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Many stories making the media rounds these days say that diversification offered little protection in 2008. First, these reports are factually incorrect. Although most asset classes performed poorly, there was one notable exception: bonds. Despite the credit crunch, the flight to safety ensured that Canadian Bonds as a whole returned 5.2% for the year. Second, even within stocks, diversification offered a measure of protection. Recall that U.S. equities lost 23.5% compared to the 33.8% loss in Canadian stocks.
Third, it is unrealistic to assume that diversification across equity markets will somehow help avoid a poor year. A cursory glance at market history would have shown that such an assumption is false. The TSX Composite, S&P 500, MSCI EAFE Index and MSCI Emerging Markets Index all lost money in 1990, 2002 and 2008. One of the lessons of the Long-Term Capital Management crisis (When Genius Failed is a good book on LTCM) is that in times of financial stress, the correlation among equity markets tends to go to 1. In other words, there will be no place to hide in stocks. It has happened before and it is almost certain to happen again and equity investors should be prepared to endure rough sailing when it does.
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21 responses so far ↓
1 EconStudent // Feb 11, 2009 at 10:09 am
CC: Nice post. I didn’t know it was the same in 1990 and 2002. REITs didn’t do well this time either.
Do you think there are any signs that there might be a second market crash?
2 anon // Feb 11, 2009 at 12:41 pm
So I had a meeting with the “financial advisor” from Scotia to create a portfolio for the bonus (if any) for my RRSP.
She tells me that I can only buy Scotia or Fidelity funds through them. I go to their web site, it lists a whole bunch of other funds, from TD, CIBC etc. I look up a good number of them with low fee and no load …. and I call Scotia back and say, if you are only selling me the Scotia or Fidelity, why are these listed?
Oh you can buy those they say, but they’re all with back load.
I ask the woman, okay, well, tell me what is the load on for instance, CIBC Energy Index.
She looks it up and says, you have to buy a lump sum of
500$.
I say, that I know, but what is the load? She looks it and says, you’re right, they’re no-load.
I’m like, okay, how about “CIBC Blanced Index”? No load. How about “TD International Index”? No load. “TD Precious Metals Index”? No load.
Mmkay. WTF? Do they not know or are they lying to my face?
3 Canadian Capitalist // Feb 11, 2009 at 1:24 pm
EconStudent: Who knows? Like most people my timing tends to be terrible. All I know is the long-term outlook for stocks looks good from here.
4 Canadian Capitalist // Feb 11, 2009 at 1:28 pm
anon: I’d also look at the fund’s MER. Unlike regular funds, index funds are essentially the same, so look for the fund with the cheapest MER. Many financial advisors have a conflict of interest: they want to sell you the fund that makes them the most fees but you want the one that is the cheapest. To avoid these problems, I’d rather pay an advisor directly out of my pocket. i.e. pay them for the service (for a financial plan and asset allocation policy) and not through a markup in the parts.
5 Sampson // Feb 11, 2009 at 1:57 pm
anon;
I think the first thing you should do is get a second opinion and not go back to that ‘advisor’.
I stopped going to those bank types a while ago. If I wanted to buy solely based on their assessment of my ‘risk profile’, I could do that from home. Ideally, I’d a financial advisor to tell something I don’t already know or something I couldn’t easily learn for myself.
6 mjw2005 // Feb 11, 2009 at 2:04 pm
The fact that you read this post Anon…probably means you know more than that FA….she wasn’t lying just miss informed…still not a good sign…but the vast vast majority of people that a Bank FA deal with usually have no clue about Investments and would buy whatever the FA recomends…
Good for you to do your own research…
7 Finance Matters // Feb 11, 2009 at 3:59 pm
anon;
I tell clients all the time that the bank advisor is just given the basics about MFs and what to sell to their clients. Find a good CFP who will be able to give you advice about other things like insurance, taxes, estate planning etc in addition to helping you map out an investment strategy. I offer fee for service for those that want it.
8 Dividend Growth Investor // Feb 11, 2009 at 5:00 pm
Nice post CC. Even if you are a perma bull on stocks, it does pay to have an asset allocation to fixed income. Now High-Yield Junk bonds didn’t perform as well in 2008, but other bonds like treasuries did very well..
The 2000-2002 crisis showed investors that the best places to hide were in emerging markets, which did very well betwwen 03 and 07. I wonder what the next great theme is going to be.
Not that I care.. I will keep buying dividend stocks no matter what
9 EconStudent // Feb 11, 2009 at 5:15 pm
anon:
I am not sure how much asset you are looking into invest, but I haven’t seen anyone on CC’s blog mention about CIBC index fund fee reduction program. It requires you to have 150,000 invested in CIBC index funds and it refunds net MER of .63% annually. You can find the exact information from http://cibc.com/ca/pdf/mutual-funds/mf-aif-aug2008-en.pdf .
Index Funds that I like which TD e series doesn’t have and respective MER after after fee reduction:
CIBC Canadian Short Term Bond Index : MER = .35%
CIBC US Broad Market Index (Wilshire 5000): MER = .36%
CIBC Asia Pacific Index (includes China and India): MER = .46%
CIBC Emerging Market Index Fund: MER = .63%
The previous MER is based on the MER given by morningstar.
CIBC probably has one of the largest family of index funds available in Canada. The main limitation is 150,000 asset requirement for the fee rebate.
10 EconStudent // Feb 11, 2009 at 5:24 pm
By the way, its called MANAGEMENT FEE DISTRIBUTION DISCOUNTS in that pdf and its on page 42.
I hope this might help you out Anon.
11 anon // Feb 11, 2009 at 5:31 pm
Hi there – thank you, I actually went to this free session offered by my work with the financial advisor from the company where we are kinda forced to put our bonuses if we don’t want it “cashed out” (we get the bonus at the last possible moment so it has to go directly in the Scotia group RRSP).
I was lucky that I actually have been reading this blog for a few months so I knew what to look for. I went in the free session looking for reinforcement about what I’m going to invest and I was very surprised about the misinformation pumped at me . Just had to share
I had little time to research before having to decide the allocation for this, I now noticed that the TD energy index has a lower MER than the energy index I chose (cibc)… will pay more attention next time..
I was very curious about the Scotia International Index though, I looked through its holdings, it’s all “Canadian TBills” and nothing else. Can they do that or must it be a
typ-o?
Anyway, thank you for all the great info here!!
12 anon // Feb 11, 2009 at 5:59 pm
EconStudent – Hello, thank you very much! I don’t have that much floating around though, but it’s good to know.
13 Canadian Capitalist // Feb 11, 2009 at 7:18 pm
DGI: I avoid junk bonds, corporate bonds etc. They have high correlation with equities. I also avoid long-term bonds and my fixed income is solely in short-term bonds. In the future, when real-return bonds (TIPS for you guys) have better yields, I’ll pick some up.
EconStudent: I was aware of the CIBC MER rebate, I’ll probably make a post out of it next week. Thanks for the idea. I haven’t given much thought to CIBC funds because I figure small investors will go with e-Series funds and larger portfolios will opt for much cheaper ETFs.
anon: Most financial planners, esp. the commissioned ones, won’t suggest low-cost, low-turnover portfolios. Bay Street and Wall Street are giant fleecing machines — they want to extract as much fees out of investors as possible. The bottom line is the less we pay in fees, the better it is for investors but you won’t hear it from someone whose livelihood depends on us not knowing that.
14 Dividend Growth Investor // Feb 12, 2009 at 4:31 am
CC,
TIPS is an asset class that I have not fully explored. It does give you upside whenever there is inflation, but during a deflationary environment the “par value” is decreasing..
15 Doug // Feb 12, 2009 at 8:40 am
About CIBC index funds, they have some added attractions if you can get the discount. As Econ Student pointed out, CIBC has index funds for categories that no one else covers. I don’t know of any other Canadian emerging markets index fund. Also, I don’t believe any of their funds are currency hedged. There US index fund is the only Canadian MF/ETF that tracks the entire US market; the rest are S&P500 funds.
16 Doug // Feb 12, 2009 at 8:40 am
About CIBC index funds, they have some added attractions if you can get the discount. As Econ Student pointed out, CIBC has index funds for categories that no one else covers. I don’t know of any other Canadian emerging markets index fund. Also, I don’t believe any of their funds are currency hedged. There US index fund is the only Canadian MF/ETF that tracks the entire US market; the rest are S&P500 funds.
17 Doug // Feb 12, 2009 at 8:45 am
A lot of people recommend to avoid long term bonds. This includes Jack Bogle, so CC is in good company. However, in one scenario, I could see long term bonds doing well. If deflation becomes an issue, they would be attractive.
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21 bob // Feb 20, 2009 at 4:52 pm
hi,
regarding asset allocation..
i was looking at 6 years from 2003 to 2008
TD -e funds
TD equity index e fund TDB900 gave
26.6,14,23.3,16.9,9.6,(-32.9)
TD bond index e fund TDB909 gave
6,6.5,5.7,3.6,3.2,5.7
these were their respective 6 years return
if i had invested $100,000
100% equity – portfolio would be $152,985
100% bond- portfolio would be $134,848
if instead i choose a 50%-50% portfolio with a yearly rebalance portfolio would be $148,798
all the returns(dividends) are being reinvested
equities comes up better even after losing 32.9% in the last year..
is asset allocation with periodic rebalancing required? it does’nt seem to do any good.
thanks
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