Sound and Fury, Signifying Nothing
The end of the year is a good time for a moment of reflection to consider your successes and failures as an investor. An objective review of investment decisions, performance and risk is a cornerstone of a good portfolio management process. Let’s look at some lessons of the past year and talk about a couple of key risks for 2016.
2015 can be summed up with a quote from Macbeth; “…full of sound and fury, signifying nothing”. The S&P was up only 1.5% and 10 year US bond yields were up only 0.06% to 2.26%. The Canadian market performed poorly with the TSX down just over 8% and the 10 year yield dropping 0.30% to finish the year at 1.45%. The route to these results was tumultuous as both equity and bond markets experienced some of their largest intraday moves in history.
During 2015, three unforeseeable events had huge portfolio implications for unprepared investors. The first was the almost 17% drop in the Canadian dollar – the second largest drop ever. Toron AMI always advocates that investors maintain consistent exposure to assets outside of the Canadian market. In 2015, this discipline helped your portfolio generate good returns in a difficult environment. The lesson? You need to access the deepest, broadest set of investment opportunities to take advantage of the risk reduction that portfolio diversification provides.
The second event was when the Swiss central bank abandoned its pledge to limit the appreciation of the Swiss Franc vs. the Euro. While this had a limited impact on your portfolios, it speaks to the issue of central bank credibility. If investors start questioning a central bank’s commitment to a policy, it makes a central bank’s ability to shape investor expectations even more difficult. The lesson? You can’t always count on central banks to keep their word and should incorporate that uncertainty into your portfolio construction and asset allocation.
The third surprise was the further 20% drop in oil prices – along with the overall commodity index. Early in 2015 there was so much optimism that oil prices would rebound, that many investors plowed large percentages of their portfolios into energy, only to see dramatic losses. It was not being wrong that torpedoed these investors; it was the size of the position relative to their overall portfolios. The Toron AMI exposure to energy had only a small impact on your portfolio, more than offset by other investments. The lesson? A properly diversified portfolio limits the damage from a single large economic event: “risk not thy whole wad”.
Looking forward to 2016, it seems there is more uncertainty than we have seen in years. Any number of unanticipated factors could easily alter the economic outlook materially and invalidate even the most thoughtful forecasts. In no particular order, some things we are thinking about:
• What would a Trump/Cruz presidency do to markets?
• Is OPEC going to change its oil price policy?
• Will the US consumer continue to spend?
• What if we have more terrorist events in the US and Europe?
• Can the Chinese government continue to orchestrate growth?
• Can commodities rise without an increasing Chinese growth rate?
• What if the Federal Reserve raises interest rates too quickly?
• Why is productivity not recovering?
You can drive yourself crazy thinking about all of the potential risks. The key is to ensure that no single event dominates the return on your portfolio. It is this risk management ethos that continues to be central to our portfolio management approach: we spend as much time thinking about risk as we do thinking about returns. If you get the risk management process right, the returns will look after themselves.
I wish all of you a happy and prosperous 2016.
Arthur Heinmaa, CFA
Chief Investment Officer Arthur Heinmaa offers commentary on recent market volatility: Read Here
Listen here to last week’s open conference call, where we discussed AirBnB and its competitive threat to the travel industry. You may be surprised at what you hear!
We welcome your questions and suggestions for next month’s call. Send them in to email@example.com.
Disclaimer: Past performance is not an indication of future results. The content contained in this document is for information purposes only. It is not intended as an offer or solicitation for purchase or sale of any security or financial instrument, nor is it advice or a recommendation to enter into any transaction. All individuals should obtain specific professional advice.
Global markets and interest rates broadly finished November close to where they started, masking some volatility over the course of the month. The Canadian dollar weakened against its U.S. counterpart in sympathy with commodity prices.
It has been almost 30 years since Francis Fukuyama’s essay ‘The End of History?’ put forward the thesis that the end of the Cold War and the victory of Western liberal democracy heralded a much less eventful era for geopolitics. While that seemed like a reasonable expectation as the Berlin Wall was dismantled in 1989, anyone who has been paying the remotest attention in recent years would conclude that it has turned out to be a rosy tinted forecast indeed.
Recent months have seen events happen around the world that underline how fortunate so many of us are to live our lives in relative peace and harmony. Nobody knows what the future will bring, but how should we as investors consider the impact of what we will term ‘crisis events’ on our portfolios? While the human impact is all too real, and it is reasonable to expect an economic impact to shaken consumer confidence, what does this mean for markets?
The evidence strongly suggests the financial market impact of ‘crisis events’ is fleeting and largely a short-term reaction to headlines rolling across the screen. A study by Ned Davis Research looked at a sample of 50 crisis events dating back to 1907 and stemming from both financial and geopolitical developments in order to measure the immediate and subsequent impact on the Dow Jones Industrial Average Index. The study found a mean loss of 6.8% in the immediate aftermath of the event, but what about the long term?
The study showed that despite immediate losses, the markets showed mean gains of 3.7%, 5.2%, 9.0% and 14% over the subsequent 22, 63, 126 and 253 days respectively. The three events with the biggest market impacts (the 1907 collapse of Knickerbocker Trust, the 1929 Crash and Black Monday in 1987) were all financial in nature and by definition therefore associated with substantial market losses. However even in these cases, the index produced positive returns in all of the subsequent periods measured and recouped a substantial portion of those immediate losses. The biggest loss after 253 days (38.1%) occurred following the collapse of Bear Stearns in 2008; a period where events in the financial sector were unfolding at rapid speed and with cumulative impact.
So in the face of crisis events what should we do as investors? We are all human and understandably experience human emotions upon reading the headlines after major world events. Tempting as it might be, the evidence strongly suggests that reacting to any immediate market movements is not the right course of action – a welcome reminder to maintain a long-term view as we start to look ahead to what 2016 might have to offer.
Watch Rob Spafford discuss investing in railroads on Market Call on November 25, 2015
Watch Karl Berger give 3 investing ideas as guest host of ‘The Street’
A look at some of the month’s most interesting articles, presentations, and commentary.
*Click Here: http://www.cidel.com/downloads/newsletter/
Six years ago we brought on a valuable partner in Cidel. At that time Cidel acquired a majority interest in our firm and immediately became an integral part of Toron AMI, helping us grow and deliver on our promise to our clients.
We are very proud to announce that as of the end of October, the partners of Toron AMI have exchanged their shares in Toron AMI for shares in Cidel. Some of our partners also took the opportunity to increase their level of shareholdings – a strong vote of confidence in our future.
For our firm, this event marks an important step in our plan to become a leading international investment manager and private bank. For our clients, it means we will continue to offer top tier investment solutions and superior counselling by our highly qualified team. In days coming, the portfolio management team from Cidel will be integrated with the existing Toron AMI team under my leadership, deepening our investment management capabilities for all our clients. In time, our extended partnership will provide the added benefit of Cidel’s global private banking services.
Nothing will change in our clients’ interactions with portfolio managers and in the way we manage portfolios. Clients can expect the same level of personal service experienced over the years with Toron AMI.
For me, and for all of us at Toron AMI, this is an exciting development as our firm evolves in the spirit of partnership. We are dedicated to providing exceptional professional talent to serve our clients for many years to come.
Chief Executive Officer & Chief Investment Officer
Toron Asset Management International | Cidel Financial Group
Listen here to our open conference call, where we discuss the biggest themes looking ahead in capital markets and answer questions sent in by clients.
We welcome your questions for next month’s call! Send them in to firstname.lastname@example.org.
In October, stock markets rebounded substantially from losses experienced in the proceeding months. Bond markets experienced some weakness.
October 21, 2015 was immortalised in the 1980’s movie ‘Back to the Future Part 2’ as the date the two principal characters time travel to in a silver DeLorean sports car. The tranquil market environment that persisted for most of 2015 came to an end over the last couple of months with a marked pick up in volatility attributed to a variety of factors, from Chinese growth to U.S. interest rate policy. So far there have been 61 days with a move in the S&P 500 in excess of 1%, ahead of the long term average of 54. While the end of the year typically sees volatility abate, the potential for a Fed tightening cycle to commence in December has the potential to negate this trend. What lessons can we take from the past to interpret future volatile investment environments?
In a 1981 paper the renowned economist Robert Shiller noted that movements in stock prices were excessive relative to subsequent changes in the dividend stream those prices represent. Shiller has returned to this topic several times, considering the role of investor psychology versus rational reactions to changes in fundamentals as a catalyst for episodes of market volatility. In the aftermath of the global market crash in October 1987, he surveyed individual and institutional investors over their behaviour during that period. While the passage of time has developed a narrative for the factors causing the crash, the responses paint a different picture. The survey did not come up with any particular news event that was a catalyst for the sell-off, although there were concerns expressed about valuation and interest rates. Rather, there was a strong belief that investor psychology rather than any change in fundamentals what the main factor at play, with a “contagion of fear” experienced by 40% of institutional investors. Interestingly many were influenced by a historical analog with the events on October 1929.
While 1987 was a long time ago, it’s not hard to believe that advances in communication have only facilitated the transmission of changes in market psychology since then. Human nature being what it is, such changes will invariably occur, leading to volatility episodes. It’s probably a good idea to treat any fundamental explanations with a degree of skepticism. In his 1996 Chairman’s Letter Warren Buffett said he “would much rather earn a lumpy 15% over time that a smooth 12%”. At Toron AMI our principal focus is to look at the underlying fundamentals of the companies we invest in to avoid investments likely to experience undue volatility in the underlying businesses, and we view periods of volatility unrelated to changes in the broad environment as opportunities rather than threats.
Read our quarterly recap and comments on the economy here: Q3 2015 Website Commentary
After almost 4 years of steady increases, investors were reminded this quarter that markets can also go down. Third quarter market returns were down no matter where you invested. The MSCI was down about 9% for the quarter pushing its year to date return to -7.5%. Lead by oil, commodities were down 14.7% for the quarter and 16% YTD. Even the fixed income market was down in all but government bonds, which were barely breakeven. The newspapers kept up a steady drumbeat of worries about Chinese growth. This month, we wanted to look at the size of the China impact and where there is an opportunity for investors.
The declining growth rate in China was cited as the proximate cause for the fall in markets. But how big is China’s impact on the global economy? The world economy, excluding China, is about $60 trillion. China’s imports of goods and services amount to $2 trillion, or about 3.3% of the world economy. But even if China reduces its imports by 20% (a large number), that would translate into a drop of 0.60% in the world’s growth rate. However, the world’s growth rate would still be positive at about 2.5% per year; lower but not catastrophic. The concerns about China’s impact on the global economy seem to be overdone and more about fear than fact.
With any decline in the markets, there are pockets of opportunity. First, the equity market is now selling at 14.2 times next year’s earnings compared to a long-term average of 15.1 times. Recall that the long-term earnings include many decades where long-term interest rates were significantly higher than they are today. So equity valuations look inexpensive not only from a long term perspective but also relative to the 2% return that investors would earn in government bonds. Indeed the dividend yield on both Canadian and US indexes is higher than the 10 year bond yield. Essentially, investors have an income advantage for taking on equity risk. Investing judiciously in this market should still reward the investor with a 2 – 5 year investment horizon.
Corporate bonds have also suffered during the past 6 months. The high-yield bond market is now set to have its first losing year since 2008. The interest rate difference between corporate bonds and government bonds is at level that we have not seen in over 5 years. Overall, investors have become more concerned about a weaker economy and the ability of corporations to pay their bond obligations. However, corporations are generally in better financial condition now than they were 5 years ago, and unless global growth tumbles to zero, it is unlikely that we are going to see a rash of corporate defaults. Though all corporate bonds are not created equal, by scrutinizing the balance sheets, investors can identify good risk-return opportunities in corporate bonds. Currently, investors are earning well above historic averages to invest in corporate bonds.
The fixation on weakened Chinese growth has blinded investors to so many good things in the economy: corporations have stronger balance sheets, cheaper commodity prices are good for consumers, a growing global economy, and stronger wage growth, just to name a few. In turbulent times like these, a steady focus on valuation and risk control will allow investors to take advantage of any market decline.
Arthur Heinmaa, CFA
During the past 6 years we have become accustomed to opening our account statements and seeing values continue to go up. This month, we will see a decline in market values with equity markets off about 4% and bond markets down 1% during August. With the dramatic movement in markets, it is useful to talk about why investors achieve higher rates of return over time by investing in equities.
Most investors think about volatility as market movement on a particular day. Portfolio managers think about volatility as measured by standard deviation – not just in a day but over whole periods of time. Standard deviation is the measure of the “spread” of data: the higher the spread, the higher the standard deviation, the higher the volatility and the risk. The standard deviation defines the risk that we can expect during a given time. For instance, a treasury bill has a known return and maturity date so the price moves very little and correspondingly has very little volatility (or risk). On the opposite end of the spectrum, a small cap equity has no certainty of any return and could have high volatility. In general, we can expect that the greater the uncertainty of the investment, the higher the volatility.
Now here is the key insight: if all we wanted was low volatility, our only option would be to invest in treasury bills, achieving a return of close to zero. If we want a return greater than treasury bills, however, we have to be prepared to assume a greater degree of volatility. Essentially, higher volatility is the price you pay for potentially higher returns.
To understand volatility in returns, consider the case where you have two investments: Investment A has a return of 1% and risk of 1 and Investment B has a return of 10% and a volatility of 5. How to invest becomes a function of how much risk are you willing to tolerate. Over time the second investment would generate a higher rate of return but the price would vary greatly from day to day. By being willing to assume the higher price volatility you can achieve a higher rate of return which illustrates why equity markets have outperformed treasury bills over time.
At Toron AMI we spend as much time on risk as we do on expected returns. We try to make sure that any one event does not unduly impact the portfolio and that the companies in which we invest have the financial strength to thrive in a weak economic environment. By employing a disciplined portfolio construction process, we have been able to reduce the volatility of our portfolios without sacrificing performance.
In today’s volatile markets, some companies on our watch list have dropped to levels where they offer compelling value. We will use this market volatility to purchase those companies and add to any underweight positions. Volatility can be your ally if you take advantage of it.
Arthur Heinmaa, CFA
Oil prices have dropped drastically over the past year yet oil production globally continues to grow. Why? At Toron AMI, we see two main sources of this growth: OPEC’s increase in production, and improved technological efficiencies in the U.S.
Read all about it in Crude Market Thoughts
What are the global relationships that define the price, the availability and the security of oil supply worldwide? Since oil prices began falling almost a year ago, so many questions have arisen. How did we get here?
Read this insightful piece by Tim Hague and the Toron AMI Team to understand the Geopolitics of Oil.
Watch here for Karl Berger’s discussion on the Canadian Dollar : the worst is yet to come.
Read our quarterly recap and comments on the economy here: Q2 2015 Website Commentary
Our roads are clogged, public transit in major Canadian cities pales in comparison to other world class cities and high speed trains simply do not exist. While estimates on the size of Canada’s infrastructure deficit vary, the conclusion is the same: we have underinvested for years and the amount needed to fix our infrastructure is massive. It could be as much as $350-$400 billion. Our quality of life and ability to compete on the global stage depend on the performance and quality of our public infrastructure.
Governments are beginning the address the problem, but commitments are short of what most experts believe will be necessary to meet our future needs. In the recent federal budget, the Government set up an innovative Public Transit Fund, funded at $750 million over the next two years and $1 billion per year after that. They also promised $5.35 billion per year for municipal, provincial and territorial infrastructure under the New Building Plan.
However with 30-year Government of Canada bond yields at just over 2 percent, it begs the question of whether there will ever be a better time to invest in infrastructure. Government deficits are always a hot topic, but increasingly the public is beginning to understand that there is a big difference between deficits tied to investing in infrastructure and those related to program spending. In personal terms, it’s like a home mortgage debt versus a loan to fund regular monthly expenses. It may be that our governments are missing the opportunity of a lifetime to borrow at the lowest interest rates in over 100 years to invest in an economy that has grown at over 5% annually (well below current rates) over the last 50 years.
We will always need infrastructure to improve the productivity of Canadians so that we can remain competitive. We also need to ‘think outside the box’ and explore many ways to finance improved infrastructure, such as enhancing the productivity of infrastructure services, managing demand through pricing mechanisms and many others identified by the Conference Board of Canada in its influential 2011 report and recent discussions. We can all agree that there is a critical need for investment — how we finance it is an important choice for our future.
Attending Berkshire Hathaway’s 50th Annual General Meeting – James Porter, Partner & Managing Director
The world came to Omaha on the weekend and I had the privilege of being there to see Warren Buffett and his partner Charlie Munger hold court at Berkshire Hathaway’s (BH) Annual General Meeting. The meeting itself was unlike any shareholders’ get together that I have witnessed. The venue and the surrounding city were overwhelmed by the devoted who traveled from China to Sweden to help celebrate the company’s 50th anniversary. Just getting a seat was a real adventure. Visiting the BH displays and shopping made the holiday season at the malls comparatively leisurely. As for the shopping (some of it exclusive to the BH AGM), one could visit a model home, buy candy or pick up some underwear (Berky boxers and Berky bras certainly seemed to be big sellers).
The kick-off was a surprisingly slick video comprised of commercials for Berkshire Hathaway companies peddling everything from snacks to banking services, along with humorous skits featuring Warren and Charlie. There was also a medley of Beatles tunes with revised lyrics celebrating 50 years. The famous Q & A lasted for six hours with both men, an octogenarian and a nonagenarian, fielding questions with wry humor.
My favourite anecdotes were Buffett admitting to a quarter of his calories coming from Coca-Cola products, and saying (to paraphrase), “I see a lot of happy people consuming Coke and Dairy Queen treats, I don’t see a lot of smiles on people leaving Whole Foods!”
Some highlights from this Toron AMI partner’s perspective:
- A company’s culture matters above all. What people do is more important than what they say.
- Without a doubt, BH has invested well. When asked for five key criteria, they answered they simply don’t work that way. Every business they buy is evaluated, but not with a pre-determined framework.
- On job cuts that have occurred in companies they invest in and on wages both men were very direct: They don’t buy companies to make cuts, but they expect efficiently run enterprises. While they each had slightly differing views they both agreed that simply raising the minimum wage is not the best solution; the focus should be on skill development and improvement to socio-economic mobility in the U.S.
- They are highly optimistic about the future of the U.S. and believe the next generation will be far better off.
- Charlie Munger spoke at some length about his views on China. He believes that China is finally finding a pathway to release the potential of its people and that U.S. – China trust will be critical to both nations’ futures. In particular, he cited the work to end corruption as a necessary step for the Chinese people and system.
It was abundantly clear that Buffett and Munger don’t just buy stocks; they invest in businesses with great long-term potential and superb operators. That certainly strikes a chord with me and my partners at Toron AMI as it is the key to building long-term wealth.
All in all, it was a great experience to be there!
We are pleased to announce that Barry Da Silva has joined the Toron AMI team on May 1st as a Portfolio Manager with investment research responsibility for the Energy sector.
Barry Da Silva’s Background
Barry has extensive analytical and portfolio management experience. He comes to us from one of the country’s larger investment managers, where he was a Canadian equity portfolio manager. Prior to that he spent a decade as an investment analyst and portfolio manager at OMERS, one of the leading Canadian public sector pension plans. There Barry had research responsibilities for a wide variety of industries and developed detailed expertise that he has leveraged as a Portfolio Manager in both the Canadian and U.S. markets. Barry has a B.A. in Commerce and Economics from the University of Toronto, and holds a CFA charter.
Toron AMI & Our Canadian Equity Team
Barry will be a significant contributor to the team, our process, and our ability to continue providing our clients with excellent Canadian equity investment returns. The Canadian equity team follows a disciplined bottom-up approach to stock picking and portfolio construction. Each portfolio manager within the equity team, led by Bob W. Gibson, is responsible for research on specific industry sectors, and participates in the stock selection and portfolio construction process.
Please contact us should you have any questions or require more information. All of us at Toron AMI are excited about this great addition to our team, and look forward to working with Barry.
This weekend, Toron AMI’s James Porter is heading on a road trip to Omaha to attend the Berkshire Hathaway Annual General Meeting and hear from Warren Buffett!
Watch this space next week for Toron AMI’s take on this fascinating event.
“The capitalist system is under siege. In recent years business has increasingly been viewed as a major cause of social, environmental, and economic problems… Companies are widely perceived to be prospering at the expense of the broader community. ” This statement appeared in a 2011 Harvard Business Review article by Harvard business professor Michael Porter and management consultant Mark Kramer. Just look at the Occupy movement and how it has spread around the globe to see this observation in action.
The way to combat massive social problems, they propose, is to make business the solution – they call it ‘creating shared value’(CSV). CSV “is not social responsibility, philanthropy, or even sustainability, but a new way to achieve economic success.” It is addressing a social issue with a business model. At its heart, CSV means “businesses must reconnect company success with social progress.”
The CSV idea has injected new energy into the CSR and sustainability movements by rightly advocating a better alignment between a company’s core strategy and the social problems on which it can have an impact. The role of business is so crucial because only it has the capital and knowledge resources to make a difference – both alone and as a partner to NGOs. Watch Michael Porter explain the case for letting business solve massive societal problems like climate change and access to water.
Can these ideas really work? Some degree of rethink is certainly necessary. Companies that embrace these ideas are guided by leaders who value the importance of long-termism – understanding that real value and real wealth are created by adopting a long-term perspective, including the full impacts of their activities and the needs of future generations.
As investors, we need to be aware – but also tolerant – of the short term impacts of long-term thinking, and watch for the new business and investment opportunities as they arise and influence existing industries and ways of doing business.
While there has been much talk about the destabilizing effects of the oil price drop, as the price stays relatively low it is increasingly important to recognize the opportunities for Canada in this new reality. Perhaps surprisingly to many of us, the Canadian economy is more diversified than is often assumed. In fact, the effects of falling oil prices have likely created conditions which actually provide new opportunities.
This informative piece by Toron AMI’s Pierre Bouchard was initially written for our clients and consultants abroad, but it is also a great primer for Canadians seeking to understand and invest in Canadian markets within a global context.
Read the full report here: Falling Oil Prices – The Canadian Opportunity.
Consumers are often attracted to brands that have stood the test of time. For most of us, this is usually measured in decades or perhaps a couple of centuries. We are used to seeing companies come and go over the years, and certainly through generations. American Motors and British Leyland are examples of former giants known to most of the Boomer generation and their parents, but that are no longer standard bearers in today’s automotive industry. Japan, however, is quite different when it comes to company longevity. Even today, you can buy sake in Japan from a company that was in business back in the 1100s.
From our western perspective, we think of Japan as an advanced economy with a strong culture and traditions; we know the country for its global household brand names like Sony and Toyota. But Japan also has one of the world’s fastest aging populations and an economy beset by 20 years of deflation from which it may now be emerging. These are experiences that provide the rest of the world with valuable learning. Despite these recent economic challenges, Japan has been able to foster numerous successful centuries-old companies which are now facing brand new challenges to their existence.
This article is a reminder that change can come quickly – even to things that seem like they’ll last forever. Also, that longevity alone doesn’t create value in a company. Every generation of management and investors needs to ensure that the business is robust and ready for the opportunities and threats that come with change.
Read here as Joe Pinsker of the The Atlantic explores the impact of changes in culture, business and law on some of Japan’s oldest businesses.
Read our quarterly recap and comments on the economy here: Q4 Website Commentary
Check out Pierre Bouchard and Robert Spafford’s insights on the energy sector’s ripple effects and their top Canadian dividend stock picks in the Report on Business, Globe and Mail, January 14, 2015.
Or for Globe Unlimited Subscribers, click here: Q&A: Top Canadian dividend stock picks from Toron AMI’s Pierre Bouchard
Read the insightful commentary of our Portfolio Managers here: Q3 2014
The senior deputy governor of the Bank of Canada, Carolyn Wilkins, recently discussed the rise of Bitcoin and other e-moneys and how they might eventually amount to a material part of the financial payments system, and empathised the need for Central Banks to be aware of such emerging trends and proactively develop contingencies for the future should the time come that they become material.
What better time to reexamine this important discussion piece our own Stephen Caldwell produced on the Bitcoin phenomenon in December 2013?
Read it here: Bitcoin Phenomenon TORON AMI
In this discussion paper by Pierre Bouchard, read about how climate change concerns and perspectives shape our thinking about investing.
Read it here: TORON AMI and ClimateChange_April2014