All posts by Jonathan Chevreau

Motley Fool on Market Cycles: How worried should investors be?

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Talk about strange timing! Last weekend, right before this week’s sharp market sell-off, the Motley Fool Money podcast featured an interview with Howard Marks, the influential money manager at Oaktree Capital. Marks has just released his second book, Mastering the Market Cycle, which I promptly bought and downloaded on Kindle and read over the (Canadian) Thanksgiving weekend.

Subtitled Getting the Odds on Your Side, the book is only Marks’s second, following the 2011 publication of The Most important Thing: Uncommon Sense for the Thoughtful Investor. What was clear about the podcast and the book is that Marks felt that the current market cycle is closer to a top than bottom. In fact, late in September Motley Fool Money’s lead podcaster Chris Hill titled a blog “How worried should we be about Howard Marks’ Market Caution Warning?”

Cautious Optimism

Maybe a little, it turns out, although at the time of that podcast Marks’ mood was one of “cautious optimism.” Since then the market seems to have shifted a bit more from optimism to caution. As it happens, Wednesday’s 800-plus plunge in the Dow occurred just two days after I personally started to rebalance our portfolios, partly inspired by my weekend reading, so the new book was quite relevant.

Book publishing being what it is, and with much of it largely written in 2017, Marks doesn’t come right out and declare that the market is near a top; authors tend to be aware that books need to stand up for a few years. However, a quick look at his web-based market commentaries underline his cautious approach. As Hill pointed out in his conversation with Tim Hanson, Marks’ memos may not be quite as well known as Warren Buffett’s, but he nevertheless has a strong following.

At age 72, Marks has seen more than his share of market cycles and claims to have been able to profit from most of the biggies: from the 1999 Tech Wreck to the 2007 Global Financial Crisis. In fact, he’s been around long enough to remember the famous Nifty 50, which were perhaps analogous to today’s mania for FANG stocks. Continue Reading…

Retired Money: the glut of books about Trump and prospects for Boomers’ retirements

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As the yellow highlights show, books about Donald Trump now dominate the New York Times’ non-fiction bestseller lists

As my latest MoneySense Retired Money column recaps in depth, roughly half of the top ten New York Times bestselling non-fiction books are about the Donald Trump presidency. You can access the full column by clicking on the highlighted headline here: How Trump’s policies are affecting my investment choices.

Soon after the 2016 election that brought Trump to power, my financial advisor and I would exchange emails about the latest books: initially biographies and warnings and then in the last year the current glut of books about the actual presidency and the administration.

I’m normally a fan of biographies and love him or hate him, it’s hard to ignore the life of Donald Trump, considering that everything he says or tweets can impact us all. Yes, he may or may not be a threat to the looming Retirement of the baby boom generation of which he is on the leading edge, but his hair-trigger temper and proximity to the nuclear codes gives us something more to fear than merely our financial survival.

Some of the books I mention do give some insights into the implications of this presidency for the global economy and stock markets. Others are mere political diatribes from the left or the right, while still others are more salacious tell-alls. Stormy Daniels, I’m looking at you! (The book is titled Full Disclosure.)

As the column mentions, there are a number of books written by rabid left-wingers who are convinced Trump is a serial liar and a treasonous sellout to Russia president Vladimir Putin, but there are also several written by conservatives and republicans who are more sanguine about it all. In the latter camp I’d include Conrad Black, Ann Coulter and David Frum, plus a few titles from FOX news personalities who are obviously sympathetic with “The President,” as they like to refer to him.

Crazy crazy or Crazy like a fox?  Continue Reading…

Vanguard: The hidden $1.3 trillion player in active management

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Vanguard’s Daniel Wallick addresses financial advisors at 2018 Vanguard Investment Symposium

While the Vanguard Group is best known for being a pioneer of index mutual funds and exchange-traded funds, it also happens to be one of the world’s largest practitioners of active management. In a presentation Tuesday in Toronto that is taking place across the country, Vanguard executives said the US$5 trillion of money it manages worldwide includes $1.3 trillion in active management.

Vanguard Investment Strategy Group’s Head of Multi-Asset Portfolios, Daniel W. Wallick, presented financial advisors with a framework for constructing portfolios that combine active and passive approaches to investing. The heart of Vanguard’s approach remains broad cap-weighted indexes (or so-called Beta), which is what Vanguard says it means when it uses the term “indexing.”

For many investors, the broad diversification, low costs and tax efficiency of its mainstream index funds and ETFs may suffice.

But, depending on the desired complexity, Vanguard can incorporate “factors” like momentum, value, or liquidity, all factors that have shown a persistency for generating alpha (outperformance) over long periods of time. Beta and Tilts (to for example, overweighting the home country or large market caps) can be combined for the single most important task of Strategic Asset Allocation but overlaying this can be the addition of potential “Alpha” sources like Security Selection and Timing.

“Strategic asset allocation through market-cap-weighted indexes makes for a powerful tool,” Wallick said. And over 10-year periods, asset allocation policy continues to be the biggest source of variations in returns. Asset allocation explains 86% of return variation in 303 Canadian balanced funds tracked by Vanguard, 91.1% of 709 balanced funds in the U.S., 80.5% of 743 balanced funds in the UK and 89.1% of 580 balanced funds in Australia.

Cost trumps talent, patience is crucial

The 3 keys to successful active management = long-term performance

Vanguard sees three keys to successful active management: Cost, Talent and Patience. Wallick described the in-depth process Vanguard uses to select subadvisors for its actively managed funds but hiring talent has to be within strict cost-control parameters.

“Cost is a powerful indicator of future alpha.” But once the talent has been identified and hired, patience is required: Vanguard research over 15 years found that of 2,200 initial funds, 22% survived and outperformed, 24% survived but underperformed, and 54% did not survive. But even among the 22% that survived and performed, 98% of them underperformed in at least four years.

By focusing on both low costs and rigorously overseeing actively managed subadvisors, Vanguard multi manager funds have outperformed their Lipper peer-group averages by various percentages: 78% of them over 1 year, 83% of them over 3 years, 76% of them over 5 years and a whopping 100% over 10 years.

Factor-based funds vs traditional active funds

There is a half-way position between traditional beta-based Style index funds and ETFs and traditional active funds. The former (Beta) provide low cost, low turnover and lower tracking error while traditional active funds provide the opportunity to add alpha, albeit at a higher cost, potentially greater volatility, and less transparency and control. Between these are factor-based funds and ETFs, which provide consistent targeted exposure as well as low cost, but may have higher tracking error and potentially higher turnover. Continue Reading…

Retired Money: How to beat the banks at their own game

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My latest MoneySense column reviews the new book by ex banker Larry Bates, titled Beat the Bank. As the headline suggests, it’s all about how to beat the banks at their own game, which ironically can mean owning the big bank stocks themselves! The full column can be retrieved by clicking on the highlighted text here:  Tips for DIY investors on beating the Big Five banks.

The formal launch date for the book is this Thursday: September 13, 2018. I first met Bates over lunch in March as his manuscript was nearing completion, where he expounded on what he called the “two Bay Streets.” Old Bay Street and its secrets are the focus of chapters 4 and 5, and New Bay Street is chapter 6.

Old Bay Street is not the investor’s friend

Most experienced investors will have encountered Old Bay Street at some point. This is the traditional investment industry: the commission-based mutual fund and brokerage industry, insurance company reps, investment “specialists” in the bank branches and various salespeople who call themselves “advisors.”

New Bay Street = Discount Brokerage, ETFs & fee-for-service planners

The New Bay Street includes providers of low-cost index funds or Exchange-traded Funds (ETFs) or online robo-advisers that automate the purchase and rebalancing of ETFs along with setting asset allocation.

At 62, Bates is well into his own “Victory Lap,” leaving employment for self-employment. Actually, his New Bay Street model isn’t all that new, as it describes models similar to what I myself described back in 1998 in my own financial book, Findependence Day. My version consists of buying ETFs at a discount brokerage and using a fee-for-service financial planner. The same year, similar principles were also described in Stop Buying Mutual Funds!, by Mark Heinzl, now a Globe & Mail stock market columnist.

Dinosaur banks have the lowest T-REX scores

Bates has fashioned something he calls T-REX scores  This is an acronym for Total Return Efficiency Index Score. A T-REX score of 100% would be paying absolutely no fees at all, no matter how long your time horizon.

Mutual funds with 2% annual fees would have T-REX scores of 54% over 20 years and true fees of 46%, but the longer you hold, the worse the performance; thus, over 40 years the T-REX would be 41% and the true fee 59%. Fees of 3% inflict even more damage. This is the basis for his statement that long-term customers of Old Bay Street lose half their money to fees. You can find more at his website at www.larrybates.ca.

The pure DIY model of buying individual stocks or bonds at a discount broker yields the highest scores: a T-REX of 96 to 99%. (Remember, the higher the better, with 100 being perfect).

Continue Reading…

Retired Money: Should you worry a large TFSA will trigger a CRA audit?

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MoneySense/Shutterstock

Should you worry that a large TFSA will trigger a CRA audit? My latest MoneySense Retired Money column looks at a legal debate between the Canada Revenue Agency and taxpayers who have succeeded too well in growing their Tax-free Savings Accounts (TFSAs) with shrewd investing. You can access the full story by clicking on the highlighted headline: Why the CRA is targeting some TFSAs in court. 

If you’ve contributed regularly to the TFSA since it began in January 2009 you now have $57,500 of cumulative contribution room. With decent growth, it’s easily possible to have accumulated $100,000 in a TFSA by now: in fact, the CRA told me for the article that of the 13.5 million TFSA accounts that existed by 2016, 18,000 have balances of at least $100,000 (a number that includes myself and my own Millennial daughter, thanks to a few good FANG stock picks).

A Globe & Mail article last week profiled several ordinary Canadian investors and financial bloggers who have TFSAs of at least $100,000. See How to Grow your TFSA: Tips from Financial Bloggers to Fatten Your Account.

My MoneySense article quotes an unnamed investor who is being audited because his TFSA has grown to $500,000, owing to  timely growth of some private technology companies. He doesn’t think $100,000 is enough to trigger an audit but suggests $250,000 may be. In other words, the CRA may be fine with TFSA doubles but five-baggers will invite scrutiny and ten-baggers most certainly so.

But the real controversy involves TFSAs that are run as de facto securities trading businesses. The Globe highlighted this latest crackdown in an earlier article in July but was merely the latest of a series of TFSA audit scares that have been surfacing virtually since after the first year the program existed.

Shrewd stock-picking is not “aggressive tax planning” 

Some of those earlier audits involved TFSAs that soared because they held private companies but my guess is that, as in my own case or that of my daughter, the vast majority of TFSA holders are neither day traders nor experts in investing in private companies. We only buy exchange-traded funds or blue-chip North American stocks, including the FANG tech giants (Facebook, Amazon, Netflix and Google).

True, depending on when you bought them, it’s quite possible TFSA investors may have experienced 5- or even 10-baggers on stocks like Facebook, Amazon or Netflix. I doubt many investors would make concentrated bets on just one or two of these but if they did, then a $250,000 TFSA would not be inconceivable. That might invite scrutiny from the CRA but I strongly doubt they’d have a case for running a securities business.

Based on the CRA numbers cited in the MoneySense column, Tim Clarke estimates the CRA would have to audit 9,000 TFSAs in order to “recover” the amount of tax specified in the July G&M column that sparked this latest round of TFSA audit worries.

“I love how they say successful traders are conducting ‘aggressive tax planning’ “, Clarke told me in an email, “The purpose of TFSAs was stated in the budget that announced them to be a vehicle to allow taxpayers to save for retirement and other legitimate purposes. How can being successful at that be aggressive tax planning?”

 

TFSAs remain a critical tax-shelter for retirees

If you’re a retiree or close to it, presumably your TFSA will be invested fairly cautiously, just like an RRSP or RRIF, which means some combination of blue-chip dividend-paying stocks and fixed income. The TFSA is too valuable a tax shelter to get scared by audits of a handful of aggressive investors. Keep in mind that unlike RRSPs, you can still keep adding to your TFSAs well after age 71, to the current tune of $5,500 a year, and perhaps with future inflation adjustments.

There’s no reason that a retiree shouldn’t keep adding to their TFSAs until their late 90s or even beyond: not necessarily with “new” money but from post-tax money liberated from non-registered investments or after tax is paid on forced annual RRIF withdrawals.