End of year tax planning notes

Now is about the time to think about how your portfolio should look at the beginning of 2011.

In general, it is usually a wise decision to realize capital losses if you have capital gains to offset them with (i.e. in 2007, 2008, 2009 or 2010 tax years). Each realized loss dollar will result in a “refund” of half your marginal rate for that year. One usually wants to back capital losses into the earliest possible year (2007) if available, but if you have a lumpy income stream, then the high marginal rate year would be the correct decision.

Conversely, if you anticipate lumpy income in the future, realizing capital gains in the current tax year if the current year is a low income year may be optimal – these sorts of optimization calculations are never easy to perform.

The big change from previous years is the looming conversion of income trusts to corporations. Most income trusts will be distributing income until the last possible moment. For most, this means trust holders at the end of the year will be receiving income distributions. For those holding trusts in registered accounts (RRSP, TFSA, etc.), the optimal time to move them out of the registered accounts is at the beginning of 2011 and into non-registered accounts. This assumes, of course, that there are substitute investments that bear income that can be placed into the sheltered account.

You can perform this by doing an asset swap in the case of an RRSP; just that non-registered assets that are swapped into the RRSP will have a deemed disposition – a capital gain will be realized at this point. Capital losses are not allowed to be recognized with an asset swap, so if you plan on swapping assets that are in a current loss position, you will have to wait 31 days before repurchasing in order to avoid the so-called “wash rule”.

Tax planning is quite complicated, but in terms of portfolio management, it involves in placing as much income (interest income, REIT income, and solely in the case of an RRSP and not TFSA, US corporate dividends) as possible into sheltered accounts, and as much tax-advantaged income (eligible Canadian dividends, capital gains) outside the registered account. Unlocking the assets from an RRSP in a tax efficient manner is also a non-trivial issue to examine, which strongly depends on personal circumstances. The TFSA is a simple matter with our existing rules – it should always have something inside it.

Watching carefully

I wish I had something more substantive to write other than to say that I am observing the marketplace, but that is all I have been doing. There are hints of another upcoming economic storm, but it is difficult to say – the messages that my tea leaves give me are very scatter-brained at present. One of the advantages of having a relatively large cash position (the largest I have ever been since 2008) is that you can take advantage of panic, but I do not see panic yet – thus, no point in diving in. I do see a reversal in the markets, but I am not confident in my conviction.

A common question is – if I am convinced we are headed down, why not just sell everything and be in a perfect position to buy cheaply?

The answer is simple – I might be wrong. It could be the case that this selloff in long-term fixed income products is primarily profit taking, or a transient blip in what has been a profitable uptrend. Also, I do not know when the time to “buy cheaply” is. I might miss the opportunity. There are too many unknowns, plus there is the possibility I am devoting my research time to the wrong group of equities – my research simply didn’t have enough time to screen all the candidates in late 2008/early 2009 and thus I made some, in retrospect, sub-optimal investment decisions.

One of the easiest ways to evoke powerful emotions in the market is by being heavily invested in cash, but watching the rest of the equity market rise without you. An example is stalking an investment candidate close to your buying point, but watching it going up without participating in any upside. There is a sense of lost opportunity, but one always has to console themselves with the fact that there will be future opportunity – just that it will be in a different security and you have to be patient.

Have recent buyers in the past few months been the type of people that sold out in 2009 and didn’t participate in the massive gains subsequent to the economic crisis? Have these people been getting back into the market in droves? Equity and fixed income markets would suggest this is the case.

Patient I will be. The worst mistake that can be made is by forcing your cash to work in sub-optimal investments. The cash earns a small yield, but at least it is a positive and not negative number.

Whistler Blackcomb public one week

The reorganized entity of Whistler Blackcomb went public and has been trading for one week:

It has been trading narrowly around its (reduced) $12 price. With the announcement of inclement weather in the Greater Vancouver area and the early opening of the ski resort, it has not resulted in a budge in the share price.

I earlier covered Whistler Blackcomb and was not terribly positive on them at their IPO price.

Short term Bank of Canada rate snapshot

BAX futures suggest that the overnight target rate will be held at 1% for the December 7, 2010 Bank of Canada meeting:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 NO 0.000 0.000 98.690 0.000 0
+ 10 DE 98.710 98.715 98.710 0.000 4741
+ 11 JA 0.000 0.000 98.675 0.000 0
+ 11 MR 98.600 98.610 98.600 0.000 12558
+ 11 JN 98.460 98.470 98.460 0.000 15591
+ 11 SE 98.280 98.300 98.290 0.000 13157
+ 11 DE 98.140 98.150 98.140 0.010 7394
+ 12 MR 98.020 98.040 98.030 0.000 3483
+ 12 JN 97.930 97.970 97.950 0.010 274
+ 12 SE 97.850 97.930 97.910 0.010 108
+ 12 DE 97.780 97.830 97.830 0.010 7

The rates do suggest that by mid-year we might see another 0.5% increase in rates throughout 2011, but this is financially speculative noise peeking through the woodwork. 3-month corporate paper is yielding 1.17% at present, so there is not much of a divergence between existing rates and implied December 2010 rates.

In terms of long-term rates, Canadian 10-year bonds have crept up to 2.98% at the end of November 10th trading. While this is not anything significant in terms of the range over the past 12 months, it is up about a quarter point over the past month. The big scare for real estate gurus out there was likely in the early second quarter (April) when 10-year bond rates went to 3.7%. Still, this is nothing close to the past decade’s average of 4.3%, and the peak rate of roughly 5.96% back in the year 2001.

I am struggling to make what is a rather boring interest rate post interesting, so I will leave it here.

Clearwater Seafoods debenture refinancing

This is slightly old news, but on October 7, 2010 the management of Clearwater Seafoods Income Fund are trying to get $45 million in debentures, due at the end of the year, out of the way without excessive cost.

The terms they offered are the following:

– Higher Interest rate: The proposed amendments provide Debentureholders with an interest rate that will be increased by 3.5% from 7.0% to 10.5%.
– Lower Conversion Price: The conversion price will be reduced from $12.25 per Fund unit (“Fund Unit”) to $3.25 per Fund Unit.
– Extended Term: The maturity date will be extended from December 31, 2010 to December 31, 2013, and the amended debentures will not be redeemable prior to June 30, 2011. As such, Debentureholders will have a longer period of time to receive a higher interest rate and potential to exchange their debenture for equity in an entity that is poised to create significant value for unitholders.

The higher interest rate is the only appealing sweetener for the holders – the conversion price decrease is insignificant when compared to the present unit price of 86 cents per unit; the extension of the maturity is also not beneficial when considering that it puts them behind in order with a series of term loans and a bond maturing on August 2013.

If I was holding the debentures (which I am not), I would walk away this deal.

If they dropped the conversion price to $1.00/unit, I would consider it. $3.25/unit, however, is a ridiculously high conversion rate.

Even if the debenture holders were stupid enough to approve this deal, they will not be collecting their coupons for too long since the company actually has to generate cash to pay out. It will not be long before this whole company has to give out a lot of equity to get rid of the high debt on their books. It would be one thing if the company were operationally running well but was financially leveraged too highly, but it just appears that this company is not particularly profitable, but management talks like it is.

When management has to use language like “potential to exchange their debenture for equity in an entity that is poised to create significant value for unitholders” in a pitch to debt holders, I have my doubts the right people are running the company as they are taking their owners and creditors like idiots.

The public will find out on November 12, 2010 whether this proposal goes through or not.

As I have previously disclosed, I have no holdings in Clearwater Seafoods equity or debt.