Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Investment Synergy: From the 1960s Takeover Craze to Today’s AI Revolution

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The term “investment synergy” entered common investor use during the takeover craze of the 1960s — but we see a new synergy that’s a big plus for investors.

Image courtesy TSInetwork.ca

 

The term “synergy” entered common investor use during the takeover craze of the 1960s, when businesses started to expand by taking over companies in unrelated fields. This was supposed to make the combined companies grow faster than if they had stuck to their own fields.

The acquirers borrowed a term from biology to explain their rationale: this mix-rather-than-match growth strategy brought synergistic benefits. Synergy refers to an interaction between two or more drugs. The total effect of the drugs is greater than the sum of the individual effects of each drug if taken separately. For instance, today’s treatments for cancer, prostate and other health issues often call for prescribing two or more drugs. The combined impact may be more powerful and beneficial than you’d expect from adding up what they could do separately.

However, the synergy effect can also be negative. For example, combining alcohol with tranquilizers or opiates can lead to negative outcomes, even death.

The impact of 1960s investment synergy-seeking growth was uneven. Sometimes it worked, but it was better at producing temporary gains in stock prices than lasting gains in corporate earnings. In later decades, however, it turned out that unwinding synergy-seeking takeovers could lead to even larger profits.

This unwinding broke companies up into a “parent” and one or more “spinoffs.” The parent would then hand out shares in the spinoff to its own shareholders, as a special dividend.

A number of academic researchers have studied the outcome of spinoffs. Most found that spinoffs produce some of the most dependable profits you can find in the stock market, at least for patient investors. The academic findings were so impressive that we called spinoffs “the closest thing to a sure thing that you can find in investing.” (In fact, we were so impressed that it spurred us to launch our Spinoffs & Takeovers newsletter.)

You can find a number of processes in finance and investing that seem vaguely biological or scientific. For instance, consider Moore’s Law. It refers to the 1965 observation made by Gordon Moore (co-founder of Intel Corp.) that the number of transistors in a dense integrated circuit (now called a microprocessor) doubles about every two years. As a result, costs drop by half, and computing speed doubles. (Manufacturing progress later cut that time down to 18 months.)

This high growth rate was due to improvements in the basic design of early transistors. The continuing improvements spurred fast growth in the profits of Intel and other microprocessor stocks, and sharp gains in their stock prices in the 1980s and 1990s. Around 2005, however, the rise in computer processing speed began to slow. Now some bearish analysts predict that Moore’s Law is dead. They say the effect is bound to peter out because microprocessors can only get so small before they quit working. Meanwhile, cramming too many processors on a chip can lead to over-heating. Continue Reading…

Take advantage of the U.S. Manufacturing Boom with this Industrials Monthly Income ETF

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Image courtesy Harvest ETFs

By Ambrose O’Callaghan, Harvest ETFs

(Sponsor Blog)

The passing of three important pieces of legislation in 2021 and 2022 thrust the United States manufacturing sector, and industrials, into the spotlight. But what are industrials, anyway? When we are talking about industrials, we are referring to a sector that is composed of companies that produce goods used in construction and manufacturing that encapsulates several sub-sectors.

Some of the most prominent sub-sectors in the Industrials space include Aerospace & Defense, Electrical Components & Equipment, Industrial Machinery & Supplies & Components, Rail Transportation, and others. The Industrials sector is drawing attention in 2024 for several key reasons.

Today, we are going to explore the resurgence in U.S. manufacturing, the burgeoning aerospace and defense space, and the merits of Harvest’s first-ever covered call Industrials ETF. Let’s jump in.

The resurgence in U.S. manufacturing

According to the U.S. Department of the Treasury, real manufacturing construction spending has doubled since the end of 2021. This increase occurred in a supportive policy climate after the passing of three key pieces of legislation: The Infrastructure Investment and Jobs Act (IIJA), the Inflation Reduction Act (IRA), and CHIPS Act. These three pieces of legislation provided funding and tax incentives for public and private entities in the manufacturing construction space.

The U.S. Treasury Department report shows that the computer/electronic segment has represented the largest component of the U.S. manufacturing resurgence. However, the growth in the size of that segment has not been offset by a reduction in spending in other manufacturing sub-sectors. Construction in areas like chemical, transportation, and food/beverage have all enjoyed growth through 2022, just at a reduced pace. The chart below shows the top manufacturing construction projects by value and location since August 2022.

The CHIPS and Science Act was signed into law by President Joe Biden on August 9, 2022. It included US$39 billion in subsidies for chip manufacturing on U.S. soil. This included 25% investment tax credits for the cost of manufacturing equipment. The chart below shows construction spending in the manufacturing space over the past two decades, bookended by a surge after three pieces of legislation.

Deutsche Bank research indicated that 18 new chipmaking facilities began construction between 2021 and 2023. Indeed, the Semiconductor Industry Association reported that more than 50 new semiconductor ecosystem projects have been announced after the CHIPS Act.

Aerospace and defense spending today

The aerospace sector involves the design, manufacture, and operation of vehicles that travel in aerospace. Meanwhile, the defense sub-sector produces and seeks to sell weapons, and military technology. Continue Reading…

Four Strategic ways to invest in U.S. Stocks using BMO ETFs

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Image courtesy BMO ETFs/Getty Images

By Erin Allen, Vice President, Direct Distribution, BMO ETFs

(Sponsor Blog)

As of May 31, 2024, the U.S. stock market accounts for approximately 70% of the MSCI World Index1, making it a significant component of global equity markets: and likely a substantial portion of your investment portfolio as well.

While Canadian investors often favour domestic stocks for tax efficiency and lower currency risk2, incorporating U.S. stocks can enhance exposure to sectors where the Canadian market — predominated by financials and energy — falls short, particularly in technology and healthcare.

For Canadian investors looking to tap into the U.S. market affordably and without the hassle of currency conversion, there are numerous ETF options available. Here are four strategic ways to build a U.S. stock portfolio using BMO ETFs, catering to different investment objectives.

Low-cost broad exposure

If your objective is to gain exposure to a broad swath of U.S. stocks that reflect the overall market composition, the S&P 500 index is your quintessential tool.

This longstanding and highly popular benchmark comprise 500 large-cap U.S. companies, selected through a rigorous, rules-based methodology combined with a committee process, and is weighted by market capitalization (share price x shares outstanding).

The S&P 500 is notoriously difficult to outperform: recent updates from the S&P Indices Versus Active (SPIVA) report highlight that approximately 88% of all large-cap U.S. funds have underperformed this index over the past 15 years.3

This statistic underscores the efficiency and effectiveness of investing in an index that captures a comprehensive snapshot of the U.S. economy.

For those interested in tracking this index, BMO offers two very accessible and affordable options: the BMO S&P 500 Index ETF (ZSP) and the BMO S&P 500 Hedged to CAD Index ETF (ZUE), both with a low management expense ratio (MER) of just 0.09% and high liquidity.

While both ETFs aim to replicate the performance of the S&P 500 by purchasing and holding the index’s constituent stocks, they differ in their approach to currency fluctuations.

ZSP, the unhedged version, is subject to the effects of fluctuations between the U.S. dollar and the Canadian dollar. This means that if the U.S. dollar strengthens against the Canadian dollar, it could enhance the ETF’s returns, but if the Canadian dollar appreciates, it could diminish them.

On the other hand, ZUE is designed for investors who prefer not to have exposure to currency movements. It employs currency hedging to neutralize the impact of USD/CAD fluctuations, ensuring that the returns are purely reflective of the index’s performance, independent of currency volatility.

Large-cap growth exposure

What if you’re seeking exposure to some of the most influential and dynamic tech companies in the U.S. stock market, often referred to as the “Magnificent Seven?”

For investors looking to capture the growth of these powerhouse companies in a single ticker, ETFs tracking the NASDAQ-100 Index offer a prime solution. As of June 27, all of these companies are prominent members of the index’s top holdings4.

The NASDAQ-100 Index is a benchmark comprising the largest 100 non-financial companies listed on the NASDAQ stock exchange. This index is heavily skewed towards the technology, consumer discretionary, and communication sectors, from which the “Magnificent Seven” hail.

BMO offers two ETFs that track this index: the BMO Nasdaq 100 Equity Hedged to CAD Index ETF (ZQQ) and the BMO Nasdaq 100 Equity Index ETF (ZNQ). Both funds charge a management expense ratio (MER) of 0.39%. Again, the key difference between them lies in their approach to currency fluctuations.

Low-volatility defensive exposure

You might commonly hear that “higher risk equals higher returns,” but an interesting phenomenon known as the “low volatility anomaly” challenges this traditional finance theory.

Research shows that over time, stocks with lower volatility have often produced returns comparable to, or better than, their higher-volatility counterparts, contradicting the expected risk-return trade-off. Continue Reading…

Private Equity: A Portfolio Perspective

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So don’t ask me no questions
And I won’t tell you no lies
So don’t ask me about my business
And I won’t tell you goodbye

  • Lynyrd Skynyrd
Image courtesy Outcome/Shutterstock

By Noah Solomon

Special to Financial Independence Hub

I know virtually nothing about investing in private companies. However, I do know a thing or two about the theoretical and practical aspects of asset allocation and portfolio construction. In this vein, I will discuss the value of private equity (PE) investments within a portfolio context. Importantly, I will explain why PE investments may contribute less to one’s portfolio than is widely perceived.

Before I get into it, I am compelled to state one important caveat. Generalized statements about PE are less meaningful than is the case with public equities. The dispersion of returns across public equity funds is far lower than across PE managers. Whereas most long stock funds fall within +/- 5% of the average over a several year period, there is a far wider dispersion among underperformers and outperformers in the PE space. As such, it is important to note that the following analysis does not apply to any specific PE investment but rather to PE as an asset class in general.

The Perfect Asset Class?

PE allocations are broadly perceived as offering higher returns than their publicly traded counterparts. In addition, they are regarded as having lower volatility than and lower correlation to stocks. Given these perceived attributes, PE investments can be regarded as the “magic sauce” for increasing portfolio returns while lowering portfolio volatility. In combination, these attributes can significantly enhance portfolios’ risk-adjusted returns. However, the assumptions underlying these features are highly questionable.

Saturation, Lower Returns, & Echoes of Charlie Munger

It is reasonable to expect that average returns within the PE industry will be lower than in decades past. The number of active PE firms has increased more than fivefold, from just under two thousand in 2000 to over 9000 today. This impressive increase pales in comparison to growth in assets under management, which went from roughly $600 billion in 2000 to $7.6 trillion as of the end of 2022. It seems unlikely if not impossible that the number of attractive investment opportunities can keep pace with the dramatic increase in the amount of money chasing them.

Another reason to suspect that PE managers’ returns will be lower going forward is that their incentives and objectives have changed. The smaller PE industry of yesteryear was incentivized to deliver strong returns to maximize performance fees.  In contrast, today’s behemoth managers are motivated to maximize assets under management and management fees. The name of the game is to raise as much money as possible, invest it as quickly as possible, and begin raising money for the next fund. The objective is no longer to produce the best returns, but rather to deliver acceptable returns on the largest asset base possible. As the great Charlie Munger stated, “Show me the incentive and I’ll show you the outcome.”

There are no Bear Markets in Private Equity!

It is also likely that PE investments on average have both higher volatility and greater correlation to stocks than may appear. The values of public equities are determined by exchange-quoted prices every single day. In contrast, private assets are not marked to market daily. Not only do PE managers value their holdings infrequently, but they also must employ a significant degree of subjectivity in determining the value of their holdings. Importantly, there is an inherent bias for not adjusting private valuations when public equities suffer losses. Continue Reading…

The Benefits of Geographic Diversification for your Portfolio

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TSInetwork.ca

One key factor in successful investing — apart of course from picking good stocks (or ETFs that invest in those stocks) — is to diversify your portfolio.

Our main suggestion would be to make sure that your holdings are always well-balanced among most if not all of the five economic sectors: Manufacturing, Consumer, Utilities, Resources, and Finance.

That way, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or changes in investor fashion.

By diversifying across the sectors, you also increase your chances of stumbling upon a market superstar: a stock that does two to three or more times better than the market average. These stocks come along every year. By nature, though, their appearance is unpredictable.

It’s also essential to diversify within each sector. For example, you shouldn’t let technology stocks dominate your Manufacturing holdings, nor let telecommunications or phone stocks dominate your Utilities holdings.

What about geographic diversification?

We’ve long said that most Canadian investors should hold the bulk of their portfolio in high-quality, dividend-paying Canadian stocks well balanced across the five sectors (or ETFs that hold those stocks).

We also feel that virtually all Canadian investors should have, say, 20% to 30% of their portfolios in U.S. stocks (many of which also offer you international exposure through their foreign operations).

Beyond that, top international stocks or ETFs can also add valuable diversification to your portfolio—through exposure to foreign businesses and to foreign currencies.

To demonstrate how geographical diversification can benefit investors, we examined the risks and returns of an ETF portfolio consisting of 50% Canadian equities, 30% U.S. equities, and with 20% in equities around the rest of the world. We then compared the risk and returns of this diversified portfolio with a broad Canada-only index.

Geographic diversification can cut risk and raise returns

Our results showed that the risk of the diversified portfolio was lower than the Canadian-only portfolio, while the returns were higher. Continue Reading…