Thursday, December 24, 2009

The slippery slope of the yield curve

The year end market activity and news around the world is fascinating right now.

The benchmark 10 year yields for Canadian savings bonds has moved from approximately 3.25 to around 3.6 today. The move has taken about two weeks. Central bankers have confirmed that they will set overnight borrowing rates at near zero for at least 6 months to a year, so we should expect long term interest rates to remain low. They also expect inflation to be a non-existent factor for the average citizen.

If any of that is actually true or not is only verifiable in hindsight, but for the time being, it is what the best evidence leads one to believe. If the programs and expectations of the various central banks of the world develop more or less as they are anticipating, what does it all mean heading into the new year and what will happen to the bond market?

What will this mean for the DIY bond investor?

I previously mentioned that I turned down a 5% interest 10 year corporate bond. The bond has dropped 2% in value to 98.2 and the yield has subsequently increased to 5.3%. It's not a staggering change, but it's enough of a swing and in such a short period of time that it warrants attention.

Buying long-term bonds carries the increased risk that interest rates could rise rapidly in the short term and the relative value of your bond will decrease significantly in this situation. The 100 face value of your 5% bond is cut in half when there are new bonds on the market of similar duration that offer 10% interest. Your 100 dollar investment will be redeemable before maturity for only 50 dollars. If you are unable to hold to maturity, or if the dramatic decline in price of assets causes the issuer to default, you could lose big.

That's why I turned down any 10 year bond I was offered. I did once accept a bond that was investment grade, 10 years and yielded 7.95%. I don't care what happens, that is always a healthy rate of return and it's unlikely the value will ever fluctuate greatly, but that was a lucky break.

When speaking about the average DIY investor, trying to save up for his retirement, the strategy is simple. Credit spreads between corporate and government bonds and high yield bonds have all returned to pre-crisis levels. The yield curve is as steep as it has ever been and the past two weeks have returned the bond market to one of the steepest yield curves in history. The stock market, particularly financials and commodities (as this makes up most of the Canadian economy) have mostly kept the gains made from march-august but have mostly seen much more modest to zero gains since then. Natural gas prices have steadily, if unevenly reverted back to seasonal and cyclical price increases.

In this environment the DIY investor is wisest to stay away from investing in any long duration bonds. Corporate bonds are very expensive relative to the prices available last year and up until august 2009. With the United States treasury gearing up to roll over an estimated 2 trillion dollars of debt via auctions, it is likely that this recent rise in long term yields could be a precursor to a much more significant and long-lasting rise in interest rates.

If this is true, then the next sixth months could be a period to stay on the sidelines or to stay in cashable GICs, waiting for a better opportunity to present itself (and it will). During this time, the DIY investor should just stay informed and remain interested in the news and the various bench mark prices, yields and maturities. Further research into the debt structure of the corporations you hold bonds with will help further refine your criteria and ability to spot a bargain in the corporate debt market.

And if the DIY bond investor has managed to make some money with the stock market, it might be an interesting time to take a chance on some small-cap investments and look for capital gains. Investing in large cap, dividend payers, is a good idea unless you are buying at the top of the market. Because most indexes around the world have been relatively flat since august, that makes for a much riskier investment, though there are always countless exceptions.

Friday, December 11, 2009

50%+ return, guaranteed... in ten years

Is it worth it to purchase an investment-grade bond that matures in December 2019, and pays 5.05% interest annually?

This is the question I faced recently. My advisor knew that I was interested in filling out the rungs on my bond ladder.

During a day of rising interest rates and hence falling bond prices he called to recommend taking a 5% holding in a single bond issue from a Canadian telecom company.

The bond is BBB with a stable or positive outlook. These companies have large subscription bases and steady cashflow. Default is unlikely or, more accurately, a very remote possibility.

So is this a wise investment?

Large money managers like pension funds and insurance companies love long-term returns in excess of 5% that are guaranteed because it makes covering their expenses infinitely easier.

Despite the difference in net-worth, the DIY investor faces a quality of life and peace of mind that comes from stable, guaranteed income that is similar to a profitable fund (manager).

While the large fund has pension benefits or liability claims that are often burdensome on the overall ability to create a profit, the DIY investor faces the many challenges of work, family, savings, trying to live and support a household, dealing with unexpected calamities, etc.

Both parties need stable income to overcome any ups and downs in the real world, and hence actually have a mutual affinity for the bond market and achieving yield in excess of the government benchmarks without being exposed to default risk.

But for the DIY investor like me, who has great bonds in the short and medium term and few bonds in the long term (5-10 years), I don't face the same pressures going forward that a large fund faces. I face the pressure of generating as much income from my employment as possible, protecting my savings from losing value, investing my savings in a way that will guarantee my principle contractually and include all interest payments.... that's all I need to be concerned with.

So this 10 year bond, 5.05% interest bond is sitting there, wondering if I'll put a relatively large sum of money in the company's hands for a full decade.

I decided to pass on the investment. While the cash is still sitting there perfectly safe and fresh and clean, it is not earning anything. I am ok with this. You can argue Canadian Dollars are worth 10% more now than they were a year ago, but that's not what we need to consider now)

Benchmark bond prices have suffered the occasional selloff and rally over the year and have provided some remarkable opportunities to make money using simple buy low sell high rules, trading the everyday bond issuers we see in Canada.

If this recent sell off is not part of a broader decline in bond prices, meaning inflation and/or market fears and debt fears are shaking, but not fundamentally shifting price support for bench mark bonds and industries and hence interest rates won't rise, I will have missed an opportunity. I will have missed at a chance to take advantage of a potential capital gains situation, or just simply enjoying a return that beats all the marketed products available.

If interest rates are really going up sooner and harder than we have expected, my money is now ready to be deployed to a medium term maturity and high interest rate, thanks to my ongoing study of the Canadian Bond Market.

If I had failed to study interest rate trends (once they hit bottom, they can only go up) and purchased a large bond issue right before interest rates start to rise, the value of my investment will be diminished. I'll likely never be able to sell without a loss before maturity because it will trade at less than 100 every day. To make it even worse, I wouldn't have as much money sitting around to purchase higher interest bearing bonds.

Be careful and remember: "he who fights and runs away, lives to fight another day"

Thursday, October 1, 2009


So if you like what you hear about guaranteeing the return of your principal and a 7% return, why not move more money into bonds.

This article will provide a brief overview of all the basics.

However, it's written for an American audience and I think there are a few important things to ignore:

1) ignore anything related to municipal bonds and professional management, the market place and advisors typically work in a different fashion in Canada with respect to the bond market

2) ignore the section which tells you that a minimum of $100 000 is needed in order to safely purchase individual bonds.

The reason for number one is simple: the tax codes are different in Canada and the US for municipal bonds- they are usually exempt from many taxes in the US.

As well, because the Canadian bond market is dominated by a small handful of financial institutions, the fee structure typically works differently for professional management. You typically pay a hidden fee that is included in the final price you pay per bond.

The reason for number two is the purpose of this post. If you pay attention to what I've written about here and here, I believe it is possible to safely purchase and invest individual investment grade corporate bonds in units as small as $5 000 for the individual DIY investor, using a discount brokerage.

The investor starting with approximately $5 000 - 50 000 dollars to invest in fixed-income will have two distinct advantages over any bond fund currently available in Canada

1) There are no bond funds which come with a guarantee to repay your principal by a specified date- this is a very important distinction if security, preservation of capital and the ability to sleep at night are a high priority for the investor (which they always should be, no matter how young).

2) Through careful and deliberate purchases of individual bonds (filling up one rung of the ladder each time you have new monies to invest), the overall performance of the investor's fixed income portfolio will exceed the yield offered by any bond fund by about 1%, or 100 basis points.

Number one is straight-forward, number two is a little more complicated but can be easily summarized:

1) Bond funds typically promote their suitability to retail investors because of their size, and their ability to diversify among issuers and therefore eliminate any credit risk or exposure to interest rate/inflation pressures. While this is generally correct, I've repeatedly made the case that laddering a portfolio of individual bonds can achieve the same effect.

2) Because bond funds are so large and because they are compelled to buy and sell more and more bonds, if not own all the bonds in the market (like some etfs), they always carry a large amount of bonds that are among the safest and therefore lowest yielding while incurring costs that are eventually passed on to investors, further diminishing yield.

3) The individual bond investor can safely ignore the lowest returning bonds in favour of lower-rated, but still financially stable (BBB investment-grade rated or above) corporations. Using a discount brokerage can reduce management fees to approximately 0.01 – 0.05% of your assets each year. It's simply not possible or worth your time to get high quality investments for less in any marketplace. The net result is a total higher yield for the DIY investor who chooses to ignore bond funds and engage in the often difficult and obscure task of building a rock-solid bond portfolio

Wednesday, September 30, 2009

Why are investors still sitting in cash- relevant to interest rate trends?

During this period I've been holding more GIC's than usual, as I waited out a market collapse and restructuring.

During this same period, a great deal of investors, who suffered horrible losses due to poor investment strategy, exposure to margin calls and other various gambles; have been shifting money out of losing asset classes (usually in the form of mutual funds or etfs) and waiting in cash for a different approach.

This has been the typical scenario I have faced along with most if not all of the retail investors in Canada. Before the credit crisis and ensuing collapse of worldwide economies, GICs were always capable of generating some amount of short term interest. In the early 1980s, guaranteed deposits with banks could issue interest over 7-10% for a 1 year investment. Why would you ever just sit in cash, no matter how liquid the form, when you could earn 10% simply by not touching it? People have all different reasons for investing, but the logic is simple.

During the worldwide meltdown of the past year, central banks lowered the rates at which they lend money to approximately 0.25%, this has had the consequence of reducing the interest on the typical savings account or 1 year GIC to the lowest point in history. These products still offer an interest rate in the range of 0.5-0.7% and you can typically negotiate a price with a financial services representative. The important fact remains, once the fees for these products (and there are always fees, hidden or not) are deducted from the annual yield, you are left with a return of approximately 0%. You are being paid absolutely nothing to simply wish to preserve your cash.

The mainstream media is reporting that a great deal of investors are sitting in cash because those who have switched out of one investment or asset class always place the money in cash. Investment advisors and DIY investors rarely ever have any idea when and where to invest money. "Rules" of investing, typically apply only when you are reinvesting into a product, usually an interest payment, mutual fund or DRIP with common equity in which you reinvest whatever growth occurs in dividends or your savings at regular intervals. There is a much larger problem when you are forced to have your principal returned (like with a bond), you suffer such terrible losses or you are forced to liquidate your holdings (like with funds and stocks that offer poor long term returns and margin calls).

So here is the relevant fact to consider if you are being told you have missed a rally and are tempted to throw large wads of cash at the stock market: when economies experience deflation, which is what investors are witnessing at this time, interest rates are so low that a 0% return on a portion of a portfolio of investments is still technically a positive return. The logic is simple, if the purchasing power of your money does not decrease over a one-year or two-year period, you will not lose any money and have not missed any opportunities to make greater earnings in the future.

Investors chase poor investments because they feel pressure to earn returns on their investments that are equal or superior to the market, underperformance equates to the destruction of your wealth from this perspective. However, intelligent and informed fixed-income investors never fret over missed opportunities in market rallies. The nature of a laddered portfolio requires long-term discipline to evaluate macroeconomic fluctuations (ie. Interest rate trends) in order to locate where they likely are in any given economic cycle. This equates to having money on hand to always pick a valuable investment that will grow above any foreseeable inflation rate and preserves capital.

The unusual thing about this meltdown is that it has created a synergy of intention among panicked and savvy investors. The frightened are scared to do anything with their money because everything they have done so far has at best provided no long-term returns (at worst bankruptcy and foreclosure), however because of the scale of the meltdown, interest rates of tumbled so low, and banks allowed to get away with so much, that even the wealthy and conservative are given pause as to where to find the best medium and long term value.

In a situation of global deflation, there may be asset class rallies like we've seen in oil and the stock market, but it doesn't mean the value of your money has been diminished, there are just as many if not more long-term gains to be made so long as you have the patience to find them.

Thursday, September 24, 2009

7 months later...

Well, it's been about a year since credit markets were frozen.

Last year at around this time, the economy, bond market and stock market went into a dramatic freefall. After a brief rally, the so called 'bottom' of the decline in major stock markets was reached in March.

Throughout this time, the Canadian corporate bond market has been robust and bountiful to the interested and savvy investor.

The nay sayers, who would not alter course and abandon the common perception of bonds vs. Stocks and asset mixing as I've suggested here on this blog have experienced a whirlwind.

Imagine losing half of your portfolio in 6 months and regaining half of your losses over the next 6 months.

You would now be left with 75% from the peak of your net worth. After the rebound, a large amount of investors who follow the common asset mixes are looking at their portfolios and realizing, over the long term, a total return of approximately 0%. This means they have made up all of their losses but have experienced no long term return on all of their savings.

They are still on thin ice and are simply praying that the current market rally (which suffered a one day loss today in Toronto of about 2%) continues on an aggregate pace of 7-10% growth a year from this point till the end of Barack Obama's second term.

No one seems to have learned that they could have been guaranteeing that return at a minimum for the next ten years if they had focused on the corporate debt market in Canada through this past 12 months.

So what specifically has happened in the Canadian bond market that you haven't been hearing about in the mainstream press?

1) investment grade corporate bonds, which dropped to their lowest value in march, along with the stock market, have increased in average prices, from the bottom in march, (and dropped in average percentage yield of interest payments) by approximately 50%. This is already the largest one-time rally in the Canadian corporate debt market's history. It's still not as exciting as technology stocks, or the 100% return some Canadian Financial common stock investors have seen, but tech stocks rarely pay dividends and bonds offer a guarantee and security over and above any shareholder. Investment grade corporate bonds have also been paying interest rate coupons at comparable yields to common bank stocks in Canada.

2) Throughout the entire financial crisis, companies which came to the large financial institutions in Canada and asked to borrow money in the form of corporate debt (senior debt instruments, convertible bonds, callable bonds and to a certain extent preferred shares) were consistently able to secure large financing from every major bank. What this means is that every bank had enough spare money lying around to give it to a corporation that wanted to issue bonds (anywhere from $75 million to $3 billion). The banks, having received the bonds and the right to the interest payments in exchange for all that money would create a secondary market, where the large institutional investors had first bids on everything and the retail bond desks would be stocked with the remains which are divided amongst the different brokerage houses. Throughout this process the banks are able to extract commissions and fees, further lining their already government secured pockets. This is how the corporate debt market functions in Canada (and typically throughout the capitalist world) and it is important to note that throughout the entire financial crisis it continued to function in much the same way it always does.

3) The devil is in the details. You have to follow the news and be in contact with a competent financial advisor to truly understand the current situation we find ourselves in now and the situation described above leading up to the present time. Even if the bond market in Canada was able to withstand a sell-off and rebound sharply without freezing overnight, like in the US and throughout the world, it's important to know why the bond market was selling off and what the likely consequences were for all asset classes. You need to be able to act on your knowledge of interest rate trends if you want to get good quality bonds at a discounted price or attractive yields from undervalued companies.

4) i) If corporate bonds sell off dramatically (this is what happened in september-march): it means the investing world is deeply concerned about the future profitability of entire sectors of the economy, yields will rise- a good time to buy (especially if you don't want to put money into the stock market, you'll get guaranteed stock market sized returns (7%+) for 5-10 years. Ps. The people who are worried are not investors, they are speculators.

ii) If corporate bonds stage a dramatic rally, like they have from March until the present time: it brings companies into the marketplace which would have otherwise been intimidated by all the speculation to pay back extra capital in a time of recession. Essentially, companies have been looking at the actions of central bankers to provide financial institutions with emergency money and ultra cheap loans (sometimes financed by the printing of money in the case of at least the US and the UK) and have gained confidence that they will be able to make all the necessary interest payments and have enough money to repay or refinance the principal. The Canadian bond market is a prime example of this virtuous circle playing itself out. Now endangered companies like Air Canada and the airline rewards company Aeroplan have been able to come to the big banks of Canada (in coordination with other financial institutions), and ask for loans knowing the banks still have money to keep financing their operations through the recession. A good time to buy safe investments that offer higher interest payments than government bonds.

iii) While the stock market has provided the ultimate thrill of a lifetime for someone who bought and held a portfolio of common stocks in March or early April, for someone who had the misfortune to invest at anytime in the last ten year period, they are still at approx. 0% total return, despite the wild ride since March.

Where will corporate debt (and the stock market) move? If history is any indication (which it is often not) then the economy may very well resume a period of robust growth and the stock markets of the West may continue to rise. Debt markets will likely offer similar and slowly diminishing yields in Canada during the initial periods of recovery. Unfortunately, this could also mean that all the extra money that was created actually makes its way into the economy. Basically the cost of everything starts rising because there are simply too many corporations with too much money bidding up the price of their business inputs which leads to higher costs for the consumer. The federal bankers of the world are often quoted as saying that they have learned from the past and know now when to remove money from the economy (meaning they raise interest rates on government loans and bonds and end loan programs) They are now often being criticized for being too focused on inflation, when they have been ignoring asset bubbles, but that isn't the main point. The main point is that past experience has showed government stimulus to create growth but to also create inflation, which destroys wealth. We are essentially forced to take Ben Bernanke and Mark Carney at their word each time they talk about the economy and the intentions of their respective institutions.

So if we listen to what they say it's simple:

The economy has bottomed; there is some small growth in GDP expected in the future based on the current economic situation. There is still a great deal of printed money and government spending floating throughout the financial systems and trickling down into the general economy. The economy would likely not be growing and might still be experiencing a decline of unknown severity without government spending. The good news is that for the time being, the government spending has acted in the fashion that it was intended (to create movement of capital and stabilize businesses through debt instruments). This will likely bring renewed earnings, private investment and spending which will grow the economy with the hope of creating employment.

The difficulty lies in the removal of government spending. Too soon and credit markets could suffer- actually a good time to buy investment grade bonds again. Although it could mean ongoing unemployment, prolonged recession and another big downturn in the stock market. Too late removing money and raising interest rates and we wind up right where we were last year: unsustainable asset bubbles propped up by artificially low interest rates that suffer a bi-polar, calamitous and destructive collapse requiring radical intervention- a great time to buy, after the collapse.

I've never seen a central banker in the modern era that even remotely resembled Goldilocks to me. But we, as the citizens and investors of this world, are left with no choice but to hope they get it right.

You expose yourself unnecessarily to the risk of another decade of 0% or worse if you ignore the bond market.

Sunday, August 2, 2009

interesting veiw from the PIMCO bond desk- keep learning about interest rate trends

take a look at this article

interesting to see what an insider, who performed very well this past year, what they expect from central banks moving forward.

As a Canadian bond market investor, we are possibly in for the same situation- mark carney will leave the benchmark rates largely unchanged, and there will be little economic forces acting to persuade him to change that.

what would it mean for our economy? well, previous economic history has shown that when the trend of interest rates to remain at rock bottom levels, for the yield curve to look very steep (meaning it's extremely easy to borrow short term money, and more expensive for long-term money)
In this sort of situation, banks will earn a great deal of profit. Why? because they are capable of borrowing capital from the government overnight, for about 0% interest and lending it to households and businesses for anywhere from 3-6%. This means by doing nothing they can earn a 5% return on a loaned asset. This has been called liquidity injections, monetary easing, whatever.

What it really is is allowing banks to borrow money for free. In this situation, the little guy who puts his money in his savings account will earn next to no interest. GICs will generate next to nothing. people will be more incentivized to either invest their money in physical assets which they feel will return higher than a bank account (buy a house, start a business, etc.) or they will want to put it in the stock market.

This situation is what people in the media these days are calling "the first signs of recovery", "is the recession over?"

and by all practical measures, it looks like we did avoid a total disaster... for the time being. Economies are just like ecosystems, they are resilient and yet exist in an extremely delicate balance. The stock market is booming, the housing market is bottoming and unemployment is slowing it's rise- not as many business are seeing unsustainable losses. In essense, the actions of the central banks of the world are working as they should.

In the Great Depression, the actions taken by the central banks of the world, including the raising of interest rates, had the exact opposite effect that they were originally intending their actions to have. When catastrophe was amplified by poor decision making, the public was further panicked and a negative, self-reinforcing spiral downward was continued for years on end.

In the current era, our leaders seem to have learned from the errors of the predessors and we are seeing the positive consequence of stabilizing initiative and aid.

So... coast is clear, right? recovery is on it's way? DOW 14000 by 2010? celebrate good times, c'mon?

If that were true, that we have restored a clear path to growth and that the stock market is on it's way back to the old highs, the central banks of the world would already have increased the benchmark interest rates.

The central bankers would see that the banks were making billions of dollars of of imaginary money that the government lent them, and they would see that business were making money from consumers who were willing to spend. This would have the consequence of triggering inflation- money would be moving around at a faster and faster pace- more and more deals means more and more profits, means more and more loans means higher and higher valuations for the underlying assets which are acting as collateral for loans
it seems like it's a positive, and self-reinforcing trend that makes everyone richer- which it is.
but the problem is the speed at which it happens. Some inflation means growth is occuring somewhere in the economy. But when money flies around for free, like it is now, and people spend it like it's free, which it is, all those seemingly positive things happen too fast and regular, little people can't earn enough money to keep up with the rising costs. Bingo, inflation is a big, big problem

So, if the current authorities have proven themselves capable of handling serious problems with the ability to learn from the mistakes of the past, why are they continuing this policy of free money?

look at what the guy from PIMCO is saying. If they raise interest rates now, it could recripple the financial institutions of the world, and we were just in that situtaion. The underlying economy is still fragile, it needs all the help it can get.

in this situation, inflation is still a possibility, but it's a possibility we still have to work to achieve.

Tuesday, July 28, 2009

understanding interest rate trends: contrarian history

who knew that the recent economic super-bubble was built on a empire of easy money?
a small number of people who can now claim 20/20 hindsight.
how did they make their observations?
who are they anyway?

After doing a lot of research (reading books, the news and talking to experienced investors) I came to see that the people who understood what interest rate trends say about the overall economy were the ones who were predicting an impending calamity.

Hardly anyone got the timing of when catastrophe would break out in the financial markets and spread into the real economy. In fact, the few people who did move out of the stock market right before the crash were usually just lucky to have cashed out at the right moment.

But all of these people, who understand interest rate trends, were relatively protected from losing great sums of money in the crash, largely because before the economic crisis they were considered highly conservative investors.

At one point, some people do make large bets on the stock market and perform well. But overall, their personal savings (and their recommendations for the average Canadian retail investor) were always conservative.

Why were they conservative if they were experienced and educated with respect to interest rates and finance in general?

because they understand that falling interest rates are generally related to easy money. If it's easy for corporations to borrow and for banks to lend, this generally inflates the economy and inflates the value of the stock market.

So why be highly conservative?
Because if you do the extra homework required to understand international trade and debt you would have seen all along, how deeper and deeper into debt the entire western world was becoming- excessive and increasing debt is never sustainable.
you would have therefore focused on protecting the majority of your capital by ensuring it is repaid to you in full and that you are earning an amount of interest that is safely above the current inflation rate (a spread of 5%- or 500 basis points- from the rate of inflation to the amount of interest paid is generally considered an optimum return for investment grade bonds).
you would have (if you were so inclined) still put some money in play in the stock market, to enjoy the upside, but also perhaps taken a greater risk because the majority of your money is guaranteed to be repaid- this could be more profitable or much less- depending on your choices.

My point is that I follow the wisdom of those who enjoyed success and longevity of their successes. I maybe don't understand the lessons when they're first taught. Who among us has ever been told we need to understand interest rate trends, and immediately forgotten to make it our top priority?

it is certain, with respect to understanding interest rate trends, that you will educate yourself and see the world in a different way once you do.

Monday, July 27, 2009

ladder your portfolio- a.k.a. bondage gear

We are likely witnessing a historic period in modern history.

Historic with respect to the movement of interest rates, inflation, exchange rates, employment, GDP growth, quality of life.

The key to outperforming market averages for the fixed-income investor comes down to preparation, discipline and execution.

preparation: this should be the easiest step

- plan 10 years into the future (this is the extreme long run, and should be the most flexible, least certain expectations)

- plan 5 years into the future (without the ability to plan and save with 100% certainty for at least 5 years you will not be able to meet or exceed the average market rates of return)

- once you have determined how much money you will be able to save and invest over the next five years (minimum), begin following the news related to interest rates, inflation and GDP

discipline: this requires the most concentration, understanding and synthesizing of information

- if you are living in a period of rising interest rates, it is to your advantage to avoid longer term and lower yielding bonds (you will not have sufficient cash on hand and will miss the chance to buy new issues at higher average rates)

- if you are living in a period of falling interest rates, it is to your advantage to buy and hold attractive medium to long term bonds ( you will already be outperforming new issues of similar duration),

i.e. if you buy a 5 year bond interest 6% and interest rates fall for 24 months (which they have in the past) , a newly issued 3 year bond may only yield 2.8%, buy you will already have a bond of similar duration (5 years minus 24 months) that pays more than double the new issue. even worse, new 5 year issues will yield only 4.5% interest

- credit ratings matter, you don't' need everything to be AAA, in fact you don't really need to be afraid of having nothing higher than AA (any provincial bond is rated AA).

-if you stick with AAA investments, you will be receiving the lowest yield for 'the most safety', but provinces in Canada will not go bankrupt either, fyi.

- you must avoid a high concentration of BBB, bbb issues and diversify among AA, A, BBB

execution: the most difficult step

- without an effective financial advisor, it is extremely difficult to be confident, informed, decisive, or savvy. An effective financial advisor confirms all of your expectations for how much money it is possible to safely earn, while occasionally exceeding those expectations to improve the quality of your life

- following through on the rules of creating a diversified ladder requires intuition and fact analysis eg. many thought that interest rates would never go lower than they were after 9/11. not only have they never returned to those levels, they have reached a point of essentially absolute zero- the central banks of the western world simply can't lower the interest rates any further. the point is, the investor needs to understand the way defeciet and debt affect the economy and what effect interest rates have on a debt situation (this is basic macro and micro economics)

-only through repeated experience or testing can an individual develop a savvy ability to understand the relationship between interest rates and the type of individual bond purchases they ought to make ( this doesn't mean you need to be a pro, but you will have to actually do homework to understand the nature of interest rate trends, and it's not the easiest, most entertaining topic)

Saturday, July 11, 2009

I'm in Asia! learning stuff!

granted there are lots of cost saving ways to travel in south east asia.

the downside? you have to travel for at least 24 hours and fly literally to the other side of the planet.

as well, depending on where you go, no one will understand english.

I'm in the philippines because it still is an undeveloped tourist destination: it's even cheaper than thailand or vietnam and many of the beaches and resorts are pristine.

the best part: everyone one here loves Americans (they don't distinguish between white people from north america) and everyone (even those with little or no education) can understand rudimentary english.

It's very easy to get around and no one will over-hustle you: they simply aren't used to a tourism industry like thailand or vietnam (depending on which city and region you choose).

So what am i doing here? well, i mentioned previously that i spend a lot of time looking for alternative investments since i left the world of traditional asset mixing. Just so happens that i have a personal connection with a fellow who is highly connectd with the asian development bank, head quartered in manila.

did i ask for a specific deal, strategy or investment opportunity? NO.
what i did is called networking. I took the effort and time to find this person and to simply have a conversation. In essence, it was a global cold call.

We talked at length about my personal background and i had the opportunity to seek his opinion on much of the global turmoil taking place. His views on what counts as stable, what counts as volatile and what counts as a bargain are all well informed and based in the real world of securing credit (from a multitude of central banks and global financial institutions) for medium to large size firms involved in import/export trade throughout all of asia.

What did i learn that i can relate to you?
a few basic opinions, with the caveat that my new friend admits even the most informed cannot predict the future.

but he did point out the long, protracted nature of the current recession.
he pointed out that there is still a great deal of bad debt that has not worked its way through the global financial system (credit card debt is now just starting to become a serious problem for global financial institutions).
when asked, he pointed out that automatically, the rest of the world has been moving away from the american dollar as the international currency.
a basket of international currencies used by large, global financial institutions for transactions, referred to commonly as "special drawing rights" (SDRs) are now gradually becoming the defacto world currency.
He also noted that among international central bankers, there already exists a consensus that the world will eventually eliminate free-floating currencies and create a single world currency.
THis is a very difficult thing to accomplish and will not be realized for years, perhaps decades (if ever- no guarantees on the future)

But he was very clear, the old currencies: the pound, the american dollar, even the euro are in for a very, very bleak future. If you hold investments in these currencies, if you attempt to trade with these currencies, you will be very stressed for a long, long time. you may even lose a great deal of money.

what does it mean for the canadian bondage freak?

a declining US dollar will destroy the majority of canadian exporters. this will completely overwhelm any short-term recovery efforts and likely drive up unemployment, drive down exports and delay any significant growth in the economy.

the consequence is lower earnings across the board. your mutual funds are not coming back. you will be lucky if they remain at their current levels.

your fixed-income? keep it 7 years max. and widely diversified

why? every central bank in the world is printing money. those who ignore history are doomed to repeat it. we're in for inflation (not a guarantee, but an educated guess). if you're strictly buy and hold, you have to avoid the long-term (even if it means taking a lower total yield). if you stick with a bond mutual fund or buy something 10-year, 20-year or god forbid 30-year, you could stand to underperform the market dramatically.

don't buy stocks, unless they are a totally dominant company that is having a down period, and don't overly invest in stocks.
keep buying bonds, but remember, inflation will be higher than people might expect and you need to be able to purchase new issues at higher interest rates, because interest rates will rise. the federal governments have done as much as they can to hold rates down for the time being, but if this really is the big bad unravelling of the empire of debt the West has built, it's going to be a long, slow, painful road to recovery

Saturday, June 20, 2009

Rainy day money, why not double-down?

For a young investor (say under 35).

You are starting out your investment career.

You are determining how much money you dream of having when you are an old fart.

You don't want to work very much or at all for spending money

You want to pass some money on to people (spouse, kids, and relatives) after you die.

You want to feel wealthy and independent (you want income to exceed expenses without busting your ass all the live-long day)

Wouldn't it be nice...

So what do you do?

Typically, you go to the people you've been banking with all your life (likely a service rep. at your local financial institution)

Or you can trust your parents to tell you what to do

Or you can trust someone who is older than you and followed a path to riches and is open and honest with you about money.

But you will typically know someone who works at a bank, and they will refer you to an investment advisor.

It's not entirely unlike asking someone if they know a good dentist- if they've ever been to a dentist, the odds are they know a relatively competent one.

Emphasis on relatively. With respect to dentists, relative means that from one certified dentist to the next, there may be a few perks like softer chairs or newer equipment, but the skill and dexterity of every dentist is extremely consistent across ages, areas, sexes, etc. for all dentists.

Relatively speaking, the 'average' competent investment advisor is competent relative to someone who throws darts at a board or bets on cock fights as a way of determining your investment strategy.

Relative to a skilled and honest investment advisor, the average advisor is no better at generating consistent returns than the average DIY investor.

What I'm speaking of relates directly to why I feel that young investors are told they are 'young enough' and 'therefore have a high enough risk tolerance' to invest heavily in the stock market. This line of reasoning introduces the theory that because the investor is so young, inflation, the rise in their wages, and taxation liabilities will require the need for immediate tax relief in the short- medium- and long-term.

Within this world-view of investment, bonds will never be profitable (even if they guarantee to return your money) because of historic returns of bonds vs. Stocks, inflation and taxation issues.

Sadly, this world-view does not correspond to reality. This world view makes sense only on the premise that stocks are capable of beating bonds by at least a factor of 2-1 and also relies on the notion that stocks will always be taxed at a rate that is almost 5-1 in favour of stocks (this changes completely once you retire and depending on rrsp and now tfsa context).

Tell someone to save up $500 000 (or better still save only $250 000 and borrow the rest at 5% interest), tell them they can get a 10% return, pay about 10% in tax because of the dividend tax credits you'll receive

Bingo, you are some old fart earning about $ 45 000 every year after tax. That should be enough to support a healthy and affluent lifestyle for a long time, still leaving a nice chunk of change to pay for your funeral, burial, headstone and give something to the kids, etc.

There are now millions of westerners who were sold this line of reasoning, told that they could sleep at night and are now facing the sad reality of impoverishment and never being able to retire.

This line of reasoning has earned thousands of investment advisors a steady income of anywhere from $ 75 000 - $125 000 every year. Every year that they were telling people not to worry, telling people that the bull market was on, telling people it was too late to sell, it goes on.

But there are always people who understand that excessive return means excessive risk. There are people who demand that they get their money back in less than 10 years, no matter what. There are people who understand some of the basics of macroeconomics and follow the news and history. These people are not afraid of inflation or taxes. These people instead focus on working hard, proving their worth in the world and getting compensated for a job well done. To these people, your best weapon against inflation and time is your own two hands. Your labour is what fights inflation because wages rise faster than stocks or interest rates in inflationary economies.

For these brave souls, these 'bondageers', there is but one simple rule: DO NOT GIVE AWAY YOUR SAVINGS!!!

If you intend to save something, it must never go down in value. That is why it is 'saved'- think evangelicals getting into heaven, they go only up.

High yields be damned, my capital is there for the future, for emergencies, it must never be allowed to fluctuate in value and must always be contractually guaranteed to be repaid in my name by whoever holds it as investment. Furthermore, never trust someone more than you can throw them. 20 years until you repay me? Forget it. 10 years? In this environment, it's a stretch.

The bondage freak is into power. "I give you my money. You better repay me. Pay me back my money and give me points for every day that you have it. Don't like it? Too bad, there are all kinds of players out there who are happy to hold money, and make enough of it on their own to gladly give me points."

It is these people who fear not the economy, its mood swings, the rise of china, inflation, Caesar, Huns, Visigoths, it matters not.

Seek to protect what you have saved from this cruel world. Seeking growth from that which is the product of labour is to seek derivative output from a non-productive entity. This is akin to gambling. Gambling is what you avoid by saving money. Gambling is not what you do with saved money.

This is not happy news for anyone who plans around the 10% fantasy. You are more likely to go back in time and have sex with Bo Derek while on the set of '10' then achieve your financial goal.

Monday, June 8, 2009

How does a bondage freak fare when interest rates plummet?

Bit of an unrelated article, but it's always interesting to see how George Soros is doing and what he's thinking.

George Soros, in case you were unaware, is a Hungarian born immigrant to the US of humble beginnings. Soros said that when he was young he wanted only to be a philosopher (a seeker and debater of truth and knowledge). In his twenties and without a family depending on him, Soros rationalized that if he was able to get a job on wall street, and frugally save up his salary over a ten year period, he should be able to save approximately $500 000 of which he could sustainably invest and draw upon as needed for the rest of his life. With that nest egg, Soros would then be free to write and comment on the world and hopefully earn extra income from becoming a published philosopher.

By the time the 10 year period was expired, Soros was a billionaire investor and worldwide guru. He was described as 'the man who beat the bank of England'- correctly predicting a sell-off of the British pound on the eve of major fiscal announcements.

So what lessons can we draw upon for the bond market investor?

Well, we are living in a time of historically low interest rates. This has frightened many retail investors away from bonds. They fear the boogie man of 'inflation down the road'.

Have you heard people in the media throwing this phrase around? It's not a legitimate fear. Economists understand that society actually needs a constant level of inflation in order for the entire economy to continue to expand. This is why all the intelligent analysts were more concerned with fighting deflation (which we are still experiencing). History has shown that preventing any form of inflation causes much more havoc than benefit.

So 'inflation down the road' is not only an expected thing, it's a good thing. This is counter-intuitive to what everyone in the media or the investment advising industry tells average retail investors.

But how can it be a good thing for a bond investor if interest rates, even long term, are declining and declining and declining? Surely this will expose an investor to the risk that inflation will rise more rapidly than it has in the past, while their bond investments are earning a very small yield- so small that it might be less than the inflation rate.

This is why you ladder your portfolio, and this requires you to change the way you think about earning money.

If interest rates plummet, and you have bonds coming due- you should follow the advice of what George Soros is talking about in the CNN article.

I'm not saying buy a mutual fund or etf for China (though you probably will make money with that investment), but you should find "the right assets rather than saying 'I'm not interested in investing'".

What this means for the bond investor is that you GO SLOWLY.

If interest rates for short term and long term bonds drop substantially, it may be in your best interest to take more short term bonds to provide flexibility in 1-3 years if inflation rises. It may be in your best interest to buy lower quality, but still investment grade BBB bonds that still pay interest that's around 6-7%. It may be in your best interest to move some of that returned money into the stock market (this spring was probably the greatest time to buy banks stocks in Canada ever).

Or you might buy any other asset that you feel is profitable.

When you keep over 90% of your money in guaranteed investment vehicles you can shift money around to 85% bonds 15% stocks, so long as you remain overall conservative, you can adjust to provide a steady cash amount of income every year.

But if you stick with bonds, and interest rates plummet and remain depressed, your overall portfolio will eventually start showing a lower total % yield, and this will eventually translate into smaller amounts of cash.

So what will this mean? So long as inflation and interest rates are at historic lows, the price for a great many of the goods and services we consume will remain at a steady and/or declining level. Your portfolio of diversified issuers and maturities will reflect the general growth and contraction of inflation and the economy. You will receive less total income, but your standard of living and ability to plan for your financial future will likely be completely unaffected.

Once the gradual rise in interest rates begins again, you will begin to buy new issues at higher rates, meaning you may be at the beginning of an economic cycle and earning less compared to new entrants into the market. However, the flexibility of a laddered portfolio will provide consistent opportunities to catch up and eventually rise above the average market returns.

Sunday, June 7, 2009

10 percent is a fantasy

People need to consider the difference between real and nominal.

Nominal is what you see, real is what it actually means

I've noticed that a lot of young investors, trying to plan for their retirement are using 10% as their expected annual return.

They expect that if they can earn a long-term average 10% annual return and reinvest everything, the power of compounding will eventually turn them into multi-millionaires.

Starting out with a house worth $ 400 000, a mortgage worth $300 000.

Savings from their job is about $ 150 000, imagine if they borrow an additional $100-150 000 to invest in the stock market.

Imagine they have to pay interest on all their loans at around 5%

Imagine someone tells them that they can get 10% return from their investments every year.

Seems like the investments might be able to pay off all the interest on your loans and then some.

After the loans are paid off, the investor is much wealthier than if they had not borrowed money to put in the stock market.

But how long does it take to pay off the principle? That makes a big difference in the time the investor ever actually sees any improvement in their standard of living (eg. Having a big wad of cash in your hands at all times).

But here is the most important thing: that 10% number is not guaranteed. In fact, in every document you ever read, it clearly states somewhere that there are explicitly no guarantees anywhere on anything in the financial industry.

So where does this 10% figure come from? From the article I linked last post, the argument is made that this figure is basically a fabrication of the investment advising industry. Why would an investment advising industry pick this figure and promote it as the way to make your retirement dreams come true?

Because it is double the average return of bonds, which averages around 5% annual return over the long run. I'll comment more in the future about this number, but it's also in my original post.

So what happens to people who sign over their money because an investment advisor is telling them it's a 'more efficient' way to make money?

They get convinced that they are 'young enough' and have a high-enough 'risk tolerance' to put most, if not all of their hard earned savings into mutual funds or the stock market. All products which do not promise to repay your capital.

Why do people buy into this? Greed is an obvious answer. So is the lack of good information on the real returns offered in the long-term for the various asset classes.

It's a simple rule: you can't make good decisions without good information. Investment advisors have promoted a long-term annual return from the stock market at 10%, 8%, 7%. It doesn't matter. The truth is, whatever the return has been it is characterized by extreme long-term volatility. You essentially have to hope (for your entire working life) to be lucky when you retire and begin to start drawing on your investments, ask anyone who is experiencing that now (old, tired, lost lots of money and can no longer afford to retire).

The bond market? It fluctuates along with economic cycles as well. But unless the issuer is bankrupt, your principal was protected the whole time.

Bonds have beaten stocks over the past 40 years. That is an entire working lifetime for the average middle class investor. What will the next 40 hold for us? Where should we really think about putting our money? And what should we really expect to earn for doing nothing?

Thursday, May 28, 2009

Bonds are the new black.

Time for a rant on what I've learned about the DIY Canadian investment blog community (if that is indeed a thing that can have a name like that), people posting online about what everyone else in their situation should do with their money (this is regardless if they are a financial advisor, some dude, or a big outfit), following this or that bit of information. Lots of times there is a nice little graph or a box of numbers next to another box of numbers.

Many people enjoy posting their own financial information. Not just their particular investments but their whole list of debts and assets, their jobs, incomes, how big is their family, etc.

I have no problem with people who want to share personal information, especially if their intention is to selflessly help others. However, most of what people consider to be their business is in fact just that- it's their business and no one else's. Privacy is about minding your own business. This isn't a rejection or defensive posturing, just a mutual understanding that my economic and social context is unique to me. It's what makes me 'me' and not 'you', the 'other'.


What am I talking about?


I'm talking about how I've learned to ignore information (like the analysis and trends and fancy equations and statistics) as the key to distilling, understanding and utilizing the underlying reality of the various investment strategies and attitudes.

This is what philosophy is all about. Those guys that people talk about- Plato, Aristotle, they were guys who had a holistic (if still primitive) view of what a person should do with their life (their view of the soul is like how we view our retirement nest eggs) and how to go about doing it in the best way possible.


What does philosophy really have to do with investing?

1) Philosophy is about the pursuit of truth.

2) Investing is about weighing risk with return.

3) Return is cash money in your hands; risk is the absence of certainty about that return.

4) If Philosophy is about truth (which is about validity and certainty) and investing is about risk (which is about the certainty of making money),


5) understanding certainty and using that understanding to our advantage will allow us to maximize return (cash money) while minimizing risk (uncertainty).


So what happens when, in a variety of quips, comments and suggestions, you present the consequences of this line of reasoning to the Canadian DIY financial community?

The answer is not much.

You see, when people have 'bought in' to a line of reasoning, and worse still, put their own financial nest egg behind a line of reasoning, it becomes a very touchy subject.

Though it's easy to divulge how much we have with who and where and how much we owe on this or that, it's actually much more psychologically (and philosophically) difficult to admit compete and total failure.

Indeed, it was Nietzsche who best espoused the idea that without the understanding and acceptance of complete and total failure, one can never enjoy true success. Though he lived a lonely and miserable life, he viewed humanity in organic terms and, wishing in an alternate life he could have been a gardener, Nietzsche argued that the failures of ordinary people are like the dirt and roots and worms and detritus. If they are understood and cultivated properly, they will combine and yield a beautiful flower. If they are mismanaged, they will rot.

This is an apt analogy for a flawed investment strategy. When the reality is that stocks do not always beat bonds, and over the last 40 years bonds have beaten stocks, an individual who attempts to understand and accept reality will adapt.

A logical adaptation, if we attempt to remain consistent, would involve less effort attempting to make significant gains or investments in the stock market.

You see, this is essentially my line of reasoning before the market crash and I took it from my parents (who got it from their parents) before me and it meets a lot of static.

The static takes the form of people who believe that bonds are not available with high enough interest to beat inflation (consistently proven incorrect when dealing with a properly laddered portfolio), people who believe that investment-grade corporate bonds are at a significantly higher risk of default than a government bond (consistently proven incorrect over time), and (perhaps worst of all) people who view the return of capital as a burden- best avoided by purchasing a stock or mutual fund and holding it forever (this is a philosophical disagreement, I buy some equities but I love when I see I have cash waiting to find a new home in my accounts and argue it is never a burden if you always have the ability to wait for a good value investment).

I believe the accepted notion of a 30-70, 50-50 or 40-60 asset allocation, the belief of diversification, and professional management has been completely compromised and undermined by the real world experiences of ordinary people. People who could have been convinced of any asset allocation so long as it beat inflation and preserved a nest-egg, were lead into investment vehicles that charged a lot of money and in the end provided little or no protection from stock market volatility.

As a logical consequence, I have determined that the entire investment community is as flawed as the products they sell, analyze, discuss and throw their money behind. People who argue about the benefit of estate, tax and insurance planning do a disservice to the role an accountant provides (at a fraction of the cost and with no conflicts of interest) and exaggerate how difficult it is for the average person to determine their need for those things on their own for free.

Financial advisors are your best friend, but only when they understand how to treat you and your money with the respect you deserve. If you remain uneducated to the actual returns of the various asset classes that you can invest in, you will drastically increase the likelihood that you will unknowingly lose money when you think you are helping to 'grow' it.

There are some people, like 'NurseB911' who writes his blog about his financial journey, that are starting to catch on to reality.

The rest would rather refuse to look at their financial profile and continue to hope and pray the DOW magically goes back to 13000. The smart money has been slow and steady FOR ALL ETERNITY.

Monday, May 18, 2009

Is Obama Reading My Blog?


But here are two articles that are consistent with the investing philosophy of the fixed-income investor. A.K.A. the bondage freak.

It is also totally contrary to what all DIY investors believe, but just look at the articles first.


So, there are two reasons I use the title space to ask if Obama is paying attention to my investing philosophy (which is by no means unique, and as this article shows is actually quite old)


  1. Obama keeps approximately 90% of his family's savings in cash and bonds. The articles say that he keeps about 90% of everything in US Treasury notes and a chequing account. It does not disclose the maturities, or the specific nature of his treasury notes (we should assume Obama is getting a pretty good price and yield from his broker).
  2. Obama had several mutual funds, but chose to put all the equity investments (about 10%) in a mutual fund, which is an index fund. It invests large amounts of the investors' capital in shares of companies that fit on a list of social issues that are an important part of the life and values of the Obama family.


I look at those two points which are featured in the article and it reinforces the attitude towards investments that I have been advocating on this blog and in my life.


The fundamental approach and attitude is that you need to protect and preserve your capital.

Once you have done this, you should be free and confident (and, in essence, obligated) in pursuing the accumulation of wealth through a successful career you enjoy (not through growth of an equity portfolio), as well equity investments can be made to reflect your interests and personality without overly risking capital.

If I can speculate about the investment strategy of Obama:

  1. Best Case Scenario:

He is taking this conservative asset allocation strategy and using it as a way to provide the financial security to allow him to focus on his career. He can likely earn money above the inflation rate, and he can pay his taxes and this would provide enough money to support the quality of life he had enjoyed before he became "Chocolate Jesus". He's in the perfect position, after he serves the public, to accumulate and mobilize vast amounts of 'money capital' because of the tremendous amount of 'social and political capital' he will have created if his investments in his career strategy (aka. Domestic and foreign policy of USA) are successful.


  1. Obama is prudent and imagines what would be his Worst Case Scenario?

His government is corrupted and ineffective. American influence, prestige and power are reduced along with the value of the US Dollar and the stock market. Obama is ushered out of office in a single term after Sarah Palin and the re-animated head of John McCain sweep the 2012 elections. In this worst of all futures, Obama is left with no fame (except failure, disappointment and disgrace), no connections and no or little ability to build and/or mobilize vast amounts of money.


If Obama starts his presidential life with about 1.2 million in investments and about 1 million in his home, and then follows most DIY investors, he could be looking at a 39% loss in his investment portfolio.

This could mean that his 1.2 million in investments could shrink to 750 000, with no job, no ability to earn big money, and two daughters who have high expectations about their future education. Obama would not be left with enough retirement savings....

However, follow Obama as he follows the age-old strategy, where you stay conservative with your cash and savings, and are aggressive and bold in your career- and your small equity investments, investing in whatever you are respectively passionate about. Even if currency depreciation afflicts the holders of American investment vehicles like treasuries, the highly liquid nature will allow Obama to move his entirely protected nest egg into higher-income earning vehicles. He won't have to worry about taxes, because Palin will eliminate all taxes as a way to eliminate all abortionists, gays and minorities.

Wednesday, May 13, 2009

Interest rate trends and GICs

So I talk a lot about fixed-income investing and usually like to focus on investment-grade corp. Bonds.

But when I look at my investment portfolio and the changes that have taken place over the past few years, I think it's important to comment about interest rates.

Following the 'benchmark' bonds, issued by the federal government, that are used for bank to bank lending; following the medium and long-term 'benchmark' government bonds; and following the popular GIC rates is critical in becoming educated in the Canadian bond market.

If you visit this is an excellent resource for tracking US government issued debt.


Look at the "yield curve", this graph plots the various maturities according to their current market yield.


Two important facts:

  1. The volume of bonds (government and corporate) that are exchanged on a day to day basis is roughly 10x greater than the value of the volume of cash exchanging hands via the stock markets of the world
  2. Because there are so many different types of issues and different maturities of bonds from each individual issuer, it is uncertain and unlikely that individual bond issues will be traded every day. This is the 'liquidity risk' people refer to when holding bonds, when interest rates (or the price of your bond) fluctuate and they hope to sell their bonds in order to capitalize, only to find that selling their bonds is difficult.

Because of these two facts, it's possible to think of the bond market as a kind of ocean cruise-liner (please refrain from Titanic analogies), which parallels the vitality of the overall economy. When investors the world over have confidence in the economy, the government or bonds in general, it typically drives up the price of all bonds and when the government is encouraging growth, it typically lowers interest rates to encourage lending and ultimately lead consumers to avoid putting their money into savings. Governments can be like the captain, ordering to speed up or slow down the ship- lower interest rates typically encourages growth, higher interest rates encourage saving money and taking it out of the economy to curb inflation.

In the previously described situation, the world before the economic meltdown was fairly reflective of my description. After the meltdown, a flight to safety and the lowering of benchmark rates for intra-bank lending has created the perfect storm. Captain Bernanke has ordered all men to the coal furnaces; fire the engines, full steam ahead! Benchmark interest rates of all maturities have plummeted to the lowest point in history.

This is important for me, because when I moved my money into fixed income, I temporarily placed a lot of it in GICs. The strategy is simple: Most advisors recommend, and a common misconception is, that it's to your advantage to be fully invested at all times.

Conversely, the way the corporate bond market works, it's actually best to buy in increments (part of the reason laddering your portfolio so that 10% of your portfolio value is freed up each year for reinvestment). So as I moved out of equities and income trusts and into the fixed income market, 1 year GICs- cashable after 30s days without penalty- are an ideal holding point for my investments if I'm not sure what to be looking for right away.

Due to giving my attention to my own search for alternative investments and the way things worked out with the economic meltdown, I've ended up holding onto the majority of my GICs, I started holding cash at 3% and the last time I purchased any (in September of 2008) the yield was about 1.4%. Now that the Federal Reserve systems around the world have gone to work, the yield for a similar GIC is now literally 0%. It's getting close to the point where you have to pay for a GIC to hold your money....

This is a problem for me as the GICs will be due in September. Fortunately, I believe the credit markets have not collapsed and this has turned into the greatest time to purchase corporate bonds in recent history.

The moral of the story is what I will call the DNAGS dynamic multi-sector wealth factor.

DNAGS stands for DO NOTHING AND GO SLOWLY. The secret of wealthy people who have managed to preserve and grow their wealth is their staying power. Sure, it's important to be confident, aggressive and pursue opportunities as they arise. What is equally important is staying conservative and using a conservative philosophy to avoid being overly-committed or jumping in too early into an investment before verifying it's soundness (this has the consequence of typically looking for moderate total average yield- with the bonus of enhanced security and confidence in your investments).

So as it is, I have about 4 months until my last GIC is due, month by month, I've been moving out of GICs (starting with those which yield about 1-1.4%) and into corporate and some provincial bonds.

So far, I've been able to take money that was earning about 1% and turn it into investment-grade bonds (no maturity longer than 6 years, so far) that are yielding about 6%

This is at least a full percentage point (or 100 basis points) better than the corporate bond ETFs available in Canada. I paid my advisor an average one-time commission of 1% of the purchase price.

Monday, May 11, 2009

Microsoft now a defensive play?

As an additional sign that the credit markets have not collapsed, the biggest and most historical software company of them all is offering its first debt issue.

This is an excellent example of the opportunities and frustrations that retail bond customers face.


You read this article in the morning, and as the defensive investor the idea springs to your mind:


"I've always wanted to get a bit of the action from the Microsoft business, but the stock has done horribly these past few years and I'm too conservative, even with my speculative investments, to ever purchase common equity in the company I will likely use every day for the rest of my life."

"The currency risk was always too much to deal with to make the stock an attractive investment after the tech Bubble burst"

"Now that they have issued so many billions of dollars in bonds, I can grab an AAA-rated investment that yields interest of a full percent above federal bond rates of similar maturity, that's a good deal!"

"I should be able to call my broker, or I can use my discount brokerage to purchase some units... oh joy!"


So here is the sad reality, why some people are turned off from the Canadian bond market, and what you should do as the DIY Canadian investor.


  1. When Microsoft issues this debt, they have already arranged for ALL of the billions of dollars to be purchased the moment it is issued.
  2. This works the same way that underwriters work for IPOs. A very large financial institution (or a group of financial institutions) will put up the entire cash amount up front to Microsoft, who then has an additional 2 billion dollars of capital to play with. Microsoft is then responsible for paying the interest on this capital and returning the full amount on maturity
  3. Once the major financial institution(s) have the bond issues in their possession, they will create a secondary market for them.
  4. First, they will sell the bonds (with a slight mark-up to pay for overhead and sales commission) to institutional investors (these investors include pension funds, insurance companies, government investment funds, even smaller financial institutions).
  5. Once the institutional investors have had their fill (the big boys eat the meat, the little guys get the scraps) they will retain the left-over bonds for you, the retail investor.
  6. By the time you get to purchase these bonds, if you ever do, the mark-up, and fluctuation in price could reduce the spread above a treasury note of similar length to zero.

What does all this mean?

It means that if you follow the news about debt issues, you are likely to be disappointed. What is more important is following trends in interest rates (which typically reveals where in an economic cycle you find yourself). Specific companies are not the primary focus of the bond investor- assets, debts, revenue and expenses are the primary concern of the savvy bond investor.

The FP article is interesting because Microsoft has never had to issue bonds (maybe they're starting to run out of money) and the article points to the resiliency of the investment-grade corporate debt market throughout the financial crisis (this strength has been widely overlooked, I do my best to change that).

But this story is very little help if you are trying to establish your diversified bond portfolio. If you lack this insight into the bond market in Canada, your first reaction is probably disappointment

The bigger picture is that when the corporate bond market grows (with the highest-rated corporations, like Microsoft leading the way) it encourages every single competitor to do the same. This has the net result of increasing the yield offered to investors (both institutional and retail) in an attempt to lure more capital.

I asked Hank Cunningham, the sagely author of In Your Best Interest: The Ultimate Guide to the Canadian Bond Market, what the retail investor should do if they missed an opportunity to purchase an attractive yielding bond.

The appropriate response is simple: wait for another investment grade corporation to have a new bond issue. So long as there are investors seeking the reliability and solid return of corporate bonds, there will be investment grade companies that are more than eager to meet that demand.

Sunday, May 10, 2009

Checking out the new format as I learn to use office 2007 for the first time in 2 years.

The credit markets are not collapsing, as we had earlier feared.

Tuesday, May 5, 2009

big time returns... a nice time but not a long time, so have a good time, your stock can't rise everyday.

I've repeated on several occasions that I never keep more than 10% of my own net-worth in the stock market.
I'll just focus on how and why i came to take this attitude and why it's made me enjoy the stock market more even if my exposure is less and to look at equity investments for what they really are (at least through my jaded, hippy-hating eyes).

This view probably started out as an asset mix of around 20% (think pareto's principal- which i don't follow anymore), and from 2005-2008, became more and more conservative. It was mostly because i simply dislike extreme volatility in any aspect of my life where it's not absolutely necessary. Over the past decade the stock market had been booming, but it had also been busting and booming back at a very high rate. I disliked the constant boom and bust so much that i decided to get out of the market. The final sale i made was BMO. I purchased shares at about $62 in July 2006 and sold them in February of 2008 at $57.

at the time i felt like i was taking a beating but just happy to get out.
Everything in my portfolio for the remainder of 2008 was in bonds and GICs (luckily, i was able to buy 1 year GICs, cashable after 30 days, that yield 2.8-3%) Current GIC yields of similar duration are about 0%... I also kept a very small position in a major energy company.

So while i hated the market for what i perceived as volatility. The crashing housing prices in California and Florida and Arizona were in the news, and i was thinking maybe it's time to take the cash and just buy a nice vacation home, and finally be finished with Canadian winters.

I never put two and two together and luckily never bought any property (i had never been offered Mortgage backed-securities or asset-backed commercial paper) and i was just as surprised when the meltdown of October-March crippled the global economy.

That being said, i was also lucky enough to be doing a great deal of reading into macro economics, personal finance and DIY investing at this time. (i was so put off by the stock market, i was wondering if there was any other decent alternative to my bonds- which were earning quite nicely through it all..... the answer btw, so far, is NO).

When i finally rounded out my general investment knowledge by looking at the recent works by Nial Ferguson in "the Ascent of Money" and doing some further background that included Nasim Nicholas Taleb, author of "the Black Swan" among other books on chance and investing, i decided this blog was the next step.

This blog represents my conclusion that the whole notion of diversifying an equity portfolio, that you should balance 50% stocks and 50% bonds or anything similar to this, is a myth.

This blog is my attempt to verify or discredit the belief that the most efficient and safest way for your investments to not go down in value, beat inflation, earn a steady return and provide a fully customizable portfolio for your specific needs is.... BONDS (specifically investment grade corporate, provinical and even real-return government of canada bonds).

If you pay any advisor 1% or more of your capital every year just to manage your money, it is a myth that you need to pay that much just to preserve capital and create growth.

I started this blog with the idea that putting anything more than 10% of your assets in an allocation that does not promise to protect your capital is too risky- investing is about assumptions of what will happen in the future and these assumptions always contain risks we ignore or are unaware of and that is why people lose money when they don't have to.

Im happy that the rebound of march- april has restored an average of 25% people's retirement savings (for those that stayed invested). There are a lot of people who lost over 50% and have little to no chance of ever recovering from the peak, but this is why we call the market volatile and why i'm too scared to put a 1/4 of my money into that arena.

when i do put money in the stock market, i realize it's to my advantage to take more risk. I'm already prepared to take a loss so i want to take the most speculative risks. Do all those crazy trader strategies- buy the companies people are terrified of, buy the companies you like that no one has ever heard of and hedge like a mad man. That's the nature of speculation and it's the form of venture capitalism the stock market provides. If you are prepared for the downside of an unprofitable company, but you like their product and you personally believe in it (like some eco-small-cap-companies, or bio-tech, or whatever) you should enjoy the role of capitalist and your economic vote to increase the resources of whatever belief you attach to your preferred company. your money could, obviously evaporate completely, but when you take only 1% of your net worth and throw it away at a cause (which you had hoped would be profitable) you can also consider it a form of charity and the government does allow a tax credit for the loss if it all goes horribly wrong.

frankly, looking at the corruption and admitted failure to make any meaningful long-term progress from some large and established charities, i think the argument can be made that (specific, highly-speculative) investing in the stock market is an equally charitable form of donation.

Sunday, May 3, 2009

buying a bond vs. stock in GE as a medium term investment (about 5 years)

As a Canadian, this dilemma has a serious caveat.
If a Canadian investor wishes to add shares of General Electric Co. to their portfolio they must open a U.S. dollar account and purchase the shares on the NYSE in U.S. currency.
This means that you take the additional currency risk, with respect to the total cash distribution paid out each year, or when you sell all the shares, and convert the money back into Canadian currency (should you choose to do so).
If you want to spend the earnings of your US currency investment inside the states, this isn't a problem
It is still a factor to consider when making an initial purchase (dollar-cost averaging is an applicable strategy that can smooth-out the volatility of currency value, but more transactions also increase the total cost of transaction fees).
If you want to spend the money you earn form your GE shares in Canada you face the additional currency volatility (i.e. if you need money when the value of the Canadian dollar has sunk, it can drastically reduce the buying power of your earnings, hence lower actual cash yield).

taking those factors into account, GE is one of the most diversified, industrial, commercial, media and unfortuantely financial companies in America. The financial hoob-a-joob that took place within that branch of the company has taken the entire corporation to the brink of insolvency.
Fortunately, all major financial institutions in America and around the world are able to borrow money at about zero% and lend it at 5-6%. This is a guaranteed way to keep otherwise bankrupt companies in business during what can be called a mini-depression.

The price of each share was around $25-$35 US ever since it split in 2000. Then in March, when the S&P500 hit 666, it was at about $6.66. Since then, the S&P closed friday at 877 and GE shares were trading at $12.69. The last dividend payment was $0.31 and nobody is sure if it will be maintained or reduced going forward. If you buy the shares on friday, the average yearly cash distribution is (barring a dividend cut) 9.77%.

Can't lie, in the medium term, that is a very, very attractive offer. even if the dividend is cut by 50 or 60%- that's still a good offer, looking at the long-term value of the company (excluding any currency risk).

As an individual investor, look to see if you're willing to go on the roller coaster ride of the future with this company. the value of your capital ($10000-$20000) will be fully put on the line to thrive, survive or decline along with the future prospects for solid revenue growth and the value of the Canadian and US dollars.
If you like what you see, be brave, bold and determined.

Or, if you're just into the idea that instead of taking all the whopping big risks the company has to make for a juicy 9.7% return, you wanted to take an alternate path, providing a great more deal of stability when dealing with the future earning potential of this mammoth and wildly volatile company, avoiding the stock market entirely.

Currently their is a bond issue from GE circulating around most of the retail bond trading desks in Canda. The features of this bond currently are as follows: It matures in june 2014, the original coupon rate was 4.4% and currently is available at 5.3%.
this means that the bond was issued at units of 100 that cost $100 each. your minimum investment is therefore $10000.
But because of all the current global economic uncertainty and decline, investors who sold off their stock (sending the price plummeting an average of 60% from the highs) also sold their bonds, in the belief the company could go bankrupt because of the inherent weakness in the financial arm.
the difference in the sell-off of GE bonds is that the $100 unit price fell to as low as $90 and is currently sitting at around $95 per unit. This means the minimum investment is now $9500, which is why the yield is 5.3% for new investors and still 4.4% for anyone paying $100 per unit.

Also, when the bond matures you will have the additional capital gain. This means your capital will be returned to you in units of 100 that have a value of $100 each. The only reason the cost per unit was reduced was because of investor pessimism. This bond is still A-rated and considered investment grade. The sell-off of the GE Financial bonds was moderate and short compared with the stock. If you invested $9500 originally, $10000 would be returned to you at maturity on top of all the interest payments received before then.
Questions about the future remain, but any bank that can borrow at 0-1% and lend that out at 5-6% is going to make steady money. I also know that my bond payment (guaranteed to be cut only after common shares and Warren Buffets preferred shares) falls in that 5-6% range so it's likely they will be able to make my interest payments untill maturity.

If you feel safe and confident about the company, you press the buy order and the brokerage will transfer the money and you start to receive your payments. You are not dealing with any foreign currency. all of these transactions are available in Canadian dollars.
As the bond investor, if that looks like a good return (about 3% above a similar government of Canada bond) with little to no risk of taking a loss, why take the risk of a big loss just to get the big gain?
money is what you earn, investments are what keep your money safe.

Friday, May 1, 2009

interesting view on canadian banks

Thursday, April 30, 2009

how to purchase a bond

step one: be a millionaire.

-sadly, this step is often the most difficult. However, once you finish step one, i promise all the other steps are very easy to accomplish.
- if you can't finish step one, don't worry there are alternatives to engaging in the retail investment grade corporate bond market, which i'll discuss in a bit
- the reality is, if you go to a large financial institution or any investment group, only the high-net worth individuals have the chance to work with the senior advisors. if your investments are at the $200k-500k range, or less than a million bucks, you still likely will get stuck with an inexperienced advisor who will likely not understand how the bond market works and suggest government of canada bonds, bond mutual funds or etfs exclusively and then try to put too much money in equities (this is different depending on your age/pension context)

step two: do a thorough investigation of investment advisors.

- You need to be willing to ask friends, family and colleagues (it can be awkward talking about finance) about their investment advisor or if there is someone experienced they can recommend.
-meet with a variety of investors (at least 4) and ask them about their strategy (never get talked into opening an account right away) and ask them what they think about bonds, what their experience has been buying bonds for clients, and ask them how they interact with the bond desk
- if they tell you that the bond desk can make life difficult for them- walk away. the advisor does not know how to effectively work the retail bond market
- if they tell you that the majority of their activity is with the bond desk and that they have a solid, and ongoing relationship with the bond traders, this is a good sign they know how to consistently get you safe bonds that have an attractive yield (the historical average for investment grade corporate bonds of a 5 or 10 year maturity is 3% ABOVE the government of Canada rate. much higher or lower yield should raise your attention to a risky/bad investment)
-NEVER, NEVER, NEVER trust a young, or inexperienced advisor if you want to invest in bonds. It takes years of experience and relationship building with a Financial Institution's (BMO, TD, CIBC, BNS, RBC, etc) bond desk in order for an investment advisor to be able to effectively structure a large and diversified, laddered bond portfolio
- The reason is also simple: young advisors, and advisors with a small amount of clients need to extract more commissions and fees from that smaller pool of clients than an established advisor with a large book of clients. In order for the established advisor to make his salary, he doesn't need to depend on large commissions of any one client, unlike the advisor who is just starting out and needs to churn his small number of accounts just to make money.
- even if you are lucky enough to get a senior investment advisor, you must still be educated in the corporate bond market in order to work on an even playing field with your advisor, which requires that you complete the final step.

step three: do some studying (you will not need to have any type of expert knowledge, but you will have to become knowledgeable) i.e. build your own fund of investment knowledge.

- study the credit history of the companies you wish to invest your money with (available at
- study your personal context and what kind of investments are you comfortable with making (sometimes you only want to be half invested and leave some in GICs or a savings account, sometimes you need dividend income, not interest income, sometimes you want to be fully invested- you need to figure what is the right mix for you)
- i personally believe, and from what i read from people like Niall Ferguson, Nasim Nicholas Taleb, and countless other wise souls, YOU CANNOT PREDICT THE FUTURE. Worse, you will never be able to predict the future and it's actually in your best interest to expect that the worst outcome is the most likely.
-expect and plan for the worst in all circumstance while still being hopeful that things will be rosy.
-this attitude leads me and others (counter to the popular DIY investor strategy)to believe your personal savings should remain in investments that promise to repay your capital and that any investment in equities should not total more that 10%. This way, your claim to future performance is only what you stand to lose (10%) and you have prepared for the worst while leaving hope for the best.
- Every day you need to read the paper and follow the news related to the companies you have invested in. Their respective industries, the state of global trade, finance and output, and the level of debt of nations and corporations are all things you need to at least have a basic understanding of.
If you:

1) read the paper everyday and

2) do a little extra homework on the company you want to buy bonds in (just knowing if they have too much debt, have good assets, steady revenue, etc.) and then

3) know the credit rating of your bonds,

this is all the extra homework you will need.
a good advisor will act as a way to reconfirm what you are already expecting.
In essence, you are paying your advisor to provide you with bonds that meet or exceed your expectations.

- following the news and the credit rating of your company will allow you to determine if it's best for you to keep your bonds in short term lengths to maturity or longer term, or which type to keep long term and which type to keep short term
- a bond portfolio is fully customizable to your particular context, so you need to know where you stand.


So, you don't have a million bucks to invest? well, you can still build a rock solid bond portfolio on your own that should have a similar average yield to the millionaire portfolio, just scaled down to your particular heights.

1- register with one of the big financial institution's online discount brokerages (TD and BMO offer the best bond inventory, tools for making a laddered portfolio on your own, current credit ratings, and the best prices). But, to get the discounted fees, you usually need to have at least $100 000. if you don't have that much, you may have to pay some additional costs to keep the account open. Other discount brokers may not have the additional costs, but they are less likely to have the variety, quality and prices of the big boys (TD and BMO).

2- go to the library or book store and get either edition (the 2nd is a little more up to date) of Hank Cunningham's book "In Your Best Interest: The Ultimate Guide to the Canadian Bond Market". Most of what i say is basically repeating his strategy. he also runs a website, where he takes questions directly from people-
I have no personal connection to this man. It's simply my experience that the only book i would have needed to read (if i had no other experience, information or advice) in order to make safe investments was that one book. And i have read almost all personal investment books currently on the market. Hank is one of the most successful and most recognized 'bondies' in the business in the history of Canada and every single experienced investor and advisor i have ever talked to has talked about the exact same strategy time and again: laddered ten year portfolio of investment grade corporates and provincial bonds. If you want to know the secret of how rich people preserve their wealth and pass it on to the next generation, this is it.

3- follow the same strategy outlined before when it comes to knowing some of the basics of the companies you want to buy a bond from, the basics of your economic needs and the basics of the state of the current global economy. You simply don't need to be an expert. Most experts actually don't know about bonds and if they do, they admit that the average joe is just as capable of making the right choices for their investments if they just did the little bit of extra homework.

4- you will be the one creating your bond portfolio, not an advisor. so it's up to you to spread your money out. the simplest strategy is to put maximum 10% of your investment in each year up to ten years. That way, 10% of your money is freed up every year to reinvest. If inflation is rising, interest rates will also, likely, rise and that returned captial can be invested at the higher rates. the same process is repeated every year. Barring hyperinflation (which is a very remote but real possiblity), you have greatly reduced inflation risk to a fixed-income portfolio.

5- it's important to diversify a bond portfolio because any single issue for a company has some risk of default, or some bonds have a 'call' feature, where the company can decide to give you your money back whenever they want. This isn't a big problem if only say 1-5% of your capital is being returned, but what if you put 30% of your capital into one callable bond because you liked the yield and thought it wouldn't be called, and it's called at a time when interest rates are next to nothing (this is currently happening with some bank bonds).
for each company that i have a bond issue from, i put no more than 1-7% of my capital in that one company, as a way to avoid being overly invested in a single issuer.

6- once you have figured out the right mix of companies and the right amount of money to have invested, take some and put it into the stock market. I say this because once you have built your bond portfolio, that's it. it's finished. you can't tinker with it. the value won't fluctuate if you hold to maturity. in essence, it's a sleep-at-night portfolio. It's a boring way to make money, because it's slow and steady. Imagine the tortoise and the hare. Well, it's wonderful to be the tortoise because he's the hero of the story and he wins the race. But you are a human and you need something to keep you motivated and interested in your investments and not to forget when you have money coming due.
i put no more than 10% of my money in the stock market because i really like it when people promise to pay me back. no one in the stock market ever does that. But i still need some excitement and stock market-induced adrenaline in my life, so I put my money in canadian bank stocks (i know equity people who call these widow and orphan stocks, well these day's their downright speculative) and energy stocks (primarily as a hedge against the type of inflation triggered by rising oil and gas prices). IMO once you have protected the majority of your money, go crazy with the rest. if you want some dividend income, you should have fun on the stock market and see how you can fare. Your probably won't lose it all, but even if you lose over half through stupid investments and trades, you'll have learned the lesson without risking your life savings and you can write-off the capital losses on your tax statements.