Archive for January, 2013

The 2012 Sleepy Portfolio Report Card

January 28, 2013

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Background

I started the Sleepy Portfolio in 2005 to benchmark my personal portfolio, which at that time was mostly invested in individual stocks. The portfolio started off with an initial outlay of $100,000 but no new money has been added since. This is not simply a model portfolio; it reflects investment returns that can be obtained in the real world by accounting for costs such as spreads, trading commissions, MERs, foreign exchange conversion charges etc. For example, when the portfolio was first assembled in 2005, it cost $29 to make a trade and 1.5 percent to initially convert Canadian dollars to buy US securities. Note, however, that the portfolio is assumed to be held in a registered account, so it does not take taxes into account.

The portfolio has a target allocation of 5% cash, 15% short bonds, 5% real return bonds, 20% Canadian stocks, 22.5% US stocks, 22.5% Europe and Pacific, 5% Emerging markets and 5% REITs. The entire portfolio (apart from the cash portion) is invested in broad-market, exchange-traded funds (ETFs) trading in the Canadian and US stock exchanges. The cash portion is invested in a high-interest savings account that is available through many discount brokers.

4Q-2012 Update

The Sleepy Portfolio gained 2.52 percent since my previous update. During the calendar year 2012, the Sleepy Portfolio gained exactly 10 percent. It is instructive to compare the current portfolio holdings with that of year end 2011. We find that over the course of the year, positions in real return bonds and REITs were trimmed back and additions were made to positions in Canadian equity, Developed Markets ex US and emerging markets. Rebalancing the portfolio helped because developed markets and emerging markets were among the best performing asset classes of 2012.

Here’s how the portfolio looked as of December 31, 2012:

Asset Type Security #s Price Current Value % Portfolio Target % Delta
Cash TDB8150 9144 $1 $9,144 6.34% 5.00% -1.34%
Bonds TSX: XSB 705 $29 $20,304 14.07% 15.00% 0.93%
  TSX: XRB 275 $26 $7,090 4.91% 5.00% 0.09%
Canada Equity TSX: XIC 1445 $20 $28,380 19.66% 20.00% 0.34%
US Equity VTI 440 $73 $32,063 22.22% 22.50% 0.28%
International Equity VEA 945 $35 $33,106 22.94% 22.50% -0.44%
Emerging Markets VWO 170 $45 $7,528 5.22% 5.00% -0.22%
Other TSX: XRE 392 $17 $6,711 4.65% 5.00% 0.35%
Total       $144,325    

There will be no new transactions because all asset classes are now more or less on target.

Portfolio Expenses

It is worth noting that the weighted average MER of the portfolio is currently a miserly 0.21 percent. That means the portfolio incurs a MER cost of just under $210 per year per $100,000 balance. If the same portfolio were invested in typical Canadian mutual funds that charge a MER of 2.5 percent, the MER cost would be $2,500.

Of course, a portfolio composed of ETFs will incur trading costs. But the Sleepy Portfolio gets by with very little trading. During the last year, five trades were made in the portfolio for a total trading cost of $50. The portfolio also incurred costs involved in converting currency to purchase US-listed ETFs. These costs added up to about $51. Expressed as a percentage of average portfolio value during the year, trading costs amounted to just under 4 basis points. The total expenses incurred by the portfolio in 2012 was therefore just 25 basis points.

Group RESP Plans are Loaded with Fees

January 21, 2013

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In some of the long-running posts on this blog (for example, see Is a Group RESP Plan Right for You?), Group Registered Education Savings Plan — usually referred to as scholarship plans — cheerleaders (often sales people) continue to post comments on how Group RESP fees are a bargain compared to bank MERs. These cheer leaders conveniently forget that the mutual funds recommended by this blogger and other objective observers for RESPs feature Management Expense Ratios (MERs) of well under 0.5 percent. Parents saving for their child’s education in self-directed mutual fund RESPs at the big banks will find that the MER charged by the mutual funds is usually their only expense.

Let’s consider two new parents George and Simon. George opens up a Group RESP for his newborn and Simon opens up a self-directed RESP. We’ll assume that both George and Simon contribute $2,000 to their child’s RESP for the next 3 years. We’ll also assume that both RESP portfolios are invested in similar securities and the returns are flat over those years. Simon’s total expenses are straightforward to figure out. He invested a total of $6,000, earned Canada Education Savings Grants worth $1,200 and paid about $60 in fees over 3 years ($12 in the first year plus $24 and $36 in subsequent years).

George on the other hand is discovering that Group RESPs are loaded with fees. He counts the many creatives ways in which he is charged fees in a typical plan:

Insurance Premiums

The fee meter starts running before contributions even reach the Group RESP account. George has to pay for group life and total disability insurance. There are no opt-out provisions (except in Quebec) even if George has plenty of coverage through other sources. A typical Group RESP will deduct roughly 1.7 percent of contributions (plus HST) as insurance premiums. So, after deducting $38.50 in insurance premiums, only $1,961.50 is deposited into George’s Group RESP account.

Cost over three years: $116

Depository Fee

Group RESP vendors charge a fee for simply depositing a RESP contribution into the account. The fees depend on the frequency of contributions. Since George is making annual deposits, he will be charged $6.50 plus GST per year.

Cost over three years: $22

Enrolment Fees

And now for the sticker shock! George’s contributions to a Group RESP are used to purchase units. Since George wanted to contribute $2,000 over 18 years, he chose to make annual contributions. In George’s case, 1 unit is valued at $55, so George purchases 35.53 units ($1954/$55 per unit). Enrolment fees for each unit is $100 and over half the contributions of the first three years are used to pay the enrolment fees.

George has purchased 35.53 units, which means enrolment fees cost a stunning $3,553 and the $6,000 contribution over three years is reduced to a balance of just $2,309.

Cost over three years: $3,553

Just as an aside, it is worth noting that $67.50 per unit is paid as compensation to salesperson. In this example, the salesperson earned a commission of $2,407. Is it any wonder that the vast majority of Group RESP cheer leaders are the sale people, not the parents invested in these products?

It would only be fair to point out that some Group RESP plans guarantee a partial refund of the enrolment fee, which would lessen the impact of fee somewhat. However, parents should keep in mind that even a full refund of enrolment fees eighteen years down the line has a significant impact on the bottom line in terms of opportunity cost (income that would otherwise accumulate on the fees is foregone) and inflation (a dollar that will be received in 18 years is worth just 70 cents today if inflation is 2 percent).

Management Fee

Unfortunately, the fleecing isn’t over yet. Group RESPs charge a management fee of about 0.70 percent for investing and administering the account. Eagle-eyed readers will note that this fee alone is greater than the fees incurred in a self-directed RESP invested in low-cost mutual funds. Since enrolment fees eat up such a large portion of George’s contributions over the first three years, the management fees he pays out is also lower than the competition.

Cost over 3 years: $30

Bottom line on Self-Directed RESP and Group RESP Fees

The bottom line over the first three years is quite simple. The self-directed RESP incurred a total cost of just $60. The group RESP incurred a total cost of $3,721.

What about the next three years? The enrolment fees is fully paid up but the Group RESP still remains the fee leader. We’ll continue to assume that rates of return for both plans are zero. The self-directed RESP will incur total fees of $180. The group RESP will incur total fees of $265 (Insurance: $116; Depository fees: $22; Management fees: $127). You be the judge of which plan will cost you more.

Asset Class Returns for 2012

January 2, 2013

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Despite the turbulence investors encountered throughout the year due to lingering problems in Europe and political wrangling in the US, asset class returns in 2012 turned out to be quite satisfactory. Bonds provided modest, low single-digit returns. Canadian stocks also provided modest, high single-digit returns. Foreign stocks had a banner year with returns from the United States, Developed Markets excluding North America and Emerging Markets all in the mid-teens despite the Canadian dollar appreciating modestly against the US Dollar.

REITs had another fantastic year returning 17 percent and extending the 24 percent, 22 percent and 55 percent win streak of the pervious years. One wonders how long the good times are going to last.

Asset Class 2012 Returns
CAD/USD 2.21%
DEX Universe Bond Index 3.60%
DEX Short Term Bond Index 2.01%
DEX Real Return Bond Index 2.85%
Canadian REITs 16.97%
   
TSX 60 8.07%
TSX Composite 7.19%
   
S&P 500 (in CAD) 13.49%
MSCI EAFE (in CAD) 14.78%
MSCI Emerging Markets (in CAD) 15.66%

Asset Class Returns for 2012

If you are interested in asset class returns for previous years, Norbert Schlenker of Libra Investments maintains a spreadsheet of total returns for various asset classes going back to 1970.

Sources: Bank of Canada, PC Bond Analytics, MSCI Barra and S&P Dow Jones Indices.

PS: Note that percentage returns are inclusive of dividend or interest or distributions.