Mortgage Rates are Rising

In a post I made last month I made reference to an attractive 5 year fixed term mortgage
that I received from a peer of mine at TD Canada Trust with an interest rate of 3.64%.

That post generated a number of emails from readers and friends wondering what rate they could potentially receive on a 5 year fixed term mortgage and the merits of choosing a fixed over the historically better variable rate mortgage.

As I answered a recent email from a friend I took notice of the posted rates on TD's website for a 5 year fixed term; currently at 4.55%. That's a stark difference between their posted rate of 3.95% when I was shopping for a mortgage near the middle of May and works out to an increase of 0.60% or (60 basis points) over a period of only three months.

What made it more interesting for me was that there has been no change in interest rate policy from the BoC and no change in the posted rates for GIC's at the bank.

Now most of the time TD is able to discount their rates up to around 0.30% for preferred customers, but even then customers are looking at a 5 year fixed rate of 4.25% vs. the 3.64% I received. 4.25% is still a good rate on a historical basis, but the rise in posted rates at TD and other financial institutions is raising a few alarms for me. Rates moving 60 bps in only 90 days demonstrates to me a strong reaction from the banks to where they perceive interest rates moving over the next year.

The banks are still lending to customers, but the price has gone up considerably in such a short period of time with no change to interest rate policy or short-term investments. All investors know that interest rates have only one direction to go, but the speed and scale of these rate increases definitely should be something individuals who face a mortgage renewal in the next six months take note of and act accordingly to.

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Actively Trading Corporate Bonds

An anonymous reader recently left the following comment on The Bond Guide – Investment Guide to Corporate Bonds


“Thanks for the great website and info on Canadian bonds. I’m a private investor, fed up with being wilfully kept in the dark about the genuine value of bonds.

From the link you provided to CBID I can now see my broker charges me something close to 2 basis points on bond purchases, which makes it very difficult to make capital gains when my bonds premium value goes up. I know you are probably not supposed to give advice but I was wondering what you think about private investors actively trading bonds (so buying investment grade at a discount and selling when the price goes premium)?

I ask because before reading all the great links you have provided I always thought of bonds as safe but rather boring as I believed one was always limited to the profit on the yields. I’ve noticed now that many bonds I have bought at discount are worth perhaps 7 or 8 basis points more now. I’m very tempted to sell those bonds with a nice capital gain, and just reinvest into other quality bonds at par or at a slight discount. Any comments would be appreciated.”


Writing The Bond Guide certainly opened my eyes to a lot of information and advice on corporate bonds that I hadn’t thought of or recognized before. One big issue for many retail investors is the premiums that brokerages charge for corporate bonds and the lack of availability of issues to investors. Certainly more transparency is needed and I’ve linked to articles on this blog in the past where regulators are looking into giving investors more transparency in fixed income products.

Corporate bonds and fixed income investments are different then equities, but certainly no investor can be faulted for selling an investment at any premium over their purchase price. We’re all invested to make money and even though bonds are often looked upon as long-term investments taking profits in the short-term because of advantageous valuations make complete sense. If you understand the risk when you invest then taking the reward becomes a very easy decision to make.

The difficulty with selling portions of your current fixed income portfolio at any point in time is replacing the issues you plan to sell with buying bonds of similar credit quality, interest rate risk and duration. There may be other corporate bonds that are currently trading at larger discounts, but those issues may be trading at those prices for specific reasons that may not appear at first glance.

One example would be if you’ve bought a bond from company ABC Incorporated and there is now another issue trading at a larger discount. With all risks being equal making a switch by selling your bond at a premium and buying another at a discount makes sense from a reward perspective. Why wouldn’t an investor lock in a gain and attempt to replace their investment with one of similar features and prospects?

The difficult task is when an investor looks to sell one bond and buy another from a different sector, different company or the bond has inherently different risks than what you previously held. The strategy that the anonymous reader is suggesting is similar to how many investors in preferred shares behave in the fall each year for tax-loss harvesting. By selling their preferred shares in one series to buy another series from the same company they often achieve a similar yield and end up crystallizing a capital loss against gains from other investments.

The choice between which bonds to sell and replace will depend on the individual investor, but certainly there is a strong case for protecting your gains by selling into strength and then re-investing into better prospects. I do this myself with individual equities and fixed income investments should be no different as long as an investor understands the costs and risk of their decisions.

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Protecting Investments from Inflation

Today’s post comes courtesy of a question from The Personal Finance Clinic held by the moneygardener, Canadian Capitalist and Triaging My Way To Financial Success.


Vince writes,

My problem is as follows: I am an immigrant who has been in Canada for 6-7yrs and have no RRSP room to speak of, and can only count on a small CPP. All my savings and investments are in a non-registered account.

How do I protect myself against inflation? Do I buy short term bonds (XSB), real return bonds, or do I stay with common shares?

My allocation if I include property is about 60/40 FI/Equities.


Inflation is certainly a hot topic for many investors since every pundit in the media has an opinion of where inflation will appear and to what degree of severity with hyperinflation being a term that’s been thrown around far too loosely as governments attempt to stimulate economies.

Any conservative investor, regardless of risk or investment style, needs to concern themselves with inflation in all market conditions because inflation affects the real value of your investments. If your investment portfolio returned 4% after costs last year and the inflation rate was 2% your real return for the portfolio was only 2%. What an investor wants to do is achieve returns in their portfolio that outpace inflation over the long-term and provide them with equal or greater purchasing power in the future.

Investing for inflation is really not much different than wanting a raise each year that matches your increases in the cost of living. Essentially your portfolio should be giving you a raise each year in your income to offset the increasing prices of goods and services you use.

To answer Vince’s answer directly it’s not whether he should invest in only short-term bonds, real return bonds or common shares but how much of each to hold over the long-term.

Short-term bonds provide decent inflation protection at the expense of a much lower yield than a longer yielding bonds because you’re not taking on the same interest rate risk. Real return bonds maintain your investment from inflation and you only need to buy a weighting large enough for your desired allocation. Common shares, specifically ones that pay dividends, offer an investor a few advantages in terms of protecting against inflation. Companies that own/operate inflation sensitive assets such as real estate, commodities and infrastructure tend to fare better in valuation terms than other companies. Some dividends stocks pay a dividend and increase that dividend on a yearly basis above the annual rate of inflation then have already achieved your desired goal if the dividend continues to be paid regardless of the effect on share prices. Because dividends, for Canadians, are eligible for the Dividend Tax Credit in a non-registered portfolio the taxation of dividends is less than that of gains from interest (bonds & GIC’s) or from capital gains.


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ADT - Receive $200 Cash Back!

As I mentioned in previous posts I purchased my first home in late June and have been busy moving, unpacking, fixing, updating and settling into the new digs during my days off. One condition of our move was my fiancées firm suggestion that I invest and have installed a security system in the home to protect ourselves, our possessions and home from theft, fire and flooding.

As a normally frugal (ok...I’m cheap) individual I wasn’t sold on installing a security system at first but I sat down and considered some of the pros and cons of the decision. Here is a quick list of some of the items I included in my table:

Pros:

• I could save 10% on my home insurance with my current insurance company
  
• When I work nights my fiancée sleeps worry-free
  
• When I leave my home (for work, vacations, day trips, etc) I have the peace of mind that my possessions and home are protected
  
• A home security system is a serious deterrent for burglars since an alarm attracts attention and silence is a burglars best friend
  
• Available integrated CO (carbon monoxide) and smoke detectors as well as flood sensors in the basement
  
• Battery backup for 24 hours in the event of a power failure

Cons:

• Cost is roughly $37/month or $445/year (taxes included) for basic systems with most companies
  
• No security system is foolproof or an absolute deterrent to theft
  
• Good doors, windows and a well lit home can provide just as much deterrence
  
• Fire, flooding and theft are rare occurrences in our current neighbourhood
  
• Hassle of arming and disarming a security system when exiting and entering our home
  
• Noise from an alarm arming and disarming on each exit and entry

For the most part the pros outweighed the cons when I took cost out of the equation. An $80 savings on my home insurance isn’t a substantial amount, but it helps and the alarm gives me a piece of mind when I’m away from the home whether the additional security is tangible or not. I took the time to research about a dozen alarm companies before I decided that ADT was the best fit for our needs. The company is considered by many to be very reliability in their monitoring, their system had the most user friendly equipment for our needs and the company provided some additional services that I was interested in. I also found in my research that ADT directly monitors our home themselves and does not use third party companies. The installation was about 5 hours for the size of the home we have and includes wireless features on all doors, windows and two keychain remotes. I was very impressed in how clean the system integrated into our home and the professionalism of all the staff I dealt with. I was even able to take advantage of a discount on the installation of the system that was better than the $99 special quoted on the ADT website (that I learnt only applies to a new hardwired system in your home). I’m sure many people have and enjoy hardwired systems, but wireless sensors made a lot more sense for me because I didn’t like the idea of wires running around every window and door. The $200 ADT mail-in cash discount on my a ADT system was hassle free and I actually received my discount upfront which was a great incentive instead of having to wait a few weeks for the delivery of a cheque in the mail. The code for the $200 ADT mail-in cash discount works anywhere in Canada or the US for home or business purposes and expires on September 30th, 2009. I did call the company and had them create a PDF file for the code that my readers can access 24/7 through Google Page Creator and I will be requesting they extend the discount beyond the current expiration date (I will update the PDF online prior to Sept 30th).
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The Competitive Analysis

One of the most challenging areas that investors deal with when performing an analysis of a company is not with understanding the individual corporation but the competitive landscape in which it operates. Every company has competition and competition comes in a variety of forms. The importance for identifying competitors, industry trends and customer behaviour is the difference between becoming a reactive investor versus a proactive investor. If you are able to identify a trend before the market takes notice you can stand to better benefit from your investment decisions.

Today I’ll share some more insights into how I conduct a competitive analysis in my own stock analysis process.

From Taking Stock in IGM, Part I:

Whether big or small you want to take the time to see what the competition is doing and how that directly impacts the ability of the company you’re examining to operate and grow.

Frequently in this section of my analysis I’ll find a company or set of companies that are competitors to the stock I’m researching and any significant competitor immediately receives their own situational analysis. This is because any prospective competitor could either be a better investment prospect (after completing all the research) or a potential acquirer of the specific business I’m analyzing.

By creating a new SA on a competing company this helps to give me a broader perspective on the industry both domestically and globally. There have been numerous occasions where I thought one company was a market leader and attractive investment only to find out that a competitor traded at a cheaper valuation or had better long-term fundamentals. My own analysis of PepsiCo (PEP) prior to investing in Coca-Cola (KO) is one example of this situation where PEP’s product diversification actually hurts their profitability because it lowers their margins (both gross and profit).

A Competitive Analysis is an important tool for a number of reasons:

1. It assess the strengths and weaknesses of current or potential competitors
2. Allows an investor to put offensive and defensive strategies into context to assess opportunities and threats
3. Identifies competitive advantages/disadvantages within in industry/sector
4. Helps an investor understand the specific competitive advantages/disadvantages within an industry
5. Generates an understanding of where the industry has been, where it is presently situated and where the industry is going in the future.

Before you start a competitive analysis you want to make sure you have an adequate set of criteria for comparing companies in your selective categories. If you decided to compare management between two of more companies make sure you set an appropriate number of criteria that evaluates each corporations top leadership based on collective competencies, investors’ return on equity, years of previous/relevant work experience, education, percentage of ownership, accuracy with forecasting results and other important standards.

There’s a lot an investor can learn by focusing on the goals, mission statement and corporate culture of a business. If management is saying one thing and employees are saying another then an investor needs to scrutinize whether management has their fingers on the pulse of the business, are actively involved in the daily operations of the company and have shareholders best interests at heart. Simply stating a commitment to corporate culture or a mission of teamwork doesn’t cut it and actions always speak louder than words.

Assessing for a competitive gap is one of the more difficult or advanced items to a competitive analysis and not every investor will want to take the time to conduct this. Assessing for a competitive gap is looking at a company’s current or future products/services and determining whether demand from their intended target market (or another) will gain momentum after adoption in the product life cycle. Often new products and services don’t gain traction because they don’t adequately fill an underserved segment of consumer or business demand and rarely, in the case of Apple’s iPod product, there is a dramatic adoption by a market that grows into expanding global demand. Identifying these competitive gaps where a product/service exists for a company in the face of laggard competitiors takes a certain amount of skill and will also give you a much broader view of the industry and other prospective companies to invest in. If you choose to concentrate on a competitive gap you want to make sure that a product or service is scalable, distinctly unique, protected or is an experience or product that is easily replicated by its end consumer.

Some tips that I would suggest an investor use would be:

• View each company in the competitive analysis as if you were a customer of the business: describe what you like, what other customers like, explain your experience(s), what you would improve/discard, etc.
• Check the public filings: investigate public filings of the corporation and press releases by their media relations department to find out what they’re up to and currently pursuing.
• Always assess for potential new competition: is there a company that offers a competing product/service cheaper, more effectively, faster or is there a competitive gap that is already served or underserved?

Remember that competition is fierce, unrelenting and sustainable for a company. A competitive advantage is rarely sustainable and a company may need to go to great financial lengths to protect their moat. Gaining a sense of exposure to competition is a vital component to a competitive analysis. An investor will also want to scrutinize:

• Rivals within the industry
• Customers
• Suppliers
• Product substitutes
• Threat of new entrants

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