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)
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
One common misperception is that traders have to go both long and short in order to capture significant Alpha. The truth is that a properly built, long only trend following system can outperform the major benchmarks.
The recent SEC ban on short selling financial firms is not an obstacle to traders wishing to make money. Even if the SEC banned shorting on all stocks it is still possible to make large annualized rates of return over the long run.
In order to demonstrate this I created a, Computer Based Trend Following Trading System which trades the components of the Dow Jones Industrial Average which were present in 1999 (I used the components of the 1999 DJIA because I already had the data on my computer).
Using a long-only, momentum based trend following techniques, I back tested the system for the last 20 years (Since the beginning 1988). I limited the size of each position to 10% of total equity of the system.
The system on a backtested basis generated a 63.26% annualized ROR (rate of return) for 20 years by trading the components of the DJIA.
Letting profits run and cutting losses short has allowed the system to generate a massive total return of 1,804,000.00% over 20 years.
The system has generated significant draw downs of over 30% multiple times. This however is common of many trend following managers such as Abraham Trading Company, Rabar Market Research and Chesapeake Capital.
Two major assumptions not included in the back tested result is that large sums of assets under management can distort the market prices of the securities it’s trading. The second major assumption is that commissions have not been included for the 2400 trades which would have been made over the last 20 years of simulation.
I still need to conduct a Monte Carlo test on the data to further back up the statistical significance of the data. As well I need to preform further tests of the system using other sets of historical data.
Click Below to Enlarge Image:
Disclaimer: The Tarik.ca Technical Trading System is only a back tested model and stated profits are virtual. Past performance is not indicative of future returns. Tarik.ca is for educational purposes only and should not be taken as advise or solicitation, to buy or sell any financial product or security.
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.
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
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 dividend 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 dividends are the main attraction to trusts, dividend stability and safety should be an investor’s principal concern. Trusts which cut their dividends 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 dividend 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 2 to 4% yearly on top of the 9% dividend 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.
As fossil fuels become increasingly more expensive in the future as old fields deplete, while unconventional sources become increasingly common as global demand for energy keeps rising, electricity will play a critical role in powering the world. Recent advancements in battery and electric engine technologies as demonstrated in the new Think and Tesla automobiles demonstrate the economic and environmental potential of electric vehicles while not compromising speed or distance. As renewable power becomes cheaper relative to fossil fuels, the demand for electricity will rise at above trend growth. Renewable power from hydro and wind are stable, established, require no fuel and are ultimately cheap. Solar power is still many years away from being economically feasible.
The Tarik.ca Sustainable Renewable Power Index is a market cap weighted index which invests in Canadian companies which derive greater than 50% of their income from wind and hydro installations. The goal of the index is to capitalize on the growing importance of electricity in our energy mix.
Index Constituents (% Weighting)
21.6% – Great Lake Hydro Income Trust
21.3% – Canadian Hydro Developers
14.0% – Algonquin Power Income Trust
10.4% – Macquarie Power & Infrastructure Income Trust
8.7% – Innergex Income Trust
7.9% – Plutonics Power
7.6% – Boralex Power Income Fund
4.0% – Innergex Renewables
2.1% – Earth First Canada
1.6% – Western Wind
0.4% – Synex International Inc.
0.3% – Run of River Hydro Inc.
Index Performance (1 Year) : Click Below to Enlarge
Since Dec 18th, 2007, the Tarik.ca Fundamentals Canadian Equity Fund has returned 26.89 %
The Performance of Market Indices since inception:
S&P/TSX Composite Index : 12.80 %
S&P/TSX SmallCap Index : 7.57 %
S&P/TSX Income Trust Index : 20.83%
Dow Jones Industrial (USD) : -1.28%
Nasdaq (USD) : -1.41 %
FTSE All World ex-US (USD) : 1.83 %
The Tarik.ca Canadian Fundamental Fund has preformed remarkably well since inception on December 18th 2007. These are some of the significant highlights
ARC Energy Trust has increased distributions by 20%, making it the only Natural Gas weighted trust to increase distribution since late 2006.
Canadian Oil Sands Trust has increased distributions twice since December, up a total 50%, due to it’s unhedged exposure to crude oil.
Royal Utilities a Saskatchewan coal producer was bough out at a 25% premium, by Sherritt.
Potash Corp of Saskatchewan has experienced strong performance due to strong potash prices.
Macquarie Power & Infrastucture and Great Lakes Hydro are experiencing strong water flow in their Hydro facilities and strong cash flow.
Capvest the closed end fund, has preformed very well as the discount to NAV has shrunk while the underlining NAV has performed well as income trusts have outperformed the TSX Index.
Fording Coal Trust has performed extremely well as metallurgical coal prices have doubled in the last year as global steel production grow at above trend and as mine disruptions have been experienced in China and Australia.
Tarik.ca Canadian Equity Fund : Performance Graph (As of May 8, 2008)
Click below to enlarge
Tarik.ca Canadian Equity Fund : Investment Weightings (As of May 8, 2008)
Click below to enlarge
After a long month of exams, I’m returning from my long hiatus away from Tarik.ca. My work on the Tarik.ca Technical Trading System is virtually complete. The system now trades all 16 Beta-Pro leveraged ETFs, including eight ETFs which return 200% the daily performance of it’s benchmark and 8 other ETFs which return 200% of the inverse daily performance of it’s benchmark. The system will switch between long and short positions on the ETF depending if the underlying benchmark is going up or going down based on trend following techniques. The system also incorporates a 3% trailing stop loss in order to lock in gains. While only 51% of trades were profitable, the system still managed to return 38% in the last year this is due tho the fact that the system was designed to cut losses and let profits run. A buy and hold strategy for all 16 ETFs would result in a small slow negative performance equal to ETF fees plus leverage loss due to the series of returns. Hence the system’s performance is inherently market neutral to the direction of the underlying basket of ETFs. However, market volatility is positively correlated with performance. Periods of high volatility are positively correlated with high returns and periods of low volatility are correlated with small returns. The system is relatively safe, as I’ve increased the number of ETFs trading, draw downs have decreased dramatically, while profits are virtually the same reducing non-systematic risk. Backtested the system experienced a maximum draw downs of 9% in a market environment where many benchmarks at one point experienced up to a 20% decline.
Disclaimer: The Tarik.ca Technical Trading System is only a back tested model and stated profits are virtual. Past performance is not indicative of future returns. Tarik.ca is for educational purposes only and should not be taken as advise or solicitation, to buy or sell any financial product or security.
Click to Enlarge Image:
In the world of finance risk has become synonymous with volatility. But is volatility a good measure of risk? Quite simply it’s not.
Beta is currently the financial industry’s main way to measure volatility and hence their version of risk. A Beta greater than1 means the security is more volatile than the market average. A Beta smaller than 1 means the security is more volatile than the market. Because an asset class has a low beta does not mean its safer.
For example when examining the stocks of financial companies most have a beta smaller than 1. Does that mean they are less risky? The answer is simply no. Different companies have different risks.
Financial companies, typically considered a “conservative” investment, have a special type of risk, that of leverage risk. For example a quick look at BMO’s balance sheet tells us that they have 377 billions in assets and 360 billions in liabilities, leaving the company with 17 billion in equity. In contrast EnCana has 47 billion in asset and 26 billion in liabilities leaving them with 21 billion in equity. A 4.5% drop in asset leaves BMO with no equity while it is 45% for EnCana. All you need is 4.5% of assets (i.e. mortgages, loans and other investments) to go default and BMO will no longer exists. The dangers of being leveraged has recently been observed with the recent asset write downs at many large US financial institution due to the current credit crisis. This has resulted in many firms panicking and looking abroad for capital (i.e. from Dubai and Singapore) to shore up their balance sheets. Leverage is not only dangerous when asset values decline at banks, but leverage is also dangerous if liabilities (i.e. deposits) decrease which can result in a bank run, as recently observed at Bear Sterns. In the case of BMO a 9.5% drop in deposits (about $22.8 billion) will leave BMO insolvent.
As investors it is important that we understand the risks implicit in different types of investments instead of relying only on Statistical Analysis such Beta, Standard Deviations and Probabilities which are all based on previous performance. And because pass performance and volatility is not indicative of future performance and volatility we should take most statistical analysis with a grain of salt. Many risks have to be analyzed when investing, a few are outlined below:
1) Bonds are subject to inflation and interest rate risks.
2) Financial and commodity companies are subject to leverage risk.
3) Commodity companies are subject to commodity price risks.
4) Companies are exposed to management risk.
5) Foreign companies are subject to currency risks.
If investors continue under the current statistical paradigm of analyzing risks, while ignoring and failing to analyze real risks it can leave investors vulnerable to loses such as those in financial companies over the last year.
In free and open markets, the Efficient Market Hypothesis (EMH) is a function of the information available to profit seeking investors. However there is one scenario where the Efficient Market Hypothesis breaks down, that of collusion. While most most markets are inherently efficient there are a few notable exceptions to the rule.
The most common example of market collusion is government intervention in the foreign exchange markets. Currently many Asian currencies are pegged or manipulated by their respective governments. Governments may execute such interventions in order to stimulate exports or in other cases to make imports cheaper. The fact that Governments aren’t profit seeking institutions distorts the Efficient Market Hypothesis. In Hong Kong, Saudi Arabia and in Dubai for example, their currencies are perfectly pegged the US Dollar. However, due to US government pressures, China is following a strategy of slowly revaluing the Yuan at higher values against the US dollar.
This creates an interesting situation for profit seeking investors. Investors can invest their US dollars into Chinese Yuan and make virtually guaranteed profits, assuming the current exchange rate policy continues, which currently runs at 7% appreciation per year. So how can an investor exploit this flaw in the Efficient Market Hypothesis? For starters one can open a Yuan savings account in China. However, for most individuals this is not an option. For most investors the Market Vectors – Chinese Renminbi/USD ETN (NYSE:CNY) is the easiest route to take. Unlike the Rydex CurrencyShares ETF (Exchange Traded Fund) which physically own the currency in the form of an interest bearing bank deposit, the Market Vectors Chinese Reminbi ETN (Exchange Traded Note) is a note which does not pay interest. The note own futures contracts instead of the actual currency and are a liability of Morgan Stanley. Unfortunately, there isn’t a Yuan Currency ETF which currently exists. As long as Morgan Stanley does not go bankrupt the ETN is just as safe as an ETF without the interest payments.
Question
COS 2007 earning is 1.55 per unit but the annual dividend is 3. Explain why the dividend is higher than the earnings? Will the high dividend sustainable given the low earning figure? Thanks
Answer
Hello, In the Income statement we have revenues and expenses and we are left with Net Income(or Loss). Net Income(or Loss) is then transferred to the Balance Sheet account as retained earnings(or deficit) under Shareholder’s Equity. Dividends are a temporary balance sheet account under shareholder’s equity. When dividends are paid out, it is paid out from retained earning. Hence, EPS is INDEPENDENT from dividends. EPS does not show earnings before dividends.
The real reason COS.UN pays more in dividends than it makes in EPS can be explained by its legal structure. Income Trusts have to pay all out all CASH FLOWS FROM OPERATIONS, in order to retain their Income Trust status.
In order to calculate Cash Flow from Operations we take the following formula (Cash Flow from Operations = Net Income + Depreciation and other Non-Cash Expenses). We add back Depreciation because it is a non-cash expense, which does not effect cash flows. Because Cash Flows from Operations are always higher than Net Income COS (as do all Income Trusts) will pay out more than EPS. That’s why most income trusts have accumulated deficits instead of accumulated retained earnings when we observe the balance sheet.
To analyze the sustainability of dividend payments we need to look at the Cash Flow Statement. COS.UN dividends are sustainable as dividends last year were smaller than cash flow. They paid $791 million in dividends last year while Cash Flows from Operations were $1377 millions, giving us a dividend payout ratio of 57%, which is one of the lowest and safest in the energy trust sector.
Note: Their EPS currently looks low at a $1.55 for the Trailing Twelve Months, however if you exclude the one time tax loss (declared in Q2 2007) for income trusts their adjusted EPS is closer to $2.80. And assuming oil prices stay north of $90 their forward EPS as of Q2 2008 should be around $3.40.
Hope that helps.
Using Fidelity Wealth-Lab I created the following trading system with the aim of creating absolute returns. The trading system currently trades in and out of HED (Which tracks 200% the inverse of the TSX/S&P Energy Index). Over the last year the system has returned over 60% while the ETF has returned -13% on a buy and hold strategy. The system switches between long and short according to short term technical indicators including, moving averages, RSI and others. The system also uses automatic trailing stop loses for risk management and the system also works well on the other Horizons BetaPro ETFs. The System is not yet to be complete. The system will eventually hold all 9 leveraged BetaPro ETFs on a equal weight basis, in order to lower non-systematic risk and to decrease the size of a max drawdowns.
Click the graphs below to enlarge:
Curious to see the predictability of fundemental financial measures, I decided to do a series of regression analysis on 4 important financial measures. I took the top 30 holdings of the TSX/S&P 60 Index and performed a regression analysis comparing 1 year returns against Net Margins, Return on Equity, P/E and EPS Growth.
Below are the regression analysis comparing 1 year returns to : Net Margins, Return on Equity, P/E and EPS Growth.
Taken individually, no financial measure can tell an investor any important information about the quality of an investment. Moreover, the most quoted financial measure, that of the P/E ratio actually has a positive correlation with returns and is the worst measure. However, when all the measures are combined together (see below) we get a strong positive correlation with an r value of 0.74. These discoveries reinforces the idea that individually no single financial measure is of any use; but when used in combination, financial fundemental measures are reasonably good at predicting potential returns.
Bloomberg News is the best website for general financial news. The article are well written and unique. The website also features an Economic Calendar, various indicies and other specialty news and financial items.
http://www.bloomberg.com/
A biweekly report put out by the Commodity Futures Trading Commission that shows the number of long and short positions held by traders in the U.S. commodities markets. Long positions are futures contracts that have been purchased; short positions are contracts that have been sold without the seller owning the underlying contract. The reports also show the open interest, or number of contracts that exist, in the market. Traders look at the report for signals about whether the market is likely to move higher or lower.
http://www.cftc.gov/marketreports/commitmentsoftraders/index.htm
Seeking Alpha is the leading provider of stock market opinion and analysis from blogs, money managers and investment newsletters, and a provider of its own high-value, complementary financial content.Seeking Alpha is different from other finance sites because it focuses on opinion and analysis rather than news, and is primarily written by investors who describe their personal approach to stock picking and portfolio management rather than by journalists.
http://seekingalpha.com/
SEC Info is the Securities and Exchange Commission (SEC) EDGAR® database and Canadian Securities Administrators (CSA) SEDAR® database service on the Web, with over One Billion links created within the SEC/CSA documents and exhibits. You can find prospectuses, who owns which companies, annual and quarterly reports and other company information.
http://www.secinfo.com/
ShortSqueeze.com provides short interest stock market data and services, users will be better informed of short selling in the market, track shorts in stocks.
http://www.shortsqueeze.com/
Only Earnings.com lets you get the latest corporate information, with access to: The most reliable Investment Event Calendar available anywhere displaying Earnings Releases, Conference Calls, Splits, Dividends, Economic Events and more. Live Webcasts and Online Replays of Earnings Calls, Annual Meetings, Investor Meetings and more. Annual and Quarterly Report. Transcripts and Event Briefs (non-biased summaries of corporate conference calls). Company Profiles. Management Presentations. Press Releases. Information Requests and E-mail Alerts. Corporate Governance – including Management Biographies, Insider Transactions, and more…
http://earnings.com/
View Open Market Operations performed Federal Reserve.
http://www.ny.frb.org/markets/omo/dmm/temp.cfm
View North American Coal prices form the Energy Information Agency. http://www.eia.doe.gov/cneaf/coal/page/coalnews/coalmar.html#weekly
View North Americans Natural Gas Inventories, updated weekly at 10:30 A.M. Thursdays. http://www.eia.doe.gov/oil_gas/natural_gas/ngs/ngs.html
A Precious Metals Website, containing news, prices, articles and commentary on Gold, Silver and other PGMs.
http://kitco.com/
The best Financial Statistic Blog on the internet, applying statistics to finance.
http://bespokeinvest.typepad.com/
The Toronto Stock Exchange website, containing information on companies, indicies and trading.
http://www.tsx.com/
Contains the prices for all most Futures Contracts.
http://quotes.ino.com/exchanges/
List the Premiums and Discounts on Canadian Closed End Funds.
http://globefunddb.theglobeandmail.com/gishome/plsql/
Canadian Small-Cap informational resources.
http://www.agoracom.com/
Watch Bloomberg TV live.
http://www.bloomberg.com/streams/video/LiveBTV200.asxx
Find Uranium Prices
http://www.uxc.com/review/uxc_Prices.aspx
A Canadian Prefered Shares Website
http://www.prefblog.com/
Basic Canadian Stock Screener provided by GlobeInvestor.
http://www.globeinvestor.com/v5/content/filters
If you go to Google Video there are over 20 lectures posted by professor Krassimir Petrov in the the feild of Economics and Finance. So far i’ve watched 8 lectures and plan to finish listening to the rest of the over the next month. He teaches Economics from the Austrian perspective unlike most universities which teach from the Neo-Classical Keynesian perspective. Economists from the Austrian school have the best track record out of all economists.
Krassimir Petrov holds a Ph.D. degree from the Ohio State University in Economics (1999). During 2000-2004 he worked at Sterling Commerce, a subsidiary of SBC Communications. Since 2005 he has been a full-time Assistant Professor at The American University in Bulgaria teaching Macroeconomics, Money and Banking, International Finance, etc. Since 2007 Dr. Petrov currently writes a newsletter for Agora Financial. He is an Austrian economist and uses for his analysis the Austrian approach to investing.
Link:
http://video.google.ca/videosearch?q=Krassimir+Petrov&num=10&so=0&start=0
Note: His best lectures are the those on the business cycle and inflation, his investment lectures deal mostly with technical analysis and i would not recommend them.
In 2007, only 24.3% of active funds outperformed the S&P/TSX composite index last year. In contrast, 51.8% of Canadian small/mid cap equity funds outperformed the S&P/TSX SmallCap Index according to S&P. Furthermore, only 5% of large cap fund managers beat their respective index in the long term (10 years). In contrast, 35% of small cap fund managers beat their respective index in the long term (10 years) .
Furthermore as highlighted in “A Random Walk Down Wall Street”, by Burton Malikiel. Small Caps, since 1926 have returned an annual rate of 12.6% while large caps have returned 10.4%. Large caps have a standard deviation in return of 20.2% and with small caps having a standard deviation in return of 32.9%.
When doing the math an investor has much better potential when investing in small caps in the long run. And small cap mutual fund are more likely to outperform their index when compared to large cap funds.
Investors often perceive small caps as risker for many reason including: their higher volatility, low analyst coverage, low news coverage, fear of internal corruption, and fewer buy recommendations lead to investors to avoid the asset class.
However for investors who are willing to conduct their reasearch, there are more opportunities in the small cap sector. As Hesperian Capital noted, “It is an Axiom of the markets that it’s easier to show a 50% return on one dollar than a million dollar.” Because smaller companies simply have more growth potential.
The main reason small cap managers outperform their large cap counterparts is due to the Efficient Market Hypothesis. The Efficient Market Hypothesis (EMH) asserts that financial markets are “informationally efficient”, or that prices on traded assets, e.g., stocks, bonds, or property, already reflect all known information and therefore are unbiased in the sense that they reflect the collective beliefs of all investors about future prospects. However in the small cap arena, the Efficient Markets are not as prevalent as in the large cap arena due to lower investor and media coverage. Hence, making potential returns to investors who are willing to put the time and effort into the reasearch of small cap companies greater.
Mutual Funds such as Hisperian, Sprott and Resolute have prospered due to this philosophy. As Eric Sprott recent remarked, “But we don’t like buying the big guy. We like buying the little guy that no one else is buying.” And as Hesperian Capital noted “It is an Axiom of the markets that it’s easier to show a 50% return on one dollar than a million dollar.”
The Sprott Canadian Equity Fund did not make an annualized 29% rate or return over the last 10 years for no reason. Their ability to reasearch the less transparent, higher growth and unnoticed small caps are directly responsible for their success.
However small caps aren’t for everyone. Due to the lack of readily available reasearch, investing in the small caps requires much more reasearch and grounds up analysis, failing to do so will expose one to a a higher degree of risk.
Constructing a core-satellite portfolio with a market cap weighted ETF’s for your large cap exposure and a high quality Mutual Funds for your small cap exposure would be the best approach for the average retail investor when faced with the Efficient Market Hypothesis.
The Coal sector in Canada is extremely small. Unlike the United States, Canada produces much less coal on an absolute and on a per capita basis. According to the BP Statistical Review, Canada produced 32 million tonnes oil equivalent of coal in 2006, while the USA produced 595 million tonnes of oil equivalent coal.
Metallurgical Coal, also known Coke, is a higher grade of coal which is used as a fuel and as a reducing agent in smelting iron ore in a blast furnace. While Thermal coal is often of lower quality and is used only in powering coal power plants.
In Canada, Fording Canadian Coal (TSX:FDG.UN) which is the largest Canadian coal company by market capitalization and by production. Fording makes quarterly distributions to unitholders using royalties received from its 60% interest in the metallurgical coal operations of the Elk Valley Coal Partnership. Elk Valley Coal Partnership is the world’s second largest exporter of metallurgical coal, supplying high-quality coal products to the international steel industry. Because of it’s position as a low cost producer Fording is one of the top holdings in the Tarik.ca Fundamentals Canadian Equity Fund.
Another large Canadian coal company is Royal Utilities Income Trust (TSX:RU.UN). Royal Utilities is a thermal coal producer, unlike Fording which is a metallurgical coal producer. Prairie Mines & Royalty Ltd., the operating company, is the largest thermal coal producer in Canada, mining 94% of all the thermal coal produced in 2005. With a total of eight surface mines in Alberta and Saskatchewan, the Company generates a substantial portion of its revenue from long-term contracts with major electric utility companies in the two provinces.
Other than those two companies there are no major coal producers, however there is about a dozen or so coal junior developers and minor producers including : Western Canadian Coal, CoalCorp Mining, Grande Cache Coal and Others.
In the US there is a coal ETF (NYSE:KOL), while producing good diversification, the large holdings in Chinese ADR exposes the investor to overpriced Chinese companies coal companies, who’s growth don’t justify their market prices. Furthermore, close analysis of the holdings show that the fund own consumers of coal and coal bed methane gas producers which make natural gas and not coal.
All performance figures are since inception.Tarik.ca Fundamentals Canadian Equity Fund (Since Dec 18, 2007) : 14.02%
Tarik.ca Technical Program Trading System (Since Jan 18, 2008) : 35.82%
Tarik.ca Strategic High-Yield Fixed Income Fund (Since Dec 20, 2007) : 12.97%
The Performance of Market Indices are as of December 18, 2007
S&P/TSX Composite Index : 2.47%
S&P/TSX SmallCap Index : 4.68%
S&P/TSX Income Trust Index : 7.19%
Dow Jones Industrial (USD) : -5.21%
Nasdaq (USD) : -10.97%
FTSE All World ex-US (USD) : -4.54%
Scotia Bank Universe Bond Index : -0.85%
Tarik.ca Canadian Equity Fund : Investment Weightings (As of Feb 21, 2008)
click below to enlarge
Tarik.ca Canadian Equity Fund : Performance Since Inception (Dec 18, 2007)
click below to enlarge
Visit the Model Portfolios page for more information regarding the individual funds.
Over the last 3 years of observing and participating in the financial markets one interesting phenomena is the heavy emphasis on what to buy. Almost every analyst will tell you what to buy but rarely will anyone tell you when to sell, or any sort of exit strategy when investing in an asset class.
Over the last week I’ve read two books. One of which was “One Up On Wall Street”, by Peter Lynch who is the legendary manager of the Fidelity Magellan Fund. Notice the importance at evaluating the company’s marketing marketing metrics (i.e. market share, customer satisfaction) and financial metrics (i.e. return on equity, earnings growth). While reading the booked I picked a few of the features which Mr. Lynch looks for when deciding if he should sell an company.
1) The company has lost market share and is hiring a new advertising firm.
2) No new products are being developed, spending on research and development is curtailed.
3) Acquisition(s) in unrelated businesses. For related businesses acquired the company has paid to much for the acquisition.
4) Sharp Increases in long term debt.
5) Company has a high P/E relative to it’s peers for similar growth.
6) New products are disliked and the products currently in the pipeline keeps growing.
7) A large division in the company is exposed to an economic slump (i.e. ETrade’s Subprime Business)
8)There is no insider buying in the last year
9) The company growth rate is slowing and has been maintaining profits through cost cutting.
10) The balance sheet has deteriorated.
11) Company cuts cost but still can’t compete with foreign firms.
12) Final Demand for the product is slowing.
13) Same store sales have been falling
14) Top Management is leaving to other companies
15) The P/E is twice as high as earning growth protections.
16) Inventory are increasing
17) The company sell most of the product to one buyer who is having difficulty
18) The company offers rights to buy the stock at a discount.
As a technology enthusiast I often follow many of the latest developments and breakthroughs in technology. One such breakthrough has been podcasts. Podcasts are simply online syndicated radio programs. Using an audio RSS aggregator such as iTunes you can subscribe and organize multiple podcasts in one place. Financial Podcasts if used properly and selectively can be a tremendous source of learning. While not a replacement for a proper financial education, they can be used as supplements while commuting to work, moving between classes and while doing work around the house. Allowing one to maximize the value of his/her time and to make the most of one’s MP3 player. Personally I listen to about 4 hours a week using Podcasts and they have been great value. Below are some of the most educational, finance and economics podcasts which I listen to:
The Financial Sense News Hour
Prominent guest experts and authors in the 2nd hour usually provide invaluable insight and perspectives.
http://financialsense.com/fsn/main.html
Bloomberg Podcasts
Bloomberg On the Economy will feature prominent University Professors and Portfolio Managers, giving you various opinions and views on both sides of issues and developments.
http://www.bloomberg.com/tvradio/podcast/
Mises Institute
The Mises Institutes publishes various lectures on Austrian Economics, which offers a much better alternative to mainstream Kaynesian economics, including issues important to finance including the Austrian Theory of the Business Cycle, the Austrian Theory of Money and Credit and other important finance related economic issues.
http://www.mises.org/rss.aspx
Mises Institute : What Government has Done to Our Money
http://www.mises.org/Feeds/moneyRSS.xml
MarketWatch Stupid Investment of The Week
By discovering what qualities create a stupid investment one can better avoid stupid investments in the future.
http://feeds.marketwatch.com/marketwatch/podcasts/marketwatchstupidinvestmentoftheweek
Australian Stock Exchange Podcast
Has invaluable lectures from portfolio managers on how they value companies, risk management techniques and other investing strategies.
http://www.asx.com.au/resources/podcast/index.htm
Even though the financials do not have as strong fundamentals as other sectors, there is value to be found in select companies. Laurentian Bank, which was my last pick in the financial has returned over an 18% gain since January. Using similar metrics I have picked 3 Canadian financial firms which I believe will outperform the TSX Financial Index.
1) GMP Capital Trust (TSX:GMP.UN) is a Sector Outperform at $19.30
The most attractive of the Financials is GMP Capital Trust. GMP is an investment banking house, which operates in three business segments: the Capital Markets segment, which consists of the investment banking, equity research, and sales and trading capabilities of the Fund; the Wealth Management segment, which consists of the full-service investment brokerage services of the Fund, and the Private Capital Management segment, which consists of the capital, strategic direction, business and financial advice provided to mid-market and early stage companies by EdgeStone Capital Partners, L.P.
GMP has an Return on Equity of 50% and a Net Profit Margins 32%. Furthermore, they are experiencing growth rates north of 30% and have been consistently raising their dividend payouts over the past few years, with a current yield north of 11%. At a current P/E of 8 times earnings this company presents tremendous value.
2) TSX Group (TSX:X) is a Buy
TSX Group Inc. owns and operates two national stock exchanges, Toronto Stock Exchange, which serves the senior equity market and TSX Venture Exchange, which serves the public venture equity market; Natural Gas Exchange Inc. (NGX), which is an exchange for the trading and clearing of natural gas and electricity contracts in North America, and Shorcan Brokers Limited (SBL), which is a fixed income inter-dealer broker.
While the recent acquisition of the Montreal Exchange is slightly dilutive, it now makes the TSX the only exchange in Canada for all equities and derivative contracts, giving it pricing power and eliminating any competition. The TSX has a 35% Net Profit Margin, a Return on Equity of 74% and is experiencing good earnings growth. While expensive for a financial at 20 times earnings, the fundamental profitability and growth warrant a higher multiple. The TSX has been constantly raising dividends, the dividend payout has increased over 450% over the last 5 years, with a current yield of 3.3%.
3) CI Financial Income Trust (TSX:CIX.UN) is a Buy
CI Financial Income Fund (CI) is a diversified wealth management firm. The principal business of CI is the management, marketing, distribution and administration of mutual funds, segregated funds, structured products and other fee-earning investment products for Canadian investors through brokers, independent financial planners and insurance advisors, including Assante Capital Management Ltd., Assante Financial Management Ltd. and IQON Financial Management Inc. CI operates through two business segments. The Asset Management provides the majority of CI’s income and derives its revenues principally from the fees earned on the management of several families of mutual, segregated, pooled and closed-end funds, structured products and discretionary accounts.
CI Financial has an Return on Equity of 37% and a Net Profit Margins 34%. Furthermore, they are experiencing growth rates north of 15% and have been consistently raising their dividend payouts over the past few years, with a current yield of 8.5%. At a current P/E of 11 times earnings this company presents reasonable value.
On a weekly basis Bloomberg News publishes an Oil Sentiment Index. This index measures where institutional traders and investors believe Crude Oil will go over the next week. Last week on Thursday the 7th of February the survey indicated: 4% believed Crude prices will go up, 20% believe prices will stay the same and 76% beleived prices will fall over the next week.
This was the most bearish survey reading since the inception of the Bloomberg Oil Sentiment Index, many years ago.
So What happened since last Thursday?
Since then Oil prices have risen from $86.50 to $95.50, a 9$ increase in price which translates to a 10.4% increase in price of Crude Oil in the span of a week, which is the largest weekly gain in the price of Crude Oil since last November.
In Conclusion, crude oil prices have experienced an out-sized gain, in a period when investors and traders were the most Bearish on prices. So event though the investors and traders are highly educated and have plenty of experience they still fail to properly predict the market direction. In fact, the track record from this and other similar sentiment measure has been surprisingly bad. If anything these sentiment survey are slightly negatively correlated as we seen last week when prices went up when sentiment was negative.
When watching and reading the financial press they constantly push forward the idea that the P/E (Price/Earnings) ratio is the single most important measure to value a company. However in reality P/E ratios are overused and over glorified. However, in reality we have to take many measures of value and profitability when evaluating an investment. So what is Return on Equity and how can we use it?
Return On Equity : Measures the rate of return on the ownership interest (shareholders’ equity) of the common stock owners. ROE is viewed as one of the most important financial ratios. It measures a firm’s efficiency at generating profits from every dollar of net assets (assets minus liabilities), and shows how well a company uses investment dollars to generate earnings growth. ROE is equal to a fiscal year’s net income (after preferred stock dividends but before common stock dividends) divided by total equity (excluding preferred shares), expressed as a percentage.
Over the last year I have started to emphasize heavily investing in companies with high return on equity. Companies with high return on equity quite simply have superior management producing superior profitability. Once you populate a list of companies with high return on equity, you want to pay as little as possible for these superior results from a company with a low P/E and P/B with strong earnings growths to top it off.
For example (As of Jan 1st, 2008):
*Net Margins, Return On Equity, P/E are for the trailing 12 months. P/E are based on January 1, 2008 prices.
Notice, by buying companies with above average (ROE/PE and NM/PE scores) relative to other companies in the industry you can reduce your risk by increasing your margin of safety, by avoiding overpaying for a company. In the Financial sector Laurentian Bank outperformed Citigroup by 25% through this method. In the Energy Sector, ARC Energy outperformed Canadian Natural Resources by 24.5% through this method.
Furthermore, while Apple has a high Return on Equity and Net Margins the fact that you are overpaying, at 39 times earnings reduces your margin of safety making the investment more susceptible to a downturn as we have seen this year where the stock has plunged 40%. At these new current prices Apple is still the same great company, and purchases at these level have a high margin of safety unlike before where there was a big premium. Remember a good business is not always a good stock.
As Benjamin Graham said : “In the short run, the market is a voting machine but in the long run it is a weighing machine.” Because there will always be new opportunities which will appear, there is no rush to go out and overpay for a company, be patient buy a business and not a stock.
In Conclusion, by buying a company with a high Return on Equity and a high Net Margin at a cheap prices (denoted by a high ROE/PE and NM/PE) you can increase the margin of safety on your invested capital by not overpaying for the company, while still accessing companies with superior operating results.
Compound growth is one of those phenomenon that most people understand yet fail to apply to their investment strategies from an income perspective. When investing for dividends the key is not to get the company with the highest yield, the key is to buy a company which can continuously grow their dividend rate year after year.
Let’s examine the following case:
Firstly, you have to identify an industry will long term potential for growth and within the industry pick a company with a good record of steady growth and superior management as measure by margins and return on equity. In this Example I will pick the Energy Industry and my Company pick is EnCana which in 2002 had a dividend yield of 1.5% ($0.05 /quarter) at a price of 13$ per share. At today it pays ($0.40/quarter) or equivalent of a 12.3% yield on your original capital not including any capital gains.
This is the equivalent of an 800% pay raise in just 6 years; can you get that from any job?
Lets Say you invested in bonds in 2003 your yield was around %4, today in 2008 your yield is still just 4%. While Encana yield grew from 1.5% to 12.3%.
When investing in “Dividend Growth” you create the turbo equivalent of a laddered bond where rates reset at higher rates every year.
Dividend Growth for long term investors will provide above market returns in the long run and will beat 95% percent of mutual funds, yet it is such a simple and easy technique.
When it comes to the cost of trading most investors only think of the direct costs, also known as the commissions. However there is another more important indirect cost know as the bid/ask spread premium.
This is especially important when investing in illiquid stocks or products. On an illiquid company or product, the bid/ask spread can cost as much as 10% of the purchase price. However usually the Bid/Ask spread on most stocks and ETF’s are never greater than 0.10%. Large spreads can also appear in liquid stocks and ETF’s, when the underling security has a high beta (a.k.a volatility).
Definitions:
Bid Price : The price a buyer is willing to pay for a security.
Ask Price :The price a seller is willing to accept for a security, also known as the offer price.
When buying and selling a stock, CEF or ETF one solution is to put a limit order on the security to protect yourself if the spread is wide. Last Friday for example, on the TSX, I’ve noticed that an individual bought an ETF at a 58% premium since there was no liquidity, so the closest ask was at such at such large premium. If this individual took just 10 seconds to put the limit order he would have saved lots of money.
While one usually will not face large spreads, being aware of this is critical if ever you encounter a situation where you want to buy or sell an illiquid product.
As I have been researching computer based trading systems i’ve been studying the techniques and practices of other computer based trading systems. Until recently I have not realized that such a huge percentage of daily volume is purely computer based trades. These include everything from arbitragers, quant hedge funds to limit/stop orders. There is a positive correlation between volatility in the financial markets and the percentage of all trades which are program based on any given week. If you want to see the weekly program trading reports you can visit the NYSE website.
To see the weekly statistics released by the NYSE visit:
http://www.nyse.com/marketinfo/datalib/1152267398806.html
We often hear on that inflation runs at 2% or there about, but are these figures accurate? Fundamentally inflation is the increase in the supply of money an it is not an increase in prices. However inflation is usually always lower than money supply growth rates, why is that the case? The reason is that the economy growth often absorbs the new money supply. So to get the real rate inflation use the following equation:
Inflation = ((Total Year Two M1,M2,M3 Money Supply – Total Year One M1,M2,M3 Money Supply) / (Total Year One M1,M2,M3 Money Supply)) – Year 2 Real GDP Growth Rate
When compared to Government statistic these inflation figures are more accurate for various reasons. Government inflation figures exclude energy and food (as if we do not drive or eat). And Government figures are hedonically adjusted, meaning when prices go up the weight in the index goes down and when prices go down their weighting increases and hence do not measure the same standard of living over the years.
Below are the inflation rate for the last few years when calculated appropriately:
2003-2004 : 5.2%
2004-2005 : 5.5%
2005-2006 : 6.0%
To get the M1, M2, M3 money supply figures in Canada visit:
http://www40.statcan.ca/l01/cst01/econ07.htm
To get the Canadian GDP Growth rates visit:
http://www.canadianeconomy.gc.ca/english/economy/#top
All performance figures are since inception.
Tarik.ca Fundamentals Canadian Equity Fund (Since Dec 18, 2007) : 2.83%
Tarik.ca Technical Program Trading System (Since Jan 18, 2008) : 19.65%
Tarik.ca Strategic High-Yield Fixed Income Fund (Since Dec 20, 2007) : 12.99%
The Performance of Market Indices are as of December 18, 2007
S&P/TSX Composite Index : -2.13%
S&P/TSX SmallCap Index : -2.50%
S&P/TSX Income Trust Index : -2.40%
Dow Jones Industrial (USD) : -5.58%
Nasdaq (USD) : -8.57%
FTSE All World ex-US (USD) : -6.26%
Scotia Bank Universe Bond Index : 1.47%
Visit the Model Portfolios page for more information regarding the individual funds.
The Tarik.ca Technical Program Trading System, is a computerized program trading system which will use technical analysis (a.k.a. what academia calls “financial voodoo”) to evaluate the merit of such systems and their potential returns. The system seeks not only to beat the S&P/TSX Composite Index but it seeks absolute returns. The system will use Stochastic Oscillators, Parabolic SAR, RSI and William %R in combination to increase accuracy of market timing. The system is an alternating long/short technical computer trading system which will trade in and out of leveraged Canadian listed ETFs in order to achieve Hedge Fund like results. These leveraged ETFs will be from the BetaPro family including the : Energy, Gold, Financial, TSX 60,Crude Oil and Natural Gas ETFs. Commissions and Margin costs will not be included in the calculation of returns. Signals to buy and sell will be generated after market close, because of this buy and sell orders will use the market open price of the next trading day to proceed with the transaction.
To see more information on the three experimental funds which I manage visit the page entitled Model Portfolios these include:
1) Tarik.ca Fundamentals Canadian Equity Fund
2) Tarik.ca Technical Program Trading System
3) Tarik.ca Strategic High-Yield Fixed Income Fund
Since the peak in 2007 the Dow Jones transportation index has fallen more than 23%. Record high fuel prices have squeezed margins by transportation firms in to the lowest levels in year especially in the airline and in the trucking industry. Air Canada has fallen 48% in the last year while Fedex has fallen 25%. Railways which are much more fuel efficient have fallen only about 10%. Today’s diesel railroads are roughly eight times more energy-efficient than heavy diesel trucks. Railroads carried 27.8% of the ton-miles with 220,000 barrels/day while trucks carried 32.1% of the ton-miles with 2,070,000 b/day (2002 data). This fact was one of the main reasons why Warren Buffet has increased his investments in the railway companies last year. If oil prices go higher it will eventually lead to greater profits to the railway companies, as transportation switches away from trucking and airlines to the railways.
Canadian National Railway (TSE:CNR) specifically presents good value. If has margins of 24% and a return on equity of 20% much higher than industry averages. Canadian National Railway is also attractively priced at 12x P/E and 2x P/B , which is very low for a company who has higher than average industry profitability, while still experiencing growth.
On the other hand I believe the airline industry is facing a tidal wave of bankruptcies and consolidation over the coming decade, as energy prices continue to rise and as rail and sea become a preferred method of transport. Furthermore, inflationary and other economic pressures will most likely continue to hurt consumers over the years to come. This will also dampen the demand for the airlines for travel purposes on the part of consumers.
With Oil prices rising and with global demand for energy increasing investing in nuclear power is a strategic move, and that’s exactly what happened. From lows around 15$/pound a few years ago, uranium has increased to 90$/pound, while reaching a high near 140$/pound in 2007. And when considering that uranium purchases is a very small percentage of running a nuclear plant, you soon realize prices can go much higher.
Investing in Uranium can be quite tricky. The market is primarily composed of one major producer (i.e. Cameco), with less than a handful of mid sized producers (i.e. Uranium One, Denison Mines) and many small exploration companies.
With prices of uranium currently high you would think that any of the main producers would do well now. The problem with investing in Uranium, is that currently all the producers face multiple problem from flooding in mines, to acid problems to environmental problems and lawsuits.
So what’s the alternative?
What one can do however is to invest in physical uranium. This does not mean you should store some the radioactive material in your house.
The Uranium Participation Corp (TSE:U) is a closed-end-fund which holds physical uranium in trust. When Uranium was hot in April the fund was trading at a 50% premium to net asset value. However as uranium prices has cooled down the fund is now trading at net asset value, making this a good entry point. By investing in the commodity itself you can avoid the problems which the uranium companies are currently facing while getting exposure to the macro developments in the energy and uranium markets.
1) Get a Brokerage with low commission fees (e.g. Interactive Brokers, there is no reason you should pay more than 0.01$ per share). Furthermore, trade only liquid stocks and products with low bid/ask spread.
2) Once you build a profit greater than 1% on any trade, immediately initiate a stop order which covers your cost and commission, to protect you if the trend reverse. Ideally you should eventually put a trailing stop, which sells the stock if it falls more than a certain percentage the highest closing price.
3) Don’t let your mind fool you to try to average down your purchase by buying additional share. Averaging down has been shown to be physiological phenomenon which occurs as one tries to compensate for a loss. If the trend is down, the trend will usually remain to continue down until the trend reverses. If a trade goes against you sell it. You don’t have to marry your investments.
4) If you are losing money, the first step is to admit it. If you do not admit them, accept your error and analyze where you went wrong you will not be able to learn from your mistakes.
5) Don’t lose money. Don’t let emotions play with you. Use Stop Loses. Don’t average down. Just remember there are always other opportunities. Until you find one there is nothing wrong with sitting in cash.
Over the last few years the ETF industry has grown significantly, from the first ETF tracking the TSE 300 launched in 1990. Worldwide there is currently $600 Billion in over 500 ETFs. In the last two year we have seen the emergence of leveraged ETFs as well as the emergence of commodity based ETFs.
BetaPro, a Canadian leveraged ETF provider will become the first ETF company in the world to offer a series of leveraged commodities ETFs, which is an impressive feat for a small Canadian company. For the first time in history retail investors will have the ability to mimic what futures traders have been doing for decades. When the Gold Bullion ETF (NYSE:GLD) was released in the US, it opened up the previously difficult to access gold market to retail investors and fund companies. The cash inflows into the Gold Bullion ETF (NYSE:GLD) has been responsible for a large proportion in the increase in the price of gold, and now the ETF is the 8th largest holder of gold in the world ahead of China. I believe the cash inflow into these new and other commodity ETFs will bring the democratization of direct commodity investing to investors and can possibly help accelerate commodities such as oil and natural gas to higher highs as high inflows into the funds bid up prices.
The new commodity ETFs which will come out in about 1 month are:
• Horizons BetaPro NYMEX® Natural Gas Bull Plus ETF
• Horizons BetaPro NYMEX® Natural Gas Bear Plus ETF
• Horizons BetaPro NYMEX® Crude Oil Bull Plus ETF
• Horizons BetaPro NYMEX® Crude Oil Bear Plus ETF
• Horizons BetaPro COMEX® Gold Bullion Bull Plus ETF
• Horizons BetaPro COMEX® Gold Bullion Bear Plus ETF
The Tarik.ca US ETF Cheat Sheet, 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 8 pages long and growing fast as the ETF industry booms.
Click to Download the Tarik.ca United States ETF Cheat Sheet
Most of the talking heads in the financial media have been bashing our heads for years telling us that Canadian Natural Resources companies are over valued. However they could not be any further from the truth. Below are some interesting statistics which I find usually surprises and shocks most individuals.
Definition of Market Cap: Market capitalization, or the total market value of the company, is calculated by multiplying the current price per share by the total number of common shares currently outstanding.
All of the 423 oil & gas companies listed on Toronto Stock Exchange and TSX Venture Exchange have a collective market cap the size of Exxon Mobile. Yet they produce more oil and gas than Exxon.
All of the 1300 mining companies listed on Toronto Stock Exchange and TSX Venture Exchange have a collective market cap about the size of Microsoft.
All of the Gold companies listed in the Whole World have a collective market cap smaller than that of Google. Yet they produce 2x the revenues of Google.
So who is really overvalued, think of it carefully!
The recent quagmire which has engulfed the financial services industry globally has literally been a blood bath, we have seen the downfall of some of the largest private institution in the world including Citigroup and UBS. In Canada we have also seen the largest Canadian financial corporations write down billions of dollars in asset backed commercial paper.
However, with all this turmoil there is still value to be found in the financial and even in the banks. Once such bank is Laurentian Bank. Laurentian Bank is Canada’s eighth largest bank by market value. Laurentian Bank is a Quebec based retail bank which serves individual consumers and small and medium-sized businesses. The Bank also offers its products to a network of independent financial intermediaries through B2B Trust, as well as full-service brokerage solutions through Laurentian Bank Securities.
Unlike the other Canadian Banks, Laurentian Bank only had $2.9 Million dollars in write downs for ABCP (Asset Backed Commercial Paper) due to their low initial exposure to ABCP. These loses are a extremely small when compared to other Canadian Banks. Furthermore, Laurentian’s emphasis on retail banking has protected it from incurring loses in commodity speculation such as BMO and subprime loses such as CIBC.
Late last year the stock price fell over 27% with all the other banks. This move to the downside has been overdone due to the bank’s small cap nature, and I expect the bank to outperform it’s peers and the TSX Financial index over the coming year. Currently Laurentian Bank has market cap of $770 million dollar yet it has book value $1004 million. The bank is trading at cheaper levels than its peer’s yet it is experiencing above average growth rates
The Bank is currently trading at a P/E of 8, a P/B of 0.78, with an ROE of 13.85% and Net Profit Margins of 17%, with Earnings growth north of 30%.
Laurentian Bank is Currently a buy at $ 32.30 due to its strong growth, cheap valuations.
Further demonstrating its strong fundamentals, Laurentian raised its dividend for the first time in nearly six years as profit rise; it currently has a dividend yield of 3.96%.
With fears of a recession now rampant much of the excess liquidity hitting and already in the market has been looking for a safe haven. Much of this money has been following into fixed income, more specifically government treasuries.
So when deciding what bonds to buy which ones are the best?
The answer is one must first analyze the yield curve. The yield curve is a graphical demonstration of the interest rates at various maturities either 3 months, 6 months, 1 year 5 year, 10 year and 30 years maturity.
Click below to see the Canadian Yield Curve on the TSX website:
http://www.tsx.com/HttpController?GetPage=BondsRates&Language=en
The further out you go on the yield curve the greater is the interest rate and inflation risk to the bond. Hence one would want the shortest duration with the highest yield in most scenarios. The only exception is if you believe interest rates will drop significantly in the years to come.
Using this logic one should buy the 6 months Canadian bond since one can get a rate of interest almost that of the 10 year bond without having to be exposed to the fixed income and interest rate risk of the 10 year bond.
Using simple strategies like this one can minimize your risk and maximize your profits in fixed income with relative ease.
Recently I’ve been researching the income trust sector particularly in heavy detail. One industry group which has been puzzling me is the oil/gas drillers. As I’ve discovered most of the oil drilling is done by the majors themselves, leaving most of the drilling companies drilling for natural gas which is less capital intensive. Currently there are 200 drills drilling in Canada. Just one year ago there were 500 drill rigs operating. The problem is that lower natural gas prices, the strong Canadian dollar and inflationary pressures have deterred companies from drilling gas. And the drillers have experience their revenues cut in half. And making the problem worse companies including Canadian Natural Resources, PennWest Energy and others have decided to cut their gas drilling activities next year.
Above is the EIA North American Gas Supplies, due to lower drilling I expect inventories to be in the lower part of the range starting in April 2008. And as we enter the winter of 2009 gas prices will most likely be higher than today.
When natural gas prices start to increase as I expect they will start in 2008, business for the drillers can easily double as business booms and margins will increase as well. The following are a few of the major Canadian gas drilling trusts.
1) Trinidad Energy Services Income Trust (TSX:TDG.UN)
2) Precision Drilling Trust (TSX:PD.UN)
3) Stoneham Drilling Trust (TSX:SDG.UN)
4) Phoenix Technology Income Fund (TSX:PHX.UN)
In many fields of life, our views and our ideologies are often self fulfilling just by implementing certain views in our life. For example, in economics “inflationary expectations” on the part of the public has the ability to exaggerate real inflation, when rumors that a bank run might occur they do occur, when the public perceive a shortage it exaggerates the shortage.
This is also true with Technical Analysis of the various markets. By definition technical analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends.
This is also true with Trend Following which is is an investment strategy that tries to take advantage of long-term moves that seem to play out in various markets. The system aims to work on the market trend mechanism and take benefit from both sides of the market enjoying the profits from the ups and downs of the stock market.
While reading a book recently about hedge fund strategies published in 2005 a came upon a very interesting statistics. The interesting fact wast that 78% of Commodity Trading Advisers, “who are basically licensed traders” are trend following/technical traders. Less than 10% of traders follow either fundamental analysis and global macro views.
Many in academia consider the technical and momentum investment strategies uncivilized witchcraft. And they are correct. What these professors fail to understand is that if everyone does it it becomes a self fulfilling reality. With 78% of traders following these methods and now that investment firms are also embracing it it make these technical/ momentum style more effective and they will work, regardless if it is based in any real logic. Technical Analysis is important not for its logical implication but it is important because of its societal/physiological attributes relating to it. If many people do it it becomes self fulfilling.
Even though as a fundamental analysis I do not like these technical and momentum styles I still have to integrate them as one of the elements in my decision making mix, due to this reason. As traders often say “The trend is your friend”.
In future posts I will explain how one can combine technical and fundamental analysis to create superior results.
Below is an update of the Tarik.ca Canadian Equity Fund Performance. Since inception on Dec 18 the Fund has outperformed the TSX by 5%. To see the fund’s holdings see my previous post.
Click Below to View Full Screen:
Have you ever stopped to wonder how much you are paying for energy, not per liter, not per kilowatt hour, but in MBTU (Million British Thermal Unit). By converting the price of gasoline, electricity and natural gas into $/Million British Thermal Unit I’ve discovered some interesting statistics which have interesting investment themes. Using some simple high school mathematics I’ve calculated the cost of different types of energy forms.
As a Canadian living in Ontario I pay the following prices for retail electricity, natural gas and gasoline:
36.50 $/MBTU Electricity Retail Price
34.56 $/MBTU Regular Unleaded Gasoline Retail
15.22 $/MBTU Natural Gas Retail
Which leaves us with the astonishing discovery that: Natural Gas Sells at a 56 percent discount to retail Gasoline
So in the long run there will be economic arbitrage between gasoline/oil and natural gas until both cost the same per MBTU. This implies that either Oil prices have to fall 50% in the long run or that Natural Gas has to rise 100% in the long run, or some combination in between. Personally seeing that Oil prices will rise over the coming years as demand grows while supply stagnates at best, Natural Gas prices are posed to double from the current NYMEX spot price of 7.87 $/MBTU in the long run.
Furthermore, Natural Gas is a North American commodity unlike Oil; 95% of Natural Gas consumed in North American is produced in North America. Seeing that production in the US has fallen since 2001 and production in Canada has fallen since 2004 and Mexican production is also falling higher prices are only be a few years away. This is problematic as Mexican consumption grows rapidly and as as Canadian consumption is growing rapidly due to Oil Sands demand.
Furthermore the building new LNG “Liquefied Natural Gas” import capacity is slow to progress and many years away.
Moreover a combination high inflation in the oil and gas industry and a high Canadian dollar has caused drilling to plummet in Canada over the last year further increasing the odds that we will see higher prices in the future.
The main reason we haven’t seen higher natural gas prices yet is the fact that warm weather have make above insignificant above ground supplies abnormally large, while the in ground supply as well as production rates have been decreasing.
Furthermore another reason the price of Natural Gas is lower is due to hedge fund pair trades. Hedge funds have been buying lots of oil on the markets while selling natural gas at the same time to hedge their position. This has pushed Natural Gas artificially low in front month contracts but high prices persist in future prices, resulting in a steep Contango effect.
With all these problems its hard not to be bullish on Natural Gas. There a 2 primary ways to play the natural gas story.
1) Buy the US listed ETF (AMEX:UNG) which is a basket of natural gas futures contracts.
2) The second and better method is to get exposure to natural gas weighted companies. In Canada, the energy trust sector is weighted more heavily to natural gas unlike the regularly structured corporations. In addition these companies have been hit by the future taxation of trusts in 2011 by the Canadian government. And topped off with the higher Canadian dollar most trusts have performed badly. However now i the time to buy them as natural gas prices have bottomed out and as the Canadian dollar is stabilizing.
Most trust have P/E ratios below 10, while trading at 1.5x book value (Exxon trades at 5x Book!), while boosting an average dividend yield above 11%. The following trusts are poised to outperform:
1) ARC Energy Trust (TSX:AET.UN) is a Buy
2) Peyto Energy Trust (TSX:PEY.UN) is aBuy
3) PennWest Energy Trust (TSX:PWT.UN) is a Buy
The trust outlined above are poised to succeed as they boost some of the highest margins and growth rates of in the trust sector while still being attractively priced on a P/E and P/B basis making them attractive targets for acquisitions and consolidation even if natural gas prices don’t increase. And even if they are not taken out they are safe and profitable businesses with secure distributions.
While Tarik.ca Blog is recent, my experience in the financial markets date back many years. I have created many successfully portfolios over the last few years, this is the first time i’ve make a 100% Canadian Portfolio. Already in the first 12 days since inception (Dec 18, 2007) the fund has already risen 8.6% beating the TSX Composite Index. I’ve constructed this portfolio with a core-satellite approach with ETFs constituting 33.5% of the fund and other stock picks constituting 66.5% of the fund with $100 000 in starting capital. The fund which is built on an equal weight approach, as well as maximizing the negative correlation between companies within the same industry group should in theory should boost slightly lower volatility than the TSX Composite Index while achieving slightly above average returns.
Disclaimer: This is an experimental fund and the author does not currently own any of the securities in the fund.
Tarik.ca Canadian Equity Fund : Performance Since Inception (Dec 18, 2007)
click below to enlarge
Tarik.ca Canadian Equity Fund : Investment Weightings (As of Dec 31, 2007)
click below to enlarge
In the future I will post further updates on the fund and the methodologies I use in picking the companies and constructing the portfolio.
The Tarik.ca Canadian ETF Cheat Sheet lists all the Exchange Traded Funds which currently trade on the Toronto Stock Exchange including plain vanilla equity funds, fixed income products and leveraged ETF’s.
Recently a Morningstar article as noted that the TSX Composite has beaten 93% of Canadian Equity Funds over the last 5 years. This not at all a new phenomenon, in fact it is an endemic problem which has always faced the mutual fund industry. And in the longer term the failure rate is even higher. This is caused by many factors including excessive trading, high fees, bad market timing, the generation of capital gains taxes and performance chasing.
Part of the solution is to construct a core-satellite with index linked Exchange Traded Funds constituting the core of the portfolio and with stock and individual pics acting as satellite to complement the core. In the coming weeks I will further describe my process of portfolio construction as well as the benifits and the roles Exchange Traded Funds can play in an investor’s investment strategy.
Closed End Funds are basically mutual funds which trade on the open market. However unlike mutual funds, closed end funds are not created or redeemed on a daily basis. On the contrary when a closed end fund is created there is a fixed number of units created at the beginning. Hence as the Supply/Demand for a fund changes, the fund will trade at a discount or at a premium to its net asset value. Funds which trade a unusually large discount their net asset value, sometimes present an opportunity to appreciate quicker since investors will take advantage of discount to buy a dollar’s worth of asset for less than a dollar. Furthermore if a fund trades at an unusually large discount the issuer can file a “Normal course issuer bid” wherein the fund manager buys back the units and profits from the difference between the market price and the net asset value, hence causing the discount on the fund to shrink. Income oriented CEF selling at large discounts can also be attractive to investors since it artificially boosts the yield one might expect in the open market while taking on the same amount of risk.
However not all large discounts are buying opportunities. For example a well managed fund will usually sell at a premium and poorly managed funds will usually sell at discounts. One might see discounts sometimes due to difficulties such as improper NAV calculation or due to the frequency of NAV calculation. The key here is to look for larger than historically usual discount. Hence such a discount should be larger than 15% for it to be notable.
The following two closed end funds trade at unusually large discounts greater than 40% and I believe that they will perform well in the coming months:
1) High Income Preferred Shares Corporation (TSX:HPF.PR.B) is a CEF which holds preferred shares and it currently boosts a dividend yield greater than 15%. While preferred shares were weak in 2007 the fund’s shareholder oversold the fund in an illiquid market which exaggerated the fund’s decline below the NAV. The discount will not last long as yield hungry investor will come along and scoop up the fund and it’s impressive yield. Furthermore the fund manager issued a “Normal course issuer bid” which is in effect in 2008 which will close the discount.
High Income Preferred Shares Corporation (TSX:HPF.PR.B) is a Buy at $7.00
2) CAPVEST Income Corp. (TSX:CSV) is a CEF which invest in infrastructure income trusts currently it has a yield greater than 11%. The new taxation of income trusts has scared investors from income trusts and has created unusually large discount in income trust based CEFs as investors left the sector. With the income trust sector now stable I believe the discount will close as investors get attracted to the yield and as the fund manager issues a normal course issuer bid.
CAPVEST Income Corp. (TSX:CSV) is a Buy at $0.90
You can check the Premium/Discounts on Closed End Funds online at: http://globefunddb.theglobeandmail.com
To many individuals preferred shares are an obscure investment which they know little about. However with a little research you will discover that they are a great alternative to a fixed income mutual fund. Preferred share are shares who are usually issued at $25 and pay a fixed dividend per share per year. Preferred shareholders have preference over common shareholders in dividend payments, as well preferred share holders are paid out first if a company goes bankrupt before the common shareholders. This results in preferred shares being a very safe investment like bonds. Furthermore like bonds preferred shares mature and are redeemed like bonds at their issue price of $25. In the past few months Canadian bank stocks have fallen with the sub prime issues in the the US spilling to Canada. These events has misguided Canadian retail investors to sell preferred shares. In combination with the light volume on preferred shares many issues fell dramatically causing many of them to sell at steep discounts to their redemption price.
These are my current picks for 2008:
Note: To calculate yield to maturity you can use the following online calculator http://www.moneychimp.com/calculator/bond_yield_calculator.htm
Further more not all preferred shares with a high yield are good investments. Preferred shares from chartered banks have virtually no risk, however when buying preferred shares of other companies analysis of their credit rating and financial statements is required.
1) George Weston Limited (Which is the parent company of Loblaws) Series E (TSX:WN.PR.E) is now a Buy at $15.25 per share is currently boosting a yield-to-maturity of 13.785%
2) Laurentian Bank of Canada Series 10 (TSX:LB.PR.E) is now a Buy at $20.00 per share is currently boosting a yield-to-maturity of 10.608%
3) Canadian Imperial Bank Of Commerce Series 32 (TSX:CM.PR.J) is now a Buy at $18.50 per share is currently boosting a yield-to-maturity of 9.807%
4) National Bank of Canada Series 16 (TSX:NA.PR.L) is now a Buy at $20.70 per share is currently boosting a yield-to-maturity of 8.644%
Another important feature of preferred shares is the fact that they pay out dividend and not interest income. So for an individual in the highest tax bracket you multiply the the current yield-to-maturity buy 1.3x to get the interest-equivalent-yield-to-maturity of 17.92% for WN.PR.E.
Note: The preferred shares mentioned above are perpetuals, meaning that redemption is not guaranteed. Over the last 30 years we’ve been in a declining rate environment, those decreasing yields made made the redemption of preferred shares quite probable since the firm would be able to recall them and issue new shares with lower yields. However in a rising rate environment we will most likely not see the same phenomenon occurring (especially when we consider when we are experiencing historically very low interest rates). This leads to the risk that the preferred shares will never be redeemed which is a large risk. All calculations assume shares are redeemed at original par of $25, at the beginning of the furthest call date possible.
It is no surprise that Restaurant Trusts haven’t been on many investor’s radar screen with the industry boosting a minuscule market cap of 1 Billion Dollars (or 997 million dollars to be exact), they are minuscule and illiquid compared to most companies in the income trust index and are easily overlooked by most investors. However they boost a great investment opportunity with many of the restaurant trust trading near book value. Most restaurant trusts have growing same store sales allowing them to increase their distributions in a period where most income trusts are cutting their distributions. On top of the great value they present all these trust pay distributions above the average yield of S&P/TSX Income Trust Index even though they have a more secure and predictable business model than other trusts.
1) SIR Royalty Income Fund (TSX:SRV.UN)———————————14.6% Yield
2) Second Cup Royalty Fund (TSX:SCU.UN) ——————————–11.5% Yield
3) Prime Restaurants Royalty Income Fund (TSX:EAT.UN)—————14.7% Yield
4) A&W Revenue Royalties Income Fund (TSX:AW.UN) ——————9.4% Yield
5) Pizza Pizza Royalty Income Fund (TSX:PZA.UN) ————————9.2% Yield
6) Boston Pizza Royalties Income Fund (TSX:BPF.UN)——————– 9.8% Yield
7) PDM Royalties Income Fund (TSX:PDM.UN)—————————- 14.5% Yield
8 ) Keg Royalties Income Fund (TSX:KEG.UN)—————————— 9.7% Yield
9 ) Priszm Income Fund (TSX:QSR.UN)————————————– 21.8% Yield
Out of all the restaurant trusts Priszm Income Fund (Which owns Pizza hut, Taco Bell and KFC restaurants) at $ 5.45 per unit presents a Buy and the best value out of all the restaurant trusts. In 2007 units fell 54% on when distributions were cut temporarily to raise cash and as they announced restructuring plans. Now that distributions will be restored in 2008 the yield will be equivalent to 21.8%. And now that units are trading a book value there is little downside risk and plenty of upside potential. Furthermore the price of the units will most likely be bid up by yield investors, until the yield declines to about 15% since they now present the highest yield out of all the other trusts.
As the subprime debacle has unfolded many of these bonds have lost most of their value with hedge funds like the Goldman Sach global alpha fund loosing over 60% at one point. The question is currently have these bonds been oversold. For most investors this is a non issue since retail invstors cannot access these securitized mortgages anyways. But thats not completely true.
On the TSX you can buy “Global Diversified Investment Grade Income Trust II” (TSX:GII.UN) which is a closed-end-fund (which is a market traded mutual fund) containing a basket of subprime mortgages. Deutschebank recently rated the net asset value of the fund at $0.80 per unit. A few months ago the fund was trading over $8.00 resulting in a greater than 90% loss. Now that the fund is trading below its new net asset value, and now that the Canadian banks are working to get ABCP deal worked out the fund can potentially rise from its current oversold condition.
“Global Diversified Investment Grade Income Trust II” (TSX:GII.UN) is a Speculative Buy at the current price of $0.70 per unit
As I have been researching fixed income investments over the last few months I have come to the conclusion that, “Fixed Income Mutual Funds are the Scam of the Century”. My research has confirmed my assumptions that every single Canadian fixed income fund has under preformed the Scotia Bank Universe Bond Index over the last 10 years. The simple reason for this problem are the exorbitant MER “Management Expence Ratio” which fund companies charge investors. The MER on Canadian fixed income mutual funds ranges everywhere between 1% to 2%. In a world of of low yield which currently preside, where the Canadian 10 year bond is currently yielding 4.017% an investor is loosing 25 to 50 percent of their profit to management fees while the rest of the profits are lost to inflation and taxation. Furthermore fixed income managers add little value since most investments constitutes government bonds which are risk less and do not require any risk analysis. “If an investor wants exposure to fixed income the investor should manage it individually“.
The Following are some steps an individual can take:
1) One option is to simply take out a bank CD and renew it once it matures. While the yield on CD may be slightly lower than current interest rates it is still better alternative than a fixed income mutual fund. With yields at chartered banks currently above 4.5 % it beats any fixed income fund.
2) The second option is to buy a Canadian Fixed income ETF through the Canadian iShares ETFs. These Exchange Traded Fund will track the fixed income indices, while boasting reasonable MERs between 0.30% to 0.40% making them a much better alternative than buying a fixed income mutual fund while achieving the diversification. Furthermore ETFs are tax efficient and generally more efficiently managed than mutual funds. The following are the current Canadian Fixed Income ETF’s.
a. CDN Bond Index Fund (TSX:XBB)
b. CDN Corporate Bond Index Fund (TSX:XCB)
c. CDN Government Bond Index Fund (TSX:XGB)
d. CDN Long Bond Index Fund (TSX:XLB)
e. CDN Real Return Bond Index Fund (TSX:XRB)
f. CDN Short Bond Index Fund (TSX:XSB)
3) The third alternative to a fixed income mutual fund is to buy preferred shares which pay a fixed dividend per share per year. While you can buy a preferred share ETF, which is the Claymore S&P/TSX CDN Preferred Share (TSX:CPD), I would rather pick individual preferred shares. In next week’s post i will further describe the benefits of preferred shares and reveal my preferred share picks for 2008.
4) The fourth option is to buy a TSX listed capital trust from a major Canadian financial firm such as BNS Capital Trust (TSX:SBA), Manulife Financial Capital Trust (TSX:MFT), RBC Capital Trust (TSX:RYT), TD Capital Trust (TSX:TDD). When you buy a unit of this trust your lending money to these major banks/insurance companies. In return your will get around a 7% yield instead of the 4% you get from a GIC from the bank as a retail consumer. These capital trust are similar to bonds as they pay regular interest income and they will mature at a future date.
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