Rational Advisor

Couldn’t resist this, I am off to UK and Spain and will be back on Dec 1st

Here’s a nice story

My son Arjun was out shopping with his mom, something he didn’t like very much.

But when they passed a toy store, Arjun came to life. He saw a new toy in the window that he didn’t have but wanted. Arjun begged, pleaded and nagged but to no avail. He got so rude that his mother firmly said, “I’m very sorry Arjun, but we didn’t come out to buy you a toy.”

Arjun angrily said, “I’ve never met a woman as mean as you.”

Holding his hand gently, she replied, “Arjun, darling, one day you’ll get married and then you will … you really will, I promise you.”

Rational - I used to go fishing until one day it struck me: you can buy fish. What am I doing in a boat at 4:30 in the morning? If I want hamburger, I don’t track cattle down.

In studying the common traits of those most succesful at games of skill - across disciplines - researchers have found a clear tendency to focus more on process than indivdual outcomes. Poker legend Amarillo Slim has described it this way: “The result of one particular game doesn’t mean a damn thing, and that’s why one of my mantras has always been ‘Decisions, not results.” Do the right thing enough times and the results will take care of themselves in the long run.”

Rational

Legg Mason fund manager Bill Miller tells a wonderful story of a visit he made early in his career to an institutional money manager in Boston, to whom he was pitching the shares of RJ Reynolds, then trading at four times earnings.

As Miller says “When I finished, the chief investment officer said “That’s a really compelling case but we can’t own that. You didn’t tell me why it’s going to out perform the market in thenext nine months, ” I said I didn’t know if it was going to do that or not but that there was a very high probability it would do well over the next three to five years.

“He said ‘How long have you been in the business? There’s a lot of performance pressure, and performing three to five years down the road doesn’t cut it. You won’t be in business then, Clients expect you to perform right now,”

“So I said: Let me ask you, how’s your performance?”

“He said: ‘It’s terrible, that’s why we’re under a lot of performance pressure.”

“I said: ‘If you bought stocks like this three eyars ago, your performance would be good right now, and you’d be buying RJR to help your performance over the next three years.”

Whether from the pressure of demanding investors to do something, or the psychological pain of watching an investment do nothing - or worse - over extended periods, the short term thinking of Miller’s client is the norm among investors. This creates opportunity, however, for those with patience to take a longer view.

In an environment with massive data overload and with everyone trying to exploit short term anomalies in the market, the market looks extremely efficient in the short run. The inefficeinces are likely to be looking our beyond, say 12 months.”

Rational

Here are my notes on what has been happening to a Globally Balanced portfolio.

A Globally Balance Portfolio has been impacted during the last year, by concerns: around:

- Canadian interest Rates Increases in Canadian interest rates to slow the economy has impacted the Canadian Bond component. This component was flat over the last six months. 40% of the portfolio provided a zero return. Rising interest rates are negative for existing bonds. It would be difficult for Canada to continue to increase interest rates, as it would cause the Canadian dollar to further appreciate and cause a recession in the manufacturing sector. If anything, the Canadian government is at the end of their rate rising cycle. We can expect interest rates to remain steady or drop – both events are positive for the future of Canadian Bonds. We would return to normality over the next year. Key to allowing interest rates to fall is a drop in Oil and commodity prices.

- The Canadian dollar Increases in the Canadian dollar affected positive returning American and International equities negatively. Any appreciation in American and International equities is reduced by an increasing Canadian dollar i.e. if US equities perform 10%, but the Canadian dollar appreciates 12% against the US dollar, the end result to us in Canada is 10% - 12% = -2%. An increasing Canadian dollar is an unusual event, once in a decade, and at this levels a one in 30 year event. Although it is difficult to tell where the momentum for Canadian dollar appreciation will end, we are at dangerous levels, and manufacturing in Canada is being affected. There are two main reasons for an increasing Canadian dollar 1) A falling US dollar, and 2) The appreciation of Oil prices. The US dollar has been allowed to fall to stimulate export revenue and correct a trade imbalance that the US has with emerging markets. As the trade balance gets corrected there is less reason to have a lower dollar. Increasing Oil is inflationary to global economics and would lead to a global slow down; this is not a long term global sustainable event. A decrease in oil prices would lead to a decrease in the Canadian currency, and this would be a plus to any American and International returns.

The main reasons for the recent volatility are shorter term in nature, possibly lasting another year. Both reasons are linked to the price of Oil. The main events to have an effect on Oil prices next year would be the US election in November 2008, as a regime change would mean a focus on withdrawal from Iraq, as opposed to further global tensions, and increase in supply due to prices being higher allowing more wells to open.

At the end of a Bull market, in this case driven by Oil and commodities, it is difficult to tell how it will end. But as in the case of all Bull markets the ending is quite dramatic. Our managers have taken a view of being conservative in their allocations to these regions earlier rather than later. This cautious stance means that as the markets continue to propel themselves to higher and more dangerous points, a globally balanced portfolio looks worse in not riding that bull. However the experience of good managers of stewarding through multiple market crashes gives us comfort in that they are doing the right thing to maintain a long term track record.

The Globally Balanced Portfolio was established as a more prudent approach to balanced investing, because Canada makes up such a small part of the global marketplace.

It is influenced more by global events than by Canadian events and is also impacted by the Canadian dollar appreciation and depreciation on global investments.

Over the last five years this portfolio has outperformed its benchmarks and a 7% GIC had it been available then.

However, this is little comfort to investors who have recently purchased a globally Balanced Portfolio, as the short term (last six months) has shown negative returns.

to achieve the five year result of 7.04% annualized the portfolio did have to experience a twelve month return of -12.45%

Even though we do not like to see negative returns, we do understand that it is part and parcel of achieving better risk adjusted long term results, as we saw above we had to experience a -12.45% return to get a 7.04% return annualized over five years.

If we break down the components and then tackle each component with the questions

a) Why did this happen, and
b) will it continue this way

There are five main components to a globally balanced portfolio

1) 40% in Canadian Fixed Income
2) 15% in Canadian Asset Allocation
3) 20% in American Large Cap Equities
4) 20% in International Large Cap Equities
5) 5% in Global Small Caps

Now let’s take a look at the last six months and determine what has impacted the portfolio and are these lasting events that will continue to be a concern i.e. should we make a change to the allocation

The most negative impact to this portfolio in order of importance has come from

A) Large Cap American stocks which make 20% of portfolio

In local American currencies the US Large Cap Growth manager contributed the most by his positions in US technology companies such as Google and Apple. The US Large Cap Value manager has been adding to fallen US financial institutions that have been impacted by sub-prime issues. He did not hold them at the times of the problems, but has been picking them up as they have fallen in price and have become more attractive.

In US dollar terms this portfolio had a positive impact, but due to the increase in the Canadian dollar, the portfolio was negatively impacted.

Why?

The deprecation in the US component is not due to any lack of investment management, but due to the impact of a rising Canadian dollar.

Will it continue this way?

The managers believe that their portfolios are structured to be more defensive. There is attractiveness to Large Cap stocks at the end of a bull cycle. Also this US portion is being bought with appreciated Canadian dollars. So you are taking advantage of any potential turnaround in the US dollar.

It is unlikely that the Canadian dollar can continue to appreciate at this rate without significantly impacting the Canadian economy.

The managers are prepared for any slowdown in the US economy; this has been accomplished by purchasing stocks at depressed valuations to offer a margin of safety, and also concentrating on US corporations that receive a fair amount of their income from international sources.

The US is also going through a possible regime change next year, very similar to one that happened a decade before. A decade ago, we saw a change from the Bush regime to the Clinton regime, which was followed by a negative period for energy positions and a favourable position for consumer products companies.

B) Large Cap International stocks which make 20% of your portfolio

This portfolio has a value and a growth manager.

Why?

Both investment managers’ returns were impacted by a rising Canadian dollar. Also, both managers do not have a high weighting in the “hot” investment area of China.

The Value manager in turn has added positions to Japan and Telecommunications these areas have been affected by a lack of interest. He also has no Oil exposure, and believes there is no value there.

Will it continue this way?

Both managers are recognized around the world as some of the most astute international managers. There avoidance of China at levels over the past six months is wise. As an example, PetroChina now has a worth according to stock valuations of greater than Exxon and GE combined – with only about half the profit of Exxon. The managers believe there is a huge bubble in this area, and this bubble is also a cause for the increase in Oil demand. A possible bursting of this bubble will impact commodities around the world. So, the managers are cautious. China cannot sustain a growth at this rate. This is a dangerous time to be speculative, and being cautious is much more prudent. When an implosion happens investors will run to areas of more safety – Larger Cap Europe, and America, and into Dividend producing companies.

C) Global Small Caps which makes up 5% of your portfolio.

This component is made up of three Global Small Cap areas, Canada – managed by Howson Tattersall, America – managed by AIM Trimark and International Small Caps – managed by .

Why?

All three components were impacted by concerns around a slowing economy. A slowing economy means investors shift from smaller cap stocks to larger cap, more defensive stocks. All of the underlying managers also hold very little commodities as they have very little conviction that it is a sustainable growth area.

Will it continue this way?

Much of the worst impact has happened. However, at the end of a bull market small caps are less likely to add a meaningful benefit. A 5% weighting is enough to add a diversification benefit. A 20% drop in small caps would mean an overall drop of 1% in your portfolio. So any drop is not as meaningful.

D) Canadian Asset Allocation makes up 15% of your portfolio.

This component allocates predominately to Canadian assets and is made up
- Canadian Large Caps managed by Leon Frazer and Associates
- Canadian Mid caps managed by Acuity Investment Management
- Canadian Small Caps managed by Howson Tattersall Investment Management
- International Equities managed by Mawer Investment Management
- Canadian Fixed Income managed by Acuity Investment Counsel
- Risk Review managed by Cumberland Asset Management

Why?

Over the last six months the greatest impact has been due to Canadian Small Caps, due to a flight to Larger Cap stocks. The Small Cap also includes a lot of Canadian manufacturers that are impacted by a higher Canadian dollar. The other large detractor was the International manager that was similarly impacted by an appreciating Canadian dollar impact on positive international equity returns.

Will it continue this way?

Again much of the impact was due to a rising Canadian dollar, and any relief from that would be positive for this component. The Canadian Small Cap is a value manager, and is ranked as one of the top Canadian Small cap managers, they have been adding to positions that offer greater value. These positions are mostly in Canadian industrial products, which would benefit greatly from a reversal in the Canadian dollar.

Most of the other investment managers within this group are cautious of the Canadian markets. The portfolio did hold an overriding 10% in cash, this has since been released as opportunities have risen during this downturn.

It is unlikely that Canada can continue at this pace of growth, especially those sectors related to Energy. Our managers have been cautious with the Large Cap and the International managers focusing on Dividends stocks.

E) Canadian Fixed Income makes up 40% of your portfolio.

Why?

Canadian Bonds were hit by concerns around short term liquidity in late July and early August. This portfolio did not hold any of those positions, nevertheless, was impacted by the markets views on short term debt. Fixed Income in general right across Canada has also suffered due to confusion around Canadian interest rates. It is the confusion and not the direction of interest rates that is a main cause of performance. In a rising interest rate environment a manager would be shorter in term and step up the yield as higher rates come, in a falling interest rate environment, the manger would lengthen their duration to stretch out as long as possible the older rates. But a lack of direction means that managers have a harder time structuring an income stream. As such managers tend to take a middle view.

Will it continue this way?

Higher interest rates in Canada are unlikely, as they would increase the Canadian dollar. A higher Canadian dollar would lead to a recession in Canadian manufacturing, and also a real estate collapse. The only ability to reduce Canadian interest rates would come if Oil prices slowed down globally. Such a reduction would take of the pressure of inflation from Alberta, and allow a gradual reduction in rates.

A slowing of Oil prices would come from many directions, primarily a deflation of the Chinese economy, an abundance of Oil supply, and a change in the US current initiatives in Oil based countries in the Middle East. All, or any of these events is positive for Canadian interest rates.

The worst may well be over for Canadian interest rates. Our managers have remained cautious.

Bottom Line:

Much of the recent performance is due to an increasing Canadian dollar. The continuation of the current pace would be detrimental to Canada as a whole. It is also an event that has been very short in historical terms, the Canadian dollar has been increasing since September 2002 (prior to a US mid term election), with the largest gains happening in the last six months.

Next year is a US election, and a regime change. This is the same movie beging viewed again, we saw it in early 90’s when we had a US regime change from George Bush to Bill Clinton. At that time, Canada also did well until the regime change. Could we see the same happen again, it is likely.

It is a folly to believe that the Canadian dollar can continue to appreciate at this rapid a rate. We are in the last stages of this bull market, and our managers are urging us to remain cautious

Rational

GAMING to MAKE THE WORLD A BETTER PLACE

For every question you answer correctly, a starving Ethiopian child receives a biteful of rice.

http://freerice.com/

Rational - my good deed of the day!

Here’s ten questions to ask yourself before you wish to change, or redeem you rinvestment program. Answer them honestly, becuase they will affect your long term finances.

1. Has the investment changed its management approach?

If it has not and it was chosen with your long term financial objectives, then it may still meeet those investment objectives

2. Are the reasons you had this investment still valid?

Take a moment to revisit your investment objectives. This investment was chiosen because its long term goals were compatible with your long term goals.

3. Has your investment horizon changed?

If you still have several more years to invest, switching or redeeming now may be a short term mistake with long term consequences

4. Has someone you know given you a “hot tip”, or a “better” investment?

Friends and family members mean well when they give investment “tips” but is their advice backed by concrete information? Most people benefit from teh trained expertise and long term outlook that an independent financial advisor can provide in making portfolio decisions.

5. have you weighed risk and return?

You may be in an investment with minimal downside risk and good long term growth, which suits your style. Jumping to a high flyer may look appealing now but could cost you sleep over the years becasue of its volatility.

6. What is your investment alternatives if you switch or redeem now?

Will you be satisfied with a money market fund yielding less than 5% annually?

7. Willswitching investments cause you to be overweighted in a particular sector?

This may increase your portfolio’s risk should a downturn in that area of the market occur.

8. Is the investment for strong perfromance?

Some funds perfrom better under different conditions (e.g. strong vs weak markets).

9. If you switch or redeem, will your portfolio still eb properly diversified?

Having the right asset allocation between fixed income and equity investments and between domestic and international investments, between Value and Growth, between Large Caps and Small caps helps to offset the effects of market volatility over the long term.

10. Will switching or redeeming trigger capital gains and tax consequences?

Some investments held outside a RRSP may trigger a tax bill that reduces or eliminates the advantage of leaving a fund.

You need to review your investment strategy. If you are lamenting the strong perfromance of an area in which you haven’t invested or are itching to make a move, it’s wise to reconfirm investment objectives .

Overhauling a sound inteelectual framework just to satisfy a short term perfromance envy won’t help your long term objectives.

Rational

NULLUM GRATUITUM PRANDIUM - There is no Free Lunch

NE QUID NIMIS - Moderation in all things

BELUA MULTORUM ES CAPITUM - The people are a many-headed beast.

HOMINES QUOD VOLUNT CREDUNT - Men believe what they want to.

SPUCATUM TAURI - BS!

LUKE SUM IPSE PATREM TE - Luke, I am your father.

Rational - SIT VIS VOBISCUM - May the Force be with you

Investors with long investment horizons have a big advantage at the moment. It’s a simple point - bit one often that is ignored, when markets are volatile.

Of course there are signs of worry all around. Bond investments have not provided any returns to speak off, Blue-Chip companies have had a tough time getting short term loans. Inflation seems to be rising, oil prices are going up, the US dollar is almost disappearing. A mounting worry is the continued deterioration in US housing leading to a consumer slowdown that would affect global growth.

Ever since man invented markets - it started with goats and cows and morphed into credit default swaps and hybrid collateral debt obligations - one thing has been constant. prices go up, and they go down. Sometimes they go down hard. This short term volatility is the price you pay for the long-term gains the stock market delivers. it’s entirely normal. And we have to admit that we are powerless over the stock market.

Before investors sell their mutual funds, its worth remembering that diversified stock and bond portfoliso have still returned greater returns than GICs over a five year period. And as assets get cheaper, the odds of success looking out several years are actually going up.

The short term investor is going to invest based on the guess of shrt term news flow, and I can invest based on long term business fundamentals, I like my chances.

Recently Financial stocks have been taking it on the chin as investors worry about the fallout fromt eh credit squeeze. But any losses the banks incure woudl be mere paper cuts compares with the billions in profit they pull down annualyy. I continue to remind investors that Canadian and US banks have extremely strong capital ratios. So stick with quality.

When markets are going to hell, there’s nothing like a dividend cheque to cheer you up - especially when the cheque gets bigger every year. Banks, insurers, pipelines and some REITs are examples of companies that excel in this respect. So, have investments that have an emphasis on rising dividends, instead of a “sexy” story. And if these dividend companies fall in value, you are really getting the future increasing revenue stream at a cheaper price.

History can also offer some perspective. Investors who held on to their shares during the steep market dives of October 1987 recouped their losses in about 15 months - not including any dividends received in the meantime.

Volatility in and of itself, should be meaningless to the long term investor. Most people I know are far too transfixed by the value of their investments at any given moment, when they should be focused on some point in the future - when they will actually need their assets for a downpayment on a home, for college tuiton or for retirement.

As I’ve said many times. If you need your savings right now, you shoudl be in cash or a cash equivalent, not stocks. Then you have no volatility. For everyone else. the only thing that matters is what your assets are worth when you need them.

While the current market appears to be stabilizing, there are concerns that further drops will continue for months, as more real and perceived risks in the US credit and financial markets crop up. But for investors who don’t need to sell today, this is a good time to profit from the losses of those who do.

So let’s keep things in perspective as the market reacts to data like credit crunchs, banks earnings, etc. There may be more bad news and more volatility before we gain some clarity about the future strength of the economy. That doesn’t mean patient investors need lose any sleep.

Stay positive. Yes. it’s scary out there.Ooooo scary! But, it’s not all doom and gloom, folks. Remember that this, too shall pass. During the stock market crash of 1987, the Dow Jones Industrial average fell 22% in one day. less than two years later, it had recouped all of its losses. Five years later it was up 41% from its level BEFORE the crash, and ten years later it was up 253%. Just like last year people were focussing on Income Trusts, now it’s the banks, and people forgot about INcome Trusts. Similarly one year from today, people will forget about sub-prime etc, and these good companies will continue on getting their profits and dividends. In the menatime, you have the choice of taking advantage of others panics and getting the investments at cheaper prices. Also, when having a longer term viewpoint, not only returns, but also volatility and Correlation of returns are predictable.

Focus onthe long term, I know that’s easy to say, but it is the truth. Check out the chart of RBC Dividend Fund, TD Canadian Bond FUnd, Acuity Fixed Income Fund, Mawer World Fund, Brandes International Equity, CI Synergy Canadian Momentum, Cundill Security A, Leon Frazer Canadian Equity, Saxon Small Cap, Marsico Capital Management, Dreman Value Management or any of the other managers in our portfolios as an example. Do you think folks who bought 10 years ago are worried about the latest hiccup? No, they’re too busy picking out a fall wardrobe at Holt’s.

The way your portfolio is constructed is key. A good portfolio that takes risk management into account favours an adhoc process of picking whats hot each year. Dalbar is on of the institutions that has consistently demonstrated that the average institutional investor, who invests with a process outperforms an averatge investor who invests using their emotions. (source: Dalbar Inc. Quantitative Analysis of investor Behaviour, 2003).

Resist the urge to check prices every 30 seconds. if you invest in solid businesses, just hold them and forget about them - let them do they’re thing. Checking prices will only give you an ulcer.

Give yourself a break, go for a walk. Do anything to take your mind of the markets. Everything’s gonna be okay. The world has not ended, and good sound investments run by investment managers who have tonnes of experience in investing in volatile times will again shine, as they look for companies that continue to increase their profits, and thereby increase their dividends, and find new ways to increase revenue, at cheaper prices than a year ago.

Rational.

In these markets everyone’s a little afraid.

it’s your response to the fear that matters the most. Are you going to crack up, or detach yourself, analyze and respond.

Astronauts, firefighters and soilders train to respond to moments of stress and fear. The rest of us are left on our own. And in most cases the results are not good.

We generally underestimate the true dangers, and dramatically overplay violent outcomes over the more probable ones. Fear of everyone getting SARS over fears of driving accidents. And in times when we lack information, we’re prone to imagine the worst. We are only as effective as our emotions allow us to be.

Which is precisely why this curren tmarket is daunting. Consider the unknowns still in play” Credit crunch markets, US dollar falling, bubble status in Oil, China, India and other emerging market, hedge Funds and their leverages.

It’s a far different situation than the market drop in 2001, when the downturn was due to the relatively simple concept of technology stocks being overvalued.

What’s the best way to handle all of this lingering fear? Some inspiration comes from a group of researchers who been applying new techniques to get an answer. The researchers haev begin studying professional investors as they were chimps, even using MRI machines to divine how fear affects the brain.

“We are responding from a different part of the brain when we are in the midst of calm, clear thought.” says Brett Steenbarger, a psychiatry professor at the State University of New York’s Upstate Medical University, who also trains portfolio managers and hedge fund managers.
The area is the prefrontal cortex, the “executive” node of he brain that plans and reasons.

When we are fearful, blood flows away from this area towards the motor area of the brain - the one that produces a fight-or-fight sensation, we become more reactionary.

“You end up making decisions rashly without engaging in research and planning, that you might otherwise do”, he explains.

Dr. Steenbarger has found that the most important step is to get back to basics: to methodically check whether the hypothesis that got you into an investmetn still applies or not.

He recommends ways of coping with financial fear.

The frst sounds simple but is essential - training yourself to recognize fear in the first place.

The second approach is to prepare for a busted or vlatile market, much like as astronaut rehearsing emergency procedures. This helps neutralize the fear in your decision making especially in those moments when it seems so easy to give in to it.

That’s why it makes sense to decide ahead of time your range of responses if your portfolio loses say 10% to 20% of it’s value.

There is no substitute for having survived fearful experiences in the past. The best antidote for fear maybe fear itself.

Rational

Peter Munk is Chairman and Ceo of Barrick Corp, one of the worlds largest gold companies, and was also chairman of Trizec, the real estate company. he’s one of the legends when it comes to investing.

Recently (Nov 5, 2007) he was asked - what was his advice to someone caught in the middle of the recent volatility?

Peter answered” It’s the same advice given by many people - don’t sell when there is a panic button out there. Just do nothing, sit back and enjoy it. I think you sell when people feel good about things. That is, when you want to buy is when you should be selling, and when you want to sell, is when you should be buying. Look at when we sold [property company] Trizec - a year ago.”
“There is an old saying of my grandafather’s - There is room for bears and room for bulls but there is no-room for the pigs and chickens. So, if you try to buy at the lowest point and sell at the very highest, you’re never going to make it. Don’t look for the last penny. Also being always afraid will get you slaughtered.”

Rational