Managed Money Reporter Newsletter — Issue 216, April 2005

Editors: Carl Spiess & Allan McGlade

Featured Articles


Why Diversify?

We all know that chasing last year's winners is not the recipe for investment success.  But what about investing in last year's losers? Does that help returns, or is there an even better way to decide how to invest?

Recently, Templeton published fantastic research on this subject, and the material is on their "Why Diversify" site. The interactive presentation makes the point that trying to predict next year's market is difficult for individual investors (and even the pros will admit to that.)  The presentation is one of the best we've seen, as you can click on each asset class to see when they have performed well or poorly.  

So what if you just have a disciplined approach, that has you allocate even amounts among a diversified set of asset classes each year instead of picking one sector over another?  It sounds too simple to work.

The reality is, that a disciplined asset allocation driven portfolio does generate the best returns in this scenario, and is also the simplest to manage.  In the chart (right), chasing the winners results in $521,601, chasing the losers from last year, $559,247 but investing equally in the 9 asset classes each year results in $622,720.  

Why does this work?  If you click on the Global Equities legend title, you will see that asset class is never the best or worst in any particular year, but longer term, global equities have only had 4 losing years.  Investing in just the winners or losers, completely misses that asset class.  Again, why does this work? Because diversification works.

Please contact us if you want a review of your overall diversification. 

Income Trust Market

Over the last few years, income trusts  have become a phenomenon in the Canadian investing landscape.  Are trusts replacing stocks as the vehicle of choice for investors looking for income from their ownership of a corporation?

No, income trusts are simply an innovative structure to allow investors receive the regular income distributions that a business earns in a highly tax effective form.  So as such, income trusts are not a fad, they are a corporate structure that will be part of the Canadian investment market place for years to come.

The appeal of regular income has been strong for investors, who have driven up valuations of trusts to lofty measures over the last few years.  Virtually any trust (or mutual fund that invests in trusts) has appreciated handsomely since 1999, and many new issues have come to market to satisfy demand.

It is however, important to remember that a trust represents ownership of a business, and in most cases, a stable (e.g. not growing) business.  There is also absolutely no guarantee of a return of capital, or even that distributions will continue at a given level.  In fact, most resource trusts are based on depleting assets, e.g. oil and gas fields, so even with rising oil prices, at some point the well will run dry.  This important fact is often overlooked.

This summer, several trusts are due to be included in the S&P TSX index ,which will certainly drive demand over the short term, as index funds buy up the largest trusts for inclusion in the index.

So, like dividend paying stocks, trusts can make up a portion of an investor's income portfolio.  But it is always important to diversify. It is for this reason, that we recommend funds that own both stable stocks and trusts. (see our list of recommended dividend funds).  Both the Dynamic Dividend and Maxxum Dividend funds have income trusts for approximately 25% of their portfolios, however the managers are not compelled to own trusts should conditions change in the future.  The Scotia Canadian Dividend fund has 11% in trusts at present.

Investing In China

A question we often receive, is how can I invest in future growth of China.  The answer is easy, as there are several China funds available to Canadian Investors and there are also a larger number regional funds  that are exposed to the area. However, the more important question is, should you invest in such a sector specific fund?

Most managers we talk to from our core recommended international funds (Fidelity, Templeton, Trimark etc.) have a very clear grasp on the opportunities for growth in China, but also speak sanguinely about many of the risks.  Most of the managers prefer to invest in companies that have operations or sales in China.  Therefore, they can be exposed to the potential profits to be made, but also mitigate some of the political and company risk, since regulatory reporting and other standards there are still developing.  In addition, by investing in companies that can shift operations, your investment will always be exposed to the next developing areas (India etc.) without you having to time the right moment to move out of China.  

So right now may be a good time to consider adding to your foreign investments.  With potential political uncertainty in Canada for the first time in years, and a rising Bloc Quebecois, calls for the Canadian dollar to reach $.90 US, now seem far fetched.  Owning a more broadly diversified international portfolio will make sense for clients who may be too light on foreign investments at present.

Finally, many Canadian investors have benefited from the Chinese demand for resources, as Canadian resource stocks have done very well over the last few years.  You've been exposed to the growth in China without having to lifting a finger.  Now may be the time to rebalance, and more importantly, be diversified.

Current Interest Rates

Despite all the talk about rising interest rates, the reality is that Canadian interest rates remain very low.  In fact, 5 year bond and GIC rates are now under 4%.  For higher rates, we need to look out to longer terms.

Coupon Bond Issuer Maturity Date Cost Today Annual Yield Value at Maturity
Manitoba Mar-05-10 $8,370 3.71% $10,000
British Columbia Jun-18-12 $7,490 4.11% $10,000
Ontario Aug-07-14 $6,620 4.52% $10,000
Ontario Sep-08-16 $5,900 4.73% $10,000

Fun With Numbers - Build Your Own Index-Linked GIC

Many investors like the idea of a principal guarantee.  Many banks and trust companies offer investments that guarantee your initial investments, and a potentially increased return based on a linked market, fund or stock.  Similarly, segregated funds offer a principal guarantee, but have higher MERs that apply to the full amount invested.

We offer a simpler, personalized, and cost effective way to build your own index-linked GIC.  Let's take a client with a $10,000 and a 5 year time horizon.  We purchase the $10,000 Manitoba bond, above, for a cost of $8,370.  We then invest the remaining $1,630 into the investment that we want to link performance.  We now know that the client will receive all the principal back at maturity, plus whatever the $1,630 is worth.  In a poor market, where the $1,630 loses 10% a year, the $1,630 is still worth over $960, and the overall portfolio is worth $10,960 for a 1.8% return.  If that is in a fund that grows 10% a year for the 5 years, the $1,630 grows to over $2,425, and the overall portfolio matures at $12,425, a 4.8% return.  The principal has been secure, and whatever the fund is worth at the end is icing on the cake.

Of course, any portfolio that is a combination of bonds and funds is a set of individually designed index-linked notes, custom tailored for you.  Please call us for a review of your investments, and we can discuss if we want to add more principal guarantees to your portfolio.

Exchange Newsletter Cover Spring 2005Mutual Fund Reporter Recommended Website of the Month

ScotiaMcLeod Exchange Website - With so much to read each month, we realize you may not have read the insert in your March ScotiaMcLeod statement.  If you did miss it, we would like to draw your attention to the article, which focused on Treating our Equities like Real Estate.  It was written by David Cork, ScotiaMcLeod advisor and author of the best-selling "The Pig and the Python", "When the Pig Goes to Market" and the recently released, "Bulls, Bears and Pigs". David illustrates why investors need to treat their equities like real estate, and take a more passive approach to their long-term investing goals.



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