Mutual fund disclaimers

Bad Money Advice, written by a fellow that is apparently a Boston hedge fund manager, writes about how useless mutual fund disclaimers are. Specifically, he quotes a study saying that the insertion of the line “Past performance is no guarantee of future returns” has no bearing on the decision to purchase a fund.

This reminds me of trying to legislate warnings against smoking cigarettes – it started with a small warning on the box saying “Warning: The Surgeon General says that smoking is bad for your health”, but it has progressively stepped up to now, where half the package has a picture of some person that hasn’t brushed their teeth in a century and a picture saying “THIS WILL BE YOU”.

You can take it to the ultimate step of packaging them in black boxes called “death sticks” with skulls and crossbones all over them, and it still wouldn’t matter.

Same thing for fund advertising, except consuming mutual funds will only kill you financially.

Time spent maintaining the portfolio is relevant

There are two reasons why I invest. Both reasons tie into each other.

The first reason is because I want to realize a return on my capital that is higher than the risk-free rate that I would get at a financial institution. Almost everybody invests to do this.

The second reason is because I find it interesting. I genuinely like going through financial haystacks and finding needles, which is what investing is typically like – the only way to get rewarded is to work smarter (employing computers to automate manual work) and harder (doing things that computers can’t). Most value that an individual investor can bring to their own portfolios comes from the latter part.

I do not “day trade”, although there have certainly been moments in my life where I have traded very frequently (i.e. buy one day, sell the next). I have never actively looked at a chart in mid-day and said to myself “that looks good, it must be going down so I will short”, nor have I employed any computer software to automatically pick off technical indicators. I figure that if others are trading purely on price and volume information that they would have me beat by a mile.

However, an important part of individual portfolio management is that because I don’t have an investment committee, my portfolio has to be managed in such a way that I don’t have to spend too much time to “maintain” it. If I had to actively spend 4 hours a day managing positions then investing would not do me much good. Right now maintaining my portfolio is a simple matter of checking for news and once every quarter, read the quarterly report and see if the financial result is roughly in tune with what you (and not the analysts) had expected.

Out of the 10 positions I currently hold, only two of them I would say that my knowledge of their industries is “less than comprehensive”. By virtue of the fact that I expect to get paid off in those fixed income investments, the lack of knowledge is appropriate since I can spend time doing other investment research.

Screening for candidates and determining when to get into positions is the most time intensive part of investing. In this process you discover candidates, look at valuations, and determine whether something is worth ploughing capital into. If not, what price? If so, what are the exit conditions? Obviously price is one, but another exit condition could be a change to the industry, or some other information that usually is not considered at the time of initial purchase.

There is also the time to know when to not bother looking. The worst trades are marginal candidates that you put into the portfolio just because you want to be “fully invested”. While marginal trades such as these in fixed income securities are less punishing than in the equity world, both serve to deprive an investor of their ability to maximize their returns – having cash in a major down market is the best way of ensuring superior returns.

I have been doing some research, but have found marginal candidates. I don’t have much solid conviction behind this market, other than the fact that it seems to be pricing in an economic recovery which I believe is occurring, but I do not think the market is seeing further out than 2011 at present. 2011 should be a banner year for corporate profits; however, 2012 and beyond will likely be more shakier. One of the reasons is due to inventory buildup. I don’t know if the markets have priced in the post-2011 world yet of “back to normal” tepid growth.

In the meantime, I will continue looking for needles, hopefully not hypodermic.

Living off of government benefits

There is an article in the UK that describes a family with 8 young children, and the husband quitting his job because the benefits they get from the government are higher. Their take-in is about £815/week which is about £42,380/year, or about CAD$65,100 using current exchange rates.

I do not know whether the numbers are correct, and I highly suspect the article is designed to be inflammatory. I also have no idea what specific social benefits are available in the United Kingdom.

However, I have pondered what somebody in Canada or British Columbia could get if their goal is to minimize work and live off the government. I can’t think of a situation implied like the above article where you effectively have an over 100% marginal tax rate for working. There are situations that come close. There are hypothetical scenarios if your job in life is to maximize government benefits. Note the majority of these use the most current up-to-date 2010 figures, but some 2009 figures may have inadvertently slipped into the following calculations:

1. Assume you have 1 child. This will qualify you for a lot of benefits. It’s also usually better, for government benefits purposes, that you are single as having a significant other making money seriously impairs your ability the claim the benefits discussed below. If you do desire a significant other, do not marry them and live in separate accommodations will maximize the ability to obtain benefits (for you and them!). Having two children will decrease the marginal benefits received compared to having one child.

2. Earn $21,816 in the year. This will qualify you for the following PROVINCIAL benefits:
Full MSP assistance (free for those under $22,000/year, a $1,224/year annual benefit). I am also assuming no benefit with respect to Pharmacare (which has a lower deductible for lower income individuals).
– Starting July 1, 2010, the BC HST credit (for a family under $25,000/year, a $230/year annual benefit plus $230 for dependent)
Climate Action Dividend (for a family under $35,843/year, a $105/year benefit, plus $105/year for first child)
BC Tax reduction credit, essentially a non-refundable reduction in the income tax rate for low income individuals (for $17,354/year, $390/year benefit, reducing by 3.2% above the limit, so in this specific example, $247.22/year benefit)
BC Child Care Subsidy; while the requirements to qualify are not specific (they do not give a monetary threshold) this would qualify for up to a $750/month ($9000/year) subsidy for early child care. I am not factoring this in to any future calculations in this post.

You will make too much money and miss out on:
BC Sales tax credit (for a family under $18,000/year, $75/year annual benefit, reducing by 2% above the limit) – I believe this might be phased out with the BC HST credit.

3. A $21,816 income will qualify you for the following FEDERAL benefits:
– Assuming you were working at $21,816/year before having the baby, 50 weeks of Employment Insurance benefits of $230.75/week, or $11,537/year.
– The child will enable you to receive the $100/month Universal Child Care Benefit (UCCB), which is $1,200/year until the child turns 6 years old.
– Federal GST/HST credit (up to $32,506/year income, annual credit amount $631/year with the child)
Working Income Tax Benefit (WTIB), which is complicated to explain the actual calculation in a sentence, but for a single mother of one child making $21,816/year, works out to a refundable tax credit of $751.28/year.
Canada Child Tax Benefit and National Child Benefit Supplement and BC Earned Income Benefit – under $23,855/year income, the benefit is $3,528.84/year.
Canada Learning Bond (CLB), which if you open up an RESP for your child (not frequently done I am sure) will result in a $525 benefit in the RESP immediately, plus $100/year providing you qualify for the National Child Benefit Supplement.

4. Live in social housing or get rental assistance. Although it was difficult to find exact numbers to work with, apparently you can get rental assistance that will net out your rental balance to 30% of your net income. This is also why it is important to keep your income relatively low if your job is to maximize government benefits. If you earn $21,816/year, this will result in an effective rental rate of $545.40/month, which is significantly under market in Vancouver. I am going to take a gross approximation and assume $1,000/mo for a 2-bedroom apartment somewhere in Greater Vancouver which would be a subsidy of approximately $455/mo or $5,460/year.

You add all of this together and get the following results:
a. Excluding EI (which you can claim a credible argument for having paid into the program by virtue of being employed), you will receive approximately $8,252.34/year of either cash payments or payments that are otherwise mandatory that you will not be required to pay; this does not include social housing benefits, and I am excluding the RESP boost since almost nobody will be taking this option.
b. With social housing, that goes up to approximately $13,712/year.

So somebody earning $21,816/year (note: this is about $10.50/hour, full-time 40 hours/week) with a child will be receiving a subsidy of about $13,712.34. This is about 63% of their existing income level. In terms of their income statement, it would be this:

Salary – $21,816
Minus: CPP – $907
Minus: EI – $377
Minus: Income taxes – $0 (none; the child vastly increases the tax credit amounts available to the parent, plus provincial taxes are reduced to zero by the BC Tax Reduction Credit)
Net cash from work: $20,532

Add all of the following:
BC HST Credit: $460
BC Climate Action: $210
UCCB: $1200
GST/HST: $631
WTIB: $751
CCTB and supplement: $3529

Net cash after benefits: $27,313

Minus rent: $6545 (30% of income, assumed to be the “salary” in this case)

Net: $20,768

This is a good sum of money after taxes and rental. Looking at my own personal budget, assuming I had the appropriate rental subsidy as #4 above, I would actually be pulling in a mild surplus. The only real difficulty is the ability to maintain work while taking care of the child at the same time (not easy!).

Now, let’s assume that you earned $35,000/year ($16.83/hour for a 40 hour/week full-time job) as a single parent. This is the most you can earn and still be eligible for social housing benefits. This is how the math would work out:

Salary – $35,000
Minus: CPP – $1559
Minus: EI – $606
Minus: Income Taxes – $1968
Net cash from work: $30,867

We now factor in the benefits:

Minus: MSP – $1224
Add: BC Climate Action – $210
Add: UCCB – $1200
Add: GST/HST – $506
Add: CCTB and supplement – $2185

Net cash after benefits: $33,744

Minus rent: $10,500 (30% of income, assumed to be the “salary” in this case)

Net: $23,244

The difference in earning $13,184 in more pre-tax income will translate into approximately $2,476 in disposable cash after housing rental payments. While the effective marginal tax rate in these circumstances is below 100%, it is quite high (81%).

The quick conclusion that I have is that there is a high level of incentive to work part-time if you are in a middle-wage job if you are single and with a child. For example, if you are working in a clerical type job with a moderate amount of experience, the cost of having to stay at home one, two or even three days a week without pay is not that financially punishing because the government subsidies significantly make up the shortfall. Especially when you net this out with the cost of childcare, it is easy to see how people in BC that value their time more than their money would purposefully keep their income levels below the specified thresholds in order to maximize their government benefits.

The Emergency Fund concept

In a lot of basic financial advice that I read, there is usually the mention of the concept of an “emergency fund”, which is a cash stash that can be deployed in the event of unforeseen emergencies (e.g. losing your job, medical emergency, etc.).

Maintaining a cash reserve to survive many months (ideally a year) in theory is good practice. It is very difficult to run a completely leveraged lifestyle (typically known as “paycheque-by-paycheque”) because it does not take many external circumstances to impact your financial situation. However, if you have cash-like assets that can be liquidated at a moment’s notice, then it makes the concept of an emergency fund highly redundant. You can be impairing your returns by having capital deployed in low-return products.

The question is a matter of resource utilization – keeping the cash literally stored as pieces of paper (hundred dollar bills) underneath your mattress surrenders any ability to gain interest, and present a security risk if you are robbed, or if your house goes on fire. So keeping the cash in a risk-free savings account (e.g. Ally offering 2%) is the next best alternative. For most people, this is probably the best option for the “emergency fund” since their decision-making abilities to invest the proceeds might incur negative expected value.

For most financially sophisticated people, seeing the cash stored at a fully-taxable 2% might be a bit unbearable, especially when one considers that it will be a below-inflation return. Where else could you put your emergency stash? You could move into short-term corporate bonds of stable companies, but in this low interest rate environment, would be unlikely to yield more than 2%. The next step up would be preferred shares, but that entails the risk of principal loss in the event of an untimely liquidation.

Finally, this leaves longer-term maturity corporate/government debt or even low-risk equities (e.g. utility companies with stable yields). You can see why “chasing yield” becomes dangerous – as long as bond/share prices remain stable and keep pumping out the coupon payments or dividends, you feel “safe” (a very dangerous feeling in finance if you are expecting a high reward for your “safe” risk). But it only takes a 2008-type event before everything gets flushed in the marketplace. Still, there were quite a few securities out there that were relatively unaffected by the financial crisis, and you can assume they will be an acceptable risk for emergency fund capital.

Giving a numerical example, let’s say your lifestyle requires you to save $25,000 to maintain a one-year operating cash cushion without drawing any subsequent income. If you had invested the money in a short-term savings account, and had your cash-requiring emergency at the same time as the 2008 financial crisis, you still would have $25,000 in principal to draw. A few button-clicks and you will magically have $25,000 at your fingertips.

However, let’s assume you wanted to reach for yield and invested the $25,000 in a TSX index fund at the beginning of 2008. The peak-to-trough amount the TSX dropped in 2008 was 42%. So had you been forced to withdraw proceeds at the bottom of the market, you would have had $14,500 left.

This would suggest that an emergency fund, if invested in a broad-based index of equities, should be about 1/(1-0.42) = 1.73 times larger than the amount you actually need to operate. So your $25,000 emergency fund, if you want to invest them in equities, should be around $43,000 if you want to be able to have a large degree of confidence of being able to withdraw $25,000 even in the middle of a 2008-style financial crisis.

This type of math suggests that people with about 1.73x the assets required to maintain their lifestyle in the event of an emergency should really have no emergency fund at all.

If your remaining assets are in safer securities, such as secured corporate debt, the impact of a 2008-type financial crisis is significantly less; there were plenty of corporate debt issues which barely budgeted during the crisis. As an example, the debentures of a company like Penn West Energy Trust (where their ability to pay out principal is never really in doubt) fell about 10% during the financial crisis. If you could structure a portfolio around such securities, then your ratio would be about 1.12x – or about $28,000 of the “emergency fund” invested in corporate debt.

Buying stocks on margin is dangerous

Time Magazine had an article about two university economists proclaiming that young people should go on margin when investing in stocks. They came to this determination after mining the 130-year set of historical data, and taking into consideration 45-year investment periods. They suggested a 2:1 ratio.

So for example, if you had $5,000 sitting in the bank, you should go and purchase $10,000 in stocks. I would not suggest this.

David Merkel (who incidentally writes probably one of the best pages on the internet regarding real-life economics) blasts the argument for many reasons. I want to elaborate on the first counter-point, mainly that mining historical data is not sufficient to determine a future course of action.

Whenever you walk into the office of a financial adviser (salesman) person at a retail bank, the most frequent chart you will see on the back wall is the Dow Jones composite index, roughly from 1900, in non-logarithmic format (designed to make the 1929 and 1987 market crashes look like nothing). They will usually give you a pitch how the stock market, on average, has gone up 9% (in nominal, not real terms) a year since eternity and therefore, your money should be invested in some equity fund that the adviser will presumably make a healthy commission selling.

The assumption that the markets will continue going up 9% a year in the long run is incorrect. If you believe this, you will lose money.

Throughout history, markets in countries have a frequent habit of collapsing. Around 1900, the top three capitalized stock markets were in the USA, United Kingdom and Russia. Not many people would have guessed Russia, but we all know what happened after – they were utterly destroyed after the Bolshevik revolution in World War 1. In fourth place was British India, and that country looks completely different (consisting now mainly of Pakistan, India, Bangladesh) than what it was back during the dying days of colonialism.

It is very difficult to predict whether the USA will still be around in 100 years, let alone compound market gains by 9% a year.

The other comment I will make with respect to buying stocks on margin is that even if you know what you are doing, it is very psychologically difficult to watch positions go underwater when on margin. Typically you will be receiving a good (low) price during periods of very intense volatility, and it is very unlikely that you will be receiving the “best possible” price had you looked at a chart 6 months in retrospect. There are far too numerous examples of this in my own life, but one was during the middle of the financial crisis in March 2009, when ING Group’s hybrid debt was cratering:

Recall that par value on the above issue is $25, and the coupon is 6.125% given out quarterly. Looking at my own trading records, I see I purchased shares between $6.26 and $4.70, which would have equated to a 24.5% to 32.6% annual yield (assuming they do not default). The best price I could have received is $2.83, or a whopping 54% annual yield! Looking at the chart it is very easy to say “Sacha, why didn’t you put your life savings on margin into the thing at $2.83/share?” – in retrospect, I would have loved to, but there are a few complexities to take into consideration:

1. When you place your order, you implicitly acknowledge that it will likely go lower before it goes higher;
2. You have no idea how low the low will be.
3. If the issuer defaults, you are in deep do-do.

Now, I remember when placing my order that I thought I was already getting a good deal, but underestimated, by some 40%, the extent to which the market was willing to take this thing down.

Imagine if I had the snippet of knowledge that on April 16, 2010 that this would be trading at $18.91 a pop and went on 2:1 margin at a price of $4.70/share. I would have had my account liquidated on a margin call well before the bottom was reached. Even if I knew what the “true value” of something was, by using excessive margin, you are giving the market the ability to wipe out your investment before you can realize its true value. For stable asset pricing and stable yields, the argument to use margin is more coherent, but when you introduce volatility, margin will absolutely kill you.

This was a one-security case, but even when diversifying the portfolio a bit, you still would not have been able to avoid margin call issues simply because the whole market was being flushed in March 2009.

Telling young people to employ margin based on historical market data analysis is absolutely foolhardy and will only result in losses. It is difficult enough to be able to invest in equities and doing it on margin will just compound the agony even if you’ve done your research correctly and have a general idea that you are purchasing stocks below their fair value.

So for my final parting shot of the day, when a young person buys a condominium and makes a 10% down payment, and mortgages the rest, they are making a 9:1 leveraged bet on their concrete box in the sky. Does the past 10 years of Canadian real estate price history data suggest that you should be making the minimum 5% down payment and go on 19:1 margin?

The following quotation is golden advice:

One final note: when I wrote at RealMoney, I took a contrarian view that for average investors, no one should be fully invested. Even the great Ben Graham never exceeded 75% invested. My view is that average people must limit their risks or they will not be able to sustain their investment plans. A 50/50 or 60/40 balanced fund approach is best for the average person — they will never get scared enough to abandon it.

By always keeping some black powder in the keg, you will be able to pounce on opportunities that others cannot because of their leveraged circumstances. Late 2008 and early 2009 was a time to be doing this, and there will be times in the future where keeping a stack of cash will be of great benefit. I don’t sense that “now” is one of those times to be deploying cash, but certainly if we are in a 1970’s type market, we will be seeing 30-40% market gyrations both to the upside and downside.

Vancouver Moneyshow / Financial Forum

I try to make the effort to go out to the annual Vancouver Financial Forum, usually held at the Vancouver Convention Centre (where the Pan Pacific Hotel is on Waterfront). This year, apparently the conference was acquired by another company and is now re-branded as the Vancouver Moneyshow and was held at the Hyatt on Burrard Street.

The reason why I try to show up to this is because I have found it to be a rather uncanny barometer of investment sentiment, and what the “strategies of the day” tend to be. As a result, I know what to stay away from for at least the next year. I consider it to be more entertainment than anything else, although occasionally you will get some corporate swag that is actually useful.

The themes to avoid this time around seem to be heavily concentrated on gold and silver (both bullion and mining ventures), and also real estate limited partnerships.

So this year, I would like to thank the two ladies at the booth of Vale Corporation, who gave me a steel thermos. Considering I never heard of the corporation before, I much later realized that the reason why the two ladies had Latin American-sounding accents is because the company is headquartered in Brazil, and does about $30 billion in revenues a year in the mining industry.

There were a few other large-cap companies that showed up, including Proctor and Gamble, Cemex, National Bank and a couple others. I truly believe the only reason why they show up to these things is to get some vacation time out in Vancouver, although the weather this time of year was pretty rainy and windy and not hospitable.

I enjoy listening to bad investment pitches, and about half of them I classify as bad, so it takes a bit of cherry picking and research to determine which is the worst of the worst. To protect the guilty I will leave out the specific names of the companies involved.

There were three “trading schools” that had tables. One of them in particular, had a 5-day training course which you could pay $4000 for, and they give you a live account to trade 100 share lots of Apple or some stock of the day with using technical indicators they train you with. They then explained you could take the course as many times as you want with no charge, and that they train their people to do around 60 to 80 trades a week. They also said their classes have 21 people and despite them trading furiously in training, they collectively don’t lose more than around $200. I found that tough to swallow. I liked their marketing front, however – one guy and three attractive women – it implied “Want to meet women? Sign up to trading school!”. Fortunately as I left the table, I still had my wallet with me.

There were plenty of real estate “opportunities”, ranging from commercial real estate to residential apartment investing. They typically pitched a limited partnership format. One of them, which I thought was particularly atrocious, was pitching a limited partnership that proposed redeveloping a strip mall in northeastern Edmonton. The partnership would then acquire the property from a related party through a leveraged buyout (this is where the promoters truly make their ‘money’ even if the underlying project fails), the limited partners get a substantial tax-loss writeoff in the first year, and then they very patiently have to wait many, many years for payback (i.e. 2022). A great deal for them – get your money today, and maybe give it back to your investors 12 years later.

When asking the guy “So, let’s pretend I have $25,000 in my wallet, why should I invest in you guys than Rio-Can?” and the salesguy basically gave three minutes of speech about how great their property is, and how they are not exposed to “market risk” like Rio-Can is… I did say this was entertaining, right?

The companies providing charting services were also equally amusing, although they have been a mainstay at the financial forum – charts that can produce the fanciest lines and do a wonderful job of extracting value out of historical data, but with no predictive value whatsoever.

For the first time, I’ve noticed a few firms trying to get into the fundamental data analysis sales business, but the companies were relatively uninspiring. The worst of them pretty much copied all the information out of a company’s annual information form and just put it in a research report with some very bland extrapolations of their financial status in a typical research report.

I truly wonder how many people that go to these things actually think the information they receive at these forums can be acted upon with real money.

Investment returns must be calculated after-tax

One critical consideration of computing returns is that pre-tax is an easy calculation, but after-tax involves a bit more effort.

In Canada, interest income (and distributions of income from trusts) is taxed at your marginal rate. Foreign dividends are also taxed at your marginal rate. Dividend income from publicly traded Canadian companies are taxed at a very favorable rate. Capital gains are taxed at half your marginal rate.

As a result, portfolios should be structured such that income is maximized in sheltered vehicles (RRSPs, TFSAs) while Canadian dividends and capital gains are preferentially outside the RRSP and TFSA.

Your marginal rate depends on what province you live in and also what income bracket you are in.

So if you live in British Columbia, and make a taxable income of $50,000, your marginal rate rate on an extra dollar of interest income would be 29.7%. So to realize a 10% after-tax return on investment, you need to earn 14.2% on a pre-tax basis. Alternatively, you could also earn a 11.7% return via capital gains, or a 10.1% return via eligible dividends. It all amounts to the same: a 10% after-tax return.

The following tables are a simple illustration of the required pre-tax returns required to achieve a 10% after-tax return:

BC 2010 Tax Rates 10% after-tax equivalent
Marginal Cap. Eligible SB
Low Range High Range Rate Gains Dividends Dividends
$ $ 35,859 12.5% 11.1% 8.9% 10.4%
$ 35,859 $ 40,970 12.9% 11.3% 9.2% 10.8%
$ 40,970 $ 71,719 14.2% 11.7% 10.1% 11.9%
$ 71,719 $ 81,941 14.8% 11.9% 10.6% 12.5%
$ 81,941 $ 82,342 15.7% 12.2% 11.2% 13.3%
$ 82,342 $ 99,987 16.2% 12.4% 11.6% 13.7%
$ 99,987 $ 127,021 16.9% 12.6% 12.1% 14.3%
$ 127,021 and above 17.8% 12.8% 12.7% 15.1%
BC 2010 Tax Rates 10% after-tax equivalent
Marginal Cap. Eligible SB
Low Range High Range Rate Gains Dividends Dividends
$ $ 35,859 12.5% 11.1% 8.9% 10.4%
$ 35,859 $ 40,970 12.9% 11.3% 9.2% 10.8%
$ 40,970 $ 71,719 14.2% 11.7% 10.1% 11.9%
$ 71,719 $ 81,941 14.8% 11.9% 10.6% 12.5%
$ 81,941 $ 82,342 15.7% 12.2% 11.2% 13.3%
$ 82,342 $ 99,987 16.2% 12.4% 11.6% 13.7%
$ 99,987 $ 127,021 16.9% 12.6% 12.1% 14.3%
$ 127,021 and above 17.8% 12.8% 12.7% 15.1%

The following is for an 8% after-tax return:

BC 2010 Tax Rates 8% after-tax equivalent
Marginal Cap. Eligible SB
Low Range High Range Rate Gains Dividends Dividends
$ $ 35,859 10.0% 8.9% 7.1% 8.3%
$ 35,859 $ 40,970 10.3% 9.0% 7.4% 8.6%
$ 40,970 $ 71,719 11.4% 9.4% 8.1% 9.5%
$ 71,719 $ 81,941 11.9% 9.6% 8.4% 10.0%
$ 81,941 $ 82,342 12.6% 9.8% 9.0% 10.6%
$ 82,342 $ 99,987 13.0% 9.9% 9.3% 11.0%
$ 99,987 $ 127,021 13.5% 10.0% 9.7% 11.4%
$ 127,021 and above 14.2% 10.2% 10.2% 12.1%

The kiss of death – a mention in Forbes Magazine

I notice with amusement an article in Forbes – “Five Canadian Trust Survivors“, where the author basically states the following will still give out “solid” distributions after distributions are taxed in 2011:

Baytex Energy Trust (BTE.UN)
Cineplex Galaxy Income Fund (CGX.UN)
Vermilion Energy Trust (VET.UN)
Brookfield Renewable Power Fund (BRC.UN)
Keyera Facilities Income Fund (KEY.UN)

There is only one good that can come out of this article: it saves you the time from having to bother even looking at these companies. Just scratch them off your candidate list – if Forbes magazine is extolling the virtues of these companies, then it is a virtual guarantee that you are likely to be paying fair (if not greater than fair) value.

I wonder how many people actually base their purchase decisions on magazine articles such as these.

I have spent the greater part of the day trying to screen income trusts, and I don’t see any exceptional value out there. The only one (and literally one out of the forty or so that I took a detailed look at) stinks so badly that even I have no idea how their business can be made viable, but at least their market valuation is trading such that they think this company is going out of business really soon.

Canada Interest Rate Projections – March 2010 – Effect on mortgages

With all the talk about the Bank of Canada wanting to raise rates, it is instructive to look at what the futures market is saying about the issue. It should be noted that the next scheduled rate announcements are as follows:

April 20, 2010
June 1, 2010
July 20, 2010
September 8, 2010
October 19, 2010
December 7, 2010

A rate increase on or before the July 20, 2010 meeting is a guarantee. The question is how much?

The markets currently say the following:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 AL 0.000 0.000 0.000 99.480 0.000 0
+ 10 MA 0.000 0.000 0.000 99.440 0.000 0
+ 10 JN 0.000 99.320 99.325 99.360 -0.040 21736
+ 10 SE 0.000 98.870 98.880 98.910 -0.040 33614
+ 10 DE 0.000 98.400 98.410 98.450 -0.050 19923
+ 11 MR 0.000 97.980 97.990 98.030 -0.040 6402
+ 11 JN 0.000 97.630 97.640 97.690 -0.050 3215
+ 11 SE 0.000 97.320 97.350 97.410 -0.080 1445
+ 11 DE 0.000 97.040 97.060 97.140 -0.090 707
+ 12 MR 0.000 96.810 96.840 96.910 -0.080 50

The three-month interest rate will be:

June 2010: 0.68%
September 2010: 1.13%
December 2010: 1.60%
March 2011: 2.01%
June 2011: 2.37%

Reading my tea leaves, this would suggest that the Bank of Canada will raise per the following schedule:

April 20, 2010 (No change – 0.25%)
June 1, 2010 (No change – 0.25%)
July 20, 2010 (+0.75% to 1.00%)
September 8, 2010 (+0.25% to 1.25%)
October 19, 2010 (+0.25% to 1.50%)
December 7, 2010 (+0.25% to 1.75%)

It is also likely that by June 2011 that interest rates will be around 2.5%.

The only effect these rate increases will have on mortgages are for floating rate mortgages (ING Direct offers them at prime minus 0.4%). This would mean that rates would go up from 1.85% to 3.35% by the end of the year and roughly to 4.1% by the middle of 2011. For most borrowers on floating rate mortgages, they will likely see their interest payments at least double over the course of the year. As an example, for somebody borrowing $300,000, their interest payments will increase from roughly $450/month to roughly $1000/month by the middle of 2011.

In terms of fixed rate mortgages, rates are essentially set by the bond market, and the bond market has already “baked” in these projected rate increases. The best available 5-year fixed rate mortgage is 3.69% currently. Given a choice between these two options, it is a rare time where taking the 5-year rate would be the prudent option.

It is likely once interest rates start to increase that banks will increase the “prime minus” spread from a typical 0.4% currently to around 0.8% – the peak discount which was seen in the last housing rush.

Either way, the lack of ultra-cheap credit will have an effect of slowing down the housing market considerably.