Foresight - Fall 2021

It is hard to believe we are almost 18 months into a new and unexpected bull market. Equity markets have surprised on both the speed of their recovery and the valuation levels they have reached. We would be ingenuine if we were to say we expected the US S&P 500 Index to double from its March 2020 bear market low of 2200 to over 4400 in August 2021, a level that is 30% higher than the February 2020 pre-pandemic all-time highs of 3390. Post our portfolio rebalancing and equity purchases in March/April 2020, we happily could have sold stocks after a 50% run to August 2020, and yet would have missed the further 33% run they have had since then. What to do in these times? Well, enjoying the ride is a good place to start! How high will they go before we experience a meaningful correction? Should investors sell their stocks and sit on the sidelines and await the inevitable correction? Investors must be careful when they are planning for the next bear market. If the S&P 500 was to drop 20% from current levels (technically a bear market) the index would fall to approximately 3500, which is still well above the pre-pandemic all time highs of 3390.

That said, we continue to monitor portfolios monthly and follow our investment management discipline of rebalancing portfolios in order to maintain the individual asset allocation plan weightings of fixed income and equities. In this run-up, as equities outperform fixed income and become overweight within the asset allocation plan, we will take stock profits and buy bonds to bring the asset allocation plan back into line. When equity markets do correct, we will happily rebalance the portfolios again, this time selling bonds and buying equities “on sale”.

Inflation continues to be a concern. Although, the concern has been flipping from the worry that inflation rates will increase too quickly for the sustainability of global growth to inflation remaining stubbornly low. Our fixed income portfolios have slipped into a slightly negative return in July for the trailing 12 months, due to a slight increase in bond yields. To mitigate against the potential risk to bond prices from higher bond yields, we continue to remain very short term in our bond portfolio, using a combination of 1-5 year bond ladder, floating rate bonds and inflation-hedged real rate-of-return bonds for approximately 90% of our bond portfolios.

Technological innovation continues to drive global economic growth and helps businesses and consumers to adapt to new circumstances, like the pandemic we are living through today. Online shopping, eCommerce, digital banking, and video streaming have seen tremendous growth over the last 18 months and have provided services that have helped consumers and businesses to interact, survive and prosper. It is our view that individuals, families, and companies will adapt to a new normal. There will be new businesses prospering from this changed environment and others suffering and falling to the wayside….’twas ever thus! We share Mark Carney’s dislike of the phrase “This time its different!” The Chicken Littles of the stock market need to appreciate the subtlety between difference in form versus difference in substance. The form is always different...Dutch tulips...tech bubbles….sub-prime mortgages….the substance is not. Thus, responding to new normals must be approached with a steady and calm hand. We look forward to watching how these new technologies will impact  global growth and quality of life and will continue to have our portfolios participate in these opportunities. 

FINANCIAL ELDER ABUSE

As throughout their lives, the Baby Boomer Generation continues to draw attention…. now being the Golden Agers. The simple statistical demographic of the birthrate after 1945 always puts a factual hiccup on the historical data. Boomers over age 65 soon will make up 20% of Canada’s population, and are projected to hit 25% in the near future. The era of their arrival on planet Earth also coincided with relative peace and staggering technological advances in all aspects of living, including health and healthcare. As a result, not only are they a demographic bulge, but one that is blessed with much-increased longevity. They also are the offshoot of “soft statistics”, meaning that society tracks far more “stuff” than it did, or was capable of, in all previous history. This produces hard, valid data today that compares against historically much weaker data.

And so, one of the topics that society now has turned to with the Baby Boomers is “elder abuse”. Again, statistics start to proliferate, where none existed in older times. It is proffered that circa 8% of elders today are subject to some form of elder abuse. Add to that, the asterix that many/most such incidents go unreported. Further, approx. one third of those are related to financial abuse. Despite the fears of family members about telephone solicitations from evil people, two-thirds of the time, the perpetrator is known to the victim, and finally, three-quarters of those are actually the family members themselves! When you drill down through all those stats, it suggests that 1.33% of elders are subject to financial abuse within their family.

Real estate appreciation has skewed paper wealth for many elders, and facilitated access to easier credit through HILOCs, etc. Real estate appreciation also has impacted the trailing generation(s) ability to buy a home, leading to financial support from elders, thus falling somewhere between inter-vivos estate planning and shorting seniors’ financial well-being. Increasing post-secondary education costs for trailing generations also can have an impact on elder financial support, either directly, or indirectly through longer nesting periods.

The U.S. agency FINRA (Financial Industry Regulatory Authority) defines financial elder abuse as any act by a person, including a Power of Attorney, of unauthorized appropriation or conversion of funds/securities, or obtaining of control through deception, intimidation or undue influence.    

Some specific examples of potential financial abuse include:

· Abusing power over financial transactions as a Power of Attorney

· Pressuring to enter into joint tenancy accounts with the elder’s assets

· Abusing power over financial transactions in a joint tenancy account

· Refusing to restitute previously extended loans

· Attempting to limit elder’s spending, in order to preserve inheritable capital

· Attempting to gain access to elder’s wealth inter-vivos

· Withdrawing large amounts regularly, or for unusual purposes

· “Urgency” is attached to the request for transactions

The Canadian provincial securities regulators, through the national CSA, have created Canada’s  response to financial elder abuse. Their new regulations come into force at the end of 2021. The broad purpose is “to enhance protection of older and vulnerable clients by providing registrants (financial advisors) with tools and guidance to address issues of financial exploitation and diminished mental capacity”.

No doubt with the best of intentions, it is a bit of a slippery slope, potentially treading into the sphere of age-ism. Furthermore, the financial advisor community may be drawn into a pseudo-psychologist role. That said, the legal profession has already travelled this path and developed guidelines, particularly for estate work. On the plus-side, the financial advisor community is strategically placed to play the role of whistle blower as they operate on the financial front-line. Some delicate definitions have been called for…..

Financial exploitation is defined as “the use or control of, or deprivation of the use or control of, a financial asset by a person”. The legislation cites examples of warning signs of such exploitation.

Unexplained withdrawals or account closure Unexplained/inappropriate changes in risk profile Request to transfer assets to joint tenancy

PoA directives inconsistent with historical approach Discomfort with investment conservations Attendance of strangers at advisor meetings

 Vulnerability is defined as having “an illness, impairment, disability or ageing process limitation”, and that age solely should not be applied as a marker for vulnerability.

Mental capacity considers the individual’s “ability to understand information that is relevant to their decision-making and appreciate the reasonably foreseeable consequence of making or failing to make a (financial) decision”. The legislation cites examples of warning signs of lacking mental capacity.

Difficulty communicating intent/wishes Difficulty making decisions in financial matters Rapid change in persona in meeting

Difficulty in comprehension or filling out forms Confused with unfamiliar surroundings Memory loss, repeating questions or statements

 In both these lists, the regulators note that one sign alone may not be indicative.

Trusted Contact Person (TCP)

Financial advisors will be required to take reasonable steps to obtain name and contact information of a client’s TCP, including written consent to contact the  TCP in prescribed circumstances. Privacy obligations remain tantamount, so the TCP ought not to be privy to the client’s financial details. A TCP has no direct authority over the accounts.

Clients should seek individuals who are trusted, mature and able to engage in potentially difficult conversations about the client’s personal situation. A TCP is permitted, but not required, for a non-personal brokerage account, eg a corporate account. A client may identify more than one TCP, in, or not in, rank order. TCPs need not be arm’s length, ie they can be family members. TCPs need not be of age of majority. TCPs can also be PoAs, but potential conflict of this dual appointment should be considered. Similarly, the financial advisor ought not to be the TCP.

Role of TCP

· Act as a resource/liaison to client’s legal representatives, eg guardian, PoA, executor or trustee

· Assist in identifying failing mental capacity or exposure to financial exploitation

Starting in January 2022, all new account openings will require pursuit of a TCP designation. As for grand-fathering of all the existing accounts, financial advisors should pursue TCP designations through the 2022 cycle of client contact. A client’s failure to name a TCP does not preclude the opening or maintaining of an account.  

Financial Advisors’ authority

On the basis of a reasonable belief that the client a) does not have the mental capacity to make decisions involving financial matters or b) is vulnerable to possible financial exploitation, the advisor may place a temporary hold on activities in the brokerage account, including:

· Purchase/sale of securities

· Withdrawal/transfer of any or all cash or securities

A temporary hold does not freeze the entire account, but rather on specific transactions as noted above. For instance, the payment of draws for regular expenses, as evidenced by past history, is still permitted. The hold needs to be confirmed to the client “as soon as possible”, and renewed every thirty days if still in place. The hold need not, but could, be conveyed to any specific third party, such as the TCP.

INNOVATION: JANUS

Over the past six months we have been focusing on innovation in your portfolio management. In the Spring issue, we announced our Diagnostic App, named Janus after the Roman god with two faces looking in opposite directions. Our mission here is to monitor both omission and commission in a portfolio… what’s there and what’s NOT there. It is the latter that is harder to see! Thus, we compiled a Core Holdings list and can run it against individual client equity portfolios. Janus brings to our attention what’s not there. This may ultimately lead to actions which will engineer a stronger portfolio. Going forward, we will run Janus periodically on portfolios.

INNOVATION: TAX-SMART INVESTING

We have written extensively in the past on tax-smart investing aspects of portfolio management. These articles can be found in our website Library. In summary, the three kinds of investment accounts that an investor may have (RRSP/RRIF, TFSA and Trading) all have different tax treatments for the different kinds of income (interest, Canadian & foreign dividends, trust income and capital gains/losses). The result is that different kinds of income are better suited to the different kinds of accounts, resulting in a complex mosaic for portfolio engineering. In the financial industry, tax-smart investing is usually confined to capital gains management only… watching the relationship between REALIZED and UNREALIZED gains… the latter not being taxed yet! We have long practiced tax-smart investing in that narrower context. However, this Summer we opined that a broader effectiveness of tax-smart investing should be calculable.  

There are some fundamental constraints here. First, if you only have one type of account (eg an RRSP), then, by definition, there is zero opportunity to engineer tax-smart investing. Even having only two, not all three, types of accounts constrains tax-smart investing. Second, even if you have all three types of accounts, but, for instance, one of the accounts is way bigger than the other two, tax-smarting investing also is constrained. For instance, TFSA accounts typically are constrained to being fairly small due to a) the small annual contribution allowed and b) the short number of years since they were legislated. Third, if a particular account serves the purpose of providing regular cash draws to fund your life style, tax-smart investing may be compromised in the asset allocation sub-strategy in order to support the cash calls. 

We developed and beta-tested two different algorithms to create this broader tax-smart index, and did so on various portfolios. Here is what we learned: on two portfolios, each with all three kinds of accounts, and valued at $1-2M, we saw that the two algorithms provided very similar indices, and that the two portfolios also were very similar….approx 76 & 80% tax-smart efficient.      

In the sphere of Asset Allocation strategy, there are two approaches: strategic and tactical. The former takes a longer view on the market and makes adjustments less frequently, and the latter takes a shorter view which attempts to profit from sectoral momentum and adjusts more frequently. We determined that the same dichotomy may be applicable to tax-smart indexes: a strategic index and a tactical index. The March 2020 Covid Crash provides a good example. When the markets collapsed in March 2020, stocks were now “on sale”. But, there needed to be cash to make the purchase! If cash-raising required selling a stock that had just dropped significantly in order to buy another stock which had done the same, there wasn't a win in this strategy. Instead, that March we were raising the cash by selling bonds whose value had not declined. The ensuing stock purchase subsequently did well: a tactical win. The point is this: strategically holding bonds in a type of account which is not tax-efficient to bonds may be tax-efficient tactically. Therefore, that bond-holding contributes positively, not negatively, to the tax-efficient index.

We applied the tactical approach to one of the beta-test portfolios above, and the tactical index rose from the previous 80% to 90%.