A Comment -- General Comments From an Expert (A Commentary)

Earning 2% on bonds versus 7% on a stock? It’s all about the guarantee. With a Canada government bond yielding 2%, you are guaranteed to get that 2%. On the stock, 7% is not just on the dividend stream but what are you going to be able to sell the stock for when you need the money. There is a lot more risk and volatility on stocks. There is always a place for both stocks and bonds.

With the potential onset of inflation and higher interest rates, what could the impact be on high risk, high-yield corporate bonds, and is there a tipping point where the risk is going to be far greater and not worth it? We are getting close to that tipping point. The real story with the higher yield and high risk bonds is the yield pickup over government bonds. Historically that has been as low as 3% extra to as high as 12% extra. Right now we are at around 4%-4.5% extra. Relatively expensive. When that does start to turn, this asset class will sell off just as hard as equities will. Be very selective of the bonds you are buying or hire a good manager that can do that for you.

How would you structure a bond ladder with $100,000 in a registered account, including types and maturities of the bonds? On an RRSP ladder you are going out every year to 10 years minimum, because the RRSP is a long-term strategy. He would exclusively go into strip coupons with a 50-50 mix between provincials and corporates for the extra yield.

(A Top Pick Feb 24/14. Up 3.39%.) Ville de Montreal 3.5% Sept 1, 2023. Had a pretty good run alongside what you have seen in bond markets overall. Municipal space is still very cheap compared to investment grade corporates.

Target Bond ETFs (RQE-T) or (RQF-T)? He is not a fan of bond ETFs. They are targeted to pay out most of the capital, on the maturity date that you put in on day 1. Bond funds are a great one-stop shop giving you exposure to the bond market without having to do a lot of legwork. If you have more than $10,000, there is no reason why you shouldn’t buy bonds directly. You can take out a lot of the excess manager fees. By their nature, bond funds have to sit on cash where you don’t have to. Also, these are pretty concentrated portfolios, and there is no reason you couldn’t replicate it on your own.

Convertible debentures? When you look at the convertible market, especially in Canada, you are buying the debt of unrated small cap companies. Pretty risky market. Doesn’t think there are enough names out there that you would want to buy.

Preferred shares. Can the issuer convert Fixed-Reset Preferreds to Fixed-Floating Rate Preferreds after 5 years at the rate reset time? Every 5 years, with most of the preferreds but not all, as an investor you have the option of taking a new five-year fixed rate or going to a floating rate for 5 years. Interestingly the spread that you get on the preferreds versus Canada bonds is preset at the time of issue.

Laddered GICs? With government bonds, you can cash them in any time, but with GICs, you are locked in and can’t get your money out. Because of that, GICs do give you a better yield. GICs are constrained to just financials, and you have to trade every 5 years. With the bond market you can go a lot further to maturity, and you can create a much better long-term strategy.

Markets. There has been a huge rotational correction in the market. Generally speaking you have a lot of the broad indices around the world moving up. Both tech stocks and small caps that were doing really well until March, and then basically went to sleep for 3 months, are back participating in the market.

Stock selections. He does “computer assisted stock selection” with MorningStar/cpmas (?) providing the framework. Has his own recipe that then puts different weights on various characteristics, such as ROE, stock price change, PE multiple, etc. Has approximately 730 stocks in his database, and is looking for stocks that are in the top 5% which, hopefully, will have above average earnings growth. He typically invests in small to midsize companies in order to get the growth.

Technology Stocks. Since the beginning of 2013, tech stocks have done very well with lots of financing related to that. A lot of Canadian companies are starting to show good performance. US investors and venture capitalist investors are looking north of the border, which is a good source of competition and awareness. During the Internet go-go years of 1997 to 2000, you had stocks trading at unbelievably high multiples. You have that now in the US with many of the concepts stocks, but there are very few Canadian stocks caught up in that mania.

Markets. Europeans are worried about major deflation. The ECB was the buyer of last resort for EU bonds and they finally came in. It makes no sense that yields are lower than US treasury. There are major issues in Spain with youth unemployment. You want US exposure with a currency hedge. He does not want exposure to the Euro right now. Rails have earnings driving stock prices so they are not really too expensive. Oil by rail probably has a couple more years to go. Pipelines are what he thinks we need, however. He can’t buy new highs in rails here. The trend is probably not over, even if stretched, though.

Markets. Kind of a perfect storm. Sentiment is at its best in years. The greatest frustration was that fundamentals were sound, but we were in an environment where buyers didn’t give a damn, but now things have changed. We are seeing US and Canadians coming back. Falling Loonie, high Nat Gas price and best environment in 10 years, and narrowing in differential are all factors for the energy sector. Last winter was one of the coldest on record and we had one of the largest Nat Gas withdrawals ever. You would think production would be up, but it are actually down. If we have a very cool summer (Florida, Texas, etc.) that would be a risk to Nat Gas.

Educational Segment. Alternative ETFs – how to mitigate downside risk with lower volatility ETFs. Most money is in cap-weighted index ETFs. Cash flow or dividends impact weighting in Fundamental index ETFs. Minimum volatility indexing looks how stocks perform over time, how they react with other stocks in the same universe and puts them together to reduce risk. Charts of Fundamental Index, Minimum Volatility Index and Market Cap weighted Index ETFs by Black Rock. Each one performs best in different market phases. But people are putting them together now.

Developed economies/markets versus Emerging economies/markets. Continues to have a bias towards developed economies, where he feels growth is stabilized and where he expects to see growth accelerate, which should be beneficial for dividend paying stocks, in particular stocks in the financial sector. Favours, industrial stocks and even some of the consumer stocks. In developed markets, the deleveraging process has encompassed government, households and financial institutions. Consumer balance sheets in the US have never looked better. In Canada, we are still somewhat highly leveraged, so he favours US consumer oriented stocks, and likes having a little bit of US exposure in his Canadian funds, which gives it good diversification. Companies have done a great job of reducing corporate debt, so if you look at net debt compared to EBITDA, it has been cut in half in the last 3-4 years. This gives them a lot of room to buy back stocks and continue to increase dividends.