Toronto
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Toronto, Ontario
M2N 5Y7
(416) 733-3292 x 221

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TriDelta Investment Counsel – Q1 2014 investment review

Posted on April 8, 2014 by Ted Rechtshaffen in Bonds, Equities, Investing, Quarterly report

Executive Summary

After strong investment markets in 2013, there were some real questions about valuations heading into 2014.

At least for the beginning quarter of the year, we remained fully invested and leaned a little aggressively. This has paid off as the quarter was quite positive for stocks (more so for Canada than the US). Even bonds and preferred shares had a bit of a rebound, continuing some of their gains from the last quarter of 2013.

The question remains whether to take a little bit off the gas to defend against a potential pullback or to continue to move fully forward.

As we write this, we continue to be impressed with the projected earnings growth that corporations are providing. If this growth is achieved, then markets are not particularly expensive at this point. This gives us some confidence, but we are a little more wary today than we were at the beginning of the year.

IF we make a strategic shift at some point this quarter, there are many ways to adjust portfolios.

These could include:

  1. Shifting our stocks a little away from cyclical companies to lower volatile sectors.
  2. Lowering our stock weightings across all client profiles, and moving short term to higher cash in anticipation of buying back in at lower prices.
  3. Lowering our stock weightings and increasing our bond and preferred share weightings.

While we are prepared and ‘at the ready’ to make some of these adjustments, we are not doing so right at the moment. We need to see signs of slowing corporate earnings before we would pull the trigger – and at the moment we are not seeing it.

The Quarter that Was

From a global perspective, the first three months of 2014 did see some volatility as global equity markets dipped and recovered.

Fixed income markets benefited from a flight to quality during this period and a slight psychological shift against higher rates anytime soon.

Globally, signs of improvement continued in the North American markets. The post-Olympic turmoil between Russia and the Ukraine increased global tensions especially in Europe, where many countries rely on Russian oil and gas for much of their energy. In some emerging markets economic numbers came in on the weak side raising concerns in these high growth areas. Overall the mood is still net positive and we continue to see very little pressure on interest rates rising meaningfully. As long as earnings growth continues, equities and corporate bonds should be stable.

Global equity markets as a whole performed well during the period with most indices up 6 – 10%. The notable exceptions were China and Japan, which were negative, while Italian equities were some of the best on the globe rising close to 15%. These are all viewed as Canadian currency returns.

Emerging market equity returns were slightly down during the first quarter, but were saved in the last two weeks as a strong rally helped eliminate a decline that came close to 10%.

Precious metals rebounded with a vengeance as Gold rallied right out of the gate and at one point was up more than 17% before a correction late in the quarter reduced almost half the gains.

In the first quarter, fixed income exhibited broad based strength. The Canadian bond universe, FTSE TMX Canada (formerly DEX) Index, recorded its first monthly negative return of 0.19% in March of this year after gaining 2.96% in the first two months of 2014.

Our view on interest rates

18011768_sDirection of interest rates is far from certain as a variety of conflicting economic signals in our mid-term time horizon. The global macro economic landscape has marginally deteriorated, while U.S. economic conditions haven’t seen any dramatic improvement since the US Federal Open Market Committee (FOMC) embarked on tapering their asset purchase program. The FOMC has also definitively said (as definitive as they can be given that their actions are subject to many variables) they will be moving overnight interest rates higher by the spring of 2015.

We do not share the moderately aggressive FOMC assessment; however, we recognize the need to end tapering and to return monetary policy back to managing overnight interest rates, and not managing the yield curve. We believe geopolitical uncertainty, a cooling Chinese economy, struggling EU region, and weather tainted North American economic statistics make it immensely difficult for the FOMC to remain committed to any policy action – other than the expected tapering – that may jeopardize the fragile recovery. The greatest uncertainty is whether the recent strong economic news in the US continues. Given these factors, interest rates should not rise meaningfully and should remain in the same trading range as established over the past 12-months.

The Canadian economic landscape could be described as somewhat less cloudy compared to our neighbours down south. The Bank of Canada Governor, Stephen Poloz, has been more transparent. Interest rates are to remain low for the foreseeable future. This has been helpful for market participants, but a struggle for those who prefer to have a stronger Canadian dollar. His clarity reinforces the trading range for 10-year government bond yields to be trapped below 3.00% for some time to come. This is good for mortgage rates and for long term bond returns.

Given the current economic landscape, coupled with geopolitical and ongoing economic concerns, and the disparity over the course of monetary policy action, we remain supportive on corporate bonds and will seek to add to overall portfolio yields through moderate term extensions (holding longer term bonds).

How did we do?

First quarter 2014 was a very positive one for TriDelta clients. Depending on risk tolerance/asset mix, most clients were up between 4% and 5% for the quarter, with the high growth oriented clients doing better, and the most conservative returning a little under that range.

The TSX had a total return of 6.0% and the S&P 500 was up 1.8%. A stronger U.S. dollar during the quarter helped all of our American holdings adding 3.9%. The broad Canadian Bond Universe was positive as well returning 2.8%.

What worked well in Q1?

In our equity portfolios we noticed a shift away from riskier assets during the quarter which worked well for us as our process focuses on stable earnings and dividend growth. From a sector standpoint our underweight in Financials and overweight in Utilities added to the performance of all portfolios.

Sectors – Cdn Health Care +13%, Utilities Cdn +1.3% & U.S. +9.8%, Cdn Energy +10.5%

Best Performers – Core – Forest Labs +38%, Magna +26%, Constellation Software +18%

Best Performers – Pension – Canadian Natural Resources + 18.6%, Merck & Co. +17.8%, Alliance Resource +16%

What did not work well in Q1?

U.S. Equities lagged their Canadian counterparts by a decent margin. This was the first time Canadian stocks have significantly outperformed the U.S. equities on a quarterly basis since 2010. The stronger U.S. dollar helped overcome this disparity in returns. Overall U.S. stocks performed in-line with Canadian equities when currency was factored in.

Sectors – U.S. Consumer Discretionary -0.64%, U.S. Telecom +0.56%

Stocks – Core – Air Canada -21%, S&P 500 Short -9.4%, Element Financial -12%

Pension – North West Co. -4.3%, Corus Entertainment -4.2%

Dividend changes:

Dividend growth is a core theme of our investment management and stock selection. In order to highlight this importance we show quarterly dividend changes. This quarter was very positive and we were proud to own the following companies that increased their dividends:

Company Name % Dividend Increase   Company Name % Dividend Increase

Tim Hortons

23%

 

Cisco Systems

12%

Magna

19%

 

Transcontinental – A

10%

Suncor Energy

15%

 

Cdn Utilities

10%

Home Capital

14%

 

TD Bank

9%

Cdn Natural Res

12%

 

UPS

8%

Moody’s

12%

 

General Mills

8%

Lorillard

12%

 

BCE Inc

6%

Summary

We have enjoyed strong returns for another quarter, but equity valuations are getting close to the higher end of the acceptable range. As long as earnings growth continues we are comfortable with equities going forward – but we are watching very closely for any shifts in direction.

To put it in the most technical terms possible ‘we’re staying at the party, but just dancing closer to the door’.

Thank you for putting your trust in TriDelta.

TriDelta Investment Management Committee
 

Cameron Winser

VP, Equities

Edward Jong

VP, Fixed Income

 

Ted Rechtshaffen

President and CEO

Anton Tucker

Executive VP

 

Lorne Zeiler

VP, Wealth Advisor

 

Borrowing to invest? There are times when it makes sense, like now

Posted on April 6, 2014 by Ted Rechtshaffen in Investing

ted_financial_postDebt, margin, borrowing, leverage. All supposedly bad words for investors. Things they should be sure to avoid.

There are times when I agree. Today is not one of those times.

Today I can get a five-year fixed mortgage at 2.99%. If I use those funds to invest in a taxable account, the interest costs become tax deductible. After tax my borrowing cost drops to about 1.6%. If I am in the 46% marginal tax rate (income between $136K and $514K in Ontario in 2014), then my after tax cost is just above 1.6%.

If you know that your cost is 1.6% annually for five years, what are the odds that your investments will do better? How much risk are you taking?

One place to start is to look at the last 991, five-year periods for some guidance. I would do that by looking at the broad U.S. market S&P500 going back to January 1926 and ending June 2013. Over 991 different five-year periods – a new period starting and ending every month – we can see how many beat the pre-tax borrowing cost of 2.99%. From an after tax perspective, U.S. stock dividends are taxed the same as interest income, but capital gains are taxed at half that rate. Maybe a fair proxy to make the tax equal would be a five-year return of 2.5%.

As it turns out 79% of the time you would return greater than 2.5%, and come out ahead by borrowing at todays’ five-year mortgage rates. That is a pretty good average. Of interest, this includes two very long periods of success.

From December 1937 to April 1965 – for over 27 straight years this would be a winning bet, never having a five-year rolling period with a total return below 2.5% annualized.

Then from December 1973 to July 1997 – another 23+ years of unbroken five-year rolling periods without ever having an annualized total return below 2.5%.

Are we part-way into another 20-year run? It is certainly possible. Both of these long runs followed a severe recession.

What about the bad news?

The worst five-year period of most of our lifetimes was -6.64% from March 2004 to February 2009. You would have to go back 76 years to find a five-year period worse than -6.64% (August 1937 to July 1942).

iStock_000017297953XSmall

Let’s say you like this 79% odds of winning, and you like the fact that the average five-year total return is 9.8%. Even if you take taxes and a small fee out of the picture, you are looking at an after tax return on average of 6%+, when the cost is just 1.6%. This can be a serious wealth builder. If someone borrows $200,000, on average they will create $50,000 of after tax wealth over five years.

What if you want those 79% odds to increase to 90%+, and you are OK with a 5% after tax return?

One option would be to essentially lock in a gain with only a small amount of risk.

If we borrowed with a five-year mortgage, and put 75% into the S&P 500, and put the other 25% into mid-range corporate bonds, you could definitely lower your risk of a loss.

As an example, we own a Corus Entertainment bond that comes due in 2020. Its bond interest is 4.25%, but you can buy the bond at a discount. In fact, its yield to maturity is 4.69%. What this means is that if we can assume that Corus Entertainment will be able to pay its bond when it comes due, your total return will be 4.69%. Given that your borrowing cost is 2.99%, then you have essentially locked in a 1.7% gain every year. I recognize that this is closer to a six-year bond, but it can easily be sold in five years at something very close to a 4.69% yield to sale.

This type of bond stabilizer can make this strategy (or any investment portfolio) a lower risk of loss.

Other options can be to add blue chip names with strong Canadian dividends.

Maybe the strategy is 60% S&P 500, 20% bonds with a 4%+ yield to maturity and a roughly five-year maturity, and 20% in BCE, National Bank, and TransCanada Pipeline.

These three stocks combined have an average dividend yield of 4.37%, or 3.1% after tax – just the dividend has a 1.5% after tax bonus over after tax borrowing costs on the mortgage. Of course, there is risk of capital loss from the stocks, but these three companies are among those lower volatility names that would have a low chance of a five-year price decline.

Based on the facts above – I am going to say it straight. Borrowing at 1.6% after tax and investing in a diversified portfolio for five years, is a smart thing to do, and one that growth investors (who understand the risks) should be considering today.

Ted can be reached at tedr@tridelta.ca or by phone at 416-733-3292 x221 or 1-888-816-8927 x221

Reproduced from the National Post newspaper article 5th April 2014.

Tax time

Posted on February 25, 2014 by Anton Tucker in Tax prep, Tax Strategies, Uncategorized

It’s almost Tax Time. Here is a list of some items worth noting for this year’s tax filing.

  • RRSP contribution deadline:  March 3, 2014 to be able to deduct on your 2013 tax return.
  • Due Date for filing: Taxes owing on all personal tax returns are due April 30, 2014.
  • Life Changes: Newly married/separated, moved, started a family, etc? These changes can affect your tax outcome.
  • Direct Deposit: CRA will stop issuing cheques as of sometime in 2016. Direct Deposit can be set up with your 2013 tax filing.
  • Ontario Healthy Homes Reno Tax Credit: Over 65, or do you live with someone over 65? You may qualify for a tax credit when you make your home more accessible.
  • Foreign Income Reporting: Taxpayers who own foreign property NOT used for personal use and/or are assets used in an active business, may need to file a separate “Foreign Income Verification Form”. Specified Foreign Property includes: amounts in foreign banks, shares in foreign companies, real estate holdings outside Canada, and others. The penalties for non-compliance are severe.
  • U.S. Status: Please advise us of your U.S. Status.
  • Ontario Trillium Benefit: If you qualify for this benefit you can now choose to receive a single payment in July of 2015, or monthly beginning in July 2014.

Given the ever changing landscape of tax regulation research shows that approximately seventy percent of individuals and small businesses use tax preparers to file their taxes. We believe that it is money well spent to consult a professional and should be viewed as money well spent. Preparing tax returns can be complicated and understanding each taxpayer’s unique situation is crucial in ensuring the best tax outcome.

At TriDelta we work with many accountants and tax experts and will be happy to refer you to a specialist depending on the complexity of your financial situation.

Shoebox Tax Prep & Accounting Services compiled this list of tips to get you thinking about your tax return www.shoeboxtaxprep.ca

Retirement trends

Posted on February 24, 2014 by Ted Rechtshaffen in Financial Planning, Retirement Planning, RRSP

15732402_s

For most of us, the concept of retiring at 55 is dead. It is dead because many would struggle to finance a retirement that will last 30 plus years, but also dead because many people are realizing that they don’t actually want to be retired for 30 years.

Since 1975, the average number of years spent in retirement has grown by more than 30%.

Not everyone seems to be enamoured of that idea — Statistics Canada said last week in a comprehensive survey that once-retired people are returning to the workforce in droves. About 60% of those aged 55 to 59 opted to return to the workforce, the survey suggested. And about 45% of those aged 60-65 elected to return.

The study doesn’t nail down if it was money or other reasons that drove us back to the working world but these are significant numbers that we likely wouldn’t have seen 40 years ago. The study stopped at 65 but I think in the coming years we will see more and more people working well into their 70s.

According to The Canadian Human Mortality Database, the average life expectancy for a 55-year-old male is 27.1 years, or to age 82. Given that it is an average, roughly half of all 55-year-old males will live beyond 82. This is based on 2009 data.

In 1975, the number was 20.7 years, or to age 75.7.

This may not seem like a huge difference at first, but looked at another way, the average length of retirement for a 55-year-old male has grown 31% since 1975, from 20.7 years to 27.1 years. That is very meaningful.

If we look at the same numbers for a 65-year-old male, today the average life expectancy is another 18.8 years, versus 13.8 in 1975. This represents a 36% increase in average retirement for a 65-year-old male since 1975.

For females, the trend is the same, but slightly less dramatic. A 55-year-old female can expect to live another 30.5 years on average, meaning roughly 50% of 55-year-old females will live beyond 85. This has grown 17% for women since 1975.

A 65-year-old female can expect to live another 21.8 years, meaning roughly half will live beyond 86.8 years. This has grown 22% for women since 1975.

The point of all of this is that retirement planning needs to change, and a significant part of that relates to employment.

Let’s take a look at a 55-year-old male today.13850719_sa

He may have 20 to 40 years of life in front of him and may be nearing the end of his career. This makes no sense for most people – both for financial and quality of life reasons. There needs to be a better fit between this person’s skills, work goals, financial goals and the broader workplace.

This shouldn’t be that difficult to figure out.

The private sector is always looking for people to hire that will add to a companies’ profitability.

In many cases, someone who might have been making $150,000 a year working full time at age 55, might be very happy to work six months a year or 20 hours a week at age 65 and make $50,000.  This could be very productive for many companies.

I believe that there are currently two factors preventing a better workplace fit for those who want to work into their late 60s and 70s, and even 80s.

1) 9-5 workdays That rigidity certainly isn’t good for traffic during rush hour, but it also prevents too many valuable workers from continuing to work. Whether it is a much shorter or flexible work week or more piecemeal project work, there needs to be more workplace creativity in order to be able to take advantage of the great talent available.

2) Ageism There continues to be a belief that older workers can’t contribute or add value. Their ‘old school’ ways and lack of technology skills or “unwillingness” to burn the midnight oil are typical comments heard in the workplace. Despite these perceived weaknesses, we also know that things really get done based on communication skills, people management, problem solving, and looking at things from a different perspective.

This reminds me of an ‘old school’ manager I once had who would often be seen going over his files from the ’70s and ’80s. Occasionally he would pull one of them out, blow off the dust, and say “let’s see how we dealt with this same issue the last time.” It was amazing how often we would discover that today’s new business issues had already been dealt with many years before.

There is also a broader economic issue for Canada. As a country we would be in much better shape if we can tap into the productivity of those over 65. This wasn’t such a big issue in 1971 when those over 65 were just 8% of the population. Today that number is 16%, and it is expected to be 24% in the next couple of decades.

If 65 really is the new 55, then we better figure out how to make it work.

Ted can be reached at tedr@tridelta.ca or by phone at 416-733-3292 x221 or 1-888-816-8927 x221

Reproduced from the National Post newspaper article 20th February 2014.

RRSP – When an RRSP is not enough

Posted on February 24, 2014 by Ted Rechtshaffen in RRSP, Tax Strategies

ted_financial_postRRSPs are simply one big tax game. The aim is to get at least the same (if not better) tax refund when you put money in, than you will be forced to pay when you ultimately withdraw from your RRSP or RRIF.

For those who make a high income – let’s say $300,000 in taxable income – RRSP contributions are great. Depending on the province, every dollar they contribute to RRSP’s effectively lowers their income by $1. This provides a lower tax bill of 39 to 50 cents.  As long as tax rates don’t change, you are guaranteed not to lose the RRSP game because at worst, you will have to pay the same rate when you withdraw funds from your RRSP or RRIF, as you rece22185731_sived when you made the contribution.

Therefore someone with a high taxable income should definitely contribute to their RRSP if at all possible.  The challenge is that they often have more money that they would like to shelter but the RRSP contribution limit doesn’t allow for it.

For most people, they can contribute 18% of their earned income. In the case of the $300,000 income earner, that would translate into $54,000, however the limit comes in to play for them at just $23,820 for 2013.

In order for this person to improve their retirement planning, they have several options:

1)   Maximize TFSA contributions.  For a couple, you can add $11,000 to your TFSAs this year.  In my estate planning work, especially when looking out 30+ years, we try and structure things so that TFSAs are the last pool of assets that are left in an estate – as they face no taxes (other than probate).  TFSAs will become almost as important as RRSPs for retirement planning.

2)   Make a portion of your taxable (non-registered) investments growth oriented, low income investments.  These funds will create low taxes along the way, but should grow nicely over a long period of time, and can fund retirement without having to worry about being taxed on withdrawals.  Examples of high growth, no dividend income companies might include: Adobe Systems, Priceline, Google, Constellation Software.

3)   Use insurance as a tax sheltered alternative.  If this person wanted to put $40,000 a year into their RRSP but is limited to under $24,000, one alternative option would be to put the other $16,000 into a life insurance policy on a parent or in-law. The ideal age for this type of insurance is 65 to 75. Assuming a parent is 30 years older than you, and passes away at age 90, then you will receive a non-taxable payment at age 60, just in time for your retirement. In many cases, the rate of return on this investment will be very good – 7%+ after tax equivalent – and the investment will help diversify your returns as the insurance is not correlated or tied to stock markets, real estate or bond markets . While some people feel that this is an inappropriate ‘investment,’ we have found that many parents are happy to help their children and ultimately their grandchildren in a way that costs them nothing other than a short health checkup.

4) Tax strategies such as flow through shares – which can come in two forms. Flow through shares are aimed at helping to lower the tax bill for those who have incomes in a top tax bracket. The first form is better known.  In this case you invest say $50,000 into a flow through, you can get significant tax savings through a variety of investment credits. The risk is that you must invest these funds in highly volatile companies that are usually doing mining exploration. The second form is less well known, and is more conservative. It essentially takes away the investment risk, leaves you with a tax savings that is potentially smaller, but is guaranteed from Day 1.

5)   Other strategies for high income business owners, incorporated professionals, and occasionally for key executives of a corporation, would include strategies called Individual Pension Plans (IPP) and/or Retirement Compensation Arrangements (RCA).  These strategies are too complicated to address in detail here, but serve as tools to provide additional pension income to those who are restricted by the RSP contribution limits currently in place.

While RRSP contribution limits do impose some retirement planning challenges for those with a high income, a variety of good tax planning exists to provide some alternatives that might be even better than simply having more money going into your RRSP.

Ted can be reached at tedr@tridelta.ca or by phone at 416-733-3292 x221 or 1-888-816-8927 x221

Reproduced from the National Post newspaper article 13th January 2014.