Finance – Page 84

Market downturn

(Update: This post is already obsolete – this post was written before the 9% spike down in the major indexes!)

This week is the first week in a long, long time where my portfolio has taken a dive. I suspect it has been the same for others. If right now was the end of the week, it would be around -3%. This is not a reason to panic by any means, I think my financial strategy is appropriate for myself and I have enough cash (or cash-like instruments that can be liquidated) to take advantage of a “real” downturn, especially if this Greek crisis turns out to be something significant (which I do not believe).

However, what is interesting is to see what else has dropped:

– Canadian Dollar vs. USD: down about 5%
– Crude and Natural Gas (in USD): down about 8%
– Gold: Interestingly, not much change, if not a little higher.
– S&P 500, TSX 60: down about 5%
– 5-year government bond yields: down from about 3% to 2.8%
– Implied future 3-month interest rate changes: Lower; December 2010 to 1.70%; June 2011 to 2.37%

What’s odd is why Gold (which is a commodity that got hammered during the 2008 financial crisis) has not tanked with the rest of the market. Maybe there is a fundamental psychological shift in action.

The other comment is that the consumption of fossil fuel energy is not likely to abate with the Greek crisis, and most Canadian oil-related stocks have been hit. I’ve always thought that if you are a consumer of fossil fuels (which almost everybody in society is), it is wise to hedge this with ownership in some energy-producing assets, purchased at the right price.

Never use market orders

A trading example (of which I did not participate at all) of the day – the company in question is Pacific & Western Credit Corporation:

We see the stream of trades:

Time	Price	Shares	Change
14:11	3.000	200	-0.250
14:11	3.010	400	-0.240
14:11	3.000	3,000	-0.250
14:11	2.760	900	-0.490
14:11	2.900	500	-0.350
14:10	3.160	5,000	-0.090

What happened?

Some guy put in an order to sell 5000 shares, and got filled in at 3.16. This might have triggered a stop order, which was sent to the market at the nearest available bids, in this case 2.90 and 2.76. The market maker likely stepped in at this point and picked up shares at 3 and above. Right now the bid-ask is 3.12-3.17.

The advice I have for absolutely everybody is you should never, EVER use market orders. If you must hit the market, enter in a limit order buy at the ask or above, or a limit order sell at the bid or below, but never use market – it is just giving a blank cheque to people that most certainly rip you off.

Whoever was on the selling end of those 900 shares at 2.76 paid about $360 for the privilege of getting rid of their shares at a low price.

TFSA teaser rate dropped at ING Direct

ING Direct offered a 3% interest rate on TFSA accounts in early January; this was presumably done to capture people’s money in the account. They dropped the rate to 2% at the beginning of the month of May, which is more reflective of the market rate.

Ally continues to be the best option for short term savings accounts, offering 2%. They also offer 4% on a 5-year GIC, which is currently the best rate available.

As Garth Turner points out, GIC products have problems concerning liquidity (in the case of the 5-year GIC you will relinquish 1.5% interest), and also taxability (as ordinary income is fully taxable). He is suggesting the world of preferred shares or corporate debt, two fixed-income products which have different characteristics than GICs.

James Hymas has an excellent document which explains the differences between preferred shares and GICs.

If your goal is to preserve income (note: not capital) then preferred shares generally are a better option than GICs for a multitude of reasons. The only problem for most people, however, is that you’ve got to be doing your homework. If this is done correctly, you will be able to obtain a tax-preferred advantage of likely 200 basis points, if not more, than the prevailing rates offered by GICs. Judging from most of the comments seen in an average post on Turner’s site, it seems that most want to be spoon-fed ticker symbols to purchase.

A good investor but not a good fund manager

Imagine an investment manager that is so good that they can double their money whenever they put money into the market. However, this manager is only able to do so once every five years and is smart enough to know when he is invested outside his “window of opportunity” he will dramatically underperform the market and thus will go to cash during the rest of the time. This investor would be in the top percentile of all investors by virtue of his ability to obtain a 15% compounded return, year over year (doubling your money every 5 years is very close to 15% compounded annually). However, just imagine if he had a hedge fund and investors piled on board after his first 100% year and reading his annual reports:

Year 1 letter to shareholders – We were fully invested in the market, but have now gone to 100% cash. Our performance on equities has resulted in a 100% increase in our net asset value since the beginning, a very good year. We will look for more opportunities in the future when they present themselves.

Year 2 letter to shareholders – Thank you to the new investors for joining hedge fund XYZ. We have been 100% invested in cash, earning 3% on cash. We have found nothing suitable to invest in.

Year 3 letter to shareholders – We have been 100% invested in cash, earning 2.5% on cash. We still have found nothing to invest in.

Year 4 letter to shareholders – We have been 100% invested in cash, earning 2.75% on cash. We have found nothing to invest in. Believe me, we are trying!

Year 5 letter to shareholders – We have been 100% invested in cash, earning 2.5% on cash. We’re really looking hard for investment candidates, some might be on the horizon soon, but we can’t tell at this moment.

By this time, most of the people invested in the hedge fund would have already exited. “Why bother investing with this guy when he isn’t going to be investing our money?” If the investment manager was working for a larger company, chances are the manager would have been removed, even though he was working in the long-term interest of the fund.

Of course, by the time clients have removed all of their money from the hedge fund, the manager on year 6 sees opportunity and has another year of a 100% return. People, attracted by the performance, come back to the fund in droves, only to witness their money being invested in money market instruments for another 4 years.

This is one of the big advantages that an individual investor has, assuming they are capable enough to hold high levels of cash during significant market downturns. An individual investor does not have to sacrifice their strategy for political reasons (i.e. fear that their clients will pull money out of their fund). This political advantage can be exploited by those with ironclad discipline to hold cash for lengthy periods of time.

It is usually very difficult to measure the performance of these individuals over a short time period – it would have to be measured over a lifetime. The Buffett/Munger partnership is the best example of people that were not afraid to hold onto their cash for opportunistic moments.

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.