective client a few years ago has always stuck with me. She told me her adviser had done well for her in the previous five years, but had been letting her down more recently. After reviewing the data, we discovered the opposite was true. Her portfolio was actually holding up well in the current year relative to a weak market, but had performed poorly over the longer term – the return didn’t nearly reflect the strength of the post tech-wreck markets.

Most investors know how a few of their individual stocks have done, some may have a sense of whether a mutual fund has been good or bad, but a vast majority have no idea how their overall portfolio has performed. This knowledge gap, which is especially evident at this time of year when clients are opening their year-end statements, is a unique and disappointing element of wealth management.

How has it come to be? There is plenty of blame to go around. Investment companies spend time and money selling products with the promise of better returns, but rarely show returns on their statements. Buy side firms (investment counsellors) do a better job than sell side dealers (brokers and banks), but no one is where they need to be. And neither are the clients. Few investors maintain any kind of discipline around monitoring their portfolio, despite the fact that their financial health depends on it.

In the face of this sad state of affairs, our firm just updated a report that helps clients assess their returns. It covers a wide range of topics, but some key themes permeate throughout.

This is important!

With the decline of the defined benefit pension plan, responsibility for investing is increasingly falling to the individual. To make the necessary decisions about asset mix and security selection, investors need to know how they’re doing and what’s working for them. Without an accurate assessment of the past, making future decisions is challenging to say the least.

Context

As my story at the beginning illustrated, what’s most often lacking when clients assess their results is an understanding of the environment their portfolio is operating in. They don’t know if losing 2 per cent last year or earning 4 per cent over the last five years is good or bad.

Ideally, investors should construct personalized indexes. This default portfolio, or benchmark, would blend the returns from various market indexes in proportion to their particular long-term asset mixes (cash, GICs, bonds, Canadian stocks, foreign stocks). The investors then have something to compare their returns to, and assess how their strategies and hired help have done.

Unchanging criteria

Too often a fund is bought for long-term reasons and then judged by how it’s done for the short time it’s been in the portfolio. It doesn’t make sense. If a fund was selected using the four Ps – philosophy, process, people and performance (long-term) – then it should be consistently measured against those same criteria.

This is particularly important for investments that have been weak performers. After all, not all components of the portfolio do well at the same time (if they do, then the portfolio is not properly diversified). Staying focused on the initial selection criteria will help investors determine how likely it is that the laggards will one day take their turn carrying the load. And importantly, it will give them the confidence to allocate money to these areas of weakness when their plan calls for it.

I should note that it’s hard not to focus on the laggards when reviewing a portfolio, but it’s important to also look critically at the current winners. Short-term glory shouldn’t obscure the need for an ongoing assessment.

Action and inaction

In the end, a thorough portfolio review produces lots of grey. Black and white conclusions, such as consistently poor performance, personnel or philosophy changes, and excessive fees, are the exception, not the rule. Most performance gaps require more study and patience. On that note, I can say unequivocally after 28 years of observation and painful experience, the biggest weakness investors have is impatience. They don’t wait long enough for their strategies to play out and as a result, sell when the assets are most attractive. In my view, a proper performance assessment helps foster that much-needed patience.

How is Your Portfolio Doing? Version 2.0

Mon, 23 Jan 2012 08:55:17 PST

By Scott Ronalds

Early last year we published a report on how to assess your portfolio’s performance. The paper laid out a framework for evaluating your investments, focusing on five areas: gathering the facts, reviewing the market environment, analyzing the numbers, assessing the potential for future returns, and determining when to take action.

The report was well received by investors and won the Best Stewardship Initiative at the Canadian Investment Awards last month (read more).

Today we’re releasing an updated version of the report. All the market returns have been updated to December 31, 2011, and we’ve made a few small refinements.

We’ll also be publishing a supplementary report next week that uses the framework to assess the performance of the Steadyhand Balanced Income Portfolio, which is a hypothetical model portfolio used by a large number of our clients.

Assessing performance is a key element of investing. Our goal is to provide a practical framework to make the task less onerous.

ETF Sales - Underwhelming and Disappointing

Tue, 17 Jan 2012 17:35:12 PST

By Tom Bradley

This week the 2011 sales numbers came out for Canadian ETFs (exchange traded funds). For the year, $7.6 billion flowed into ETFs (net of outflows) and total assets in the 200 plus funds finished at $43 billion.

While the number of funds exploded in 2011, the ten largest still accounted for 87% of net sales. Seven of the top ten best sellers had an income orientation, including bonds, preferred shares and covered call strategies. Under that theme, the BMO Covered Call Canadian Bank ETF, which was new in 2011, garnered the second most dollars overall ($708 million).

To put these numbers in context, net sales of mutual funds in 2011 totaled about $20 billion. There would have also been money flowing into individual securities and investment counseling firms.

To me, the EFT sales numbers are both underwhelming and disappointing.

They’re underwhelming because ETFs have been the rage over the last few years. There has been a constant flow of new products and the media and bloggers have written about ETFs extensively and positively. In the context of a wealth management industry with over $1 trillion in client assets, $7 billion doesn’t represent much of a market share swing.

There are some reasons why ETFs are gaining ground more slowly than I expected. First of all, it was generally a tough year for new flows. Weak stock markets caused investors to park more of their assets in GICs and high-interest savings accounts.

The second reason is structural. In Canada, the bank branches don’t sell ETFs directly. This leaves the ETF firms on the outside looking in at a large and growing part of the market. As a result of this, the sales numbers understate the rate of ETF growth in the distribution channels where they are available.

I’m also disappointed because when I strip out the flows (and assets) related to professional investors – institutional managers using ETFs for asset mix shifts and liquidity; hedge funds and market timers actively trading them – I have to wonder what portion is being used by individual investors to implement low-cost, long-term strategies. I don’t know the number, but suspect it pales in comparison to the money that’s going into high-cost, index-like structured products.

I also find the numbers disappointing because it appears there was some serious performance chasing going on. I recognize that fixed income ETFs are an improvement over most other pooled products, but the assets in this category increased 44% in 2011, a year when the bond market was up 10%.

At Steadyhand, we compete actively against ETFs (we recently published a report comparing Steadyhand clients to ETF investors), but I still want these simple, low-cost products to have a bigger impact on the industry landscape. The wealth management industry is making too much money off the backs of Canadian investors. I expect and hope that better equity markets, along with Vanguard’s entry into the market, will amp up these numbers in the years to come.

Podcast: 2011 in Review

Thu, 12 Jan 2012 13:50:08 PST

By Scott Ronalds

2011 was a great year for bonds and a not-so-great year for stocks. Interest rates declined further (10-year Government of Canada bond yields ended the year below 2% for the first time in a century), leading to strong price gains in government bonds, and to a lesser extent corporate bonds. Debt concerns in Europe and political lollygagging weighed on investor confidence and most stock markets around the world had a poor year. Double-digit losses were common in Europe and Asia, while the Canadian market dropped 9%. The U.S. was a lone exception and eked out a small gain.

In this podcast, we review the performance of our funds and highlight some of the key messages from our Quarterly Report.

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