Case Study 1 – Retiring Business Owners

In the early 2000s after running a business for more than 30 years, this couple sold their operating company to the next generation. The proceeds were enough to provide a comfortable retirement lifestyle as long as they achieved a reasonable return on the assets. The plan was that after retirement they would continue to receive an annual payment from the operating company, in effect buying out their interest in the company from company earnings over time.

They were responsible for building a portfolio to replace the income generated from the business. In the early years the returns were barely adequate. Their advisor in Montreal had built a portfolio of large cap growth stocks. Generally the returns on the accounts were lower than expected. While the portfolio looked reasonable – most of the invested companies were names they could recognize – the problem was the investments didn’t capture all the return that was available from the markets in which they were invested.

These retirees were not being compensated for the risk they were taking. As well, some of the positions showed significant under performance which served to further drag down the returns.

Finally, the portfolio had a very aggressive asset allocation. This type of “allocation creep” often occurs in an effort to temporarily boost returns. The large growth stocks, paying dividends, were perhaps incorrectly assumed to be less risky than other stocks. The portfolio had little diversification outside a couple of sectors in the Canadian public markets.

It was a similar story for their US dollar stock positions. In addition, during the holding period, the Canadian dollar had advanced 25% against the US dollar.

Of particular concern was there was almost no fixed income in their accounts when we first met. They had invested in the royalty trust sector assuming the large cash distributions were a proxy for bond income. The net result was very little financial flexibility; their portfolio could not stand up to a stress test.

We began managing their portfolio in August of 2006. It turned out that any deferred capital gains were offset by capital losses on other positions, especially when the currency loss was added to the analysis. The result was we were able to reposition the accounts, selling most of the securities, without creating a taxable event for them. Though these timing events are random in nature, the sale of all of their income trust units proved to be particularly timely.

By Year End Our new portfolio had the following characteristics.

35% Fixed and Preferred shares
28% Canadian Equity
22% US Equity
15% International Equity

The returns to equity position were now tracking the market returns. We had tilted the portfolio from large growth to large and small value. The international equity exposure newly introduced to the mix was the best performing asset class. Overall the portfolio was performing better with less risk from an asset allocation and diversification perspective. In addition the overall fee costs to the portfolio were reduced form about 2% previously to 1.25%. In our opinion, the portfolio was in a much better position to absorb future shocks while continuing to provide the required return.

Shortly afterwards in March 2007, we moved the practice to Richardson Partners Financial. These clients happened to be out of the country. We offered to complete the necessary paperwork with them but they declined, preferring to deal with matters on their return. This proved to be a costly decision. The new advisor assigned to their account sold off most of the portfolio. These sales resulted in significant capital gains being realized for the 2007 tax year. The taxes owing were offset through the purchase of a tax shelter, which in the end, magnified the error. Predictably, in unison with all equity investments, the positions purchased fell dramatically in price throughout 2008 so that at year end they had a current tax bill on a portfolio that was dramatically lower in value. They were now in a difficult position. They had lost confidence in their advisor and their asset base was below a level which would provide the necessary income support for them in retirement.

In November of 2008 we began managing their portfolio for the second time. Losses were taken on positions we replaced with a portfolio which looked much like the original approach we had set up for them. To create additional cash flow from their tax filings, losses were carried back against the capital gain realized in their 2007 tax filing.

Timing is random but we are happy to see these clients back on the right track. They tightened their spending belt and reduced the cash requirements so as to give us some time to re-build the portfolio. In spring of 2008 we captured additional risk, and return, with an over exposure to Canadian financials. By end of summer, the assets had rebounded and we were approaching previous high water mark, net of distributions, or cash back to them. They are very happy with what we have accomplished together.

“I have been investing in the market for more than 35 years, and after going through 3 different investment advisors at the age of 76 years old, I have finally found a Financial Advisor who is not motivated by buy/sell commission cheques but is paid on portfolio performance and takes a direct interest in my accounts!”

“Patrick is always available, and on occasion when he is busy, Irene is a great back up with great knowledge of our needs! When I first met with our previous adviser he stressed “KYC” (know your client), the only thing he knew about me was the size of the commission cheque he was going to generate after I signed on, after that I was forgotten about as a client. I could never get hold of him as he was too busy chasing new business at various bank branches!”