Me & My Money; A Disciplined Investor

If you had an opportunity to read The Globe and Mail this Saturday morning you might have noticed a familiar face or name in the Me & My Money section of the business news.

Larry MacDonald kindly took some time over the past week to interview me for this weekly column that highlights investors' strengths, weaknesses, investing style, portfolio and successes.

For readers visiting this site for the first time I encourage you to navigate through the site and its content. Triaging My Way To Financial Success recently turned two years old and there are approximately 250 posts on topics that discuss value investing, investment fundamentals and helpful resources for new investors. Start with a Tour of the site and be sure to visit two key sections of value for frequent readers; Top Posts and the New Investor Index.

The featured column is available to read for 7 days on The Globe and Mail website here and if you miss the content I've pasted it below this post for readers.


Don't forget to contribute your questions to The Personal Finance Clinic which closes on May 31st, 2009.


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A disciplined investor

Blogger aims to emulate Warren Buffett with his investment choices

Larry MacDonald
From Saturday's Globe and Mail, Saturday, May. 30, 2009

Brad Ferris

Age: 28

Occupation: Healthcare/Business Consultant, living in London, Ont.

Portfolio: Stock holdings include Bank of Nova Scotia, Canadian National Railway Co., IGM Financial Inc., Rogers Communications Inc., Royal Bank of Canada, Saputo Inc., TMX Group, Colgate-Palmolive Co., Coca-Cola Co., Procter & Gamble Co. and Wal-Mart Stores Inc.

Investment approach
Mr. Ferris is an investor in the Warren Buffett mode. Like the investment legend, he prefers to buy shares in reasonably valued companies with “enduring competitive advantages,” or in the words of Mr. Buffett, “moats.” They are stocks “I can see myself holding well into my fifties,” he says.

When picking companies with “moats,” he prefers those that regularly raise their dividends and are eligible for the dividend tax credit. A goal is “to create a growing, tax-efficient stream of income for early retirement.”

As outlined in his blog, Triaging My Way to Financial Success, several “value rules” guide his stock picks. One is that a company's business must have sustainable, high profit margins. It is hard for a company to grow over the long run without solid profit margins.

Disciplined investor
During the bear market, Mr. Ferris not only stayed invested but worked extra hours to generate money to buy stocks while they were on sale. As an April 6 post to his blog indicates, stock purchases included Russell Metals Inc., Manulife Financial Corp., Canadian Tire Corp., Husky Energy Inc. and Fortis Inc.

Asset allocation
The fixed-income portion of his portfolio is set at 30 per cent, equal to his age as most financial advisers would recommend. But this will drop to 5 per cent when he buys his first house because he views home ownership as similar to owning a “giant bond” that appreciates by up to 4 per cent a year.

His Canadian dividend stocks are held outside of a registered retirement savings plan. They make up half his portfolio, departing somewhat from the rule that one should diversify globally. He sees this as a necessary tradeoff to his goal of building a portfolio of tax-advantaged, dividend stocks.

He is keeping contributions to his registered retirement savings plan to a minimum. One reason is that he can get a bigger tax deduction when he moves into a higher income tax bracket. Another is that he doesn't need particularly large savings in a registered plan because he will be receiving retirement income from a defined-benefit pension plan.

Best move
Last fall, he bought preferred shares in Westcoast Energy Ltd. and Power Financial Corp. at prices around $15 and yields above 9 per cent. “Those preferred shares now trade for over $20.”

Worst move
In 2006, he purchased shares in lumber company Norbord Inc., largely on the basis of the opinions of well-known value investors. In 2008, the shares were sold for a loss of 44 per cent.

Advice
“My worst mistake was … a failure to think independently,” he says of his Norbord investment. Investors need to do their own due diligence too, he advises.

“My Deficit is Right on Budget…”

Business and politics has a messy history together and for good reason when you consider the individual personal interests that are placed ahead of the collective populace on far too many occasions. Corporate bailouts, selective support of industries and regulations all have positive or negative impacts on each side depending on who is flexing their collective muscle more.

In the late fall Charles made a comment to me on the topic of national finances at the height of the credit cycle stating confidently in a humerous Jim Flaherty impersonation, “My Deficit is Right on Budget!”

It was fitting that yesterday the finance minister disclosed that the anticipated federal deficit will be in excess of $50B for this current year. While he quickly took a moment to put that number into context as only 3% of Canadian GDP I have a difficult time gauging the true grasp the government has (in any political party) on the current economic impact of this recession.

In November there was “no deficit”, in December “there will be a deficit”, January brought a forecasted deficit of over $30B in the federal budget and now the number has ballooned to over $50B; or 3% of GDP. The problem, for Canadians and our businesses, isn’t the yearly deficit but rather the cumulative deficit we inherit before a surplus is eventually reached. Balancing the budget in 2014 won’t help much if the cumulative deficit we rake up is in excess of $80B (assuming sunshine on the horizon).

What lessons can investors take from this? Be diligent.

Personal finances are a crucial and important component of any wealth creating strategy. Having a budget is vital; staying within a budget is necessary. Governments have deep pockets (business and tax payers) to fix their mistakes. Investors and individuals have to look out for themselves and budget accordingly.

I made a comment today on themoneygardener when MG asked the question, “how much can we afford?” that touches on this subject with the importance of living within your means. Individuals can’t take deficits on like a government and in difficult times (such as right now) personal finances are vital for your financial success. With deficits spiralling out of control in all levels of government I urge individuals to take a proactive approach and show initiative in creating a flexible budget that considers multiple factors that affect your income and spending.


Don't forget to contribute your questions to The Personal Finance Clinic which closes on May 31st, 2009.


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Fixed Income Alternatives, Update I:

In March I wrote a post titled Fixed Income Alternatives where I disclosed to investors some of my activities with fixed income products that often fly under the radar of investors and the market. I highlighted the benefits of one group of investments called CorTS’ (Corporate Backed Trust Securities) that had been trading at depressed prices in the fall of 2008 at the height of the credit crisis.

I wanted to provide an update on these investments as well as two other series of preferred shares I purchased and held in my foreign fixed income portfolio within my RSP. What I want to show is the return of each investment based on my cost versus a potential investment in the common stock over the same time period.



All but four of the fixed income investments beat their common share peer and there was no decrease in dividend/income from the fixed income group with a number of the common shares cutting their dividends.

So far the Fixed Income Alternative shares of the group have returned 4.61% in income and appreciated significantly. There is a temptation to sell the CorTS’ which are trading above their par value, but when I consider the income, yields on cost and the high credit ratings of the group I still intend to hold them for a 3-5 year period.


Don't forget to contribute your questions to The Personal Finance Clinic which closes on May 31st, 2009.


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Stuck in the Past and Too Focused on the Future:

I have to admit that lately I’ve found myself rolling my eyes at the slew of content written in the financial media with regards to investing opportunities that are based on research, statistics and past performance.

One common mistake almost every investor has made at some point in our past experiences is a tendency to look to historical returns to anticipate future gains or performance. We assume, inaccurately, that past events will occur again in the future with some degree of replication. The simple fact is that no period, no event and no situation is ever exactly the same. There are variations of mistakes that will follow familiar trends, but no period of history has been repeated exactly as before.

Compounding these problems is the fact that the majority of investors rely on past performance as the basis of their evaluation process for prospective investments. We use P/E ratios based on past earnings, look to the historical growth rate of dividends and cashflows and tout a company’s strong history of performance as an indication for future achievements.

Likewise far too often investors are naive in estimating the infinite potential of an investment opportunity by disregarding the fundamentals of investing, neglecting to rebalance and overweighting their portfolios in only the best performing groups of assets. Their belief is that the market can only move in one direction and they don’t take appropriate stock of the situation, potential risks and deteriorating fundamentals that would protect them from risk.

I’ve been caught on more than one occasion in both camps and learnt from those lessons. One of my core strategies is to focus on the current fundamentals of companies by studying operations, short-term strategies and qualitative features that help me to stay grounded and realistic in my opinions of what a company is doing with respect to the past and where I anticipate them to be in the future. Getting too far ahead of myself in either direction from the present skews my interpretation of today’s events and how those relate to future performance.


Don't forget to contribute your questions to The Personal Finance Clinic which closes on May 31st, 2009.


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Canadian Currency Hedge Strategy

I’ve mentioned a few times in past posts the importance of identifying unsustainable trends in the economy and business cycles of companies. Every investor needs to be proactive in their investing activities to identify risk because far too often each of us are solely reactive to developments in the market and this leads to significant losses of our capital and opportunity for gains. Trees never grow to the sky and when a stock chart or market goes parabolic gravity has a sickening effect on the scale and speed of its inevitable descent.

I practice diversification by investing outside of Canada and this directly exposes me to varying degrees of currency risk each time I purchase a foreign stock, bond, mutual fund or ETF. As a long-term investor I recognize that volatility in FOREX (foreign exchange) comes with the territory of being diversified globally and that over the long-term currency fluctuations tend to even out. But as an investor in the accumulation phase of his portfolio construction I’m concerned about the short-term effect of currency volatility because it can impact the price I pay for an investment and any gains (income, capital gains, interest) I subsequently receive. While I view currency exchange as a cost of investing I want to always minimize my exposure to costs as much as possible because costs directly impact my ability to achieve short-term gains and compound long-term results.

Calculating a fair-value for what you want to pay for any foreign currency is difficult, but I tend to look to historical averages to get a sense of how far in one direction or another the specific currency has moved. Last year the Canadian Dollar (CDN$) traded well above its historical average to a high near $1.13US and you didn’t have to be an economist to figure out the dramatic effect that would have on our export economy; the valuation was unsustainable. My expectation of where the CDN$ will trade over the next decade or more is between $0.75-0.85US and if I have an opportunity to trade my loonies at par with the USD I view that as a key short-term opportunity. My expectation is that in the future when I contribute to my RSP to invest in US stocks I’ll likely get $0.75-0.85US for each CDN$. The problem for many investors is that they buy US stocks with CDN$’s, receive dividends in USD and then convert that those dividends back into CDN$’s. The costs incurred from all these activities can add up quickly and significantly diminish investor returns.

In my situation I’ve chosen to keep all foreign equities and fixed income investments in my RSP to minimize taxation (exempt from 15% withholding tax), decrease my foreign currency costs and maximize compounding growth. The only time I purchase USD is when I make a contribution to my RSP and all subsequent dividends are paid and maintained in USD within the account.

Although I believe that over the long-term (20-30 years) currency fluctuations cancel each other out any short-term devaluation of the CDN$ will hurt my ability to contribute the same amount of cash to my RSP for USD denominated purchases.

What I wanted to do was hedge to some degree my recent RSP contributions and planned contributions for 2008-2010 as I expected the CDN$ to depreciate back towards a more sustainable level. It would be difficult to completely hedge my entire position (too costly), but with oil at an apparently unsustainable bubble and the CDN$ moving so closely instep with the price of crude oil (in USD) I decided to place a small hedge in my RSP to help buffer any potential slide in currency valuations. My major motivation for this move was to maintain my purchasing power within the RSP without losing a significant value of it in CDN$’s. The intention of the hedge is to act as an insurance policy. If the valuation of the CDN$ doesn’t change I don’t need the hedge and can eventually sell it for only a loss of opportunity cost. If the CDN$ depreciates significantly I can sell the hedge off in pieces and use/combine the proceeds to make purchases within my RSP to offset the unhedged loss of value in CDN$ when I make new contributions to my RSP account. When I contribute new money from outside my RSP (in CDN$) the loss of purchasing power isn’t as significant because the hedge acts as a balancer.

Example:

Say I contributed $5,000 CDN to my RSP at parity, received $5,000 USD and purchased my hedge for the full amount. In twelve months the parity between currencies has now moved so that the CDN$ is worth $0.80US. What I can now do is contribute the same amount to my RSP in CDN$ ($5,000) as before and sell $1,000 of my hedge to achieve my desired contribution of $5,000 USD.

My choice for the hedge last summer was the PowerShares Double Short Oil ETF (DTO). The reason for choosing the double short ETF versus a regular short ETF was that I didn’t need to expose as much of my capital at risk for the same effect, the ETF was already priced in USD and the correlation of the price of oil to the CDN$ was closer than other alternatives. The effectiveness of this intended strategy was that the hedge would increase at double the decline of the CDN$. I bought the shares in July of 2008 and slowly over the past year began selling small portions of the hedge as the CDN$ and oil depreciated.

As mentioned before my intention is to not fully hedge my RSP over the long-term due to the historical ranges that many currencies range in over time and an inability of any investor to accurately anticipate the direction of valuations of currencies. But as a young investor focused on accumulating assets for future wealth I wanted to protect my purchasing power now without having to add a higher amount in contributions for the same effect. This strategy was fairly simple to implement and shows that an investor doesn’t have to do an “all or nothing” hedge. Having a small position in key investments can protect a portion of your portfolio and at times that’s all you need. The mistake many investors make is they feel they need to hedge their entire position for risk when only half or less can do the trick for the intended effect.


Don't forget to contribute your questions to The Personal Finance Clinic which closes on May 31st, 2009.



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The Personal Finance Clinic

Whether you are in good financial health, directly experiencing the downturn in the economy or concerned about the state of your personal finances the authors of Canadian Capitalist, the moneygardener and Triaging My Way To Financial Success are holding a Personal Finance Clinic for our readers.

We recognize that finding the answers to your questions on topics of personal finance can be difficult in the best of times; they should not be hard to find in the worst of times.

With the abundance of material published online and in print media on topics of personal finance we are holding a clinic to tackle your best questions on a variety of financial matters. Best of all no health card or credit card is needed.

Rules:

Questions can be on topics that include personal savings, net worth, budgeting or investment fundamentals.

Readers simply need to send their question with identifying name to personalfinanceclinic @ gmail.com before May 31st, 2009.

Canadian Capitalist, the moneygardener and Nurseb911 will each select an equal share of questions from all submissions based upon our readership, personal knowledge and ability to seek research on the topics asked.
Responses to specific questions can not be guaranteed to be 100% accurate.

Canadian Capitalist, the moneygardener and Nurseb911 are not certified investment professionals and are not licensed to provide financial advice. We hold no liability for responses and our answers are intended for educational purposes only.

When possible we will supply references and/or links to articles, content and alternative tools.

We cannot guarantee that all questions will be answered in the clinic due to both the number of responses and the limitations of our personal time.

We will not provide recommendations on specific investments or their potential for investment. We will not accept questions on any specific stock, mutual fund, ETF or financial product and their investment potential for a reader.