Canadian Capitalist

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1. This Sunday is Mother’s Day. Unlike a column in the Ottawa Citizen today that suggested organic cleaning supplies (which Mom wouldn’t appreciate that?) Mike from Quest for Four Pillars suggests some frugal gift ideas that Mom would really like.
2. CIBC economist Benjamin Tal noted in a research report that investors are reacting to market volatility by sitting on a pile of cash.
3. Globe and Mail readers responded by shooting the messenger. Rob Carrick wrote in his column that it is up to investors to take advantage of market declines.
4. Tom Bradley of Steady Hand gives investors a reality check: we are in a low-return environment for equities, not “8 to 10 percent with zero downside”.
5. Gail Vaz-Oxlade, the no-nonsense host of Til Debt Do Us Part, explains her brilliant jar system of budgeting.
6. Growth in Value is suspicious of new financial products but applauds Scotia Bank should for the Bank the Rest campaign, which enables debit card holders to round up their purchases and deposit the extra money into a high-interest savings account.
7. Preet of Where Does All My Money Go is giving away a copy of KPMG’s Tax Planning for You and Your Family. All you need to do for an entry is leave a comment here.
8. Canadian Financial Stuff debated the pros and cons of having kids paying for their education.
9. Red Flag Deals featured a comprehensive article on the Tax-Free Savings Account.
10. The Personal Finance Check-Up list from Thicken My Wallet blog.

Have a nice weekend everyone. And Happy Mother’s Day to all the Moms out there.

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With the steep increase in the value of our dollar compared to other currencies, hedging against currency fluctuations has become popular and many US and international equity funds are now available in currency-neutral flavours. There are two schools of thought on currency hedging: one holds that currency fluctuations “cancel out” for a long-term investor and the other holds that currency fluctuations have a significant effect on equity performance and should be hedged away. Even if you are convinced of the need for hedging the currency exposure, there is one reason for thinking twice about hedging: cost.

Let’s take the iShares CDN S&P 500 Index Fund (XSP), which holds the iShares S&P 500 Index (IVV) and hedges the exposure to US dollars for an extra MER of 0.15%. At first glance, it seems to be a small price to pay for hedging. However, the extra MER doesn’t seem to be the only overhead for hedging. The total cost of the hedging shows up in the tracking error. IVV posted a total return of 15.78% and 5.3% in 2006 and 2007 respectively compared to the total return from XSP of 14.06% and 3.01%. In other words, XSP trailed IVV’s return in US dollars by 1.72% and 2.29% in 2006 and 2007.

Another example is the difference is performance between the TD US Index (US$) e-Series Fund (TDB952) and the TD US Index Currency Neutral (TDB904). The currency neutral version charges an extra MER of 0.15% but the tracking error was 1.8% in 2007 and 1.1% in 2006. Since the benefits of hedging are debatable but the costs are certain, it may be best to stick with direct exposure to foreign equity markets.

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Stocks have staged a significant recovery after falling sharply in the first quarter of 2008. The TSX Composite is up about 19% from its low in January and the S&P 500 is up about 11% from its mid-March swoon. If the lows reached in the first quarter was indeed the market bottom, we can classify the plunge as a severe correction - the TSX was down 18% from its 52-week high and the S&P 500 tiptoed into bear market territory when it was down 20.25% briefly. During the market storm, diversification within stocks wouldn’t have helped; cash and government bonds provided the only refuge.

While the reasonable course of action when markets are correcting is not panicking and staying the course, now may be the time to revisit your asset allocation in light of your reaction to falling stock prices. At times of market turmoil three options are available: (a) sell enough to reach your comfort level (b) stay the course or (c) scrounge every nickel you can find and invest it in stocks. If your inclination was to sell some stocks, your risk tolerance may be less than you originally believed and you may want to increase your allocation to bonds and cash (Now may not be the ideal time to buy bonds either as Government of Canada 5-year bonds are barely yielding 3%).

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I picked up a copy of The Globe and Mail newspaper this morning and was pleasantly surprised to see that Rob Carrick and Boyd Erman picked this blog for a column titled “Best of the Blogs”. Other blogs mentioned include The Dividend Guy Blog, Million Dollar Journey, Quest for Four Pillars and Middle Class Millionaire.

If you discovered us through the Globe and Mail website, feel free to poke around the site - we have more than 900 posts and thousands of comments. You can also subscribe to our feed and get full posts delivered through your favourite reader. If you prefer to have posts delivered to you via e-mail, you can sign up in the sidebar on the right (your e-mail is not shared with anyone. We have a strict privacy policy).

The Globe website is also running a poll where you can pick your five favourite finance or investment blogs.

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Warren Buffett hosted the annual general meeting for Berkshire Hathaway shareholders in Omaha last weekend. The most anticipated part of the meeting is the Q&A session that Buffett and partner Charlie Munger hold with shareholders and this year the duo lived up to expectations and dished out wit and wisdom:

• Jason Zweig of Money magazine reported on the Q&A from the “Woodstock for Capitalists”.
• Jason Zweig also covered the press conference where Buffett and Munger took questions from print reporters and came away with the highlights.
• Jeff Hull, a financial advisor, covered the annual meeting for The Financial Post. He wrote posts on how Buffett is bullish on Korea, his thoughts on the Canadian dollar, U.S. recession, sub-prime mortgages and the Bear Stearns bailout.
• Forbes carried video footage of snippets of conversation with Buffett.
• Larry MacDonald links to recent additions to Buffettology.

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Like everyone else, I’m excited when a stock I hold increases the dividend. Dividend increases in recent years have been very strong. TD Bank (TSX: TD), for instance, has raised its dividend from $1.12 per share in 2002 to $2.36 per share today, a compounded annual rate of more than 12% per annum. The joy of dividend growth experienced by TD Bank’s shareholders is hardly unique - other companies have raised dividends significantly in recent years. Will the good times last or is the party going to end sometime? Does the historical record support the prevalent notion that dividends significantly outpace inflation over the long term?

I’m currently reading Triumph of the Optimists by Elroy Dimson, Paul Marsh and Mike Staunton. The authors look at 101 years of global investment returns from 1900 to 2000 in sixteen major markets, including Canada. Researching dividend growth over that time frame, the authors note:

US real dividends fluctuated greatly in the first half of the last century, but made little headway so that by 1949 they had just kept pace with inflation. For the next twenty-one years they grew quite strongly, but thereafter fluctuated with no clear trend. $1 of dividend income received in 1900 grew, after adjusting for inflation, to $1.78 by 2000, an annualized (geometric mean) real dividend growth rate of 0.58 percent. The arithmetic mean annual growth rate was 1 percent higher than this at 1.57 percent, reflecting the high volatility of annual growth rates, which had a standard deviation of 14.3 percent.

The US experience is hardly unique. In the UK, dividends grew at a real rate of 0.40% per year and 0.3% in Canada over the same time period. In fact, out of the sixteen countries examined, just seven countries (Sweden, South Africa, Australia and Switzerland were the others) posted positive real dividend growth. The authors rightly conclude that “real dividend growth has been rather lower than is often assumed”.

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1. The Financial Post offers useful tips on getting organized for the 2008 tax year.
2. Thanks to Jon for posting the CBC news item on Canadians snowbirds buying up distressed properties in Arizona.
3. Jason Zweig writes in Money magazine about “rash, stupid and dangerous ideas about how to invest money” in a bear market.
4. The National Post carried interesting nuggets from the 2006 census data on earnings, income and shelter costs.
5. Ken Kivenko, an advocate for small investors, takes advisors, who sold ABC paper to their clients, to task for not doing the job for which they are handsomely compensated. Thanks to Jon Chevreau’s post on the lessons from the ABCP fiasco for the link.
6. Million Dollar Journey wrote about the RESP strategy for his little one.
7. I mentioned in last week’s post on a report that seemed to question the conventional wisdom that investors reduce their equity exposure as they age. Thanks to Michael James for pointing out why the study is questionable.

Blog Roundup will return next week. Have a nice weekend everyone!

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The more I learn about group RESPs, the less I like them. In the comments thread on an earlier post on Group RESP plans, a reader referred to the prospectus for the years 2000 to 2007 filed by the Canadian Scholarship Trust filed with SEDAR. I was initially excited to lay my hands on so much information - at last, I could compare past results of Group RESP with a self-directed RESP that holds fixed-income securities and make an apples-to-apples comparison between the two for a number of time periods in the past. The results would be interesting and hopefully conclusive.

Alas, it was not to be. While it’s possible to find out contribution information or EAP (education assistance payments that is made over four years to eligible students) information, it is hard to obtain both for the same plan. For instance, consider the 2007 prospectus. The Group RESP plan marketed by Canadian Scholarship Trust is called “Group Savings Plan 2001″. The contribution schedule is available in the prospectus and tells us that buying one unit for a newborn would cost $105 per year, for a 1-year old $115 per year etc. The oldest child that can be enrolled in the plan would be 12-years old for a contribution of $1,100 per year. While, the prospectus mentions that EAP of $600 was made for the 2006 year, the “Group Savings Plan 2001″ was offered only in 2006 and 2007, which means the oldest child enrolled in the plan in 2006 will be eligible for EAP in 2012. The Group plans offered in years 2000 to 2002 was called the “Optional Plan”, in years 2003 to 2005 was called the “Group Savings Plan”. So, it’s nearly impossible to tell how the plans have performed over the years.

The defendants of Group RESPs point out that the portfolio is invested in an “ultra-safe” manner. But, guess what? According to the prospectus for the “Group Savings Plan 2001″, about one-quarter (24.8%) of the assets is invested in index-linked notes. A fair comparison of group plans with self-directed RESPs, going forward, would be a 75% bond and 25% equity mix. I’m convinced more than ever that a self-directed RESP invested in a diversified portfolio in a low-cost manner is more flexible and almost certain to outperform any pooled RESP plan available today.

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The news on the housing front out of the U.S. continues to be bleak - prices were down 12.7% on average in 20 markets in February 2008 compared to the same time last year, with prices dropping 20% or more in Las Vegas, Miami and Phoenix. In Canada, at least one analyst boldly declared the housing boom “officially over”, not to mention an entire grim book on the subject but the IMF thinks that Canada is in a much better position compared to other major economies. Here’s the housing bust is playing out around the world:

Australia: Home prices have started to fall in many Australian cities (Melbourne and Sydney) and some estimates suggest property prices could fall as much as 25%. With interest rates at 7.25%, many reports indicate that overleveraged homeowners are struggling to pay the mortgage.

Ireland: The Independent newspaper colourfully labelled 2007 as “the year the roof began to fall in” and another later report notes that Irish home prices fell by an average of 7.3% in 2007.

United Kingdom: Reports indicate that the housing bubble has already started to deflate in the U.K. The Times featured anecdotal reports of falling home prices, while The Economist magazine calls for a “hard landing”.

Spain: Property sales are down, prices are moderating and home buyers are treated like movie stars.

India: After prices tripled over four years, reports indicate that housing prices have fallen as much as 20 to 30 percent.

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Responding to a question from a group of business students on what investors should do, Warren Buffett replied:

The answer is you don’t want investors to think that what they read today is important in terms of their investment strategy. Their investment strategy should factor in that [...] if you knew what was going to happen in the economy, you still wouldn’t necessarily know what was going to happen in the stock market.

A recent article in The New York Times provides a fine illustration of the pitfalls that Mr. Buffett is warning about - you may be totally right about the economy but utterly wrong about how stock markets will react. The article notes that entering 2008, investors were confident that the US economy was bound for a recession and bet that growth will outperform value, large caps will outperform value and bought into “defensive sectors” like healthcare. Investors do seem to have got the first part right as mounting evidence points to an U.S. economy in deep trouble.

But, what happened to the stock markets? Since the beginning of this year, there is little to choose between growth and value among the S&P components. The iShares 600 Small Cap Index (IJR) has outperformed the iShares S&P 500 Index (IVV) by almost 2%. And healthcare is the second worst-performing sector with returns poorer than the much maligned financial sector.

The article concludes that this is one more reason to “ignore market chatter and simply stick with a diversified investing plan that calls for investing some money in large-cap stocks and small-cap shares, in growth and value, and in every sector of the market”.

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