Month: April 2010

Trimming the long-term corporate debt position

Although not a huge fraction of my portfolio, I have trimmed some of my long-term corporate debt position in Limited Brands 2033 bonds, at a yield to maturity of 7.8%. I will be trimming more if the yield goes down to around 7.6%, and eliminate it entirely if the yield goes down to around 7.4%.

The risk-free rate (US government treasuries) for a 23-year maturity is about 4.5%, so the yield spread of 3.3% is not sufficient compensation in my eyes for the level of risk taken.

Limited Brands is a company that is in excellent shape after the 2008-2009 recession. They have about $2.7 billion in debt, compared to $1.8 billion cash on the balance sheet, and yearly free cash flow of about $900 million. Their “big name” store is Victoria’s Secret and they also operate Bath and Body Works. Although they have excellent prospects looking forward in terms of liquidity and solvency (and they have announced they will be giving out a $323M special dividend and a share buyback program, which is not good for bondholders although it speaks to the financial capability of the company to make such a move), I will lower my exposure to their debt as prices continue to rise and look elsewhere to get a better risk/reward ratio for my capital.

I think there is a good a chance as any of US bond yields rising considerably over the next few years, so this trade is also an adjustment with respect to my macroeconomic view of the world. It does lower the yield of my portfolio, but I am happy to keep the cash. It will stay as cash until such a time where I can determine where to deploy it in an efficient manner. Given what I see out of the markets, I don’t anticipate this will be a quick process.

Shaw Communications – Moving into Wireless

An article questions Shaw’s slow entry into the Canadian Wireless market.

RBC Capital Markets analyst Jonathan Allen said the delay gives other new competitors time to gain traction before Shaw is even in the market.

…

“It’s difficult to say whether Shaw launching with LTE is the right move,” Allen wrote in a research note, noting Shaw would be among the first globally to choose this network standard.

My opinion is less questioning – waiting is completely the correct decision. The reason is that there is no first mover advantage in this second expansion of the Canadian wireless domain. With incumbents (Telus, Bell and Rogers being the big three) having a dominant advantage in terms of size, capital and capability, it will be difficult for newcomers to quickly penetrate into the marketplace. My guess is that Shaw will be carefully looking at how Wind Mobile, Public Wireless and Mobilicity perform before doing their own launch.

In the strategic sense, Shaw must get into the wireless space – they have a huge customer base with their cable and internet services, but their expansion into the phone space has been slow, mainly because landlines are now obsolete. A wireless expansion that bridges the internet and voice service seems to be quite a logical move. Their system needs to be able to deliver enough reliable bandwidth to provide both voice and highspeed data service. They will also have the ability to bundle this with their cable packages, and as a result may have better success with market penetration than other providers.

In terms of valuation at a glance, Shaw’s equity appears to be fairly valued. I don’t see a compelling story that would boost their equity price dramatically – it would be an economic miracle if they doubled in five years from their current market capitalization of $8.1 billion. They also are capitalized by $4 billion in debt, supported by roughly $600 million of yearly free cash flow at present. Construction of a wireless network is likely to cost a lot more, so it remains to be seen whether they will decrease the dividend or raise more debt capital to finance it. Shaw does have the advantage of having their billing and customer support infrastructure established, which is something the other new upstart providers are struggling with.

As a company, I have always liked Shaw’s positioning and corporate direction. As an investment, I have never found them compelling. Their common shares will represent a good store of value in terms of their ability to drive cash flows from Canadian’s desire to receive cable and communication services, but I will not project much in the way of capital gains.

Why are mortgage rates going up?

I earlier stated that posted rates are irrelevant, but the change in them is somewhat more relevant. The change in mortgage rates, however, are dictated by the Canadian government bond market.

5-Year Canada Government Bond Benchmark Yield

As you can see, the 5-year government bond yield is at a high for the year – at 3.06%, it has not been this high since October 2008.

Today some of the major banks increased their posted rates to 6.1% from 5.85%. The best market rate you can receive today on a 5-year fixed mortgage, without going through too much hassle, is around 4.25%. This will likely go up to 4.5% soon.

Over the past 5 years, the peak for the 5-year benchmark government bond yield was 4.72% in the week of June 13, 2007. The posted bank rate then was around 7.3%, and a typical market rate on 5-year fixed rates would have been around 5.8%.

As government bond yields continue to increase, mortgage rates will also follow.

Chinese investing in Alberta Tar Sands

It’s making the news headlines that Sinopec, a Chinese “crown corporation” is taking ConocoPhilips’ 9% stake in Syncrude, for US$4.65 billion. This will put Syncrude’s valuation at around $52 billion.

Syncrude is a joint venture company with a strange ownership structure. They are one of the large tarsands miners in Alberta, right up there with Suncor.

What’s odd is that Canadian Oil Sands’ market capitalization is about $15.4 billion at this moment and they only have a billion dollars of long term debt. Canadian Oil Sands’ 36.4% valuation of Syncrude would be worth about $18.8 billion at the rate that Sinopec paid for their 9% stake. Obviously I might be missing something here in terms of valuation (not being able to access Syncrude’s financial statements would be an important part of this), but it seems like Sinopec might be overpaying.

China has accumulated a lot of cash (especially US currency) through exports and are concerned that it will be inflated away and are trying to find places to invest it. One way is through minority investments in other corporations, especially ones that serve the strategic purposes of the Chinese government.

Brokerage firms in Canada – Questrade Review

(June 19, 2012: A good chunk of this article is out-dated and will not be updated. Specifically they have changed their trading platform to emulate Interactive Broker’s TWS and apparently have increased their margin interest rates. The security concerns remain prevalent, although they do now ask a “security question” before logging in.)

(Article updated January 4, 2011 to update margin rates and put in a current rate of interest.)

(Readers may also be interested in reading A Questrade Failure [January 4, 2011], and Watch out for Questrade – Check those statements [February 16, 2011].)

I reviewed Interactive Brokers previously; I use them for my non-registered investments. For my RRSP and TFSA, and for TSX-traded debentures, I use Questrade.

Questrade

I transferred in my RRSP to Questrade in early 2008 from BMO Investorline. The primary attracting feature was the ability to retain US dollars in the account and not having to incur currency exchange fees whenever you transacted in US securities. Just as an example, ignoring commissions, if you bought USD$1000 of something, and then sold it the next day, you would probably pay around $40 of implied currency conversion charges at BMO Investorline. With Questrade, this is nothing, assuming you had the US currency in the account to begin with.

If you bought USD$10,000 of something and sold it the next day, your typical currency conversion charges (going from CAD to USD and USD to CAD) would be around $400 – with Questrade, it is nothing. For anybody transacting in US dollar securities in their RSP, it is an essential feature.

The RSP transfer took about a month. It also took them another couple months to refund the RSP transfer fee, but they explained this up-front.

The web-based interface for Questrade is very simple – it is missing a basic feature of “how much will this entire transaction cost” whenever previewing an order, but other than this, it is OK. The problem is mitigated by using a desktop calculator. They provide a better platform for active traders, but I have never used it and probably never will. They provide three separate logins for account information and trading, but once you’ve bookmarked them, it is surprisingly easy to get detailed access to your information. In particular, their clearing is performed via the Pension Financial Corporation, and the historical account information they provide through this interface is comprehensive. I can easily see how people that are not as “in-tune” with web navigation would find this system very confusing.

Costs at Questrade are very cheap – basically a trade costs $1 per 100 shares, minimum of $5, maximum of $10. They are also the cheapest Canadian broker to trade TSX-traded debentures – basically the standard commission charges (as if you were trading stocks) applies – so it would be about $10/trade. Most other brokerages charge around $40 per trade, plus $1.50 per $1000 par value – which could make trades very expensive. Questrade does not charge any inactivity fees or any other “garbage” fees, but something people should be aware of are fees for taking liquidity away from the market (i.e. buying at the ask, or selling at the bid) which would amount to material sums if you are dealing with penny stocks.

Questrade’s margin rates currently (as of January 4, 2011) are 4.5% for Canadian dollars, which is prime plus 1.5%. They generally are in line with other “big name” brokerages (e.g. BMO Investorline is at 4.25% or prime plus 1.25%), but both do not come close to Interactive Brokers.

I have no problems with Questrade customer support – they have an online web-chat interface and sometimes it takes awhile to get a customer support agent, but once you do get on with them, they are fairly responsive. I suspect most of the people that have complained about Questrade (and there are a lot of financial forums that have supremely negative reviews on them) didn’t have a clue what they were doing (e.g. dealing with Canadian vs. US dollar securities, or wondering why their shares got sold out when they had a margin call).

Deposits and withdrawals are simple – provide the EFT information, and a few button clicks is what it takes to fund accounts or withdraw funds from accounts. The withdraws typically take three business days to process, and I have always received my funds promptly.

For a simple buy-and-hold investor, Questrade seems to be a decent and low-cost provider. They aren’t going to win any awards for any of the other ancillary services brokerages provide (research, fancy interface, hand-holding customers), but if you don’t care about those, they serve the job very adequately for RRSP and TFSA accounts. I have no idea how they are for active traders.

Questrade’s inadequate security

The reason why I can’t give a blanket endorsement of Questrade is security – they do not offer any sort of guarantee (e.g. BMO Investorline’s Online Security Guarantee) against hackers, and unlike Interactive Brokers, if somebody managed to rip off your username and password, they can do a lot of financial damage to your account. This is my biggest concern with Questrade, and it is a sufficiently high concern that I wish they would offer some sort of guarantee against hacked accounts, and/or provide an account authentication system that is similar to Interactive Brokers. In addition, Questrade is privately held and as a result, one has no idea how financially solvent they are. Although Canadian investors are protected through CIPF, you do not want to have to reclaim your assets through this mechanism.

The reader might wonder why I am concerned about an issue that has not materialized for me – I am very cognizant of potential risks. I do not want to have to suffer through a security incident before taking measures that will protect me. I do not believe Questrade takes security seriously enough beyond the typical lip service of telling its customers to “run a firewall and a virus scanner” and as a result, some of its customers will have their accounts compromised. Although I am very computer-savvy and it is unlikely that a phishing scam will get my username and password, it could happen and I want a form of protection beyond a username/password combination to make sure that my account is protected. Questrade does not offer this.

Until they provide better provisions with respect to account security and provide some more transparency on their own financial solvency, I only will give them a tepid recommendation. The only reason why I use them is they support RRSP/TFSAs well and they allow inexpensive trades on TSX-traded debentures. If they beefed up their security, I would rate them much more highly than present. I just don’t get that warm and fuzzy secure feeling that I do with Interactive Brokers.

Unlike practically all other financial blogs out there, I won’t insult you (the reader) by offering some referral scheme, which they do offer – I do these reviews without remuneration.