Foresight - Summer 2021

Although global economies continue to struggle to find their way through the current health crisis, global equity markets remain very robust and, in most cases, at or near all-time highs. It is not surprising to see equity markets rebounding sharply from the Bear Market lows of March 2020; however we are very pleasantly surprised to see global equity markets above pre-pandemic all time highs. As a proxy for global equity markets, the iShares MSCI World Index ETF (XWD) is 9.9% above its pre-pandemic all time high set in early 2020. This performance has been led by the United States-the US S&P 500 is up 23% from all time high set in February 2020. Meanwhile, the Canadian market (TSX) is up 9.9%. These returns are “price-only”, ie do not include the dividends investors receive as well over this period. A remarkable run indeed.

As global economies recently have entered their recovery stage, Canadians have seen the first signs of inflation (April CPI up 3.4%) and the United States (April CPI up 4.2%) and, yes, bond yields are rising in both countries. For a more full-some discussion of inflation and its expected effects, refer back to our Winter 2020 Foresight which can be found on our website. The approximately-1% increase in 10-year bond yields and 1.2% in 30-year bond yields may not seem like much; however an increase off such low levels does have a significant impact on bond prices. For instance,  the iShares 20 + Year Treasury Bond ETF (TLT) is off 21% and the iShares Canada Long Term Bond Index ETF (XLB) is off 16 % from their recent 12-month highs. If these were stocks, we would be calling this a Bear Market! We have positioned our bond portfolios to mitigate against rising bond yields by maintaining a portfolio of shorter-duration bonds, floating-rate bonds and inflation-hedged real rate of return bonds. These bonds have seen very little price adjustment during this recent jump in bond yields, ranging from flat for floating-rate bond ETFs to down 2.4% on 1-to-5 year bond ladder ETFs.

In 2021 we have been working actively to take some selective profits in the equity portfolios, whilst maintaining participation in the long-term growth in what will be a “new normal” economic environment, post-pandemic. Last November we made a significant shift in our Canadian equity portfolio by selling our index-based TSX 60 and Completion ETFs and replacing with the BMO Low Volatility Canadian Equity ETF. This ETF is structured to hold a portfolio of low-beta-weighted companies that have less volatility than the overall market. These companies may not participate on a 1:1 basis on the upside of a rising market; however over the long term they can outperform the market by not falling as much in a down market.

As we look out to the new global economy in the coming years, we have repositioned the equity portfolio’s industry sector weightings: reducing our resources sector (specifically energy) and increasing our utilities sector (specifically renewable resources).   

Our resources sector holdings are made up of energy (oil), metals (nickel, zinc, copper, gold etc.) and a small weighting in forestry. Not long ago, energy made up the majority of our resources holdings. Today our direct holdings in resources comprise 40% in energy and 60% in metals. We first started buying renewable resources companies in 2013; however our available selection then was very limited and relatively small. Today, our direct holdings in renewable resources make up 30% of our direct utilities sector and 40% of our direct energy sector. We expect the renewable resources weighting to grow in our portfolios in the coming years.

In analyzing our real estate holdings, we ascertained that, even though we expect to see more normalized work and shopping habits return to the post-pandemic economy, we do not believe the “new normal” will return fully to pre-pandemic habits. Instead, we foresee that a higher level of working- from-home and shopping online are here to stay; thus, our appetite for owning office towers and shopping malls for the future has diminished. We began looking for a real estate asset that isn’t facing virtual competition like online shopping does for brick and mortar retailers. Mid-market apartments fit that profile nicely and the Equiton Private Residential REIT was added to our portfolios.

Continuing with our theme of lowering volatility in the portfolio while maintaining  growth participation, we have added the CI Munro Alternative Global Growth ETF to focus on the high growth global themes of climate, digital enterprise, health, high performance computing, digital payments, E-commerce and internet disruption.

Preferred Shares....be aware

The purposes of the fixed income component of your portfolio are a) to provide cash flow by way of interest income, b) to ensure that you have access to cash when you need it, with little or no market risk and c) to act as a volatility dampener to the stock side of your portfolio.

Recently we have had several new client portfolios arrive with 100% of their fixed income portfolio held in Canadian preferred shares. Although we also own some preferred shares in your portfolios, we tend to keep our non-government fixed income holdings (corporate bonds & preferred shares) to approximately 10%, not 100%, of the fixed income portfolio. Canadian corporate preferred shares do provide a superior cash yield to government bonds, as well as the enhancement of the dividend tax credit in taxable accounts. For instance, the iShares Canadian Preferred Share ETF (“CPD” - a basket of preferred shares) is currently yielding 4.1% vs Government of Canada 5 year bonds (.82 of 1%) and 10 year bonds (1.4%). A very healthy premium indeed!

Many investors seeking yield (“a” above) stop their analysis here and don’t look at the other two purposes of a healthy bond portfolio. Many preferred shares are perpetual, meaning they never mature. Thus, the only way to liquidate the position is to sell it in the stock market. As perpetual fixed income securities, preferred shares, like long-duration bonds, are subject to significant swings in their pricing, resulting from increasing or decreasing interest rates. Several years ago, due to low interest rates and the fear that interest rates had to begin rising soon, preferred share issuers “sweetened” the offering by including 5 year “resets” to the yield. This incented the ownership of preferred shares as they would not be locked into the current low interest rate environment of the day. However, investors did not foresee rates going lower over those next 5 years. When the resets started to kick in and lowered, not raised, the dividend yields due to the falling interest rate environment, the iShares CPD ETF saw its share price decline approximately 35% over the following 3 years.

Preferred shares do not come with a government guarantee of the return of the capital invested. Furthermore, as a corporate security, they are subject to sentiment swings in their share price, much like the underlying common stock of the company. In fact, did you know that in the recent global Bear Market of March 2020, the iShares CPD ETF had higher volatility than the TSX - falling approx 37% (“c” above) vs the TSX which fell approx 30%.

If we had held only preferred shares in our fixed income portfolio in March/April 2020, we would not have chosen to sell them at 37% discount to fund the purchase of equities “on sale”. Rather, we were selling conventional fixed income bond ETFs at the tiniest discount (“b” above). This allowed us to make that trade in 2020, which was rewarded with many 60-70% one year returns on the bank stocks we bought.

Like global stocks, Canadian preferred shares have had a significant rebound….increasing 76% off their Bear Market lows and 14% higher than pre-pandemic levels. That said, CPD is currently trading 17% below the levels of 2010 through 2013. For long term holders of Canadian preferred shares, the higher annual yield has only marginally covered the loss in share price.  In our opinion, with preferred shares having only one of the three components required for a healthy fixed income portfolio they should only comprise a small portion of the portfolio.

Lastly, we diligently practice “tax-smart” investing across RRSPs, RRIFs, TFSAs and Trading accounts. For preferred shares, this means owning them in Trading accounts, preferably, if available. We do not see this practiced in other portfolios. 

Keep your cool….?

It is late September 2008...it is mid March 2020...the world’s stock markets plunged on the news of the day. How did you feel? What did you do? Regrets? Pat on the back?

Imagine, for instance, the last 20 years of world stock markets. That’s roughly 5,000 trading days! In each one of those days, you implicitly made decisions re your investments… including ACTION (buy/sell) and INACTION (hold’em). Hold’em means you take the ride of the ups-and-downs and maintain your position. “Buying” means adding something that you hope is cheap and going up, and selling means unloading something you think is going down and sitting on the sidelines. What if you were wrong, and it did the opposite?

Lets imagine you have a proclivity to jumping off and lets imagine further you sat out .002 of those 5,000 days (10 days) which happened to be the ten best days in the 20 years. Guess what those 10 missed days would do to your 20 year return.

According to J.P. Morgan Asset Management, did you know that indiscretion for the best .002 of 5,000 days of the S&P 500 index, for instance, would reduce your 20 year return BY MORE THAN HALF?  And what if you missed the best 30 days in 5,000 days? Your 20 year return would be negative! Worse still...7 of those best days showed up within weeks of the WORST 20 days!

 The Canadian stock market and a diversified portfolio

Occasionally we have the opportunity to review portfolios managed elsewhere. We have noticed a concerning theme in a number of these portfolios: the presence of “home bias” – the tendency to invest heavily in the domestic economy. Our Canadian stock market skews heavily towards the Financials, Energy, and Materials sectors, lacking the diversity of the global, U.S. and European markets. Did you know that these three sectors make up over half of the Canadian stock market? Energy and Materials alone make up a quarter of Canadian equities, and they experienced negative returns over the past 10 years. Further, did you know that those invested only in Canadian equities are practically excluding the Technology, Health Care and Consumer Discretionary sectors? And these sectors all saw double digit annual returns over the past 10 years. The tables below show the relative weighting of these sectors globally and in Canada, and their 10 year annual compound returns.

The Canadian stock market is missing…

May 2021	Canadian weighting	Global weighting	10 year annual return - Global
Health care	1.4%	11.7%	10.9%
Consumer discretionary	4.0%	12.8%	11.7%
Technology	9.5%	21.0%	19.5%

Heavy Canadian sectors...

May 2021	Canadian weighting	Global weighting	10 year annual return - Canada
Financials	31.9%	14.5%	6.6%
Materials	12.8%	4.8%	-2.2%
Energy	12.6%	3.2%	-9.1%

Consistent with environment sustainability initiatives, effective October 1, 2021, NBIN will commence charging for paper statements and trade confirmations. The objective is to encourage people to shift to electronic delivery. Paper trade confirmations (as applicable) will be charged $2 per trade and billed monthly. Paper monthly statements will be charged $6 per quarter. Your June 2021 statements will include a message from NBIN regarding these upcoming fees. We would advise shifting to online statements and trade confirmations, if you have not already. We would be happy to help with the transition. If you have any questions or concerns, please feel free to give us a call. 

CONFLICT OF INTEREST DISCLOSURE

The Securities Commissions have initiated in 2021 a series of Client Focused Reforms, directed at investment managers and their clients. The “changes” are in three areas: “Know Your Client”,  “Know Your Product” and “Conflict of Interest”. We are charged with developing internal systems and protocols to deal with the first two. We are obliged to report to you directly with regards to the last of these three.

Examples of potential conflict of interest include:

Third-party compensation to us: We receive NO compensation from any third party for managing your investments. The fee you pay us, as drawn periodically from your accounts, completely constitutes our revenue source.

Internal incentive compensation to our staff: Our staff receive NO compensation for directing client funds to specific investment vehicles.

Competing interest among clients: The only application is “block trading”, where we sell/buy a security simultaneously for various clients. The trade may execute at more than one market price. Our system at NBIN ensures that all clients involved in the trade receive the same “average” trade price.

Referral arrangements: We neither make payments to any party, nor receive payments from any party, in recognition of a referral. 

Outside business activities: None of our staff dedicate their time to any business except A.F.T. Trivest Management.

Authority over a client’s financial affairs: This is where A.F.T. Trivest Management, or any staff member thereof, holds a Power of Attorney or Estate Trusteeship on behalf of a client. We are obliged to review our operations periodically to identify any material conflicts. If so identified, we are obliged to communicate with the client to describe the conflict and its potential impact/risk, and to communicate how the impact/risk will be addressed in the best interest of the client.