a paradigm shift, in the analysis of the canadian financial markets
As a member of the winning team at QFAC 2009 I opened the TSX on January 5th 2009; thereby, ringing in not only a new year but, a new decade. Queen’s University Finance Association Conference (QFAC) is a student run conference focusing on finance and capital markets. For more information visit www.qfac.ca.
Picture of Me (Below)
Picture of the Team (Below)
Recently I’ve completed the following research report. The goal of this project was to find a way to successfully combine fundemental and technical data to generate portfolio weighting strategies that can allow investors to experience a higher level of return with less volatility than the index. Find attached a PowerPoint presentation, the Excel source file and the PDF written report. Find below an excerpt from the executive summary:
According to Standard & Poor’s “Index Versus Active Funds Scorecard” only 12.43% of actively managed US Equity funds have outperformed the S&P 500 Index over the 5 years ending June 30, 2008.
I took this fact as an ultimatum. My goal was to create a portfolio, which would be able outperform the major market indices over a 10 year period. In this spirit I set out to design an investment strategy, which seeks to generate significant alpha through the creation of a portfolio that can generate above average return while experiencing lower levels of volatility.
To achieve this objective I set out to design a unique investment strategy. I created a portfolio that can outperform the major market indices while experiencing lower levels of volatility by combining both technical and fundamental analysis. Fundamental analysis was used to create the “Risk Asset Portfolio” by identifying the most promising investments by analyzing the corporate health of the companies within the investment universe. On the other hand, technical analysis was used to perform market timing, resulting in smoother portfolio returns across the business cycle by dynamically allocating capital between the risky portfolio and cash.
The data for this project was aggregated from the Research Insight database . The data from the database was organized within Microsoft Excel wherein the analysis took place. Performance statistics relating to the performance of various market indices was compiled with data provided by Barron’s and Standard and Poor’s. The performance history of 3 months US Treasury securities was compiled with data provided by the Federal Reserve.
I have eliminated survivorship bias through the use of a sound, non-biased, stock selection strategy. I selected the 30 DJIA components at the end of 1998 as my investment universe. The portfolio was back tested from the beginning of Q1 1999 until the end of Q2 2009, making a total of 42 quarters (10.5 years). The model assumes that transaction costs and taxes are non-existent.
Analysis demonstrates that the portfolio is highly mean-variance efficient. The portfolio has demonstrated a 4.42% annualized rate of return while experiencing a standard deviation of only 3.58%. In contrast the S&P 500 experienced a negative annualized rate of return in this period of -2.72% while experiencing a much higher standard deviation of 8.65%. When observing the fundamental analysis in isolation from the technical analysis we can observe an efficiently constructed portfolio, which outperform the market benchmarks with less volatility. The risky asset portfolio experienced an annualized rate of return of 2.30% with a standard deviation 7.35%.
(Click the Picture to Access the PowerPoint File)
(Click the Picture to Access the Excel File)
(Click the Picture to Access the PDF Written Report File)
The Tarik.ca Capped Global Renewable Power Generation Index™, is a capitalization-weighted equity benchmark. The index tracks the performance of Global Utilities and Independent Power Producers (IPP) who generate greater than 50% of their electricity production from Hydro-Electric, Wind, Geothermal and Solar Power. Component companies are not adjusted for available float. Index components are capped at a maximum of 20% of the index.
The Tarik.ca Capped Global Renewable Power Generation Index™ is unique and the first of it’s kind.
Unlike all of the new wind, solar and clean energy ETFs. The index does not hold industrial companies involved in the construction of solar wafer, wind turbines and gear boxes. The Tarik.ca Capped Global Renewable Power Generation in contrast is a pure play on a secular growth in renewable power generation.
Strong Coal and Natural Gas costs will continue to put upward pressure on spot electricity prices globally as fossil fuels continue to generate 65% of global electricity supplies. Because Wind and Hydro electricity have high fixed costs and very low variable costs the index is also poised to benefit from a secular increase in electricity prices as margins expand while most Utilities will experience flat or declining margins.
The maturing of large conventional oil fields will continue to pose a challenge to the world’s liquid fuel needs. In light of recent breakthroughs in battery and electric engine technologies, Electric Vehicles and Compressed Natural Gas Vehicles (CNG) will grow to become an ever larger portion of the global vehicle fleet. This will put even more pressure on electricity prices in the future as costs of convention electricity increases, while the demand for electricity grows significantly.
Index Constituents (% Weighting) : Click below to Enlarge
Find attached the PowerPoint file of the presentation I have recently given to the University of Ottawa Investment Club. The presentation gives a broad overview of the Canadian Energy Sector from Upstream, Midstream, Downstream and Utilities. The presentation elaborates on investment opportunities, geology, global and Canadian statistics and the nature of the energy infrastructure in Canada.
(Click the Picture to Access the PowerPoint File)
Recently I was doing research regarding publicly traded companies in Switzerland. In the process I discovered that the Swiss National Bank (SNB), which is the central bank of Switzerland is a publicly traded corporation. This fact took me by surprise as most central banks are closely held by the federal government in most counties. However, due to Switzerland’s history as a collection of independent Cantons the Swiss National Banks is owned by a wide variety of independent owners.
Shares of the Swiss National Bank are majority held (61.6%) by the various Swiss Cantons with the Canton of Berne being the largest shareholder with 6.63% of the outstanding stock. The remaining 38.4% of the outstanding shares are free floating on the public market. The wide dispersion in ownership of the Swiss National Bank has probably contributed to the historically conservative nature of the bank. This fact has historically allowed Switzerland to keep inflation rates low and keep the Swiss Franc relatively strong.
The share capital of the Swiss National Bank amounts to CHF 25 million. It is divided into 100,000 registered shares with a nominal value of CHF 250 each. The current market cap of the shares of the Swiss National Bank is CHF 100 million. A dividend not exceeding 6% of the share capital is paid from the net profit. At a current market price of CHF 1000 per share, the shares have a dividend yield of 1.5%. Movements in the price of the SNB share resembles those of risk-free long-term bonds rather than shares (as the dividend is limited to 6% of the share capital by law).
Share Price Performance Chart
Breakdown of Shareholders
Question
I would be interested in what you think of preferred shares currently – the yields are very high! My concern is about inflation in the longer term and higher interest rates. In your article you mentioned the “large risk” of the shares never being redeemed. I would be interested in your opinion on that risk today?
Thanks,
Sharron
Answer
Hello,
Because preferred shares (most of the time) are structured as perpetuals there is no obligation for the corporation issuing preferred shares to redeem them in the future.
If we ever enter a secular bull market in interest rates, preferred shares will be hit the hardest out of all debt-based instruments, due to the fact that they have an infinite maturity date (Hence they have to be re-discounted to infinity).
Consider the following example: From the highs in the late 1960’s to the lows in January 1980, long term corporate bonds fell by over 60% as interest rates rose from 3% to 18%. As the prices and yields of preferred shares closely follow long-term corporate bonds, we should expect preferred shares to perform similarly to long-term corporate bonds in the future.
In such a scenario, preferred shares would be hit even harder than long-term corporate bonds because there would be no intensive for firms to redeem preferred shares, as they would have to roll over the debt to higher interest rates. This will cause the Present Value of principal amount of the share to go to zero, unlike bonds.
If your goal is to protect your money while investing in preferred shares, you should look into floating cumulative preferred shares of Investment Grade companies, these preferred shares will move with interest rates, hence protecting your initial principal of your investment. While you might be getting a smaller yield, your principal is better protected whether we enter a deflationary of inflationary environment.
Go to http://www.prefinfo.com/
Search for “Floating” Preferred shares which and you will find a couple dozens of them. Note most listed floating preferred shares are currently not floating but have dates in the future where they will start floating.
Cheers,
Tarik
The Tarik.ca US ETF Guide, lists all the Exchange Traded Funds which currently trade in the US on the NYSE, AMEX and the NASDAQ including plain vanilla equity funds, fixed income products, international funds, commodity futures funds, fundamentally weighted funds and leveraged ETFs. The list is currently 11 pages long and growing fast as the ETF industry booms.
Coinciding with the recent release of new Beta-Pro ETFs I have updated the Canadian ETF Sheet to include these new leveraged ETFs which track the MSCI Emerging Market Index, S&P 500 Index, Nasdaq 100 Index, 30 year US Bond, USD Index.
The Tarik.ca Canadian ETF Sheet lists all the Exchange Traded Funds which currently trade on the Toronto Stock Exchange (excluding funds of funds) including plain vanilla equity funds, fixed income products and leveraged ETF’s.
After creating the Tarik.ca Sustainable Renewable Power Index i’ve decided to further analyze and compare all the companies within the index to find the best investment opportunities.
The Income Trusts in the index (demonstrated by the .UN ticker) provide much better value than the 2 non-trusts, which include Canadian Hydro Developers (TSX:KHD) and Plutonic Power (TSX:PCC). Canadian Hydro Developers is expensive relative to it’s earnings and it’s cash flow. Furthermore Plutonic Power does not have cash flow from operations.
Great Lakes Hydro (TSX:GLH.UN) is the most efficient company in the group with cash from operations yielding roughly 21% on equity. However it’s higher P/B ratio dilutes the benefits of having the highest internal returns.
Boralex Power and Income Fund (TSX:BPT.UN) provides the best value out of all the companies within the index. The over reaction to lower water flow in 2007, the one time income trust tax, temporary increases in biomass lumber prices and higher rates of goodwill amortization has resulted in shares declining over 50% in the last year. It is trading at 7.7 times Cash Flow from operations, equating to roughly two third of the average trust in the group which is around 12. At 7.7 times cash flow Boralex is trading at a multiple more akin to an oil company, not making justice to its safe assets. Furthermore Boralex roughly trades at 12 times earning, which is a steep discount relative to the group. I personally feel Boralex, just like CrestStreet is a takeover target due to the fact that it’s assets are very attractively priced at these low prices.
Question
“Can trusts go broke or dissipate or do they go on for years like General Electric ?”
Answer
Income Trusts are businesses just like any other vanilla corporation. And like any other business, they can go broke or dissipate, however this is rare occurrence. Income Trusts were created to avoid the double taxation system, wherein the same corporate income is taxed twice, once at the corporate and once at the shareholder’s level. Income Trusts do not pay taxes at the corporate level but instead taxes are levied on the unitholders income from the company. In order to attain this tax status, income trusts must pay out a majority of their cash flow in order to maintain their trust status.
Income Trusts are as safe as their underling business. In order to be able to pay their large distributions, (which are 9% on average) Income Trusts typically operate in mature and stable industries which deliver strong and consistent cash flows.
However, there are some disadvantages as well to the income trust model. Unlike a regular corporation, earnings are not reinvested into the business. For unitholders this translates into lower opportunities for future growth and ultimately capital gains, with most gains coming from distribution income.
In Canada the average Oil & Gas Income Trust sits on 11 years of reserves. If the average Oil & Gas Trust did not expand reserves they would have to dissolve in a decade. Hence the average Oil & Gas trust spends about 20% of cash flow on capex (Capital Expenditures) for exploration and development, allowing the trust to achieve modest growth in production over the long term. In contrast a company like CI Financial Income Trust (A well established asset management firm) has a very small capex (Capital Expenditures) requirement and can grow organically as assets under management grows with time.
Because distributions are the main attraction to trusts, distribution stability and safety should be an investor’s principal concern. Trusts which cut their distributions have their share often plunge. Hence commodity producing companies are usually considered the “riskiest” of all trusts as commodity price fluctuations can put them in a situation where they might cut their distributions. This is also reflected in the DBRS’s (Dominion Bond Rating Service) policy of always rating commodity trusts lower than their non-commodity peers.
In order to avoid being stuck in a situation where a trust cuts their distribution one should look at the distribution payout ratio. As a rule of thumbs one should not invest in a commodity based Income Trust with a payout greater than 75% and one should not invest in a business/real estate trust with a payout greater than 95%. One should also screen for businesses with a high profitability as indicated with an ROE (Return on Equity) greater than 15%. And since cash flow is king one should look for stability and predictability in the cash flow statement in recent years.
Ultimately, when investing in Income Trusts one should expect small capital gains of 0 to 2% yearly on top of the 9% distribution yield yearly as income is paid out instead of being aggressively reinvested in the business. For these reasons Income Trusts have historically been a great retirement vehicle by providing current income with growth potential. Unfortunately the Canadian Government’s decision to start taxing trusts in 2011 will ultimately result in many trusts converting to corporations in 2011. Since this news has already been priced in, this development poses no threat to investors and is instead an opportunity to pick up great businesses at fair prices.
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