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  • Roger Banks, RRC

Investing with Segragated Funds

- The Advantages of a Protected Portfolio


As we near the end of the first quarter of 2021 we see an economy that continues to push forward, working our way out of this crisis. Daily news is packed with headlines relating to the pandemic; 2nd and 3rd waves, real estate bubbles, market crashes, market volume, Robinhood day traders and on and on. This “noise” can understandably create uncertainty and concerns, exactly why I’m reaching out with some in-depth commentary in regard to our investments, how they work and what goes on behind the scenes after hours. My hope is to bring important insights to light, as to the process and systems that navigate our ship through global economies giving the end result of growth with downside protection!


Headline news about discount brokerage and DIY investing has skyrocketed ‘daily trading’ volume, resulting in the rise of price-insensitive passive investing due to ETF and index investments. The effect is that equity liquidity has dramatically declined over the past six years, leading to much less liquidity and potentially more distorted or volatile pricing in individual securities.


The combination of highly shorted stocks, lack of liquidity and massive, and seemingly coordinated retail buying (Robinhood, Questrade or other online brokerages) is distorting the value of companies. If the history of financial markets is any guide - and it has generally been - this can eventually end poorly for those holding large speculative positions. As an example, Options Trading is being used by investors who have no idea how Options work and the explicit risks involved. The decision is based purely on FOMO (a common human emotion called Fear of Missing Out). Other appealing, but potentially inappropriate marketing tag lines include:


· Markets are going up!

· Everyone is doing it!

· My cousin's friend just made a killing on ABC stock, so I bought some too!


Timing and risk control is always the key to returns with individual securities. When deciding to engage in the markets directly, if our investment decisions are based on things such as: following trends, headline news and being driven by the behavioral fear of missing out (“FOMO”), are we really making the smartest choices with our hard-earned dollars?


Please indulge me with a baseball analogy...

Home run hitters strike out A LOT! What wins games consistently over a long season is a high team average with consistent singles, doubles and the occasional triple. THIS is what will deliver a win! Consistent returns with downside protection.


Wouldn't it be great if we could find investments that understand economies and market cycles, that have a long history in navigating through the various market events, that understand what causes the markets to cycle and understand the leading indicators of future movements? Wouldn’t it be great to have an investment that has a process and is system-driven, allowing decisions to buy or sell a position to be based purely on fundamental analysis (Qualitative and Quantitative) not emotion?


Well, we do. This is called active management. What I just described, although not a textbook definition, in my opinion, is what creates the crucial differences between passive and active investments.


The importance of active management cannot be understated. By engaging in active management, we are empowered to invest judiciously and to take advantage of opportunities, without geographic constraints, in a diversified portfolio of sector-specific holdings.


Even though active management remains a prevalent method for many investors, I would argue that most inventors do not fully understand or recognize the value of the complex nature and diligence involved in active management of our hard-earned dollars. To help in this, here are several considerations that, although briefly presented, are the key elements you would want “under the hood” of your investment portfolio.


1. Tactical: an active management portfolio strategy that shifts the percentage of assets held in various holdings and categories to take advantage of market pricing anomalies or strong market sectors; Growth vs Value; Buying low and selling high; all executed without emotion.


2. Opportunistic: understanding and realizing from fundamental analysis when a targeted underperforming and/or undervalued stock or bond becomes present and acting on this opportunity.

3. Active RISK management: encompasses much of the following:

· the knowledge and skillset to protect against inflation and interest rate risk.

· being prudent and proactive with duration risk (i.e., knowing pros and cons of holding 5-year bonds vs a 1-year).

· understanding Geopolitical environments and potential impacts to specific sectors.

· understanding the effects of currency hedging.

· having working knowledge of supply and demand for a specific sector.

· understanding commodities and the cycles that often affect their demand.

· having accurate analysis for the movement of the Canadian dollar vs other world currencies.

· being well versed in reading market trends.

· ability to forecast economic growth or contraction ahead of the curve. …all executed using a sound fundamental analysis/process and systems.


4. Geography: actively allocating to geographic areas that offer favorable valuations, economic growth and positive Purchase Managers Index (PMI, regarded as a very accurate leading indicator of economic growth or contraction).


5. All hands-on deck 24/7: savings managed 24 hours day by a team of industry specialists and experts in specific categories. (i.e., Manulife Strategic Income Fund = 127 person staff, 4 lead managers with offices in Boston, London and Hong Kong. All working together doing specific analysis on investment direction and decisions).

6. Analysis: investment managers that meet directly with the CEO’s, board of directors, employees and customers of a potential portfolio position. A thorough review of a company's balance sheet and full financial history is made. They have a proven track record of skillfully and accurately defining market risk and determining market directions based on qualified analytics to determine where that company compares to others in its competitive peer group.

7. Specialized team: Not one person. As previously mentioned, a sound active investment revolves around a team of analysts, each with a specialized task that digs into a precise area of a stock selection, i.e., currency, economic/fiscal policy, PE valuation, sector cycle and geopolitical analysis, to name only a few of the various analyses.


8. Skin in the game: the team managing YOUR savings has their own money in the exact same investment!


9. Estate planning benefits: go to bed knowing that your savings will be handed down to your beneficiaries in an efficient and timely manner; bypass probate laws (zero legal, accounting or executor fees), protect your savings from creditors, and ensure 100% of your initial deposit is guaranteed to your beneficiaries. Bay Street firms offer complex strategies involving expensive trusts and management. The same outcome can be achieved in a much simpler form by taking advantage of the inherent benefits of Segregated Funds. You’ll potentially save your estate literally thousands of dollars in estate fees, without the added costs associated with complex trusts.


10. Tax benefits:

  1. Owning Non-registered savings is becoming more and more common for those who receive an inheritance, sell a principal residence or receive a pension transfer. With a Non-registered account, your annual distributions can be allocated to reduce the ACB (Adjusted Cost Base) a strategy only available through Segregated Funds.

  2. Take advantage of corporate class structure to defer capital gains in Non-registered accounts to help alleviate tax.

  3. Designate a Successor Holder, which enables the contract to carry on without any tax at the passing of the original owner.

  4. Annuitize payments to beneficiaries (rather than a lump sum payment) to maintain money flow over time and execute your wishes/planning after passing.

There are many other benefits of Segregated Fund investing that are worthy of a separate information piece. We will share more in the near future.


11. Beta: investments that provide low correlation to general stock markets and serve as a key to superior downside protection.


12. Alpha: investments where the systems and processes of the management team are proven to add value and added return to your investments. The “Alpha and Sharpe ratio rating” refers to the portion of the investment return which can be attributed to the skill of the management team directly, rather than the movement of the market directly. The old saying, “Price is only an issue in the absence of value” can be directly applied to an investments’ Alpha and Sharpe ratio rating.

13. Structure availability: an investment that can be held inside any investment classification. (i.e. RSP/RIF, LIRA/LIF, Non-Reg, TFSA or RESP)


14. Currency management: When buying positions in other geographic regions using the Canadian dollar, the management team must understand the impact and risk the portfolio may realize due to a rising or declining Canadian dollar exchange rate. This can have a large impact on returns, regardless of the performance of the underlying stock or bond.


15. Auto rebalancing: re-weighting a portfolio to maintain the intended risk profile. In other words, knowing when to buy low and sell high!


16. Advice and guidance on retirement planning: it is well documented that investors who work with a professional advisor improve results by as much as three percentage points annually. And that makes more of a difference than you may expect.

On top of the improved returns, a good advisor can assist with portfolio design, estate planning, retirement income planning, legacy planning, tax planning and can refer you to other professionals such as accountants and lawyers. A skilled financial advisor provides a centre of confidence for all things financial in your life.

Perhaps understated here, but I would make a case that this provides certainty and confidence with one’s hard-earned savings. Especially in times of uncertainty!


Wouldn’t it be great if our investments ticked ALL these boxes?

The benefits from comprehensive scrutiny to detail and qualified value would be hard to beat!


Well, the good news is ALL OF THE ABOVE is exactly what we have working for us in our existing portfolios! I maintain that if the most ‘independent DIY investor” truly understood active management, they would find this investment circle hard to compete with.


The point of this knowledge exposure is to bring to the forefront the deep value and potent methodology of active management that likely gets overlooked. Our investments provide sophisticated, high level qualitative and quantitative analysis, executed as a pointed strategy with specific risk prevention.


You get NONE of the above when you DIY. Of course, we can get lucky and buy that hot stock at the right time but I suggest if you feel the urge to DIY with some stock games, take no more than 10% of your investable assets to “play” with. There are a select few who can devote their days to the markets and the appropriate analysis to do a good job of it. I would also say that the vast majority of people are far too busy with their lives to take adequate time to fully research and understand the security risk involved with purchasing individual securities.


Here is a real-life example. (Data Dated March 5th, 2021) Questrade is a highly promoted DIY trading platform, which stands on the benefit of LOWER FEES.


So, here is some TRUTH to the “low fee” DIY benefits of this particular passive ETF investment platform:

Below are the actual NET returns (what we would have received in our pockets after fees) comparing two balanced funds.


Questrade balanced ETF IQ portfolio with an MER of 0.38% compared to Manulife Strategic Dividend Bundle (balanced investment) with an MER of 2.28%

A great example of active vs passive investing and the difference in performance can be directly correlated to the 16 points discussed above.


Once again proving that “Price is only an issue in the absence of VALUE!”


When we invest in this manner, coordinating with highly skilled and experienced Active Management teams, we are able to be prepared for a future that none of us can predict with absolute certainty. In an environment with many unknowns, we are absolute in our belief that you are best served by partnering with professionals, staying invested in a diversified portfolio, and sticking to a Financial Plan's solid investment framework!


If you have any questions, please feel free to reach out to us.

As always, we are just a phone call or email away and always happy to assist!


All my best with kind regards,

roger

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