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 Financial Happenings Blog 
Wednesday, March 14 2012
I have just come across an article published by McKinsey & Company in October.  It looks at the ability of company executives to time share buy backs in the USA - 

The savvy executive’s guide to buying back shares

Many of us would expect that company executives have some kind of insider knowledge that would allow them to better time the purchase back of company shares.  Unfortunately the study undertaken by McKinsey suggested anything but such skill.  In fact, 77% of companies did worse in their timing of share buybacks compared to simply gradually buying back shares regularly over time.

Another powerful reminder of the dangers of trying to time entry into and out of share investments.

Regards,
Scott


Posted by: AT 01:30 pm   |  Permalink   |  Email
Thursday, March 08 2012
If you had held cash during the past 4 years of equity market turmoil you would probably be pretty happy with yourself.  Some may even be contemplating staying in cash or at least a lot larger allocations of cash going forward.  Unfortunately just as there are risks when investing in shares, holding cash has its own key risk - preserving purchasing power.  The official cash rate at present is 4.25%.  With inflation running at 3%, probably higher for those in retirement, you can quickly see that cash is not offering much of a return above inflation.

Brad Steiman from the Canadian branch of Dimensional has looked at the tension between two key goals of most investors - Preserving Capital or Preserving Purchasing Power.  He has looked at data spanning back 111 years which is made available though the Dimson Marsh Staunton database.  The key conclusion is that the risks from investing in shares are discernible immediately whereas the risks from investing too much in cash, which is just as great a risk, may only be identified many years later.

Please find Brad's article following.


The Tradeoff: Preserving Capital or Preserving Purchasing Power

Brad Steiman, Northern Exposure

Director and Head of Canadian Financial Advisor Services and Vice President

Click on the following link to listen to a podcast of this article - podcast

Many aspects of life require careful consideration and balancing of the tradeoffs that arise from competing demands. For example, a common lifestyle tradeoff is working longer hours versus spending more time with your family. The competing demands within this decision are the income necessary to provide a suitable quality of life for your family versus the immeasurable benefits of quality time with your family. There is no right answer, but most people understand the tradeoff and attempt to find the balance that is right for them.

Successful investing and financial planning also require balancing tradeoffs. For example, a common investment tradeoff is that of risk and return. One of the competing demands is preservation of capital versus preservation of purchasing power. The former may allow for a better night's sleep during periods of heightened uncertainty and corresponding volatility, but the latter helps ensure you'll have a comfortable bed in the future when accounting for rising prices from inflation. Once again, there is no right answer, no "optimal" solution. Understanding the tradeoffs between preserving capital and preserving purchasing power will help investors find the balance that is right for them. This balance will depend on their definition of risk and attitude towards it.

Some investors may consider risk to be volatility. They have difficulty stomaching the daily ups and downs associated with investing in asset classes that experience significant price fluctuations, such as equities, because declining prices are often accompanied by predominantly negative headlines. Although information will be reflected in prices before one can react to it, this is little solace to investors who extrapolate the recent past into the future and see the bad news as an indicator of what's to come rather than a commentary on what has already happened. These investors yearn for short-term preservation of capital.

Other investors may define risk as a diminishing standard of living. They have long-term financial obligations, such as spending during their retirement years, and their primary goal is building wealth to meet those future expenses. They recognize that, while the cumulative effects of inflation are sometimes glacially slow or even undetectable in real time, inflation can be the silent killer of a financial plan. These investors desire long-term preservation of purchasing power.

Investing is relatively straightforward when the definition of risk and attitude toward it are so black and white. For example, you can virtually guarantee the preservation of capital by investing in the equivalent of Treasury bills as long as you accept the corresponding potential for the loss of purchasing power. On the other hand, you can preserve purchasing power by investing in asset classes with expected returns exceeding inflation, providing you accept price fluctuations that can temporarily impair your capital.

Unfortunately, in practice, investing isn't that simple. Individual investors rarely have black and white objectives or well-defined definitions of and attitudes towards risk. Some expect long-term preservation of purchasing power and short-term preservation of capital. Making matters worse is the tendency for the priority and relative importance of their competing demands to change through time, often in response to what's happened in the recent past.

Investors who succumb to the cycle of fear and greed end up chasing a moving target. Advisors can try to mitigate this destructive behavior by focusing investors on the tradeoffs that were made at the outset when determining their balance between assets that are expected to grow faster than inflation and those that stabilize the portfolio and reduce its fluctuations. So if an investor is now fearful and therefore more focused on capital preservation, it is time to reframe the tradeoffs by emphasizing why growth assets were in the portfolio to begin with and how the so-called "riskless" asset (i.e., bills) can actually be extremely risky in the long run.

For example, Table 1 contains annualized returns from Australia, Canada, the US, and the UK for more than a century. Bills only slightly beat inflation before tax, but this small return advantage can easily disappear on an after-tax basis.1 Nonetheless, the table clearly demonstrates that equities have delivered returns exceeding both bills and inflation by a wide margin, even when accounting for taxes.2

Table 1: Annualized Nominal Returns (1900–2010)

Country

Inflation

Bills

Equities

Australia

3.9%

4.6%

11.6%

Canada

3.0%

4.7%

9.1%

US

3.0%

3.9%

9.4%

UK

3.9%

5.0%

9.5%

In local currency. Dimson Marsh Staunton (DMS) Global Returns Database. Past performance is no guarantee of future results.

However, the tradeoff for pursuing higher expected returns of equities is accepting the risk of substantial declines compared to the relative stability of bills. Table 2 shows that equity values in the four markets have dropped from 50–69% over a two- to six-year period, whereas bills have always been flat or better (if you consider minus 2 basis points a rounding error).

Table 2: Worst Performing Periods for Equities and Bills, Nominal Returns (1900–2010)

 

Equities

Bills

Country

Period

Total Return

Period

Total Return

Australia

1970–1974

–50%

1950

0.75%

Canada

1929–1934

–64%

1945

0.37%

US

1929–1932

–69%

1938

–0.02%

UK

1973–1974

–61%

1935

0.50%

In local currency. Dimson Marsh Staunton (DMS) Global Returns Database. Past performance is no guarantee of future results.

The risk and return relationship from a preservation of capital perspective is apparent in these nominal returns, but the picture is a bit different after considering the impact of inflation. In terms of preserving purchasing power, now the "riskless" asset looks far from risk free.

Table 3 contains the biggest peak-to-trough declines, in real terms, for equities in these four countries over the same time period. It likely comes as no surprise that the magnitude of the real declines is substantial, with stock prices dropping anywhere from 55–71% after inflation. However, the duration of the declines is still relatively short, ranging from two to five years, and it took equity investors in these countries anywhere from three to eleven years to break even.

Table 3: Worst Performing Periods for Equities, Real Returns (1900–2010)

 

Peak to Trough Decline

Subsequent Recovery

Country

Period

Total Return

Years

Years

Australia

1970–1974

–66%

5

11

Canada

1929–1932

–55%

4

3

US

1929–1931

–60%

4

4

UK

1973–1974

–71%

2

9

In local currency. Dimson Marsh Staunton (DMS) Global Returns Database. Past performance is no guarantee of future results.

In contrast, the data in Table 4 for bills, or the "riskless" asset, in these four countries is revealing. The biggest peak-to-trough declines after inflation now remarkably range from 44–61%, a similar order of magnitude to equities. Furthermore, the duration of the declines extends to a range of seven to forty-one years with investors in bills waiting an astounding seven to forty-eight years to recover!

Table 4: Worst Performing Periods for Bills, Real Returns (1900–2010)

 

Peak to Trough Decline

Subsequent Recovery

Country

Period

Total Return

Years

Years

Australia

1937–1977

–61%

41

21

Canada

1934–1951

–44%

18

34

US

1933–1951

–47%

19

48

UK

1914–1920

–50%

7

7

In local currency. Dimson Marsh Staunton (DMS) Global Returns Database. Past performance is no guarantee of future results.

Click on the following link to see this data in graphical format - Preserving Capital v Preserving Purchasing Power in Australia.

More than ever, comparisons like these are needed when discussing the tradeoff of preserving capital versus preserving purchasing power. Investors feel the risk of equities in real time. Volatility is immediate and apparent as their portfolio value shows up in the mail every month or on their computer screen every day. Conversely, the risk of investing in bills and other low-volatility assets is less discernible and may take time to detect as it shows up when investors open their wallet at the grocery store or gas station many years later.

Investors may still want to revisit the tradeoffs they made and alter course if appropriate. However, changes to a long-term plan should reflect an informed decision rather than an emotional one. Fear and greed are powerful forces, but we should resist letting them dictate the tradeoffs we make in our lives or in our portfolios.

Many thanks to Marlena Lee for compiling this data from the Dimson Marsh Staunton (DMS) Global Returns Database.

1. Returns in this table are pre-tax, but actual consumption, as represented by inflation, requires after-tax dollars; therefore, if the marginal tax rate on interest income exceeds [1 – (Inflation/Bill Return)], the real return is negative. (e.g., Canada: [1 – (3.0/4.7)] = 36% but the highest marginal tax rate on income is roughly 45%.)

2. The difference in the real return of equities versus bills would increase after taxes in countries where the tax rate on income exceeds the tax rate on dividends and capital gains.

Posted by: Scott Keefer AT 12:45 pm   |  Permalink   |  Email
Tuesday, March 06 2012
 As outlined in Jim Parker's latest Outside the Flags commentary, 2012 has started much more positively for investment markets with all major asset classes followed by this firm showing gains for the first 2 months of the year.  This is an obvious turnaround tofromthe doom and gloom seen in the last half of 2011.

We should not become too optimistic as markets have an awful habit of disappointing just when we think the worst is behind us, but what we can take away are two key reminders as to the fundamentals of investing:

- It's important to be patient and take a longer term approach, and
- Don't get caught up in the hype and emotion put out by the financial media and make knee jerk decisions either on the up or down side

Please find following Jim's full article.

Regards,
Scott

author
March 1, 2012
Out of the Blocks
Vice President
68 recent views \ 68 views all-time
 

'And you thought 2011 was tough?' So went the headlines in December as media and market pundits, reflecting on a miserable year, saw no respite for investors in 2012. But markets have a funny way of confounding expectations.

To be sure, the reasons to be anxious were piling high as the year turned, with European politicians dithering over how to tackle a tottering mountain of sovereign debt, policymakers in the US running short of options and emerging markets not providing the cushion that many investors had hoped for.

The general view, as expressed through the media, was that there would be more muddling through in early 2012. "Buckle up!" warned the respected Barron's magazine. "For investors frightened by the stock market's volatility in the past six months and tired of worrying about places in Europe once given little thought, 2012 promises scant comfort — at least in the first half."

As an investor, if you had taken that advice you might be ruing it now, as global equity markets — as measured by the MSCI World index — have registered their best start to a calendar year in 21 years. The index was up by just over 10% in US dollar terms as of the end of February. You have to go all the way back to 1991 to find a better start.

Added to that is that much of the leadership for the turnaround is coming from the US, an economy that many observers just two years ago were writing off in favour of the emerging powerhouse economies in Asia. The US benchmark S&P–500 was up by 9.0% to the end of February. This is also its best start since 1991 and returns the index to the levels of June, 2008, before the Lehman collapse.

The US market's strong start followed a standout 2011, in which it was one of the best performing markets in the world. And that included most of the emerging markets.

Even Europe, the epicentre of concerns for much of the past year, has exploded out of the blocks in 2012. The Euro Stoxx 50 was up by nearly 12% over the first two months of the year, with the German market rising by close to 20% in US dollar terms.

The renewed buoyancy extended to Asia, where the MSCI Asia Pacific Index has registered 10 consecutive weeks of gains, its longest uninterrupted winning streak since 1988, and powered by strength in energy stocks. Australian stocks have firmed as well, to be up 12.5% year to date in US dollar terms — although in local currency terms, the gain has been less stellar at just over 7%.

Why the change in mood? There are several catalysts for the turnaround in markets so far in 2012.

First, by the end of last year, market participants were discounting a lot of bad news, including a couple of catastrophic scenarios. Fears of mass defaults in Europe and a possible break–up of the euro were seen as entirely possible.

While Europe can hardly be described as being out of the woods yet, the agreement by creditors on a new round of official funding for Greece has eased nerves, as has the European Central Bank's provision of another half a trillion euros in cheap funding to financial institutions.

Second, there have been signs of a turnaround in the US economy, at least compared to the view the market was taking a few months ago. At that time, another recession was seen as on the cards. Since then, official data have shown an improvement in the labour market, a rise in manufacturing orders and a climb in consumer confidence.

Third, central banks are pumping out massive amounts of cheap cash — essentially printing money — to provide liquidity to the financial system and to support the recovery. As well as the ECB's latest cash injection, Japan and Britain have recently extended their so–called "quantitative easing" programs, while China has the cut the reserve requirements for its banks.

Of course, just as it was wrong to extrapolate the pessimism of last year through into 2012, it would be foolish to forecast that the rest of this year will resemble the first two months in tone. No–one knows how markets will perform going forward, because that requires an ability to forecast news. You can always guess, of course, but we tend to think that's not a sustainable investment strategy.

The point of this is to highlight the virtues of discipline and the tendency of markets to absorb news very, very quickly and to look forward to the next thing. Unless you know what the next thing will be, you are wise to stay in your seat.


1. ‘Buckle Up!’, Barron's, Dec 19, 2011

Posted by: AT 09:45 pm   |  Permalink   |  Email
Tuesday, March 06 2012

The latest SPIVA Scorecard (Standard & Poors Indices Versus Active funds) has been released and even though there has been some slight improvement for active fund managers since the last report, the overall news remains bleak.

The key findings were:

·   The S&P/ASX 200 Accumulation Index has outperformed at least 60% of active Australian equity funds over the periods of one year or more. The S&P/ASX 200 Accumulation Index has outperformed approximately 63% of active Australian Equity General funds over the last five years.

·   Active Australian Equity Small-Cap funds have significantly outperformed the benchmark across all periods studied in this report. Over the last five years approximately 80% of active Australian Equity Small-Cap funds have outperformed the S&P/ASX Small Ordinaries Index, with this majority increasing to 90% over the last year. Both the equal- and asset-weighted average returns of the active fund category have far outperformed the S&P/ASX Small Ordinaries Index across all periods studied.

·   With the exception of active Australian Equity Small-Cap funds, a majority of funds across all categories have failed to beat their respective indices over all periods observed in this report. Over the last year at least two-thirds of active funds across most categories failed to beat their respective indices. Australian Equity Small-Cap funds are the only exception to this finding.

·   At least 80% of active International Equity General funds underperformed relative to the benchmark over the last year. Over both three- and five-year periods, at least 62% of International Equities General funds have failed to beat the index.

·   Over the last five years approximately 84% of active Australian Bond funds have failed to beat the index. However, over three years the underperforming percentage falls to approximately 62%.

·   Approximately 57% of active Australian A-REIT funds have failed to beat the benchmark over the last five years, increasing to an even larger majority of 74% when taking into account only the last year. Over both three- and five-year periods, active Australian Equity A-REIT funds enjoyed the highest survivorship rate when compared to the other active categories covered in the SPIVA Australia Scorecard.


The only bright spot to mention for active managers is in relation to small caps.  A major reason for the out-performance is that many small cap managers will dig a lot deeper than the S&P index which stops at the 500th largest company on the ASX. The manager we use for small caps uses an index style approach but invests in much smaller companies than just those in the ASX500.  This fund has also significantly out-performed the S&P index by 2.11% through 2011, 3.47% p.a.over 3 years and 4.79% p.a. over 5 years.

Concluding Comments

This research again backs up our firm’s approach to build a portfolio around index style funds which promise lower fees and better than average performance compared to their actively managed counterparts.

Click on the following link for a copy of the full SPIVA report.

Regards,

Scott

Posted by: Scott Keefer AT 09:11 am   |  Permalink   |  Email
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