2010 Q1 Stock Picking Contest Results

Posted by Preet on Mar 31, 2010 | 0 comments

A few personal finance bloggers decided to have a friendly stock picking contest for 2009 and we decided to do it again for 2010. We had made our picks back in December of 2009 and the plan was to track the calendar year performance of four picks (equal weighted for the sake of determining portfolio performance). As alluded to in my post that discussed my picks initially – don’t take these contests too seriously. A one year horizon is nothing more than gambling.

This year I decided to pick stocks at random, well… kinda. I picked some random words and then found the ticker symbols to match those words and that was basically it! Here were the words I picked:

FUN, HAT, ADD, CAR

And here are the corresponding companies:

1. Cedar Fair L.P. (FUN:NYSE) Stock price as of December 31st, 2009 (close): 11.41 and after Q1: 11.94 plus 0.25/unit dividend. YTD Performance = +6.84%

2. Hathor Exploration Limited (HAT:TSX-V) Stock price as of December 31st, 2009 (close): 1.81 and after Q1: 1.96. YTD Performance = +8.29%

3. Arctic Star Diamond Corp. (ADD:TSX-V) Stock price as of December 31st, 2009 (close): 0.055 and after Q1: 0.065. YTD Performance = +18.18%

4. AVIS Budget Group (CAR:NYSE) Stock Price as of December 31st, 2009 (close): 13.12 and after Q1: 11.50. YTD Performance = -12.35%

So on an equal weighted basis the picks are up 5.24% as a group. This puts me about mid-pack so far in the contest. Not bad considering the whole 7 seconds I took to pick my stocks, but the year is far from over!

Here are the other bloggers’ results so far:

1. Dividend Growth Investor: +9.58%

2. Wild Investor: +9.30%

3. My Trader’s Journal: +5.78%

4. WhereDoesAllMyMoneyGo: +5.24%

5. The Financial Blogger: +2.87%

6. ZachStocks: +2.55%

7. Four Pillars: -1.01%

8. Intelligent Speculator: -1.27%

9. Million Dollar Journey: -11.83%

Is Your Brokerage's Bond Desk a Profit Centre?

Posted by Preet on Mar 30, 2010 | 5 comments

Not a question a lot of people ask, but it’s an important one. As an investor, if you buy a bond from your advisor or discount broker you see the price you are offered, but how far off is that from the price the brokerage paid to get it for you?

Bond desks can either be run as profit centres or not. When I was at ScotiaMcLeod and I wanted to buy a bond for a client, I would call up the bond desk downtown and get the price for what was in inventory and it was nice to know that our bond desk was NOT run as a profit centre. Ultimately it means the client gets a better price and therefore a better return on their money.

Some bond desks, however, are run as profit centres which means that the bond traders have to take their cut and management expects them to generate revenue for the firm as well as providing inventory to the salesforce (the advisors buying and selling bonds for clients). This revenue ultimately comes out of the end investor’s pocket.

An investor who uses a brokerage whose bond desk is run as a profit centre might get a bond at 95 whereas that identical bond sold through a brokerage whose bond desk is not run as a profit centre would get that bond at a price less than 95. This is independent of the commission paid to the advisor which is a separate consideration.

I’m going to guess that this is not a question that many people think to ask a potential new advisor, but I think it is an important one.

Buying ADRs to Avoid Stamp Duty

Posted by Preet on Mar 29, 2010 | 0 comments

Coincidentally, I was talking to the portfolio manager of our index funds today and part of the conversation was surrounding tracking error and the use of ADRs and GDRs. In a post from last week I had mentioned how using ADRs and GDRs could be a source of tracking error, but there is more to that conversation lest you think you should always avoid depositary receipts.

One reason is political risk. For example, our global and emerging markets index funds try to hold the direct stocks on their foreign exchanges as much as possible, but for the case of Russian stocks there is enough concern that getting your money out of the Russian stock exchange might not always be feasible that using ADRs is preferable.

Another reason to consider using ADRs (or GDRs) is that you can avoid paying Stamp Duties. Stamp Duties are levied by certain countries for buying and/or selling stocks – it is simply a tax. In the UK, the stamp duty is 0.5% of the value of the transaction, and to give you an idea as to how much revenue is generated from stamp duties it was as high as 4.5 billion pounds in 2001 (so it likely isn’t going anywhere anytime soon).

By buying an ADR instead, you would avoid the stamp duty. So as long as you monitor the premium or discount to NAV of the ADR and deem it to be liquid enough it may very well be a superior option than buying the direct stock and incurring an instant tracking error of 0.5% off the hop.

New Canadian Small Cap ETF Available

Posted by Preet on Mar 28, 2010 | 4 comments

IndexIQ has launched a new ETF which attempts to give investors exposure to small cap Canadian stocks, but as a Canadian you will probably want to avoid this particular ETF for now. It trades with the ticker symbol CNDA.

1. The ETF is listed in the US

While you won’t have to monitor the currency fluctuations while invested, but you will have a forex drag as you would have to convert your money into USD before purchasing the US-listed ETF. Vice versa, you will have to switch it back when you want to sell your investment and spend the proceeds.

2. The MER is higher than what’s available already

The MER is 0.69% for CNDA, but iShares has an ETF with Canadian small cap exposure with an MER of 0.55%. This trades as XCS.

3. Liquidity

ETF liquidity is based on the liquidity of the underlying holdings, so the daily shares that trade are not as useful a gauge as with individual stocks. A designated broker will (usually) ensure that any orders are filled without the ETF price straying too far off of the NAV. Having said that, since this ETF deals with less liquid stocks, liquidity is more of a concern. And since it is new, there is risk that it can shut down if it doesn’t get enough assets to make it viable. The incumbent already has $100 million in assets (the iShares ETF XCS).

4. Index Selection

One of the first things I noticed is that the IndexIQ ETF tracks its own proprietary index for Canadian Small Caps. Presumably this would be to avoid the licensing fee for the S&P/TSX Small Cap Index. You would think the indices looked somewhat similar nonetheless, but you would be wrong. The IndexIQ index has a 50% allocation to materials, whereas the iShares offering is closer to 30%. So there is more than meets the eye. CNDA holds 100 names, but XCS holds 181.

5. Capacity

This is one area where CNDA might have an advantage. It looks like CNDA has a higher market capitalization minimum for inclusion – meaning that companies have to be of a certain size and if they are too small, they are excluded from the index. If there are days when there is a lot of buying or selling pressure on both of these ETFs, CNDA’s index is less likely to suffer from capacity constraints (meaning that the smallest names won’t have their prices materially affected by large purchases and sells). For more explanation on “capacity” or “market impact” click here.

Conclusion

This might be a better ETF for US investors, but Canadians looking for domestic small cap exposure can skip it for now.

A Lap Of The Blogs

Posted by Preet on Mar 26, 2010 | 9 comments

If you are new to WhereDoesAllMyMoneyGo.com, every Friday I run a post called “A Lap Of The Blogs” which provides links to articles I found interesting and think that others may want to read for themselves. I also sometimes include some commentary on what’s going on in my personal life and a weekly “racing video” since my former life was in the auto-racing industry. The name “Lap of the Blogs” is in reference to “A Lap Of The Gods” which is an old video series which chronicled on-board footage of the world’s greatest F1 drivers lapping various racetracks from around the world. NOTE: you have to visit the actual website to see the embedded video – it may not appear in your email. Just click on the title of the email to see it…

Well I’m a day late with this week’s Lap Of The Blogs, but I’m sure you’ll forgive me, and as a special treat I’m going to share some of my creative writings… from nursery school! I’m visiting the parentals and found a collection of old school work which had me rolling on the floor laughing. A masterpiece will follow the weekly roundup of links…

In other news, I had the pleasure of meeting Squawkfox this week in Kelowna and we had a great time talking about the genesis of our respective blogs. If you haven’t taken a look yet, click here to check out one of the most successful Canadian blogs on the net.

Lastly, I have to admit to something of an indulgence this week: I went in to get measured for some bespoke suits. Since I wear a suit roughly 250 days per year I thought I would give it a try as a bespoke suit should actually last longer than an off-the-rack suit which is much cheaper. From what I’ve been researching, this is due to a floating canvas as opposed to a fused canvas with production line suits. A floating canvas means that the canvas (the layer of material between the jacket and the lining) hangs independently between the layers. It will be about two months for the suits to be ready, and I’ll give a report at that time.

Around The Blogosphere

Thicken My Wallet: Why people fail in investing with ETFs.

Jonathan Chevreau: $500 million to Ontarians for the Pension Benefits Guarantee Fund.

Squawkfox: Reviews the book One year to an organized financial life

L_Mac Online: Mutual fund commissions BANNED in the UK

Big Cajun Man: Free Speech and Financial Questions

Michael James on Money: Misalignment of interests on Wall Street (and Bay Street)

Four Pillars: Middlemen

Million Dollar Journey: Wealth and Socioeconomical Class

Canadian Capitalist: How do you say “bubble” in Chinese?

Rob Carrick: Before breaking your mortgage, read this

This Week’s Racing Video

As I mentioned, I’m going to skip this week’s video in lieu of sharing some of my childhood creative writings… because they are so nonsensical! Enjoy!

When I went to the fair the first thing we did was go for a walk, and then we went on the Rocket Ride. The Rocket Ride was very weird because we saw a crab and it fell on the roof top, and then we came down on a baseball field and the crab went down on the field. The crab caught a boy’s pants and pulled them down. Then the crab started to eat the pants. Next we went to the moon with the crab and we left the crab on the moon and went back to Earth and then we ran out of fuel. Then we crased into a plane that was flying to Italy. The End.

Index Fund Tracking Error Sources

Posted by Preet on Mar 24, 2010 | 2 comments

NOTE: I’m scrambling to write this before I get on a plane and my laptop battery is near death, so pardon any typos for the time being – I’ll edit it tomorrow, and may even re-write it! It’s good to be my own editor…. :)

Not all index funds are created equal. Some actually track their indices pretty well, and some do a poor job. Most people think that tracking an index would be a relatively simple thing but you know what they say, “in theory, theory and practice are the same but in practice they are not.”

Some sources of index fund tracking errors:

1. Resampling (Or Optimization)

If an index has 500 constituents, then it is impractical to replicate all the holdings when the fund has a small amount of assets. For example when an index fund first starts trading, it may only buy another manufacturer’s ETF to get market Beta until there are enough assets in the fund to actually go out and buy some or all the holdings itself. The index fund manager may also choose to hold a portion of the 500 holdings until the fund gets really big (to minimize transaction costs). How do they pick which stocks to hold and which they don’t? It’s up to them, but one method is to pick a combination of stocks that allow them to replicate the GICS sector allocations in the index (Global Industry Classification Standard). That means that if financials are 20% of the index and consumer discretionaries are 20% and so on, they will pick the combination of stocks that allow them to match those numbers – in this case they are seeking to match sector Betas.

2. Cash Flow timing

When money is added to a fund it must then be deployed into the holdings. In the case of ETFs, if not enough money is added to a fund to buy a creation unit, it might sit in cash until the next day. If the underlying stocks move between the positive cash flow and the cash deployment, this could affect the index fund’s performance. In the case of a mutual fund, the portfolio manager (yes, index funds have them too actually!) might get a small cash flow and not be able to deploy it into all the underlying constituents – they may choose to buy an ETF for market or sector beta, or buy a portion of the underlying constituents and make up the difference the next trading day when new money comes in, or if money leaves the fund for a redemption.

3. Proxies

Some index funds (with foreign exposure) may buy the foreign holdings on foreign exchanges, and some may buy ADRs or GDRs (American Depositary Receipts or Global Depositary Receipts). ADRs trade in the US but may trade at a premium or discount to the actual underlying stock.

4. Market Access

Again, index funds with foreign exposure may have stocks that trade in markets that are closed when domestic markets are open and vice-versa. If the index fund buys the direct stocks, someone has to deploy the cash overnight – it can be the fund custodian who sub-contracts out to a foreign prime broker, or the fund might have an office in that market. But if the fund operates in a different market, they can only receive the money during their hours of operation, so the underlying stocks can change in value between the time the cash comes to the fund and when it gets deployed.

If the fund buys ADRs then you still have the issue of the ADR lagging the movement of the underlying stock since money gets deployed right away, but in a security (the ADR) that can itself be moved by supply-demand issues on the market it trades even though the underlying security is not being traded. Again, this can introduce tracking error.

5. Dividend Drag

This really falls into the cash flow management arena, but instead of the cash flows being due to investors adding or subtracting money from the fund, with dividend drag it is due to the receipt of dividends earned on the underlying stocks being held. The fund receives cash which has to wait to be deployed.

6. Securities Lending Income

Same principle as with dividend drag, except the positive cash flow is due to the income generated from loaning out stocks in the fund to short sellers.

7. Brokerage commissions

The fund itself has to pay commissions to buy and sell stocks, so this will create a drag on returns too.

8. MER

Ah yes, can’t forget this one! The Management Expense Ratio is made up of the Management Fee and Operating Expenses, and of course these will drag down performance of the fund as well.

Conclusion

These are some of the areas which can introduce tracking error and I haven’t even talked about currency concerns. Different index companies tracking the same indices can have dramatically different tracking errors and its certainly something that doesn’t get enough attention. Note that some of these factors may generate positive or negative tracking errors and some (i.e. fees) can only generate negative tracking error. In its purest form, tracking error is the absolute magnitude of the deviation from the index and is not normally referred to as being positive or negative, but breaking it down this way is helpful.

Growing Active ETF Market Means Mutual Funds Should Consider Allowing F-Class Units For Sale Through Discount Brokerages

Posted by Preet on Mar 23, 2010 | 3 comments

This past Monday I had a guest post about how Actively Managed ETFs will signal a threat to the staying power of mutual funds as portfolio stalwarts. In the face of mountains of evidence supporting indexation strategies, actively managed mutual funds with embedded financial advisor compensation have flourished. The author essentially argues that the mutual fund structure is being challenged as now investors can access active managers while bypassing the financial advisor as an intermediary. For more, please make sure to read the guest post here.

Today’s post title would be the logical reaction to the “threat” of actively managed ETFs. By allowing the widespread sale of F-class units of mutual funds through discount brokerage accounts the fund industry could help stem any potential losses.

F-Class Mutual Fund Units

For those not familiar with F-class mutual fund units, they were developed for Fee-based accounts where advisors would charge a transparent fee which was not embedded in the fund’s MER.

For example, let’s say that Mutual Fund ABC had A class units with a 2.50% MER, of which 1.00% went to the advisor annually as their compensation. The investor would not explicitly see the portion of the fee going to the advisor (1.00%), nor would they see the 1.50% going to the fund company for the portfolio management, reporting, etc. If the return for the year was 10.00%, the portfolio’s actual return would’ve been 12.50%, but the 2.50% would reduce that to the 10% the investor sees.

Now, that same mutual fund could be offered in a F class unit (same portfolio) which has an MER of 1.50%. The advisor might charge a “client advisory fee” of 1.00%. The total cost is still 2.50% but in this case the 12.50% portfolio return is only reduced by 1.50% so the investor sees a portfolio return of 11.00% BUT they also see 1.00% in fees deducted explicitly on their statement which goes to the advisor, leaving them with the same 10.00% net portfolio return.

It should be pointed out that the 1.00% client advisory fee is potentially tax deductible for non-registered accounts, which would leave the investor slightly ahead versus the A class units with the same overall fees.

So what’s the big deal? Well, for one that Client Advisory Fee is negotiable, but that’s beside the point. Right now, you can buy A-class units of actively managed mutual funds through a discount brokerage and bypass the use of an advisor, but you still pay the 1.00% that would go to an advisor. Essentially, you are paying more than you have to. Many fund companies have blocked the sale of F-class units through discount brokerage accounts in order to appease financial advisors who would be threatened by this practice. Presumably, when bought through a discount brokerage account, an F-class unit would be absent any advisor compensation and in our sample mutual fund, the investor would pay an MER of 1.50% versus 2.50%. (These MERs are just examples, they could be higher or lower.)

Hop On or Get Out Of The Way

So… if the proliferation of Actively Managed ETFs accelerates (which it has) then DIY investors will be more inclined to circumnavigate financial advisors in order to access active management without the advisor compensation drag on portfolio returns. If the fund companies are unwilling to realize that there will be an exodus then they stand to lose market share going forward.

Let me be clear with my own perspective: there is value in advice and I believe that most people will be better off with an advisor. But, the truth is that there is a significant portion of the investing public who wish to do it themselves and that demographic will increase.

Witness the FSA in the UK moving to ban commissions for financial advisors, and similar directives in Australia for CFPs. The advice delivery mechanism is changing to an unbundled structure (advice not tied to products), so making F-class units available through discount brokerages is only logical for fund companies from a business perspective.

It wouldn’t signal the end of financial advisors as some might fear. I believe there is an equilibrium (like with pretty much everything) which would shift from 10% DIY / 90% Advice to perhaps 30% DIY / 70% Advice whether the fund companies do this or not. If they do it though, they should be better off.

Comments welcome.