Archive for the ‘Asset Allocation’ Category

There is currently a good deal of discussion about the speed at which the Canadian population is aging. This aging affect is expected to accelerate in the next 20 years (see chart below). As has been the case at every stage of their generational life, boomers are going to have a dramatic impact on Canadian society as they retire. In twenty years, fully a quarter of the population will be drawing CPP and OAS. For many people, government pensions won’t be enough to cover spending requirements.

Source: Statistics Canada. Estimates of Population, Canada, the Provinces and Territories (Persons). CANSIM Table no. 051-0001; and Statistics Canada. Population Projections for Canada, Provinces and Territories (2005-2031). CANSIM table no. 052-0004.

As a nation, we are challenged to provide a financially comfortable and healthy lifestyle after retirement. Public Pension funds, CPP and OAS are designed as a safety net, providing only a basic standard of living. Personal savings and private pension plans are expected to make a significant contribution.

Private Defined Benefit (DB) pension plans participation rates have been dropping. DBs are stressed by smaller contributions from a shrinking population of workers and recently by volatility in the investment markets. According to actuarial estimates by Mercer, by the end of 2008 more than 70% of DB plans had solvency ratios under 80%. This means the total assets of these pension plans offset only 80% of the liabilities.  An unfunded liability is ultimately backed by the earnings of sponsor companies. Fortunately, that recent underfunded status has been largely reversed by positive investment returns in 2009/10.

The volatility in plan assets is a concern for corporate Canada and there remains considerable incentive for companies to reduce exposure to pension risk by converting existing DB plant to Defined Contribution (DC) pension plans. In DC plans the investment risk is borne by the employee-retiree. For private company sponsored plans in 2008 alone the number of participants in DB plans declined by 7.8%. Given the incentives, it is reasonable to expect this trend to continue. It is worth noting that public DB plans are headed in the opposite direction, with an increase of 4% of participants during 2008.

The overall result is that most Canadians are responsible to provide for their own retirement. Investors bear both the risk of managing assets and benefit from the rewards to getting it right. To a significant extent, our current wealth management strategies define our future lifestyles.

Our Policies Support Your Goals

As a leading Private Family Office (PFO) we think we have a role to play in providing a platform for successfully discharging the demands of your family’s wealth management.

We are focused on getting wealth management to work for you. Our clients understand the challenge and like most investors, prefer to work with a professional advisor. They understand that the skill set required to grow wealth is often very different from the skills needed to preserve wealth and the purchasing power of that wealth.

While financial success comes with responsibility, enjoying your wealth is best experienced once those responsibilities are satisfied. Our purpose is to help clearly define your important goals and bring you considered strategies to achieve success. We use trusted relationships though our network of professionals who are experienced at tax, legal, insurance and estate issues. We would also be pleased to work with your current trusted advisors.

We typically work with a larger percentage of the assets of our clients so that our strategies and approach can make a difference in their financial lives. We think costs matter, taxes matter and current cash flow requirements are probably not diminished in retirement. We have the tools to define a family’s unique requirements and the evidence-based investment approach to confidently get it done. Our joint responsibility is your investment success; we have a proven approach tested through many market cycles.

The motto, “our policies support your goals” refers to both our unbiased investment approach as well as to the professional standards of care of the Chartered Financial Analyst (CFA) designation which defines our business practice. We enjoy what we do and would be pleased to discuss your requirements.

Patrick

The opinions expressed in these articles are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.

New ideas are often enthusiastically embraced by the investment community. For example, Brazil, Russia, India and China (BRIC) are a current focus, attracting investment dollars for portfolios chasing growth. The question becomes, what is the right amount for your portfolio? If these countries are growing faster, is a 10 percent allocation enough? Why not put all your money there? What is a reasonable basis for the decision?

The investment world doesn’t simply replicate the physical world. As illustrated in the table below, for year ending 2009, 57 percent of the world’s population account for 84 percent of total GDP and 95 percent of stock capitalization.

Simple strategies based on one factor, such as allocating large percentages of your investment dollars to China or India may randomly work out, but such strategies probably represent more risk than intended.

Risk without return is never a good thing. For example, China recently surpassed Japan in GDP but the Chinese stock market is less than a quarter the size of Japan’s. The size difference is a measure of relative risk, and a determination of required return from a new investor’s point of view. In this example, new investors in the Chinese market require more return for Chinese investments than for investments in Japan.

Capital is generally free to move between stock markets so the dollar value or market capitalization of each market is a summary of all investor views about the prospects for that market. In a sense, the wisdom of the many, each making independent decisions can be summarized by the willingness to invest in one market versus another. In this way, relative market capitalization represents risk adjusted return for country allocation. Bigger markets are less risky than smaller markets. They also probably provide less return. Risk and return are always related.

“Perfect Country Allocation” may be achieved by replicating the market capitalization below for each country: 42 percent US, 9 percent UK and Japan and so on. In diversifying by relative market capitalization, an investor would capture the return to stocks wherever that return is realised. This investment portfolio would increase with expanding markets and decrease with relative decliners. A portfolio would therefore be perfectly diversified as to country selection. If the goal is to capture growth wherever it manifests, then this portfolio would achieve the result. Diversification works best when it eliminates the risk that provides no aggregate return, leaving only risk that provides compensation. This portfolio would capture the return to increases in earnings. It would not capture the positive or negative returns resulting from capital movements between markets.

So why isn’t everyone doing this? I think the answer lies with spending. Investors and their advisors allocate more money to markets where the money will be spent. This is reasonable but somewhat inefficient in that the domestic market doesn’t capture price changes in imports. Great economies like Switzerland, Hong Kong and Finland have relative GDP of 10 times their population weight. Canada and the US have less than 5 times or half the measure. In time, goods from very productive economies get relatively expensive. Investing in these economies or companies compensates you for the price increases. You don’t want to be the greatest investor in an economy that is shrinking in comparison to the rest of the world.

Implication for Investors

International diversification increases complexity (risk) and expense for individual investors. Yet from a North American point of view many markets are growing faster than our domestic markets. A broadly diversified approach which limits the error of investing in the wrong country at the wrong time should allow your portfolio to experience better results. Big bets on individual countries add risks that you simply don’t get paid for in the long run.

Patrick

The opinions expressed in these articles are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP or its affiliates.

Well as the above math indicates, the markets have improved so now they are  fully half of what they once were.

There are so many opinions/recipes/predictions for fixing the financial system:

Do Mark to Market assets on company balance sheets to improve visibility and certainty about earnings; or

Don’t mark to market assets as these add to volatility in earnings and in the end are estimates only

Buy equities, the recession is ending in 2009; or

Do nothing, the recession is deeper than expected and mid 2010 is the earliest relief point

Since the public purse is bailing out AIG (Citigroup, Bank America…) the new owners should protect us by reneging on employee bonuses. The principle is one of fairness to those who are preventing these companies from disappearing entirely; or

Pay the bonuses, keeping the companies whole will pay off in the future as a more valuable asset is sold. These bonuses represent insignificant dollar values

New expanded monetary policy is helpful in the short term and disastrous later; or

The US economy is expected to drive world recovery, the reasonable  cost of this effort is more US dollars in circulation

I expect many of you find all of these conflicting views compelling even as they are source of argument. I  usually find both sides of the noise plausible and somewhat meaningless as a result. The loudest opinion is unlikely to be the most helpful, or best considered. In times as these, we need to have some reasonable basis for  making investment decisions.

There seems to be a quest to define the moment of inertia, when the economy begins to grow instead of shrink.  If we could guess the day what would we do exactly? Search for a new job… buy an investment property? Maybe we could pick that exact moment to buy stocks in our retirement accounts.

Unfortunately,  we would probably be late to the party for stock markets.   If we look at the most severe recessions in the past 40 years for Japan, UK, US and Germany at the official end of each recession the local stock market had rebounded from a low of 31% in US markets in March of 1975 to a high of 137% in the UK in December of 1975. Of course the end of recessions are defined by looking back 6 months. Not helpful if you are trying to time a stock entry point or major purchase.

Good judgement starts with clearly understanding your unique situation. Investment activities should be added to after accounting for and funding cash requirements and perhaps reducing debt. In this way you will not be forced to turn what should be a positive into a negative investment experience.

It seems to me that the world has been thinking a good deal about risk and money lately. We manage money for families. We think of our roll as that of supporting our clients in achieving their stated goals. This is an important contribution, one that we don’t take lightly, and I can say very rewarding when it works as designed. Unfortunately, today is the most challenging period for wealth management of my generation. As I write this entry I realize I am writing these posts on Capital Stories to remember this time and what we did and thought as we passed through it. This is as much then for me as it is for those of you who choose to read.

In my view, fixed income investments have been a significant contributor to the financial circumstances in which we find ourselves today. As interest rates fell to 30 year lows, smart people occupied themselves finding ways to increase yield. They captured more and more risk to do so. When this risk manifested itself, investors and the sponsors of these engineered products took the hit.

Our clients have to be confortable with what we do now. Confidence is the key to future performance in that rash, emotional decisions without vision will cause the greatest losses. What we should review is our allocation to the fixed income asset class. For our clients we will concentrate on arranging maturities so that guaranteed assets mature each year to satisfy their income requirements from the portfolio. It seems to me that if a family can see where their spending money is coming from 3, 4 , 5 and perhaps 6 years in the future, our suggestion is that with the remaining capital, they can have the confidence it takes to let their longer term return assets run the course.

(Click on the chart to see a bigger version)

This chart represents my attempt at defining a normal or ”equilibrium” return to equity markets. The data starts in 1970.  Each value represents a 15 year compounded return for a portfolio comprised of one  third Canadian equity, one third US equity and one third international equity.  I think this is a reasonable period in that each data point considers at least two market cycles.The lowest 15 year period equals 8.5% and the highest, just shy of 20% compounded return. If this year ended at the values we are at today the 15 year return will be about 6%.

So how can this data help us?  Should we expect better return in 2009 and can we define what that amount might be? Unfortunately, with all due respect to market strategists and technical analysts, the investments markets are not so easily mined . The risk to equities is not altered by recent experience. We continue to have a random outcome in the short term. Cheaper doesn’t mean less risky. As my friend Brad Steiman from Dimensional Fund Advisors likes to say “stock prices have no memory.” While our expected return may be higher after a large correction  it comes with the cost of higher risk.

I think the most sensible approach is to build more efficient portfolios. If we focus getting the return provided by  the broad markets we end up with ample reward to our efforts. Our investment success should not be determined by “when” the return shows up but rather by how we participate when it does.

I will provide more detail on how we build better portfolios in future posts.

Raising money right now is expensive. For corporations, the ability to get credit is shrinking while the price, or interest rate is rising. The public stock market decline has also made selling shares to fund expansion and or general operations less likely. All companies, private and public are now working on this problem. The biggest pressure will come to bear on new ventures and expansion plans. This new challange will relate directly to economic growth rates in the next few quarters. Good companies will need to find ways to reduce their reliance on outside, expensive capital.

Investors face the same issue. A balanced asset allocation may allow you to avoid selling equity investments in this environment. Drawing down on cash and fixed income assets eventually results in a riskier portfolio but can afford you the time to make a more informed decision. In general, portfolios with sufficient cash flow have much greater financial flexibility during this difficult period.