Ed Rempel Org

Ed Rempel – Not Sold on ETF’s and Index Funds

Why I Won’t Own an Index Fund or ETF

 Skilled Fund Managers

Many investors are skeptical that there exist fund managers who have skill and who can beat the index over the long-term. Other investors believe that there are fund managers who have skill, but that it’s impossible to identify them ahead of time.

There are skilled fund managers that can be identified ahead of time. I know quite a few of them. You just have to look using the right criteria.

Identifying Skill

When looking at funds, many investors take an objective approach and study recent returns, look at ratings or statistics, or try to forecast which sectors will perform well.

Other kinds of skill evaluations are more subjective and rely on insider judgments, e.g., doctors assessing other doctors, or even actors judging performances of their peers.

The evaluation of a fund manager falls somewhere in between those two approaches, the objective and the subjective. I believe that, to find the best fund managers, you have to study them, not the fund.

Start by finding fund managers that have beaten their index over their career or long periods of time. This could be in more than one fund. They do not need to beat the index every year – just over time. Then study them to find out how they do it. Is it because of stock-picking skill?

Outperforming the appropriate indexes is just one factor in the criteria. Top fund managers are usually not trying to secretly follow the index–they’re more likely to have an effective style (like value investing), and have high “active share,” which means that they’re investing in a way that differs from the index; they also often have great experience and have their own money invested in the funds that they manage, i.e. “skin in the game”.

My All-Star Fund Managers

One of my special skills is identifying all-star fund managers — it’s essentially my main focus related to investments. I’ve found around 50 fund managers over the years who I would characterize as having superior skill, and all of them have beaten their index over long periods of time.

Most of those 50 managers are on my “watch list”. I own only a handful of those funds. Although I’m resistant to the idea of sharing statistics about my own personal investments, mostly because my investment style may not be suitable for every investor, I want to emphasize that it’s possible to identify skilled fund managers early and ahead of time.

Why I Will Never Own an ETF or Index Fund

I won’t ever own an ETF or an index fund because I’m not happy with below-index returns. I choose investments based on the fund managers–I want to invest with the Albert Einstein of investors, the absolute best. ETFs and index funds don’t have fund managers, so I’m not interested. The goal of investing is to obtain the highest long-term return after fees, and a skilled fund manager provides enough value to pay for those fees and more.

Above-Index Returns

There are really two options when you’re pursuing above-index returns: one, you can find yourself an all-star fund manager, or, second, you can choose a portfolio manager who’s paid by performance fee. When portfolio managers are paid by performance fee, they’re motivated to beat their index. If they don’t beat the index, the fees are similar to ETFs. If they do beat the index, the fee pays for itself.

Getting above-index returns is all about finding skill.

Every company needs a money manager and so might every wealthy investor

The Canadian Dollar and MONEY.CA
Money in Canada

Managing an investment portfolio was relatively easy in the 1980s and 1990s, but there has been a significant increase in complexity over the past decade. The investment climate and markets is more volatile and demanding, and today’s low interest rate and returns don’t look like they are going to change anytime soon. To get better returns, the wealthy are adding non-traditional investments such as private equity, real estate and hedge funds to their portfolios, as well as diversifying globally, which just increases the potential complications.

It’s tempting then to turn the whole thing over to someone else to manage if you can get through the sheer volume of asset managers, products and strategies to pick someone. But even among wealthy investors, there is still a lot of confusion about whether they should have discretionary or non-discretionary investment portfolios. In other words, should you and your family manage the investments, or outsource the decisions to an individual or a firm of experienced professionals? For those who lack the investment experience, time or discipline to be involved with dayto-day decision making, discretionary investment management services are a popular option. Firms that provide this are called outsourced chief investment officers and should be licensed as portfolio managers with a provincial securities regulator such as the Ontario Securities Commission.

But not all discretionary services offered by the country’s myriad banks, brokers and portfolio managers are the same and there are at least eight important factors to consider when choosing one. Does the firm: Have the skill, experience and resources to evaluate and manage assets across public and private markets? Have an “open architecture” approach, or the ability to allocate capital without conflict-of-interest to any independent asset manager from around the world in areas such as direct lending, real estate, private equity and hedge funds? Have the ability to access “best-in-class” institutional quality traditional and alternative asset managers? Provide a culture centred on client relationship management and strong communication? Offer robust performance reporting along with relevant custom benchmarks? Allow for clients to meet or speak with underlying asset managers? Take tax considerations into account to optimize returns on an after-tax basis? Offer more than a one-size-fits-all approach that utilizes just one or a few asset classes, such as stocks and bonds?

If the answer to any of these questions is no, you should probably look elsewhere, or, at the very least, realize you’ll have to compensate for that lack of ability in some other way at your own expense and time. But if your family hires an outsourced CIO, you and the advising representative (a registered individual who can provide investment advice at a portfolio management firm) will start your relationship by discussing and documenting your unique investment objectives and constraints. Topics covered should include how much investment risk you are willing to take, the desired level of return for taking on that risk, liquidity needs, tax considerations, performance reporting and benchmarks, and the asset classes and markets you will allow your portfolio to be invested in. A written investment policy statement is then provided as a best practice that documents all of the above.

Your advising representative is then authorized to make all the necessary investment decisions (within the agreedupon guidelines) and will not require consent for individual transactions. This service, which also consists of regular communication through methods that best suit your family — whether it’s in-person meetings, webcam meetings, telephone conversations, emails and newsletters — forms an important part of the ongoing relationship. The relationship is of prime importance, since your investment objectives and strategy may need to change to provide a tailored fit as conditions within your family change.

Original publication: http://business.financialpost.com/financial-post-magazine/every-company-needs-a-money-manager-and-so-might-every-wealthy-investor 

Brave Old World: Market Cycle Investment Management

The Market Cycle Investment Management (MCIM) methodology is the sum of all the strategies, procedures, controls, and guidelines explained and illustrated in the “The Brainwashing of the American Investor” — the Greatest Investment Story Never Told.

Most investors, and many investment professionals, choose their securities, run their portfolios, and base their decisions on the emotional energy they pick up on the Internet, in media sound bytes, and through the product offerings of Wall Street institutions. They move cyclically from fear to greed and back again, most often gyrating in precisely the wrong direction, at or near precisely the wrong time.

MCIM combines risk minimization, asset allocation, equity trading, investment grade value stock investing, and “base income” generation in an environment which recognizes and embraces the reality of cycles. It attempts to take advantage of both “fear and greed” decision-making by others, using a disciplined, patient, and common sense process.

This methodology thrives on the cyclical nature of markets, interest rates, and economies — and the political, social, and natural events that trigger changes in cyclical direction. Little weight is given to the short-term movement of market indices and averages, or to the idea that the calendar year is the playing field for the investment “game”.

Interestingly, the cycles themselves prove the irrelevance of calendar year analysis, and a little extra volatility throws Modern Portfolio Theory into a tailspin. No market index or average can reflect the content of YOUR unique portfolio of securities.

The MCIM methodology is not a market timing device, but its disciplines will force managers to add equities during corrections and to take profits enthusiastically during rallies. As a natural (and planned) affect, equity bucket “smart cash” levels will increase during upward cycles, and decrease as buying opportunities increase during downward cycles.

MCIM managers make no attempt to pick market bottoms or tops, and strict rules apply to both buying and selling disciplines.

NOTE: All of these rules are covered in detail in “The Brainwashing of the American Investor” .

Managing an MCIM portfolio requires disciplined attention to rules that minimize the risks of investing. Stocks are selected from a universe of Investment Grade Value Stocks… under 400 that are mostly large cap, multi-national, profitable, dividend paying, NYSE companies.

LIVE INTERVIEW – Investment Management expert Steve Selengut Discusses MCIM Strategies – LIVE INTERVIEW

Income securities (at least 30% of portfolios), include actively managed, closed-end funds (CEFs), investing in corporate, federal, and municipal fixed income securities, income paying real estate, energy royalties, tax exempt securities, etc. Multi level, and speculation heavy funds are avoided, and most have long term distribution histories.

No open end Mutual Funds, index derivatives, hedge funds, or futures betting mechanisms are allowed inside any MCIM portfolio.

All securities must generate regular income to qualify, and no security is ever permitted to become too large of a holding. Diversification is a major concern on an industry, or sector, level, but global diversification is a given with IGVSI companies.

Risk Minimization, The Essence of Market Cycle Investment Management

Risk is compounded by ignorance, multiplied by gimmickry, and exacerbated by emotion. It is halved with education, ameliorated with cost-based asset allocation, and managed with disciplined: selection quality, diversification, and income rules— The QDI. (Read that again… often.)

Risk minimization requires the identification of what’s inside a portfolio. Risk control requires daily decision-making. Risk management requires security selection from a universe of securities that meet a known set of qualitative standards.

The Market Cycle Investment Management methodology helps to minimize financial risk:

  • It creates an intellectual “fire wall” that precludes you from investing in excessively speculative products and processes.
  • It focuses your decision making with clear rules for security selection, purchase price criteria, and profit-taking guidelines.
  • Cost based asset allocation keeps you goal focused while constantly increasing your base income.
  • It keeps poor diversification from creeping into your portfolio and eliminates unproductive assets in a rational manner.

Wall Street’s Dirtiest Little Secret

As of Close of Business May 8th, no less than 53 multi-year experienced, Tax Free Income, Closed End Funds (CEFs) were paying 6% or more in federally tax free income to their shareholders.

18 issues (34%) paid 6.4% or above, and the average for the group was 6.35%. All portfolios are professionally managed by this dozen, well respected, long experienced investment companies.

Blackrock, Nuveen, Pimco. Putnam, Invesco, Alliance-Bernstein, MFS, Dreyfus, Eaton Vance, Deutsche, Pioneer, & Delaware Investors.

How difficult could it be to put together a well diversified, retirement income portfolio?

Most of these funds have paid steady, dependable, income for more than fifteen years, even through the financial crisis… several have been around since the ’90s

Yet your financial advisor has never mentioned them to you; you have never heard them advertised or reviewed in the financial press… Wall Street, it seems, would prefer that you didn’t know they exist.

But there’s even more to this story. These readily-available and much-higher-than-you’ve-been-led-to-believe-even-exist tax free yields can be purchased at bold discounts to their Net Asset Value, or NAV in Mutual Fund Terms.

A May 15th data search at cefconnect.com reveals that 85% of all Municipal Bond Closed End Funds (CEFs) were selling below their net asset values (NAVs), and of those, 20% were available to all investors at discounts above 10%.

Mutual Funds (I believe) are never available at discounts from NAV, and how many discounted munis has your advisor suggested to you since 2012 or earlier?

Municipal CEFs regularly sell at discounts, and this morning, nearly 60% were available to MCIM taxable account investors at discounts of 5% or more.


Why aren’t you asking for more information?

Retirement Income Investing: The Dreaded RMD

All of us are approaching retirement, many of us are already there, and some of us (myself included) are thinking about the ultimate IRS slap-in-the-face… The Required Minimum Distribution. It’s time to make sure that your retirement income program is actually ready.

Every investment program becomes a retirement income program eventually.

First off, you need to get to a place where you can say:

“a stock market downturn will have no significant impact on my retirement income”

This applies to everyone; income development is always important, and Tax Free Income (outside the IRA or 401k) is The Very Best. Only private “safe haven” 401k plans are capable of focusing on income development.

Retirement readiness requires active consideration of your asset allocation, your overall diversification, and most importantly, the quality of your holdings. Those of you who are relying on 401k assets to fund your retirement income requirements need to look inside the program.

If you are within five years of retirement, repositioning at the top of a stock market cycle (now) is essential; if you are in retirement, get your portfolio out of any employer plans and into your IRA… you just can’t protect yourself  (and especially, your income) in Mutual Funds or ETFs.

If you are approaching 70, the RMD is “in your face”… here’s how to handle it:

• Position the portfolio to produce slightly more income than you must take from the program.

• Take the income monthly and DO NOT pay the taxes in advance. Lump sum withdrawals require uninvested cash reserves and/or untimely sell transactions.

• Move the RMD disbursements into an individual or joint account and reinvest at least 30% in Tax Free Income CEFs.

• If you hold equities (in addition to the RMD income producers you need), set your profit taking targets lower than usual… and maintain the Cost Based Asset Allocation.

I’m relatively sure that some of you are currently dealing with the RMD incorrectly… with “lump sum + the taxes” distributions.

Some of you have been to my ongoing series of “live SRS portfolio review, Income Investing Webinars”.

Follow this link to the recording of the January 22nd private presentation and don’t hesitate to post it where ever you like… wouldn’t it be cool to have this presentation show up on YouTube.


Why so much ado about interest rates?

Mal Spooner
Mal Spooner

Why the popularity of shorter-term interest-bearing securities among Canadians, in particular GIC investments?  In fact, we in Canada are not the only investors who seem satisfied investing our money knowing that the rate-of-return might just barely cover the rate of price inflation, with a significant risk of actually losing money if inflation should rise even modestly.  And it is not just people who are content with the arrangement between ourselves and the borrowers of our money – banks, insurance companies and credit unions alike – corporations have been hoarding cash since the Financial Crisis too.

This past summer, Statistics Canada reminded us that corporations in Canada continued to grow their cash hoard rather than invest the funds in their businesses.  Of course, like people, companies don’t actually hold cash, but rather invest the money in low risk short-term interest bearing securities, often in Government of Canada T-bills and bonds, as well as commercial paper offered by financial institutions.

At the end of the second quarter of 2008, corporations held $373.4 billion in cash balances (Statistics Canada November 17th, 2009 study: Indebtedness and liquidity of non-financial corporations).  By the first quarter of this (2014) year the number had grown to a whopping $629.7-billion. So why the stubborn tendency to tolerate a near-zero rate-of-return?

There are at least two factors at work in my estimation.  One has to do with the economics of interest rates in the current environment, another with human nature and demographics.

First of all, what is an interest rate?  It embodies three important expectations-related factors: Real returns, inflation and risk.  We all are reluctant to part with our cash unless we’re able to earn what economists call a ‘real’ return.  Ask yourself, what rate-of-return would make you happy if there was essentially no risk (default, volatility) to speak of and no price inflation.  Whatever you buy today, will in theory cost you the same price next year and every year after that.  Most agree that the very long-term real rate of interest is somewhere between 2% and 4%.  Real Rates Canada 2004 to 2014However, you can easily see from the graph that the real rate of return provided by Government of Canada (as low risk as you can find) long-term real return bonds over the past ten years has been driven down since the Financial Crisis, as all governmental central banks strove to fight disinflation by dampening the general level of interest rates.

Has the return we expect from lending our funds really adjusted downward, or is it that the availability of securities providing the returns we normally demand has changed?  My guess is most folks would agree that the adage ‘once burned, twice shy’ aptly summarizes our tendency to be  biased by recent experience.  It is human nature to be sensitive to bad or good things that have just happened and to oftentimes unreasonably expect them to continue.  Also, we are confronted by a lack of options.  Securities available to us are not promising the rates-of-return we want, given the amount of risk we are prepared to stomach.

In fact, a quick look at one of many high-dividend oriented ETF’s, the iShares Core S&P/TSX Composite High Dividend Index ETF suggests that a collection of dividend paying stocks yielded 4.31% (as of October 2, 2014) over the past (trailing) 12 months.  As a bonus, the tax treatment of dividends is more generous than it is for interest income.  Indeed the stock market has done perhaps too well over the last few years, but judging by the massive dollars invested in short-term securities those equity returns have not been earned by everyday people. The issue is people just don’t seem to want the volatility that comes with investing in stocks; even when the selection of stocks is less risky than the overall stock market.  A real return with some risk is less attractive than no return at all, and it has been like this for quite awhile now. The second ingredient to interest rate levels is inflation expectations.

Source: Bank of Canada
Source: Bank of Canada

Admittedly, we haven’t seen a whole bunch of price inflation have we?  Central bank policy around the world has been more interested in creating some inflation, fearing that disinflation would prove devastating to our economic welfare.  These efforts are in fact evidenced by the historically low level of administered interest rates we have.  If our collective expectations concerning future price inflation are significantly different from what we are experiencing then our behaviour will reflect it. Could it be that the extraordinarily high commitment to GIC’s and equivalents is that Canadians, and Americans are doing it too, are content to simply keep their money (even at the risk of a small loss) intact until rates of inflation and returns get back to levels they think they can believe in?

The third important determinant of interest rate levels is our toleration for risk, and it exists in many different forms.  Our appreciation for the risk of default was certainly modified during the Financial Crisis; and in short order we’ve been willing to tolerate none of it.  We’ve turned a blind eye to significant stock market appreciation and even bond returns preferring to ‘check’ rather than ‘raise’ and ‘all in’ has certainly been out of the question.   But this intolerance to take risk has become very sticky at the individual level and at the corporate level.  This might have more to do with demographics than anything else.

Younger people are quite surprised to learn that real interest rates got as high as 6% – 9% during the mid-1980’s, and during the 90’s and up to the turn of the millennium ranged around the 4% level. (Source: I was there!)  There is a large proportion Canadians who lived through those times.  According to Statistics Canada there is roughly an equal number of young people as there are older people.  Ratio of old to young in CanadaHalf of us in Canada might consider those times ancient history (or have no interest at all in history), and the other half feel as if it was just yesterday that mortgage rates were in the double digits.

These more seasoned citizens look at the rates of return offered by the bond market and similar investment vehicles and say to themselves: “Hey, if I buy a longer term bond, I’m earning next to nothing anyway, so I’ll just put money into shorter term GIC’s and term deposits that are effectively earning nothing and avoid the risk of having my money tied up.”  Having experienced periods of rising inflation and higher real rates, they (and yes, I’m a member of that distinguished group) are inclined to wait until more generous returns come back – if they ever do come back.  And don’t forget, these same folks might actually have to spend their savings sooner rather than later suggesting that any risk of a big loss in the stock or bond market is simply untenable.

Most people when they think of Canada bonds, immediately think of Canada Savings Bonds.  They are not the same at all.  Normal Government of Canada bonds, held in mutual funds and pension plans for example, rise and fall in value as interest rates change.  Although we’ve been through a very long stretch of falling interest rates, which made bond prices steadily go up in value, there have been and will be periods when interest rates rise and people lose money in bonds.  It is smart to learn how the time value of money works and how and why bonds can make or lose money.  There is a plethora of online videos that can help you understand bond valuation and the investment in your time to learn bond dynamics is well worth the minimal effort.

The yield curve is simply a plot of interest rates corresponding to varying maturities at a point in time.  Ordinarily, we expect to earn higher returns the longer our money is lent to someone else.  GIC rates are lower when the hold period is 3 months than they are when your money is tied up for 3 years.  The same should be true for bonds.  But consider where we’ve come from:  US Treasury Dept. Yield CurvesThe graph shows the yield curves for US Treasury bonds as of October 2007 compared to the same today.  The 2007 yield curve reflects the uncertainty at that time about, well almost everything.  We didn’t know if we should accept lower rates for shorter investments or high rates for longer term bonds so the curve was somewhat flattish.  What would inflation be?  Which financial institution would be solvent?  Would the US government even be solvent?  Many questions but few answers in the midst of the financial turmoil.

The more current yield curve reflects today’s reality.  The only interest rates we can earn in the short-term are hovering close to zero, and since longer-term risk-free bonds are paying us barely one percent over inflation why assume the added risk.  If interest rates do rise from these low levels, then you will certainly lose money owning the longer-term bonds.

In a nutshell, people have doing what they should be doing – seeking shelter and waiting it out.   A side-effect of this behaviour is that our willingness to tolerate no return for lots of safety has stalled the return to financial market normality.  By stubbornly remaining in GIC’s, term deposits and money market funds we are inadvertently delaying what we desire – a decent return for taking some risk.  It’s only when money moves freely and to a large extent greedily that financial markets function properly.  This presents quite a conundrum for policy makers around the world, who’ve been praying that businesses invest in business instead of hoarding their cash, and people begin spending more and taking on more risk by investing their savings in more diverse ways.

There are many pundits who have suddenly jumped on the bandwagon predicting a stock market meltdown and impending bond market rout.  If they are right and this happens then we might finally get what we want after-the-fact; returns that compensate us fairly for inflation and risk.  In fact the stock market is suffering of late, and a shift (or rather, twist)  in the yield curve is already causing some havoc for bond managers.  The longer-term rates have declined rather than risen as expected, and mid-term bond yields have surprisingly risen – causing grief even for gurus like Bill Gross, who co-founded PIMCO and until recently managed one of the world’s largest bond portfolios.

If investors have been doing the right thing to feel secure, what should they be doing next?  Over my own lengthy career I’ve found that at some point it is important to combat inertia and begin moving in a different strategic direction.  As stock prices adjust downwards, take advantage of what happens.  The dividends paid on the increasingly lower stock prices become more attractive quickly, and remember they are taxed at preferential rates.  The world economy may continue to grow at only a snail’s pace, so why not test the waters so to speak and begin putting some funds into longer-term interest-earning bonds.  If inflation does creep up and interest rates increase some, then put even more funds to work at the higher yields.    Having done the safe thing during turbulent times, perhaps it’s time to do the smart thing.  Experience teaches us that the best time to be doing the smart thing is almost always when it is most difficult to do it.  The longer you earn nothing, the poorer you get.


Has Modern Portfolio Theory (MPT) outlived its’ usefullness?

In the early 1950s, Dr. Harry Markowitz was awarded the Nobel Prize in Economics for his work in defining the relative relationship between risk and reward when analysing investments. Considering that he did all of this work without the benefit of modern computers, this was truely ground-breaking research – and up until recently, has stood the test of time. MPT evolved into a resulting concept of plotting investment portfolios along an “Efficient Frontier” based on Harry’s formulae. The theory is that each point on the curve of the Efficient Frontier represents the greatest potential return for a given level of risk acceptance.

However, is it still valid today? I am not going to go all mathematical on everyone – I assure you – but the relationships charted and modeled by Dr. Harry were from the late 1940s and early 1950s. I think we can all agree that the economic environment today is vastly different in size, scope, volume of transactions, new products, regulation, more exchanges and other factors such as the use of arbitrage to name but one.

While I still believe there is a correlation between risk and reward, I am having increasing doubts that this relationship can be accurately modeled any longer.

Again, to avoid going into crazy formulas few would even try to follow, I decided to examine how some very large portfolios are being managed – such as the Canada Pension Plan, the Ontario Municipal Employees Retirement System (OMERS) and the Harvard University Endowment Funds. All of the data for these funds is publicly available – very easily too – and all make very interesting reading.

To quote from the OMERS website: Investing Globally
“Our goal is to diversify OMERS assets on a global basis to capture investment returns from economies that move on a different cycle than the Canadian economy and to reduce the home market bias of “too many eggs in one basket” (recognizing that Canada is less than 3% of world investment markets).” http://www.omers.ca/investments/about_OMERS_worldwide.aspx

Their investment report goes on to say “In order to satisfy its obligations and secure the pension promise, OMERS has implemented prudent and evidence-based investment strategies in public and private markets that target positive absolute returns.”

The CPP Investment Board (CPPIB) 2014 Report states: “Our distinctive investment strategy, known as the Total Portfolio Approach, ensures that we can maintain – or deliberately change – targeted risk exposures across the entire portfolio….” http://viewer.zmags.com/publication/37dab3ed#/37dab3ed/2

The Harvard Management Company (HMC) report for 2014 includes the statement: “The Policy Portfolio differs from a traditional stock/bond portfolio, including allocations to less-traditional and less-liquid asset categories, such as private equity, real estate, and absolute return strategies.” http://www.hmc.harvard.edu/investment-management/policy_portfolio.html All of HMC’s investment decisions also follow the United Nations Principles for Responsible Investment (Socially Responsible Investing in other words).

None of the reports mention a single thing about MPT. So, I decided to take their portfolios and plug them into an Efficient Frontier calculator – guess what? None of the portfolios from these well-known, and arguably leading, investment management teams fit anywhere close to the EF curve! The largest distance, interestingly, was HMC.

This is a blog – not a research paper to be sure – so I won’t bother including the graphs and numbers. To really understand this you need to do your own research and analysis – don’t take anyone’s word for it – you need to take personal responsibility in the management of your investments. But don’t let an advisor push a bunch of graphs and numbers under your nose and quote MPT and the Efficient Frontier – they are both more than 60-years old and they do not take into account the realities of markets in 2014 and beyond!

The Swiss Franc and US Dollar and Gold

I have always liked the Swiss Franc.  Even in high school I knew about the Swiss and their inherently future oriented and conservative society.  For many people now the Swiss economic standards are the ideal.

It is interesting to go back 60 years or so and to see how the United States and the Swiss currencies have diverged and how is that reflected in the price of gold and to assess what does it mean.  If anything?

Some background.

  • Prior to 1971 the franc was pegged to the US dollar and did not move far from 4.3 francs to one dollar.  But, when the US relinquished their peg to gold, the franc moved sharply upward against the dollar.
  • Using local CPI numbers, from 1955 to 1976, the franc inflated at the same overall rate as the dollar.  In each case one unit of currency was worth 2.17 at the end of 1976.  Despite the parallel inflation the exchange rate fell from 4.3 francs to the dollar and in 1976 the rate was about 2.5 to 1.
  • The Swiss must be good observers, because the US dollar fell much more in value in the next 10 years.  By 1986 the exchange rate was 1.8 to 1 and that is exactly where it should have been given relative inflation.
  • After 1986 and until 1995 Swiss inflation was lower than American and the exchange rate widened.  By 1995 the exchange rate was 1.2 francs to the dollar but based on inflation alone it should have 1.7 to 1.
  • By 2002 the relative inflation and the exchange rate came back into sync with the franc at 1.56 to the dollar.  But that soon changed.
  • Over the next 10 years the franc grew in value compared to the dollar and is now at an exchange rate 0f .93 to 1 when based on inflation alone  it should be 1.14.

Meaning please!  The US dollar is overvalued by about 23% (should be more inflation showing) or there is speculative element built in to the Swiss franc.  probably inflation expectations.

If we look at gold, we get the same story.

By the end of 1976, when the withdrawal from the gold backing seems to have settled out, gold sold for $134 per ounce.  Tracking it since using CPI adjusted US dollars we find that gold has been both over-priced and under-priced.  We can attribute that to the anticipation of the future at the time of measurement.

For example gold has traded at between less than 1.5 times its inflation adjusted price in 1976 to 1978,  1984 and 1985, and 1988 to 2006.  23 years.  It has traded as high as 3 times and has traded at more than 2 times in 1979 and 1980, and in  2009 to the present.and 1982.  Seven years.  The other years are between 1.5 and 2.  The current value is 2.15.

Suppose the Swiss are right and the dollar is overvalued.  The dollar will need to drop by 20% or so for that to be true.  And if it happens, what will be the price of gold?

If at the same time the ratio of gold price to inflation adjusted dollars becomes 1.20, then gold will sell for $725.

To believe otherwise one of two things must occur.

  • The speculative mark up on gold must be higher than 1.2 or
  • inflation must be more than 20%.

If inflation is a lot higher than 20% then we can expect that the speculative markup may return to even lower levels.  Maybe not as low as 2000 and 2001 at .68% but lower.  Say a ratio of .82 (2002 value)  With inflation of 100% by then.  Gold price would be $956

To get gold to $2,500 per ounce you need a inflation at 200% and a ratio of 1.4.

For me, gold is a bubble now and has been for several years.  Previous bubbles have worked their way out and they may again.  For those betting on gold as a speculative investment, I cannot see it at all.  For those investing 15% or so of their portfolio against a catastrophe, then I believe just like with any other insurance,  if the event does not happen I will be out money.

For a $1,000,000 portfolio with 15% in gold, and a complete wipe-out on the rest of the assets, you will need to have gold at $8,350 per ounce assuming no discount an the speculative side.  If we use the 2001 ratio, then you will need $12,300 per ounce.  (Annual inflation for three years at rates of 88% and 115% respectively)   And either of those just maintains the present purchasing power of your portfolio.

I have, over the past, seen many presentations to justify buying gold.  All used statistical deception in one way or another.  If it makes you feel better, buy some gold.  But as with the fire insurance on your house, you will be better off if you don’t collect on the premium.  There will be many unforeseen consequences if inflation is at these levels for three years.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

A Sane Article About Investment Fees

There has been much commentary on transparent investment fees in the past several months. This one in the Globe & Mail by Preet Banarjee is excellent.

Financial industry needs more transparency on fees

Preet makes several good points. For example, some advisers and fund providers are perhaps not worth what they receive and unbundling would mitigate that.

He also points out that most people do not notice the cost and they should. Partly right, but without a comparison to what happens with no fees that may be a red herring.

People need to know the fees so they can make decisions about whether the value received is reasonable given the price paid. I agree conditionally. If clients knew value then that would work. Thus the red herring above.

After unbundling, the result will be these:

  • Advisers who do not provide excellent value will be dismissed.
  • Clients with large investment balances may pay less.
  • Some, maybe many, people will do it on their own.

I find none of these to be offensive. What is troubling are the other reasonable outcomes.

  • Small balance accounts will be unable to use skilled advisers because their income potential will be too little to justify the work involved. That outcome is quite clear and well documented in the UK.
  • The non-perceptive investors think no fees means no cost. They will discover that the costs are still there, just packaged differently. They will lose both money and time.

Here’s where those hidden costs are found. Each must be replaced in the do it yourself model.

  1. Fund managers get about 0.75% on average for deciding on and executing trades, maintaining custody of assets, reporting, research and structuring the offerings. Index funds cost little while some specialized funds are much more.
  2. Dealers supervise advisers and perform other services. Compliance reviews, marketing support, training, technical support like tax questions, planning, development tools, and handout material for clients. Usually about 0.35%.
  3. Adviser share is typically between .75% and .95%. For that the client gets a person to talk to who is familiar with the goals, limits, and risk tolerance. The client gets a plan, implementation and regular follow-up. Most importantly the adviser is the client’s conscience. Most financial success is not found in yield, it is found in starting and sticking to a plan of saving for a very long time. Few individuals can do that on their own.
  4. The last part is about .25% and that is for HST. I don’t know what you get for that.

If an investor decides to go it alone, upstream fees and costs will be as much or more. Individuals have little leverage so economies of scale will be absent. Structures like tax efficient funds and the ability to balance from cash flow instead of sale and purchase will be unavailable entirely. Balanced portfolios will require continuing attention.

Opportunity cost is real. Better to spend your time as an excellent businessperson, physician, dentist, teacher or engineer than the same time spent in becoming a mediocre investor.

Supervision, planning services, technical support and focused reading material will be unavailable as there is no dealer in the no fee structure.

HST will go away, as will its value.

The great loss for many will be the adviser. Advisers help you now; probably in ways you don’t notice. A balanced approach is about more than adjusting the portfolio. Your adviser should balance you. Knowledge, motivation, impulsivity, risk, patience, discipline.

Paying fees may turn out cheaper than paying nothing.

That’s it. It comes down to value. Good advisers are worth more and weak advisers are worth less. It is the same with dealers and fund managers. If transparent fees clarify that, then let’s get to it.

I suppose there will be someone to look after the person who is starting out and has $10,000 saved. I just don’t know who that will be. Maybe banks. For the ones that think they can get something for nothing, good luck to them.

Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.


The costs of imposing a legal “fidcuiary duty” on the Canadian financial community

Presuming that reasonable people understand the need for a legally-grounded requirement for advisors – ANYONE who advices, sells, recommends, etc. any financial product or service – to have a fiduciary duty or responsibility, the next question is “WHO IS GOING TO PAY FOR IT?”

I can already hear pundits and armchair quarterbacks and experts pontificating that the industries should cover the cost of this new responsibility – and YES, there is always a cost to regulation – ALWAYS. So let us examine the cost issue a bit further. I have no way of quantifying, at this early stage, the cumulative financial impact of this additional layer of regulation, but it will add costs. For every regulation, someone has to supervise it, train advisors and employees, file reports, etc. PLUS, let’s not forget some amount of government supervision that will require more bureaucrats, auditors, examiners, investigators and support staff along with all of their associated staff and benefits costs.

The easy (and palatable) target is the financial services industry themselves – ALL of it. It is easy, politicians and regulators can say “we aren’t going to raise taxes for this, we will make all of the players pay”.

Unfortunately, this is utter nonsense of course – the only payor is the consumer – the user of the products and services is always the payor. Businesses are not going to reduce their profit expectations to their shareholders due to more regulation and the costs associated thereto. Those costs are going to be reflected in what those businesses charge for their products or services. Whether it is insurance premiums, MERs, fixed costs, reduced benefits, higher rates on loans, administration fees or something else, we, the consumers will pay for this new duty.

Please, don’t jump on me thinking I am using this as an excuse to try and stop this move – I am not – I firmly believe that EVERYONE who advises consumers about ANYTHING to do with their money, investments, financial affairs, credit, loans, mortgages, payday loans, real estate agents, general insurance agents, life insurance advisors, bank tellers, etc. SHOULD have a legally-mandated fiduciary duty and responsibility – I just don’t want people to think they are getting something for free! Remember TANSTAAFL (see a previous blog from 2012)

So the issue now is what is the limit that consumers are willing to pay for this added “protection”? How much is it worth to each of us