Rational Advisor

Okay I ‘m back to the centre of the universe!! Toronto!!

The west was an excellent trip, got to meet Archie B and his daughter Cerylann in Vancouver had a good discussion about what is Risk, and how to really measure the effectiveness of investments, and it wasn’t solely by returns over the past three years.

We got into a neat discussion about market crashes and how they always seem to come along when people least expect them. When the belief that it is not going to happen is the strongest. The reality is that we do not know when it will happen, or what will be the reason, but we do know it will happen. And that’s what prudent management is about.

Too often we get caught up in investments that do well recently and are easier to talk about, and expect them to be able to avoid market crashes. Well, it’s really easy to see how they did during a crash, and that’s to simply look at how they reacted in the last crash in 2000.

At that time, just like now, investment managers who showed the hottest or better performance were doing it on the back of one or two sectors.

One of my indicators of trouble is the performance of bond investments. If you use an Andex chart and go all the way back to 1955, you will note that poor bond performance comes before poor equity performance.

Had lunch with Scott G and Harry T, really glad to know that Harry is also such a soccer fan. My estimation of him just went up. Both Scott and Harry run a great business and understand very well the importance of having a process rather than having an emotional attachement to the markets.

A good portion of our investment decision-making should emphasize process rather than the predictability of an outcome. Studies of portfolio choice consistently show the toxic impact of emotional investing, overtrading, the power of well diversifed investing and the value that dividends and dividend growth bring to portfolio performance.

That evening we had a presentation for David C, Tom W and their clients. This presentation focused on how delusional past returns could be, and understanding that even the best investors, and I gave an example of Warren Buffet can have tough times (-45% return over two years (’98-’99), and a five year return of 0% (’98-’03)), yet they prospered and provided great returns because they stick to their discipline, even when others thought that they were wrong and left them to chase hotter investments. We all get seduced by what’s been running well, and get depressed because we don’t have some of that. The reality is that sane and rational investors like Buffett don’t get trapped into these emotions, and continue to avoid what is higher in risk. Just because something has a higher return does not make it a better investment. What has to be understood is the risk taken for that return. During those period of difficulty for Warren Buffett but exuberance for technology stocks, his investment, fell at the same rate as the “hot” investment and did not recover at the same rate. So investors left, because he did not recover as well as the hot thing. Well, he didn’t because he did not buy into those illusionary investments. We are currently being seduced by hotter investments with better returns, and the weaker (me-too) investors will fall into the traps of changing their sound investments to them, and increasing their risk without understanding that. Advisors will appease clients because it’s the easiest thing to do - move to something that has demonstrated a recent higher return - well, I will just say, that these investors have not learnt their lessons from the past crashes, and may well experience that same old ride again. Or that they do not want to confront the mis-actions of their clients because of the fright that the clients will leave them. By appeasing an investor into such investments you are not doing the investor any good, you are just fostering the bad habits - it’s like a doctor knows that the junkie wants cocaine, and knows its bad for them, but keeps on giving it to them, because he does not want the patient to go to another doctor. It frustrates me, that we see the same movie again and again, yet we think it will have a difficult outcome. Let me tell, you it never has!

Met with F and J new advisors to our firm who recently moved over from a recent purchase. F’s been in the industry a long time, this was mentioned at least four times, just to make sure that I did understand it. OK, I get it, nobody can tell you anything, you are the one that knows-it-all. Believe me, I see a hundred of you a month! apparently your understanding of how the markets work is much better than David Dreman, Warren Buffett, Tom Marsico, Charles Brandes, Gerald Cooper-Key of Mawer, Bob Tattersall, David Picton, RBC Dividend team, and the TD Bond team. yep, we agree that you are the best.

Unfortunately, this industry has a really crappy record of teaching advisors what is the right thing to do, instead it focuses on what is the right way to “sell” the product that makes the fund companies the most money. “If this thing doesn’t work, give them this other thing” - spin, spin, spin. So older advisors, sometimes get tainted in this thinking. Another concern that I see with older advisors is that they are more prone to bitch about things that have come into their industry - “Compliance was never this tough” - It’s only become tougher because of some of the ridiculous things that were done before. “There’s too much paperwork” - rightly so, it’s there to protect you and your clients! “I am independent and always will be” - B.S. you were never independent, you were prone to the company that paid your commissions! If you were independent you would have also offered solutions that paid you no commissions! Well, for you old geezers that know-it-all and don’t want to change - Good Luck!

And then I was so grateful that we met the exact opposite in Brian K, who moved over from the same firm as F and J, but had a totally refreshing outlook. Here’s a person that has been in the industry for a long time, and appreciates it’s worth and how changes can be a good thing for all. Had a wonderful lunch with him at the Cactus Club. Our main discussion was around how investment firms confuse advisors and the public by not clarifying whether they are tactical or strategic thinking in nature. It does make a difference, as it leads to unfair comparisons. We also talked about how some firms even though they stress how neutral and independent they are, are not really that way. Here’s an example, a US based firm in Canada start with an S and ends with an I, and is made up of three letters, says that it chooses the managers from an independent choice, and that no managers are related to them. Well, that’s not quite true, all the managers are related to them, because they all use that firm to do the back-office processing. So. is it a ” we use your back office, and you get us sales” deal or “I scratch your back, you scratch mine”- where was the independence! I have a litmus test that I use to see if a firm has a good bunch of managers - and that test is Mawer Investment Management, from Calgary - Mawer has won the award for the International Manager of the year for three years (the only one’s to do this - this is an incredible achievement), I think as an international manager they are tops, they are also ranked as one of the top firms by Nelsons Investment ratings. What I look to see, is if an investment program has Mawer in their program for International Equity management. If they don’t I then compare their manager in that space to Mawer, and if he does well by return and risk, I give them kudos, if not, I think there is some spin-doctoring going on. So there you go, you now have my litmus test.

That evening we had a presentation with Dianne N and crazy Jean R, and their clients. Talked about the same things that we did with David Ca and Tom W. What was most impressive was Jean R’s better half she had a real inspiring story about working hard to achieve your goals, and keeping focus. Jean told me to tell the rest of Canada that Vancouver has miserable weather - he hopes it will deter the rest of you from coming there (actually it had excellent weather).

Next day, we went to Edmonton and met with Jas M and his group. Really good guys. and a really neat office structure. If Jas is reading this, thanks Jas really enjoyed the time, and the thai dinner. Jas and me spoke about the reactions that the public has to events. Also visited the huge Edmonton Mall, and huge is an understatement, 7 blocks long, 3 blocks wide! But prices are not cheaper in Edmonton, they have no PST, the prices are just marked up, so that GST added to the price equals the price everywhere else - the only place this is not the case is in country wide chain stores.

From Edmonton, we took the really looonngg drive to Cold Lake (appropriately named - the people there were really warm). We met with Fred N, Russ and Candace, had a really good discussion, mostly around performance, and how other investments are performing relative to our strategy. At times, it seems easier to make a change because of the sheer volume of calls around performance, and the fact that other investments are doing better. They made excellent points, and I do agree that this is a tough environment for strategies that are less focussed on hot areas. All, I have to offer is that, time and again, when we get lead by the higher performing investments, or we look at the last three years of results, we fall into the same traps that we went to at the last peaks - being keenly focused on what did better over the last few years, and being led by an unsophisticated public that takes its education from the news media and thinks they can predict the future. At the peaks of the markets are where you are tested the most. Because at that point, it’s easier to give up all hope and just follow what’s giving the higher returns - this is why people jumped onto the Nortel bandwagon. The public is not aware of their own emotions, they are not sophisticated, and have very short term memories. The public screams for returns, yet when they get the negatives they don’t understand that it was part of their asking for the higher returns, it is two sides of the same coin. The best approach is to at the point of purchase to first understand the worst case scenario, and understand what you can tolerate as a loss and what that loss has been in the past.

The public will always say that I moved from here to there, and I would have been better off leaving it in the old thing. In the short term it may be true, but it the long term it probably isn’t. Also, it maybe true, when you look at returns, but it may not be true when you look at risk. And Oh yea, I understand, the public does not understand the word risk, all they want is return - well, in that case they should only be invested in a GIC! not an investment program, because any investment can have a negative! and the negative is needed to get to a positive. There has been no such equity based investment that has continually moved up, over every single 6 month period.

Believe me the companies that are being quoted now as good investments, tomorrow will turn into lousy investments, and you will go through the same cycle again. Buy what’s hot at a higher price, sell when it gets cold at a lower price - Buy High, Sell Low! When will we ever learn

The particular fund quoted to me, although Canadian and Growth in nature had a worst case 12 month return of -32% since inception, and was really a Canadian Mid Cap/Small Cap fund, according to that company (yep, I called them up to verify). So, the decision to move investments was being made to move from a global balanced portfolio to a Canadian Mid/Small Cap growth portfolio! yep, sounds sound to me. It was being compared against other Large Cap or well diversified funds. Most probably clients were not told about the downside, just how well it had done over the last three years. This unfair comparison, and reliance on quartiles are going to be the death of me. I do not have much reliance or respect for quartile rankings (even when we do better) etc. Why, simply you can see the same fund in different categories. If you don’t believe me look it up, or better yet ask me to send you the powerpoint on it to show you what a whacko job these rating agencies are doing!

If you ask me, the best thing for the public is to tell them to put things in perspective. If you have a shorter term to retirement, now is not the time to be jumping onto hot investments. Poorer returns do not mean that you are in the wrong place, just that you did not take the risk that is currently being taken, and perhaps the current risk is unwarranted. We are in a weird world, where things that haven’t happened for 50 years are happening, and we are mistaken if we think this is the new norm. The public has the right to move their investments and make mistakes - advisors should maintain their discipline and explain what their process and methodology is. Your methodology is not, what the public wants they get - if that was it, advisors would have given Nortel, Bre-X, Loewen Group, Livent, Enron, technology funds in 2000, Biotech funds in 2000 etc. And advisors would not be needed.

Please, Please, Please go back to your history books and read about what happened during the last crashes - people were moving to hotter investments, investments that had done well over the past three years, people thought it would last forever, people believed that these managers could steer themselves out of problems (B. Sterling is an example, as are many others) and they didn’t.

Stay rational, bonds are needed when you don’t think you need them. Don’t just let go of a decent investment until you understand the risks and negatives of the new choice. And do a fair comparison

Before I forget a big thank you goes to Ann W, for her excellent work and help in putting this trip together.

Rational - My wife and I had words, But I didn’t get to use mine.

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