Finance – Page 72

Watch out for Questrade – Check those statements

(Update, February 18, 2011: David Del Grande from Questrade contacted me via e-mail regarding the issue I mentioned in this post. I will keep this post updated and see if they can resolve this issue.)

(Update, February 28, 2011: So far, Questrade has not responded to my reply.)

(Update, March 30, 2011: Much to my shock, I received a voice mail from Questrade and they have credited the amount in question, plus five commissions, to my account. I checked my account status and indeed they have made the appropriate corrections.)

Questrade recently went through an upgrade, and this has caused some disruption to their service.

I noticed that they have incorrectly processed a transaction on my account concerning a debenture trade – I sold some debentures about a week ago, and normally when you sell debt you receive a cash credit for accrued interest. On the trade history, it shows that there were three trades – two “sell” orders and a “cancel sell” which offset one of the sells. I noticed the interest was given on a sale, and taken back on the canceled sale, but the remaining sale did not have the interest income. This is wrong!

It is not a huge amount of money we are considering (about $80) but this sort of process should be correctly automated – I should not be having to waste my time and their time to contact customer support to get this corrected. Other people likely have issues with Questrade, since when I try accessing their live help (which generally has been a good way to correct issues with them), I get the following message:

You have reached Questrade’s Client Services. You are in priority sequence for the next available Client Services Specialist. Thank you for your patience, the average wait time is ’55’ minutes. Thank you for your patience.

There is no way that I am going to keep the window open for 55 minutes.

I am starting to seriously question why I have my money with this firm – they offer the cheapest trades, by far, for debentures and fixed income products. However, other hassles such as this one, offset any cost savings. Since fixed income opportunities are in very short supply these days, it is unlikely I will be needing to trade those products to the degree that I did back in 2009. The other reason why I stick around is because my other broker is Interactive Brokers, where I do the bulk of my transactions, does not do RRSP or TFSA accounts.

Finally, Questrade forced clients away from their dated “Webtrader” platform and onto their “QuestradeWEB” platform. I personally preferred the Webtrader platform as it was very simple, quick and just seemed to “work”. The QuestraderWEB platform is more heavy and takes more time to navigate. I understand their need to migrate people off of a platform that was coded 7 years ago, but why can’t they design a simple user interface to a stock trading service? A poor user interface costs them money – people will trade less.

Liquidation continues

For the first time in a long time, I’m at the 40% cash level. Fortunately this is due to selling securities rather than incurring losses in the portfolio.

When I identified three targets of opportunity in the second half of last year, I should have probably doubled my allocation. This is a classic “should have” case, so it ultimately has no future-bearing consequences. I usually slip into my positions deeper as the price goes lower, and the amount of the price drop on all three securities was not sufficient to get a complete holding since the markets have generally recovered significantly since September.

Having 40% cash means that your holdings have to perform 2/3rds better than the underlying indexes to have an overall performance of the index. As much as I feel like buying puts on the S&P 500 index, standing in front of that freight train is liable to get you financially killed, so I will be patient.

Short term bond ETFs – Watch out

As people start to randomly deploy their capital in February as they attempt to fill their RSPs, fixed income solutions are likely going to be the one-click target. One of them will be bond ETFs.

I’ve noticed some slick marketing that tends to mask probable future performance. For example, BMO has a short term corporate bond fund (TSX: ZCS) advertises a “portfolio yield” of 4.65%. 4.65% sounds very good in context of the risk-free rate of about 2% you can get elsewhere.

The only problem is that when you click on the Holdings page, the weighted average yield to maturity is 2.97%!

Very roughly, what this means is that investors will earn a cash yield of 4.65% (minus the 0.3% management expense fee), but will experience capital depreciation as the bonds approach maturity.

It is likely that fund marketing will concentrate on the yield figure, and completely mask more important numbers such as yield to maturity and duration. This is another technique used to mislead retail investors into thinking they are investing in a produce that is seemingly better than it actually will be.

Long term rates are climbing

Long term interest rates are beginning to climb again. The following is a chart of the 10-year US treasury note:

Rates touched 4% early in April 2010.

The Canadian 10-year bond is exhibiting the same characteristic, with yields up roughly 0.2% over the past week. Fixed income is being sold off and presumably rotated into equities and commodities.

Long term interest rate changes are a crucial variable concerning the pricing of equities and corporate debt simply because they are considered to be a risk-free comparison. With long bond yields rising, fixed rate mortgages will also become more expensive. Right now the best 5-year fixed rate you can obtain is around 3.65%, but this will likely be rising by a quarter point or so in the near future.

The only real defence against sharply increasing interest rates is holding cash or short-duration securities – almost everything else, including gold, will get hammered.

Dividends vs. Capital Gains

A post by Michael James (via Larry MacDonald) on the emotional benefits of dividend investing I thought was very well written.

Dividend issuance is not a valuation metric – although there is high correlation between companies that give out dividends and companies with good cash generation abilities, the issuance of dividends themselves does not cause the investment to be a good value. A company that previously did not declare dividends does not become more valuable the day after they announce dividends (although the market typically treats such announcements favourably in anticipation that dividend funds will increase demand on the stock).

When you isolate all other variables, there is no difference in investing in shares of a company worth $100/share that produces $10/year in earnings and selling $10 worth of shares each year versus that company issuing a $10 dividend each year.

Most dividend-bearing companies are stable simply because they have reached that point in the company’s maturity where they can give off cash without it being adverse to operations.

There are real-life subtle differences between dividends and capital gains which must be considered.

One is that there is a taxation difference between dividends and capital gains that must be considered in an investor’s risk profile – in Canada, lower income individuals would have a preference for dividends, while higher income individuals generally are indifferent. For example, using 2011’s BC tax brackets, a low income bracket individual will have a -9.4% marginal rate on eligible dividend income and a 10% marginal rate on capital gains. A high tax bracket individual will pay 23.9% on dividends and 21.9% on capital gains.

The other salient tax point is that you can choose to defer capital gains by not selling, while dividends have to be taken when declared by a company’s board of directors.

Another consideration is that cash in the hands of management is not equivalent to cash in the hands of an individual. If you believe management is more capable of investing cash, you would want them to retain as much of that capital for reinvestment as possible. If management gives out dividends, they are implicitly stating they are not capable of producing a market-beating return on that capital beyond what they have already invested.

You see this taking effect in companies when they declare large special dividends – the stock price usually increases by some amount because the market is implicitly stating that cash in the hands of management is worth less than the shareholders.

You can also use this to determine the competence of management – if management continues giving out more cash than the company can generate, it is a negative sign.

Ultimately what matters is the total market value of your portfolio increases over time, whether those returns are produced by capital appreciation or by income generation. Sometimes the market has more demand for income and sometimes the market has more demand for capital appreciation – these gyrations in sentiment are what cause opportunities for the neglected part of the marketplace, just as how most non-dividend bearing companies in the marketplace today are somewhat discounted by the apparent lack of income produced.

There is a certain beauty in the premise of dividend investing, but ultimately it is a failed strategy if an investor does not consider the underlying operations of the company and evaluating the company’s ability to generate free cash flow that sustain such dividends. Whether a company gives off dividends in the process or not is a very minor consideration in the valuation process.