Investoid

The Loonie has been hitting 30 year highs against the US Dollar over the past week. There are several factors contributing to the rise in the dollar versus the USD, namely:

• A stronger economy vis-a-vis the US, with our quarterly GDP numbers above 3% while their are lower than 1%
• A potential for higher interest rates in Canada, as our economy is facing core inflation above the Bank of Canada’s target rate
• An overall weak USD environment, with the greenback facing downward pressure against many major currencies

The appreciation of the CAD has implications for retirement portfolios as well as short term investing. There has been some debate as to whether you should think about currency fluctuations if you have a long term view (see this Canadian Capitalist post for instance). While I think it’s hard to determine where the currency rate will be in the far future, I definitely think it’s important to consider the current exchange rate in based on historical context and react accordingly, since there is a fairly high long term volatility in exchange rates.

For instance, I have grabbed the monthly average CAD/USD exchange rate data from UBC’s exchange rate service, from 1971 (when Canada started floating the exchange rate again) to present. As you can see in the graph below, the long term (10+) changes in the exchange rate are anything but steady. They wash out over time for certain periods, but it is definitely not the majority of the time.

The average absolute deviation in average monthly prices over rolling 10 year periods is 16%, with a standard deviation of 12%. The average absolute deviation in average monthly prices over rolling 20 year periods is 24%, with a standard deviation of 10%. This indicates that exchange rates can be quite volatile over the long run.

Despite this volatility, there is an interesting cycle that takes shape. We see a cyclical rise and fall in the value of the CAD over time, with a somewhat random periodicity. Nevertheless there is a clear floor and ceiling in this currency pair’s chart. As a result I don’t think we’ll see an ever-appreciating CAD against the USD. Beyond the technical reasons, I don’t see Canada outperforming the US economy in the long term, due to their higher productivity, innovation, and financial power. But there will be times when commodities have a higher value (like now), which will inevitably give us stronger growth for periods of time. Thus, I see this oscillating graph continuing in the future.

I think we’ll have a strong dollar for at least a little while, but I believe that at some point the trend will reverse and we’ll see a reversal of this trend. As a result I am looking at buying more US assets for my accounts in the near term, since I have a long time (decades) until I will require the funds back in CAD. At some point I will be able to sell my USD assets at a better exchange rate.

For short-term investors with risk capital, going long on the CAD over USD seems to be a pretty safe bet. I would wait for news days that favour the CAD, follow the trend, and close out your positions before the end of the session.

Note:Since forex trading is a highly leveraged game, I have abstained from investing in it as of yet. In time I will investigate it more, but at this point it isn’t on my radar.

The Bank of Canada is indicating that it will raise interest rates in the near future. While inflation has been running above the BoC’s target for sometime, so-called ‘core inflation’ is now also above their comfort zone. Any interest rate hikes will have at least some effect on the economy and the current bull market we’re in.

In general, interest rate hikes are used to slow down a strong economy by making the cost of doing business (and personal living) greater, thus impeding consumption and investment. The bank has a fine line to walk between slowing down growth and causing a recession, the latter of which occurred in the early 1990s when interest rates went quite high to tame inflation.

In the markets, the financial sector is the most affected by interest rate hikes, since it directly affects their bottom line to a high degree. Highly leveraged companies will also face increased costs immediately and/or over time, depending what type of debt structures they have in place (eg. revolving credit, bond issues, etc.).

Since it’s unlikely that the bank will increase rates more than 0.25% in the upcoming move, I wouldn’t change my medium or long term investment plans around it. As I said above, the financial sector is likely to incur some short term pain so there could be some good buying opportunities in that industry. If you’re worried that there will be an elongated period of rate increases, then look for interest rate-insensitive companies, and move into more stable, slow growth companies. If the economy slows, profit growth will as well which will affect higher P/E companies more profoundly.

Like a lot of other bloggers, I think RBC’s (TSX: RY) drop of over 2% on Friday was an overreaction to marginally lower than expected results. As I’ve said before, the value of mean analyst earnings estimates is dubious at best. As lots of people have indicated, this represents a good buying opportunity to pick up RBC shares at a relatively cheap price.

Since I want to maximize the benefit of this drop, I am looking at an options trade. For instance, the July 07 $60 call options closed yesterday at $1.10, the same price they did on Friday which is where I looked at picking them up at. They had closed at $1.90 on Thursday, representing a 42% drop. As RBC’s price returns to its previous levels in the next few days/week or two, the price in the options should return to close to the level they were at (they may be slightly less due to the time decay).

I am currently in the process of switching brokers so I don’t have funds to trade this right now, but I think it’s a pretty good, but risky, short term investment. I’ll check back by the end of the week and see how the trade is fairing.

Note: this is not investment advice, you must do your own due diligence. Please see my disclaimer for full details.

Because we changed our CIBC Investor’s Edge accounts over to electronic only communication, we received two subscriptions to the National Post online. for one year. I only need the one subscription, so I’ve decided to give away my second one in a contest. Thanks to Million Dollar Journey for the idea - he did this recently on his blog.

So, if you’d like a subscription to the Post for one year, please do one of the following:

• Send me an article about “Why I like to invest”. I’m interested to know why others are motivated to take the time to do their own investing. If you have your own blog, I will link to it at the top of the article.
• Send me a question that you’d like me to answer in a post.

Please have your submissions in by Friday June 1. I will announce the winner on Monday June 4. Please contact me and include your e-mail address so I can send you the information you need to activate the subscription.

I look forward to reading your questions and articles!

I met up with my friend who’s a real estate investor in Alberta. He was bought out of the company he co-founded and is now looking to purchase 20 rental properties with the funds. He is still extremely bullish on the local market, and anticipates housing prices to increase at least 20% annually the next two years. He cites the extremely low vacancy rate (which is project to be 0.5% by 2008), continued low interest rates (and inflation), and the political stalemate over tough environmental laws nationally and globally.

As I’ve talked about before, I think the runup in housing prices has been largely based on fundamentals, although there is undoubtedly speculation in the markets. But I think prices will run into affordability issues soon, and consequently much smaller increases. One mitigating factor to this would be the onset of interest only or adjustable rate mortgages, which would fuel demand even more in the short term.

If prices increased 50% over the next couple of years, Alberta would have housing roughly more expensive than Toronto, which I don’t think is realistic in the short term. Plus, you have investors already diversifying out of Alberta due to opportunities elsewhere, like Saskatoon.

I also think there is some political risk of environmental and/or royalty legislation that could slow down, if not stop altogether, oil sands development. Many of the major producers are already complaining that high costs have forced them to re-think any future expansion. Indeed, one CEO lamented that he would not start the project they are currently working on today if costs were this high when they started. Additional costs could push many to re-think their expansions, given the current price of oil.

It will be interesting to see how the market develops during the peak summer months, which will be a good indicator if the market has plateaued or will continue its run.

I received this question from Jason, regarding high return alternative investments:

“I’m looking to distribute 50K in to some form of investment. My advisor wants to invest into my existing mutual funds, which has roughly 45K. Last year my ROI (mutual funds) were around 9% not to exciting, but it’s a gain.

I would like to make this invest more aggressive than my mutual funds. What option do I have of making a return of 15-20% other than stocks, buying via my financial advisor.”

Note: Jason lives in the United States.

Before I answered this question I needed to understand Jason’s mentality and desire for such a high return. It turns out that Jason views this money not as retirement money but rather as risk capital. He wants to have a solid financial education and is willing to lose a pretty substantial amount of money in the process (but is obviously not intending to do so). While this is a pretty large proportion of his net worth to be using as risk capital, it is his choice to do so and he is well aware of the risks that go along with trying to achieve such high returns.

That said, what can Jason get into? Here are a few of the options I found. Note that most of these involve actually buying stocks, but these stocks are vehicles for other investments.

• Hedge Funds: there are a couple of US-listed hedge funds on the markets, including Fortress Investment Group. Hedge funds have been extremely popular since the bear market in 2001, but their recent returns have been less than stellar compared to the equities market as a whole. Jason may also qualify to invest in a ‘fund of funds’ - a portfolio of hedge funds managed by a third party.
• Private Equity: this asset class has made a huge comeback in the past couple of years. These firms typically buy public companies using large amounts of debt, turn around their operations and/or break up the company, and then usually spinoff the asset(s) back onto the public markets a few years later. There are a couple of private equity firms who are public; the most notable new entrant in a few weeks will be Blackstone. If you want a sector-wide exposure to this area, check out the PowerShares ETF
• Sector speculation: you could choose a sector that looks hot right now (or in the near future), and buy the corresponding ETF. Some examples include a materials or metals ETF, uranium stocks, or energy ETFs.
• Personal lending: if you’re willing to place your money outside your broker, you could go on Prosper and lend to C/D quality borrowers. Returns for this group are around 14-18%, although you must factor in some level of defaults. Prosper uses a fixed 3 year term for its loans, so you must be ready to have your capital tied up for awhile. There is also a lot more work with this option on your part.
• Double return ETFs: there are ETFs out there that attempt to mirror the daily return of an index and double it, each and every day. This means that the ETF is pretty volatile, since your holding period returns (up and down) are compounded daily (ie. just because the market’s up 2% after two days doesn’t mean you’re up 4% - it depends on how much it was up/down each day). Nonetheless these ETFs allow you to speculate on short term runs on indices. I am only familiar with the BetaPro ETFs in Canada, but am sure there are similar ones in the States.

As the number of investors (and their level of knowledge) out there has increased, so too have the options available to the masses. You can structure a fairly aggressive portfolio with low costs today thanks to all the options available to you. Beware of the risks associated with this, and make sure that you understand what chances you’re taking when you’re chasing high returns.

If you have a question you’d like me to tackle, simply contact me.

Besides being super busy with my new house, I have been partially lackadaisical about investing due to the fact that I’m fully invested right now. I have all my RRSP money in stocks and ETFs at the moment, while my discretionary registered trading account is also maxed out.

This has caused my mind to wander away from investing for spurts. While I check up on how my investments are doing regularly, I don’t have as much mental energy as when I’m excited to look into a new investment. So, here are some tips to stay focused when you’re fully invested.

• Stay current: it’s easy to stop reading the business news, flip off BNN, etc. once all your money is in play (especially if you’re a long term investor). But it’s a good idea to check back once or twice a week to see if any major news has transpired that may affect your investments. Since proper financial investment decisions involve assumptions, you need to ensure that your assumptions are still valid.
• Pretend you still have more money: if you’re like me and really get into analyzing potential investments, it makes sense to keep doing this regularly once you’re fully invested. You might come across investments with higher return potential, and you may want to switch out of an underperforming asset. Be careful that you don’t start flipping assets too much though - only sell out of an asset if there’s a good reason (which is another blog post entirely).
• Periodically review performance: once you’ve made your investments, it’s good to review their performance on a quarterly basis. As I’ve talked about before, it’s important to look at holding period returns instead of the return since time of purchase. Look at all your investments over the same time frame. Make sure you don’t review too frequently though - you risk over-analyzing brief dips in performance.
• Do portfolio comparisons: when your portfolio is set, it’s good to look at the overall asset allocation and ensure you’re not too heavily weighted in one area. It also becomes an interesting exercise to look at the major holdings of portfolios you are interested in (be they active or passive) and see how your actual holdings, sector allocation, etc. compare. Even doing this with your friends’ portfolios can provide insight into what you’ve bought and why.
• Reallocate when necessary: it’s a good idea to rebalance holdings when you’ve had a strong period of performance from an asset class. Unlike performance reviews, I think this should be done on an as-needed basis. Have a target range for each holding/sector and rebalance once the asset is outside of that range. Bonus: since you have some funds when you rebalance, you get to do all the exciting “what should I invest in” analysis again!

The key is ensuring that you don’t face ‘portfolio drift’. By staying on top of your holdings, you will increase your returns and also keep you mentally in the game.

I just wanted to apologize for the sparse amount of posts the past couple of weeks. It has been very hectic getting ready to move, lining up contractors in this white-hot construction economy, and also working on my consulting work. I hope to rectify this next week once we are in our new house.

In the past 8 years I’ve used four different brokerages - both for professional and personal purposes. As a result I’ve learned a bit about the what the industry has to offer, but by no means have comprehensive knowledge on how all the brokerages work. I am going to start reviewing about the brokerages I’ve used. I’ll start off with CIBC Investor’s Edge.

I started using CIBC in late 2006 after I received my buyout for my wife’s and my RRSP plans. I was attracted to their offering due to their low cost (free if you meet their account minimum) self-directed accounts, and the fact that it was easy to transfer money into the accounts from our PC Financial bank accounts.

The Investor’s Edge website is fairly functional. Trading is intuitive, although I don’t like how many steps you have to take to get real-time quotes. Like most browser-based trading systems, you must hit refresh to get updated quotes, which is a real pain after you’ve used push-based systems that update when a trade is made or a new bid/ask offer is placed. An auto-refresh feature that can be set to 1-60 seconds would be helpful.

In terms of trading fees, the costs are in line with that other big bank brokerages charge, which means they are relatively high. I’m not planning on doing a lot of trading in my RRSP accounts due to the long term buy & hold strategy I have, so for me trading costs don’t have to be the lowest available.

A big feature of the self-directed accounts is that you get access to some good S&P stock research (mostly for US equities), as well as all of CIBC’s analyst coverage. I’ve found this to be an excellent resource, as I can now get more professional opinion at the touch of a button. I use this in conjunction with what I have available through my TD Waterhouse business trading account to get a more complete picture on stocks I’m analyzing or to identify macro trends.

I have enjoyed CIBC’s customer service as well. I have called them repeatedly over the past few months and have had to wait no more than 2 minutes to get a real person on the phone. In most cases I have had immediate contact with a person, which is a very nice feature. Their staff has been relatively knowledgeable and friendly.

I did have one issue with them recently regarding my Home Buyers Plan withdrawal. I had faxed in my withdrawal application last month and wanted to ensure I would have adequate time to get my funds to our bank. I called back a week later to see how things were progressing and I was under the impression that everything was fine. When nothing had moved another 10 days later, I started to get worried. It turns out that the fax had never been received. Needless to say I was a little miffed, especially since my house closed in 7 days (6 now). When I explained this in a cover letter for my fax, CIBC promptly transferred the funds. While I was frustrated with their error, I appreciated their quick reaction to the situation.

Overall I have enjoyed CIBC’s service and plan on continuing to use them for my RRSP plan.

I was reading an Edmonton Journal article on Saturday that contained some Q&A from the recent Berkshire Hathaway AGM. Warren Buffet and Charlie Munger had some memorable quotes during this session and I thought I’d share a few with you:

“There are more problems with having the wrong managers than having the wrong compensation system.”

The nature of private equity activity is that the score doesn’t get put on the scorecard for a number of years, so the investors won’t leave. What will slow down the activity is if yields on junk bonds became much higher than yields on high grade bonds.

“Investing on paper and investing with real money is like the difference between reading a romance novel and doing something else; there is nothing like having a real experience in investing.”

“It isn’t the derivatives themselves (that will cause a bubble). But the usage of them on an expanding basis in more and more imaginative ways introduces more and more leverage into the system.”

“If we’re in an oil stock it’s because we think it offers value, not because we think the price of oil is going up … We like best those businesses that require very little capital, because you can’t have a business with huge capital expenses year after year and end up with a high return business.”

I think this last quote is the most relevant to helping amateurs with investment selection: Berkshire’s magic formula is based on finding low capital intensive, high cash flow businesses. Typically these types of business will have high dividends and/or stock buybacks and/or strong acquisition growth.

I recently bought The Tao of Warren Buffet for a friend’s birthday and found that there were many good quotes in it about business, investing, and life. While some of the quotes in it are already well documented, there were many that were interesting views on Warren’s overall worldview. If you’re looking for a quick read with profound meaning, I suggest you pick it up.