2016 Year End Review

Model Portfolio Returns (%)

These returns represent the model portfolios only. They may differ from actual client results due to rounding, cash balances, the timing and amount of deposits and withdrawals, the timing and amount of dividends and other income, and fees and other costs. Please see your official client statement for complete reporting.

Growth Portfolio and American Growth Portfolio

2016 proved our most difficult year to date for the Growth Portfolio and American Growth Portfolio. After a rough first quarter, not much happened until the early summer, when a recovery unfolded into the end of the year. While the prices of our companies did not deliver gains, the financial results reported by our businesses were impressive. Over 2016, our Canadian Growth businesses increased cashflow by 12%, earning a collective 18% return on invested capital, while our US Growth businesses increased cashflow by 14%, earning about 22% return on invested capital. Our holdings are among the top 10% of public companies in terms of businesses quality. That their prices did not deliver stronger results this year is highly irregular, but not without precedent.

We underperformed 2016 for two reasons.

First, we encountered some bad luck. Usually the market rewards high quality value companies and ignores junk stocks. That was reversed in 2016 as the securities that saw the largest increases in price were of remarkably low quality. Businesses with high valuations, low or negative cashflows, high debt, high dividend payouts, and low or negative earnings growth became darlings. Meanwhile good businesses, those with cheap valuations, positive cashflows, low debt, reasonable dividend payouts, and positive earnings growth were ignored. This strange preference for junk has only occurred three times in the last thirty years, including 2016. While we firmly believe that one person’s trash can be another’s treasure, we also believe that one person’s toxic waste will be their eventual undoing. Making a habit of holding junk companies would have produced a loss of 9% per year since 1985. In comparison, a value approach similar to our own would have produced gains of about 15% per year on average. So even though we did not receive the expected outcome in this one year, our value investment process remains sound. Value investing works most of the time but not all of the time. Nothing does.

The second reason we underperformed was related to diversification. Towards the end of 2015 we correctly understood that the market was over-valued. This meant that only a few companies met our investment criteria. In the past, concentrating our capital in few companies worked very well through periods of over-valuation. However 2016 featured something rare: a series of separate and repeated market shocks (Yuan revaluation, oil volatility, Brexit, US election) that overwhelmed our model strategy. While it is normal to see one or maybe two such events of stress in a year, four in quick succession are quite rare. In the future when we cannot find a larger number of adequate investment opportunities meeting our criteria we will hold more cash instead of plugging more capital into fewer companies. This will allow us to navigate a wider spectrum of markets without giving up on long term returns. This will also provide a source of funds to purchase new holdings when cheaper securities avail themselves.

In every underperformance there is an opportunity. In that light I’d like to recognize 2016 to reaffirm an important point about investing, expectations, and dealing with disappointment. By the end of 2015 we earned about 25% more than the TSX in Canadian Growth, a gap as wide as ever. We outperformed the S&P500 by about 10% in American Growth. This naturally produced a degree of giddiness and popularity that I will henceforth take as a warning sign. In hindsight, it occurred to me that some investors joined because they fell in love with the profits over the process.

While I understand that many investors don’t like negative years, I do not agree that they should be surprised by them. Negative years are entirely normal, and to be expected in the course of our work together. There exists no investment strategy that delivers gains year-in year-out (even Buffett’s Berkshire Hathaway has its down years). Further, since we hold different securities than the market average, our returns will not be correlated to the market average. So if your expectation is similar to mine, that no one including us can possibly outperform every single year, or even produce a positive return every single year, then we have a good chance of realizing higher than average returns over the long run together. Since the short term results do not matter as much as the long term results, our focus remains solely on doing things that earn good long term results.

Now onto some good stuff. While 2016 had been a year of negative anomalies, today I see positive ones.

First, cash balances in public investor portfolios are elevated. Notably, while professionally-managed portfolios have more cash than usual, most of the extra cash is found in retail (mom and pop) investment accounts. This has proven to be a reliable contrarian indicator in the past. Such high cash balances have led to periods of positive stock market performance.

Second, since 2012 investors have been abandoning value strategies en-masse in favour of passive investing, also known as index investing or benchmark investing. Although this may seem a recent fad, the active vs passive pendulum has been swinging since the early 1920s. The passive trend has swung so far this time that it has created one of the largest distortions in history. As of 2016, the spread between the most expensive stocks and the cheapest stocks is historically wide. In the past, such a large spread has created significant opportunity and value for active strategies, a level from which value investing has come strongly back into favour. From a contrarian perspective, the more people that believe value investing won’t work, the better it turns out to work in the future. By the same token, the more people that believe index investing works best, the worse it turns out in the future. And that is good news for cheap stocks like ours. As of December, our Canadian Growth stocks are collectively undervalued by about 18%. The top stocks making up the TSX Index are collectively over-valued by about 10%. The disparity is not as wide in US markets, where our American Growth stocks are undervalued by about 20%, and the S&P500 at about fair value.

Finally, 2016 marked an important turning point in North American demographics: Millennials are now the largest living cohort in America, overtaking the Boomers. This demographic shift poses a key driver for economic growth because Millennials are now entering their household formation and spending years (Lauren and I happily attest). This should be welcome news for economic growth enthusiasts, refuting the idea we are drifting into a Japanese-style deflation. In the long term it would be reasonable to expect that interest rates are not likely to go any lower. That is not to say they are immediately heading higher either.

Although my outlook is constructive, by no means am I suggesting that any particular outcome is certain for the year ahead. Instead of relying on forecasts and predictions, our edge has always been in a disciplined rules-based value investing process. As always, we will follow our process to identify high quality investments at bargain prices. Through 2017, we will stand by the following principles, and welcome the results that come our way.

Control risk -- We minimize investment risk in three ways. First, by investing in high quality companies, and second, buying them at a discount to their intrinsic value. Third, we set an alert level if the price of a security moves beyond a certain threshold.

Seek consistency -- We search for investments that have demonstrated fundamental growth through various market cycles. 

Markets are inefficient -- The price of a stock does not always reflect the value of the underlying business. This gap between price and value creates profit opportunity.

Know what you know -- Making consistently successful macro forecasts or predictions is impossible because the future is inherently unknowable. Understanding market history can provide useful information with which to compare the present. Our evidence-based process concentrates on knowing businesses, which are more predictable than broad markets over the long run.

Avoid market timing -- Our goal is to remain fully invested throughout the market cycle by investing for a range of outcomes. When investment opportunities are few, we will hold more cash. 

Income Portfolio

The Income Portfolio earned a positive return in 2016. We experienced the same trials and tribulations as the general stock market, but with reduced volatility, making for a smoother ride. Capital gains and dividends contributed equally to a satisfying result.

Throughout the year we maintained positions in international and US dividend payers that not only saw their stock price appreciate, but also provided positive exposure to a strengthening US dollar. Canadian dividend payers experienced larger than average volatility through 2016, so did not meet our investment criteria. Our broadest exposure in the Income Portfolio remains to US dividend paying stocks at this time.

At some point the positive effects of the US dollar will reverse course, turning from a tailwind to a headwind for Canadian investors in the US market. Predicting when this will happen is impossible, so we will likely maintain a more balanced approach in currency exposure for 2017. We see potential early indications, but make no firm assertions at this time, that the strength of the US dollar trend is starting to wane. In recent months we have hedged some of our US dollar exposure in the portfolio, allowing us to participate in the market while reducing the effects of currency. Broadly speaking, the US market appears reasonably valued at this time, while the Canadian market is showing pockets of over-valuation.

In 2017 our investment process will continue to search for high quality income streams at reasonable prices. We will manage the Income Portfolio to preserve capital, grow conservatively and reduce risk.

Good advice rarely changes

Jason Zweig, writer of the Intelligent Investor column at the Wall Street Journal, once said:

My job is to write the exact same thing between 50 and 100 times a year in such a way that neither my editors nor my readers will ever think I am repeating myself. That’s because good advice rarely changes, while the markets change constantly.

From here on in I’m going to be incorporating these weekly updates into my monthly letters. I’ve enjoyed every moment of writing them over the years and I appreciate every reply, critic, and comment received. Things have been getting busier around here, business is growing, and I think my Friday mornings will be better spent on managing our portfolios and advising our clients. Thank you for reading and I hope you’re looking forward, as I am, to the next monthly update.  

What I’ve been reading this week

Andreesen Horowitz on what comes after mobile: http://a16z.com/2016/12/09/mobile-is-eating-the-world-outlook-2017/

Can you teach a computer to invest like Buffett? https://www.bloomberg.com/news/articles/2016-12-07/buffett-soros-and-the-role-of-robotic-logic-in-investing-riches

Advice on making better decisions: http://www.basonasset.com/slow-down-to-go-faster/

Nat Geo’s best photos of 2016: http://www.nationalgeographic.com/photography/best-photos-2016/


Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

Winning the game

Do you know the difference between amateur and professional tennis?

Professional tennis is about outplaying your opponent, delivering lightning fast serves and accurately placing the ball through superior play. Amateur tennis, on the other hand, is won by whoever can keep putting the ball over the net. No trick shots, no spin, just avoiding errors. In other words, amateur tennis is a loser’s game – points aren’t won, they’re lost.

That’s a lot like investing. If it requires more than one thing to go right in a row, it’s too hard. If it’s a hail mary long shot, it’s too hard. If you need a degree in quantum mechanics to understand the financial statements, it’s too hard. You don’t win extra points for difficulty.

Our best results have come from simple ideas, patience, and sticking to our process. Minimizing the most common behavioural errors and biases is the easiest way to separate from the pack. You won’t win every shot, but enough to win the game.

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

19 Fortune Cookies

Here are some deceptively simple fortune cookies on investing and the market.   

  1. You can’t be a part of the crowd and beat the crowd. To earn better returns than the crowd one must behave differently and be willing to look different.
  2. Being right doesn’t lead to superior performance if the consensus is also right.
  3. The desire for more, the fear of missing out, the tendency to compare against others, the influence of the crowd, and the dream of the sure thing pushes people into consensus behaviour.
  4.   First level thinking says that stock’s going up, so it’s a buy. Second level thinking says that’s stocks going up, everyone else has already bought it, so it’s a sell.
  5. But… contrarianism for its own sake also misses the point. Real contrarians build a case on firm evidence, not firmly held ideals.
  6. Money is a medium of exchange. Wealth is a philosophy and purpose to use money wisely. Your portfolio value is not a reflection of your wealth.
  7.  In 1949 Benjamin Graham wrote “The Intelligent Investor”. He made one mistake – investing is not about being more or less intelligent. It should have been called “The Rational Investor”.
  8. “Underpriced” is not the same thing as “going up soon”.
  9. It is impossible to know with certainty where the market will go next. But it is possible to understand the present and how it compares to a spectrum of historic conditions.
  10. Many more investors assume they have knowledge of the future direction of the economy and markets than actually do.
  11. Most investors are preoccupied with return. Few are preoccupied with risk.
  12. Risk comes from not knowing what you’re doing. Volatility is the normal fluctuations of price. Uncertainty is the range of possible outcomes. These are all different things. If you don’t understand the first one you will get confused about the other two.
  13. There is nothing riskier than believing in the absence of risk.
  14. Humans evolved “fear” as a survival mechanism for ancient dangers. Most of what we fear today is an over-reaction to things that have little impact on our daily lives. Conversely, many of the things that do not scare us are potentially the most dangerous. *This is not meant to scare you.
  15. A 15% chance of making $1,000,000 is better than a 100% of making $100,000. Probability is important. 
  16. News media is a public echo-chamber. Social media is a private echo-chamber. Search out the points of view that challenge yours, not support them. The more deeply held, the more important to challenge.
  17. The chance of Trump being elected and cancelling NAFTA: 50% chance of being elected, 50% chance of motion reaching the floor, 50% chance of passing, 50% chance of winning in appeals, 50% chance of Canada and Mexico agreeing to terms = 3.125% chance of actually happening. Probability is important.
  18. This last year has been record setting in terms of low investor sentiment. Only twice since 1987 have investors been this pessimistic for this long. After both occasions the market rallied +20% over the following year.
  19. Low expectations are easier to beat than high expectations.

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

Sock Market Adventures

There’s some common sense market wisdom that says if you like your socks on sale you should like your stocks on sale. In either case, lower prices should encourage and excite you to buy more. But while that works with socks, it rarely plays out that way in stocks.

Maybe it’s because unlike a sock, you can’t reach out and touch a stock. Of course the business behind a stock is real, but how often do you drive to your favourite factory or office building to admire the scenery? In a similar vein, value is an abstract thing that only exists in your mind, and your neighbour’s mind. In other words, I know what the colour green looks like, you know what the colour green looks like, but how do we really know we’re looking at the same colour?

There are two objective ways to determine green-ness in the stock market. Value depends on the quality of the company, and the price paid. That’s it. 

Judging the quality of a company is as simple as finding it’s return on equity over long term cycles. The ROE determines durability and long term enjoyment. For the more tangibly minded, it’s like the thread count of a sock. The higher the threads, the better the quality and the longer it will last.

Judging price is far simpler. It’s no secret that buying something at a low price is better than a high price. The lower the price, the less risky a company is. Now here’s a question: do the price changes of socks at your local department store effect the riskiness of owning a sock? Of course not. Price swings are opportunities to buy socks at good prices and sell them that at high ones, but have nothing to do with their inherent riskiness. By the same token, volatility, the ups and downs of stock price, has nothing to do with how risky a company is. Getting over the volatility = risk hurdle is perhaps one of the biggest differences that separate the rational investor from the average.

Finding stocks with high quality at a low price will create a good portfolio return over time. Quality tends to drive the long term return, while the price paid tends to drive the short term return. Just like socks, sometimes good quality makes up for paying a little too much, and sometimes good price makes up for less than top quality.

And just like your sock drawer, having 40 different pairs is a bit unnecessary. Most of us can get by on about 20 pairs, or even 15.

Ok, enough sock jokes. Stocks are begging for you to treat them as real things and not just pieces of paper. They represent tangible shares of real businesses. Finding the good ones takes discipline, but is not that hard. The hard part is seeing them for what they are in the first place. Buy them cheap and good.

What I’ve been reading this week

The people who said no to a young Warren Buffett: http://www.omaha.com/money/some-said-no-to-investing-with-buffett-early-on/article_08ca205c-d2e6-5c8b-a20a-01560aea7bbc.html

You can never escape mean reversion: http://jasonzweig.com/murphy-was-an-investor/

Index investing is not a panacea: http://latticework.com/blind-capital/

Investors are holding way too much cash and it’s not smart: http://thereformedbroker.com/2016/10/25/start-now/

Canadian housing lacks good data: http://www.macleans.ca/economy/economicanalysis/when-it-comes-to-canadas-housing-market-were-in-the-dark-here/

The simple math of compounding return: http://latticework.com/the-compounding-is-just-beginning/

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

A Good Decision

Warren Buffett is not an easy person to impress. I recently picked up a book “The Most Important Thing” by Howard Marks after Buffett said, “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book.” If you haven’t read it yet, I highly recommend it, available here: https://www.amazon.ca/Most-Important-Thing-Uncommon-Thoughtful/dp/0231153686

The excerpt below stuck out in particular. I think a lot of investors make the mistake of assuming a higher price is the sign of a good decision, and a lower price the sign of a bad one. Marks looks at the issue differently, more correctly. He explains how to tell the difference between a good random outcome, and real skill.

Investors are right (and wrong) all the time for the “wrong reason.” Someone buys a stock because he or she expects a certain development; it doesn’t occur; the market takes the stock up anyways; the investor looks good (and invariably accepts credit).

The correctness of a decision can’t be judged from the outcome. Nevertheless, that’s how people assess it. A good decision is one that’s optimal at the time it’s made, when the future is by definition unknown. Thus, correct decisions are often unsuccessful, and vice versa.

Randonmness alone can produce just about any outcome in the short run. In portfolios that are allowed to reflect them fully, market movement can easily swamp the skillfulness of the manager (or lack thereof). But certainly market movements cannot be credited to the manager (unless he or she is the rare market timer who’s capable of getting it right repeatedly).

For these reasons, investors often receive credit they don’t deserve. One good coup can be enough to build a reputation, but clearly a coup can arise out of randomness alone. Few of these “geniuses” are right more than once or twice in a row.

Thus, it’s essential to have a large number of observations – lots of years of data—before judging a given manager’s ability.

Too frequently I see investors make an investment case based on only a year or two of data – an amount far too short to reflect the variability seen over real market cycles lasting four to five years. The problem is even more widespread in real estate, where full cycles last upwards of 15 to 20 years. In either case, with an understanding of process over outcome, we can better separate who’s speculating on a wave of increasing credit availability, and who’s investing for real sustainable long term cashflows.

What I’ve been reading this week:

Confidence is not a sign of skillfulness. It’s often the opposite. http://www.mbird.com/2011/10/daniel-kahneman-on-overconfidence-and-the-illusion-of-validity/

A list of the best annual Chairman’s letters: http://jasonzweig.com/the-best-annual-letters-from-an-investor-who-read-nearly-3000-of-them/

We are ripe for value to make a big comeback: http://www.pzena.com/Cache/1001211922.PDF

Funny jokes from the Clinton/Trump laugh-in: http://www.bloomberg.com/politics/articles/2016-10-21/clinton-and-trump-trade-hostility-for-humor-at-al-smith-dinner

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

Zoom out

Bill Gates said we often overestimate what we can accomplish in the next year, but underestimate what we can accomplish in the next ten.

Changes in media and the speed of communication often make the most minute detail seem the most important. Sometimes it’s the most recent news that seems the most vital. Over thousands of years of prehistory, our brains have been hard-wired to get caught up in the moment. That immediate thinking causes us to extrapolate more recent history into the future, and forget that things move in cycles. Some cycles are faster, like stocks, and some are slower, like real estate. But the cycle always remains.

To see the bigger and most important changes Gates is talking about, we need to zoom out, not zoom in. Only by zooming out can we appreciate the context and make better informed decisions.

Here’s an example of a company that has didn’t do too much for about a year and a half. If you were zooming in, it would be pretty easy to write it off as nothing special. 

Now zoom out. Zooming out gives us the context to understand the real story, the big change. That 1.5yr period above fits in to the blue box below. Even phenomenal companies go through cycles.

We can find countless other examples of the power of zooming out. Good things take time.


What I’ve been reading this week:

Inside the investment process of Seth Klarman: http://acquirersmultiple.com/2016/10/how-to-invest-like-seth-klarman-mark-yusko/

You’re probably making these mistakes when performance: http://blog.cordantwealth.com/how-not-to-evaluate-investment-performance

Generally speaking, you want to buy when people are worried: http://www.bloomberg.com/news/articles/2016-10-12/docile-vix-masks-surging-prices-for-stock-hedges-before-election

Tips to make thinking more robust: http://www.collaborativefund.com/blog/the-most-complicated-simple-problems/

Stop paying attention to the news: http://sethgodin.typepad.com/seths_blog/2016/10/cable-news.html

Why is everyone in Canada so obsessed with leverage?: http://business.financialpost.com/news/fp-street/inside-the-risky-strategy-that-made-canadas-biggest-pension-plans-the-new-masters-of-the-universe

You don’t get above average returns holding the index: https://www.youtube.com/watch?v=N-azmBU0yII

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

Short and sweet

This week’s note will be short and sweet, but don’t let its simplicity fool you. It has the power to turn long-run odds of success deeply in one’s favour in all sorts of disciplines.

Here it is: Process is more important than outcome.

While any individual outcome can be attributed to luck or skill, it is only those arrived at through process that can be repeated and compounded over the long term.

What I’ve been reading this week:

Not listening to market strategists is a good strategy: https://twitter.com/fcfyield/status/782270624009826304?refsrc=email&s=11

Apples to apples, valuations are lower than thought: http://www.wsj.com/articles/powerful-market-indicator-flashes-sell-heres-why-it-can-be-ignored-1475687806?mod=rss_Heard_on_the_Street

Mark Zuckerberg’s book recommendations: https://www.farnamstreetblog.com/2016/10/23-book-recommendations-mark-zuckerberg/

Portfolio cash is high: https://twitter.com/ukarlewitz/status/783011812576940032/photo/1

Know your edge: http://investorfieldguide.com/to-gain-an-edge-run-up-stairs/

Stable businesses make for better investments: https://thepfengineer.com/2016/09/28/mastery-or-ignorance-part-iii/

Untangling luck and skill: https://25iq.com/2016/10/01/a-dozen-things-you-can-learn-by-reading-the-success-equation-by-michael-mauboussin/

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

The Dangerous Portfolio

If you were one of the lucky few to have an amazing 2016 in the market, you might be inclined to revisit the nature of your retirement investments.

A couple years ago I was joking around with a friend about setting up a fund that could short itself. Meaning the worse it performs, the more money the investors make. We would pack the fund with companies with the worst money-losing characteristics imaginable, the type of stuff you’d never want to see in your retirement portfolio. We would isolate companies with negative return on equity, negative earnings growth, lots of debt, and high valuations. Well, it turns out someone beat us to it…

Although you can’t actually invest in it (and who on earth would want to to?), a group called Morningstar CPMS has been tracking what they call the “Dangerous Portfolio” since 1986. And as you’d expect, the Canadian Dangerous Portfolio has been earning an annual average return of -9.1% per year. Truly scary stuff!

Now here’s where things get really interesting. Every once in a while, Canadian Dangerous outperforms. Surprisingly, about 26% of quarters since 1986, it has beaten the TSX Index. It has outperformed the Index in just two years since 1986, one of them being 2009. Even a blind squirrel finds a nut now and then.

Over the first half of 2016, Canadian Dangerous saw one of its largest increases, a gain of 17%, driving up the Index as well. Meanwhile, most high quality value strategies (the type that produce 14-16% over the long run), underperformed by a wide margin. In a classic “junk rally”, investors rewarded the worst types of companies, while ignoring stocks with the most promising long term characteristics. We were not immune to this unusual circumstance, and many of my clients were left wondering “hey, what happened?!”

Predicting what the market is going to do is never something I spend a lot of time on because it’s impossible to get right. However the good news is that according to Morningstar CPMS data, junk rallies do not last. The average shelf life seems to be about six to nine months before the market returns to normalcy and people realize you can’t make long term gains chasing bad companies around. Nine months along since the TSX bottom, the junk rally seems to be fading on cue. Not only that, those high quality value strategies are pulling themselves together once again. And that’s great news for those of us who prefer some safety in their long term portfolios.



What I’ve been reading this week:

The pros are scared, and that’s great news!: https://www.bloomberg.com/view/articles/2016-09-30/bullish-news-from-wall-street-s-bearish-seers

You don’t make money buying and you don’t make money selling, it’s the waiting in between that builds wealth: http://basehitinvesting.com/practicing-a-punch-card-approach-to-investing/

One of the largest asset managers is weary about bonds: http://www.bloomberg.com/news/articles/2016-09-27/blackrock-issues-warning-on-treasuries-as-fed-moves-toward-hike

Deal with “what is” and not “what should be”: https://www.farnamstreetblog.com/2016/09/the-chessboard-fallacy/

Overcoming your behavioural bias to chase return is one of the greatest investing hurdles: http://www.marketwatch.com/story/how-to-choose-etfs-to-get-better-returns-2016-09-24?mod=mw_share_twitter

Some data on presidents and markets: http://ritholtz.com/2016/09/stocks-predict-presidential-elections/

Good companies are not necessarily good stocks: http://www.institutionalinvestor.com/blogarticle/3588616/blog/good-companies-dont-always-make-good-stocks.html#/.V-56AvkrKUl

Champions do not give up, but almost-champions do: http://nymag.com/scienceofus/2016/09/what-separates-champions-from-almost-champions.html

Be careful where you devote your energy for learning: https://pensionpartners.com/where-ignorance-is-bliss/

Building relationships are more important than completing transactions: http://sethgodin.typepad.com/seths_blog/2016/09/wedding-syndrome.html

A bright spot on climate change: http://qz.com/791865/climate-change-charting-the-extraordinary-decoupling-between-gdp-and-carbon-emissions/

Understanding the future is about process: http://www.aaii.com/journal/article/the-traits-and-processes-that-lead-to-better-forecasts.mobile

How has changing government legislation encouraged monopoly behaviour? http://www.theatlantic.com/magazine/archive/2016/10/americas-monopoly-problem/497549/

The relationship between cashflow and physical assets: https://hbr.org/2016/09/investors-today-prefer-companies-with-fewer-physical-assets

Video interview with Howard Marks, one of the best living investors: http://www.bloomberg.com/news/videos/2016-09-28/howard-marks-keep-calm-and-invest-on


Video interview with Bruce Berkowitz, one of the best living investors: https://youtu.be/TEX6wfHWRdU

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

What can bonds say about value?

I’m going to start including below a list of interesting articles I’ve been reading. I hope you enjoy them. On with today’s commentary:

One of the big evolutions in investor thinking happens when investors stop thinking about stocks as slips of paper to be traded back and forth, and instead view them as proportional shares in real operating businesses. To that end, a stock’s intrinsic value (what it’s worth) is simply the total of all its future earnings, expressed in today’s dollars.

In an excerpt below from a 1999 article penned for Fortune Magazine, Warren Buffett writes about understanding the return from these future cashflows in terms of the yield on a government bond:

The rates of return that investors need from any kind of investment are directly tied to the risk free rate that they can earn from government securities. So if the government rate rises, the prices of all other investments must adjust downward, to a level that brings their expected rates of return into line. Conversely, if government interest rates fall, the move pushes the prices of all other investments upward.

Using this framework, we find that the higher the return on invested capital of a business, the more valuable the business – a rather common sense idea. For example, assume a “good” business is sustainably earning 20% on invested capital for its shareholders, while a “bad” business is earning only 4% on invested capital. If government bonds yield 4.6%, as they did a decade ago, then the good business is worth about 4x its invested capital (20% / 4.6% = 4x), and the bad business is worth about 0.9x its invested capital (4% / 4.6% = 0.9x). So if it takes $100 to start a business, then the good business should be worth about $400, and the bad business should be worth only $90. That’s right, in 2006, a bad business was worth less than the capital put into it!

If the yield on the government bond changes, the intrinsic values of business changes too. So if the yield falls to 1.6%, where it stands today, then the value of the good business rises to about 12.5x invested capital, while the value of the bad business rises to 2.5x invested capital. In this light, it’s plain to see how a low interest rate policy helps subsidize otherwise uneconomic business interests (or it at least gives them time to figure out how to get profitable!).

Some people are concerned that stocks today are trading at higher multiples than they were a decade ago. It is true; the average multiple is higher today. However what this concern fails to take into account is the effect of a lower bond yield on intrinsic values. As detailed above, falling interest rates mean that companies trading at 4x their capital today are very different fundamentally, and not directly comparable, to companies trading at 4x their capital a decade ago. This is one of the dangers in using things like the PE ratio to judge the health of the overall stock market through different times in history.

Higher multiples, on their own, are not necessarily a sign of overvaluation. A more rational approach would be to compare the multiple in context of the return on invested capital and government bond yield. From that perspective, it’s still business as usual.


What I’ve been reading this week:

Managing temperament is just as important as managing your portfolio: http://sethgodin.typepad.com/seths_blog/2016/08/temperament-is-a-skill.html

Maybe the drop in energy spending holds the potential for future inflation? http://www.bloomberg.com/news/articles/2016-09-19/at-500-million-a-pop-it-s-an-oil-gamble-that-has-no-precedent

People need to save more. http://www.bloomberg.com/news/articles/2016-09-20/make-six-figures-there-s-a-decent-chance-you-ve-got-almost-nothing-in-the-bank

Is real estate overvalued? http://ritholtz.com/2016/09/reits-are-awesome/

When do private mortgages become a public problem? http://www.theglobeandmail.com/report-on-business/joe-schmo-lenders-double-stake-in-canadas-mortgage-market/article31981959/

Boomers doubling down on illiquid assets…  http://business.financialpost.com/personal-finance/mortgages-real-estate/the-new-gamble-double-your-bet-on-the-housing-market-by-keeping-your-old-home-after-moving

Returns accrue to the most rational investors, not the ones with the highest IQs: http://www.nytimes.com/2016/09/18/opinion/sunday/the-difference-between-rationality-and-intelligence.html

Chasing growth doesn’t work. Return on capital is much better. http://latticework.com/the-sustainability-of-growth-vs-return-on-invested-capital/

Inspiration from Elon Musk: https://www.youtube.com/watch?v=tnBQmEqBCY0

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

Election Fever

Election season is heating up. Over the coming months you’ll likely hear about one party being better than the other for markets. Or maybe one candidate will have greater odds of delivering the next market crash than the other. Or one candidate can better influence employment than the other. If you’re one of the few that believes this kind of stuff is knowable in advance (or matters), please speak up now or forever hold your peace.  

In the spirit of the season, I’ve found something much more interesting. This is a letter written by President George HW Bush to President Bill Clinton on Clinton’s first day in the oval office. You might be surprised by what you read:

I think two things emerge from this letter that are far more relevant than trying to outguess our southern neighbours’ portfolios based on how they might vote.

First, in coming from different sides of the US political spectrum, the Presidents agree on a common goal: lead the country. Just like party politics, it’s easy to convince yourself that any one view is better than the others, particularly your own. And just like Republicans vs Democrats, investing has its debates too: value vs growth, passive vs active, new highs vs new lows and so on. The trick is to realize that all of these approaches work in their own way, on their own timing, in their own cycles, with unique efforts, for different people. In the long term, the purpose is all the same; keep leading, keep moving forward.

Second, it’s that sense of moving forward that’s so important to great leadership. The tenacity to stay on plan, not get bogged down by (inner/outer) critics, and resisting the urge to give in to detractors is leadership in a nutshell. Every tribe has its critics. A leader’s job is not to keep everyone happy, but lead on despite the unhappy. Managing wealth for yourself or others requires that same level of tenacity. Like Babe Ruth said, it’s hard to beat a person that never gives up.

As this election season rolls in, ask yourself not what your portfolio can do for you, but what you can do for your portfolio. Stay the course and don’t get caught up in election fever.

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.  

For long term use only

When you eat a chocolate bar, you expect the sweetness to last about 5 minutes.

When you watch a movie, you expect to be entertained for 2 hours.

When you buy fresh groceries, you expect to eat over the next 7 days.

A tube of toothpaste does its job for about 2 months.

The batteries in your remote will get you through the next 9 months.

A smartphone will get you about 3 years of use.

When you drive a car, you expect it to last about 10 years.

Owning a house, you’re generally happy with about 25 years.

Whenever we buy something, we make an assumption about how long it takes to get the full enjoyment out of the product. If you expected a movie to get to the good part in the first half hour, you’re going to be disappointed. If the best part of owning a car was the first 100 miles, it’s not going to work out. Different products need different amounts of time to do what they’re supposed to do.

A stock portfolio is no different. If we treated it the way we treat groceries, toothpaste or the batteries in a remote, not much is going to come of things. Stocks represent ownership in business, and business conditions just don’t change that quickly. So if you’re ok with waiting three years in between smartphones, at the very least you might consider the same amount of time for a stock portfolio. Stocks are wonderful products, as long as we keep in mind the instructions on the label: for long term use only.  

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

The law of supply and demand

How much oil will people consume next year? How many iPhones will people buy? How many movies will people go to?

These are the types of questions many investors rely on in deciding what makes a good investment. But can you spot what those questions all have in common? There’s a little something hidden in there that tends to trip up budding Buffetts.

Look closely and you’ll find that each of those questions is focused on predicting demand. The last time I checked it’s incredibly hard to figure out where and how people will want to spend their money in the future. But as you already know, it’s called the law of supply and demand, not the law of demand. And it turns out that one of these things is much easier to guess than the other.

I don’t know how much oil will get consumed, but we can get a good estimate of how much oil will get produced.

I don’t know the whims and wishes of iPhone buyers, but we can figure out how many iPhones will get made.

I don’t know how many movies people will watch, but we can find out how many movies theatres will be open for business.

The supply is easier to understand because it deals with the here and now. For big businesses and industries, the supply tends to change much more slowly than demand. Based on the limits of production, service standards, and supply chains, we can’t all of the sudden make more oil appear, or movie theatres open, or even produce 10 million new iphones overnight (as much as Tim Cook would love otherwise). So by focusing on supply, we have a steadier barometer for what the marketplace is able to bear (without having to guess what it wants).

A similar concept is at work with financial capital as well. When you see a lot of money being raised (supplied) in a particular sector, it’s doubly important to keep an eye on how much new production will be coming online. Flooding the market with new supply is rarely a good thing for prices. On the other hand, when you see capital leaving a sector or plants and machinery being shut down, it usually means supply is coming offline, and financing being withdrawn. That’s one of the reasons we often hear that the cure for low prices is low prices.

Following the trend of supply instead of trying to predict the vagaries of demand can help investors better understand the risks to their companies through the capital cycle. 

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

Low risk thinking

When I was starting out as an investor my primary goal was earning the highest return possible. Following this path I got into all sorts of troublesome stuff like options and other high risk strategies in pursuit of the golden goose. Needless to say, none of these approaches worked out. There were brief spurts of joy, and a couple +100% gainers in the mix, but overall it was a bust. What I later discovered was so counterintuitive that I literally had to rebuild the entire way I looked at investments. I found out that you don’t get better than average returns by trying to get better than average returns. That was the fool’s way of building temporary wealth. It turns out that earning better than average returns is only a by-product of seeking out lower than average risk.

There’s this mythical investing paradigm that says high risk equals high reward and low risk equals low reward, I’m sure you’ve heard it. But what they don’t tell you is that relationship has never actually been proven. Instead, the evidence points in the other direction – it is the lower risk stocks that produce the higher returns, and higher risk stocks that produce the lower returns. Intuitively, this makes a lot of sense. There are old investors and there are bold investors, but there are no old bold investors. That’s because as you get more of it, you realize that capital is a responsibility and not a reward. So if you have a lot of capital, and you need to find something to do with it, lowering your risk is not just a choice, it’s the only choice. That’s one of those common sense ideas that’s not so common.

So how does one go about lowering risk? Below are some ideas that have worked around here:

First off, the simplest idea: be careful with cash. For many people, cash might appear to be the lowest risk investment around. But earning near-zero percent interest while inflation ticks along at over 1.5% per year is actually a guaranteed loss. You don’t have to get fancy with cash, but there are plenty of options that can be competitive with the rate of inflation.

Be selective and say “no” more. I’ve never tracked it, but I would guess that I say no to about 99% of the investments I look at in a given year. If I get a call out of the blue from a stock pitcher or a mutual fund salesperson, the automatic answer is no. A close friend of mine sent me an email recently about the hidden powers of no -- say no to everything. That way you can easily tell who’s passionate and who isn’t – the passionate ones will spend the time to follow up. Whether its investing or life, without passion, there is no return.

Buying companies with growing cashflow reduces risk. Growing cashflow allows more wiggle room on your mistakes, so if you buy something at too high a price, the cashflow growth will eventually make up for the gap. For this to work the company should have a long history of sustained cash flow growth that you can see in the financial statements. History is only half of the future, so you should also have an idea of the sustainability of that growth. Could you see people still using the company’s products in their current form five years from now? Usually only the most boring and run of the mill products pass this test. These companies are the ones with staying power and make good long term holds.

Buying companies that are cheap also reduces risk. No secret sauce here, just a lot of statistical evidence showing that if one makes a habit of buying unloved stocks, they will likely earn better than average results. Of course the main issue with this approach is you need guts of steel to buy companies that everyone else is getting rid of, and sometimes cheap stocks can get even cheaper. Goes without saying this route is not for everyone, which is one of the reasons it works so well. Another thing to keep in mind is these companies usually have very short staying power, so once they revert back to normal it’s time to sell and find the next one.

By combining the previous two ideas of growing cashflow with cheapness, you get a twofer. These unloved compounders are the things low risk dreams are made of.

One of my first clients, a very wise man, once told me, “Ben, don’t lose my money”. His success has inspired me many times over, and so in heeding his advice, I avoid situations that can result in the permanent loss of capital. If the economics become dim enough, any individual company can go bankrupt and any individual trade can result in a loss. But it’s quite rare, even in the dimmest of times, that a basket of companies all go bankrupt, or that a basket of companies fail to recover from a bad market. This is not an argument to put fifty stocks in a portfolio, but it’s not an argument to put only two stocks in a portfolio. Like jam on toast, spread it out but not too thin.

The final point is something I found out from a CEO with a reputation for building good teams. Before hiring a new person, consider if he or she brings the team’s average knowledge up or down. In similar terms, before adding a new company, consider how its risk compares to the risk of the existing portfolio. Add a new company only if it lowers the average risk of your holdings, otherwise keep what you have.

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

It's a CEO thing

In this business you end up talking to a lot of successful people. Successful people run successful companies, successful people need portfolios and wealth managed, and successful people share all sorts of advice on how to be successful.

Three CEOs I’ve had the pleasure to sit down with have had this poster framed on the wall of their office. I’m not sure where it came from, or how they got it, but it might be some of the best business advice around. I hope you enjoy it as much as I do.

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

Seek and Ye Shall Find

I read an interesting tidbit this week from Michael Mauboussin’s latest missive on thirty years in the investment business. It’s the story of some curious psychological research from the 1970s.

Amos Tversky (long time collaborator with decision-making expert Daniel Kahneman), asked a group of subjects which pair of countries they thought to be more similar: West Germany and East Germany, or Nepal and Sri Lanka. Two-thirds of the subjects replied West Germany and East Germany were more similar.

Tversky then inverted the question, asking which pair of countries was more different. Strangely, this time around 70% replied West Germany and East Germany more different. Logically, the answer to this second question should simply be the opposite of the first question, but something else was going on...

Tversky was among the first to document the effects of priming. He found that asking the same question in different ways lead people to choose different answers. In effect, he proved “seek and ye shall find” to be true.

This priming effect is so deep in our decision making that it is nearly hidden from our in-the-moment cognition. This and other studies show that our minds are powerful enough to convince us that anything can be true, so long as we believe it.

So if you’re in the camp that markets are destined to crash, you will find and interpret a multitude of observations to support your cause. Or if you think we’re on the cusp of the next bull market, you’ll find plenty to support that too. Or maybe your field is US politics, and you believe that either Trump/Clinton are going to make/break the nation. The point is that if you start with a conclusion and work backwards to find the evidence, your mind will figure out a way to be right every time. The trick is that while these wheels are in motion, it takes deliberate practice to stop yourself from working backwards.

All of this makes “process over outcome” the most important mantra of investing. A repeatable evidence-based investment process is the only way to break out of the priming game. Or maybe that’s just what I choose to believe. 

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

Rain dance

Firstly, thank you to everyone who sent along gifts, letters, congratulations, and marriage advice over the last several weeks. The wedding day could not have been any better, and our honeymoon was a dream. Lauren and I are thrilled to be married, and so happy to be supported by so many people. 

As for markets, things seem to be settling down. Dare I say even getting a bit… boring. As much as I’ve spent the last six months talking about this being a time of maximum financial opportunity and hanging on through the bumps in the road, I welcome the opportunity to now let the market do the work.

The Hopi tribe of Arizona is known for performing their rain dance. And if you were to measure the rainfall before and after the rain dance, you’d find there is indeed more rain in the month after. However it’s important to note that the Hopi only perform their rain dance after long bouts of drought. Inevitably, the rain will always come back again.

With any luck, the time for our rain dance has now passed. Better now to hold onto your umbrellas.

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

A Very Rare Find

I’ve been writing for a while now about the low level of investor sentiment and what it means for the general investor. This week I want you to see exactly what I see. It could change your life.

The American Association of Individual Investors (AAII) conducts a weekly survey of their membership (about 150,000 people), asking if they think the market will be higher or lower in six months. Now it pains me to say it, but this group of individual investors could not be more wrong when it comes to how they feel about the market. They have demonstrated considerable aptitude over the past 29 years for being most bullish at market tops, and most bearish at market bottoms – a troubling “buy high, sell low” pattern emerges from their survey results. But ultimately, that’s a good thing for us because it can be interpreted as a contrarian indicator.

Today, on average only 25% of AAII members are feeling bullish about the market, a historically low reading. So I decided to go back through history and find out what happened after other such instances of low sentiment. Since there were so few times they’ve been this down on the market, I recorded what happened to the S&P 500 after only 28% of members on average were bullish (28% is still in the historically low range). I collected the results in the table below. Here you can find the average US market return for the time period following an instance of low investor sentiment. Let’s keep in mind that like anything, although this has worked well in the past, there is no certainty it will continue to work.

If there was ever a reason to put down the newspaper, ignore the pessimistic headlines, and simply focus on the data, here it is. You don’t get a lot of 25% bullish readings in a lifetime. This is one of them. 

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

Finding the point of maximum financial opportunity

How do you feel about your portfolio right now? Are you excited? Fearful? Depressed? Hopeful?

Since the study of behavioural economics started making its way into the investing world post-2008, there’s been growing interest in how investor psychology affects market outcomes. Particularly, a growing body of research has been steadily informing us about the most common investor biases, and what we might do about fixing them. Things like loss aversion (avoiding taking a loss), the disposition effect (selling winners too early), and anchoring (relying on the first piece of information received), are some of the more well-known foibles that negatively impact performance.

As much as Advisors and Portfolio Managers are learning to use rule-based systems to help avoid falling into these types of traps, the feelings that go along with them remain unavoidable. Although a good rules-based system works over time, we’re still human -- it still feels great to win and crummy to lose.

In that light, over the past 22 month bear market in Canada, I’ve noticed a general trend towards advising clients to downplay their feelings. Things like “don’t make investing emotional” you might hear from just about any Advisor.

But what if you did listen to how you felt? And what if it was entirely useful to helping you make good financial decisions? Have a look at the chart below.

So many people ditch a great investment opportunity not because the numbers don’t make sense, and not because they don’t believe things will eventually turn around. They simply can’t bear to keep feeling so bad about what’s happening to their money. Even rational people have a breaking point. But what if, next time, instead of breaking, you remember the chart above? Acknowledge the feeling, situate it in the spectrum, and act accordingly. The same works vice versa for getting into an investment opportunity for the thrill…

If you can make a regular habit of checking in on how you feel about your portfolio, and writing it down (accountability matters!), you might end up with the most useful custom-tailored investor database on the planet – your own. The more you pay attention to how you feel about your investments, the better you will be able to recognize the point of maximum financial opportunity.

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax. 

Anything can happen

So it looks like Brexit took most investors by surprise, including me. Although the referendum was clear in issuing a populist wake up call, it’s important to keep in mind that the legislative process still has final say on EU participation. With that, it remains to be seen if the UK really does leave the EU. Anything can happen.

In any event, the surprise result caused North American markets to open with significant volatility. However within the first 15 minutes of trading the hallmarks of systemic risk faded, and it looked like just another run-of-the-mill bad day. If I had slept in and come to work late without reading the paper, the decline would be indistinguishable from other bad day blips. As of this afternoon, data suggest we might be wise to expect some more fluctuations into next week, but I would hesitate to assume catastrophe and/or significant declines over more meaningful horizons. Ultimately, the Brits and Europeans will come to some sort of resolution, markets will go on, companies will keep operating, and people will keep investing.

A gentle reminder to all the panicky Petes, negative Nancys and worrier Walts out there: stick to your plans, people. You came up with them in the good times based on long term decisions and ample data so you would do the right thing when faced with bad times, the temptation of chasing short term returns, and unknowns.

During times like these I often review the chart below. It illustrates two very simple facts. First, over time there are far more good years than bad. And second, as my assistant Donna reminded me this morning, we’ve made it through some tough markets before, and we’ll do it again.

Ben Kizemchuk is a Portfolio Manager & Investment Advisor with Altus Securities Inc offering investment management and planning for high net worth Canadians. Ben focuses on the Growth and Income Portfolios and reducing tax.