Monday, September 30, 2013

More New ETFs in Canada

The explosion in exchange-traded funds (ETFs) in Canada continues with the launch of five new funds in September by Purpose Investments. I had the pleasure of talking to Som Seif (CEO) and Ross Neilson (Vice President, Sales) over dinner recently to get their take on where Purpose fits in the investing landscape. (Disclosure: Som paid for my dinner, but if you think that affects what I write, you should see how many times per week I turn down offers of far more than the cost of a dinner to place “guest” posts on my blog that masquerade as real content.)

Som Seif is a very smart, high-energy guy who started Claymore back in 2005 and now runs Purpose Investments. Ross Neilson is no slouch himself, but even he tends to sit back and watch Seif go. Som shows passion and communicates clearly in a way that I think is likely to resonate with a significant fraction of investors who hear him speak. I don’t know how his funds will perform, but I wouldn’t bet against Purpose Investments as a business.

The funds offered by Purpose all use purely mechanical strategies to take human emotions out of the equation. However, these strategies are far more elaborate than the fundamental indexing used in some Claymore products. For example, the Purpose Tactical Hedged Equity Fund (PHE) invests in North American equities, but at any given time it hedges away between 25% and 75% of the market exposure. The choice of equities and percentage of hedging are all rules-based to avoid any problems with letting people make gut-based decisions.

An interesting feature of Purpose funds is that they are available as ETFs or mutual funds. The management expenses are the same for the ETF and Series F mutual fund versions. There is also a Series A mutual fund version of each fund that charges an extra 1% per year to pay trailers to financial advisors. Compared to typical mutual funds that pay trailers, Purpose funds are quite cheap. For example, the Series A version of PHE charges 1.8% per year in management fees (the MER is a little higher). However, the management fee on the ETF version of PHE is 0.8% per year, which is high compared to an index ETF like XIU. So it’s a matter of taste whether you think of Purpose funds as cheap compared to other active mutual funds or expensive compared to other ETFs that are based on purely mechanical rules.

The mechanical strategies Purpose uses test well on past market data, but only time will tell how well the funds perform in the future. It’s hard not to get caught up in the excitement when Som speaks. But, my rational side tells me that the professional investors who dominate today’s markets know about the mechanical strategies Purpose is using. For Purpose to beat the market, they have to take money away from some very smart money managers.

One of the smart things Nassim Taleb said in his Antifragile book is that you shouldn’t pay any attention to what people say about investments but watch where they bet their own money. So, maybe you should ignore everything else I’ve said and focus on the fact that I have no plans currently to invest in Purpose funds.

Friday, September 27, 2013

Short Takes: Wealth Advice and more

Here are my posts for this week:


A Reader Question about Choosing Winning Mutual Funds

Here are my short takes and some weekend reading:

Mr. Money Mustache explains some wealth advice that should be obvious, but isn’t.

Larry Swedroe reports on studies showing that active bond funds won’t protect you in a bear market. With the current fear of rising interest rates, no doubt some investors will try active bond funds anyway in the hopes of avoiding losses.

Canadian Couch Potato doesn’t think that now is the time to abandon bonds.

Where Does All My Money Go? knocks off a few cobwebs and features a podcast with Som Seif who launched Claymore back in 2005 and is now CEO of Purpose Investments.

My Own Advisor gave a great summary of the 2013 Canadian Personal Finance Conference that was held in Toronto last weekend. I had a great time at the conference and enjoyed answering questions as part of a panel. Many thanks to Mark Goodfield, a.k.a. The Blunt Bean Counter, for a great talk and his gift of a sleeve of 3 golf balls. I’ll try not to lose them all on the same hole.

Million Dollar Journey offers some detailed financial advice for a 53-year old woman with a modest income.

The Blunt Bean Counter has a short TFSA quiz to test your understanding of the contribution limit rules.

Big Cajun Man observes that the typical career earns only about 1000 biweekly pay cheques, and you’d better start thinking about building some savings before they run out.

Life Insurance Canada has some sound advice for buying life insurance. I liked the part where he said that the word “investment” in connection with life insurance should be preceded by the word “crappy”.

Wednesday, September 25, 2013

A Reader Question about Choosing Winning Mutual Funds

A long-time reader who prefers to remain anonymous asked an interesting question about a strategy to pick winning actively-managed mutual funds. Here is an edited version of his question:
I'd love to hear your input on a friendly discussion with a good friend on active mutual funds versus passive indexing. I fall on the indexing side of the debate but I'm having trouble finding flaws with the approach he's been using.

He looks for 5-star active funds with "low-risk, high-return" characteristics as dictated by Morningstar and/or Scotia Research, then selects funds that have performed better than the group average over short and medium term (1 month to 3 years) under the same management. He will then hold these funds and review every 3-6 months or so, selling them if they no longer exceed the group average returns.

Whenever I pick a suitable index (regardless of asset class, though he favors Canadian and Global Small Cap), his funds have almost always done considerably better than the index, even after accounting for the high MER (often 3%+).

Other than the risk of that particular manager departing the fund right after he buys it, I'm having trouble identifying the downside.

Is it a viable approach or just luck so far?
There was a short period of time when I used to pore over mutual fund listings trying to puzzle out which funds would outperform in the future. However, the studies I’ve read all agree that this is futile because good performance does not persist into the future.

It isn’t possible for such studies to try every possible way to choose funds. You could focus on any one of several different time-periods for returns (1 month, 3 months, 6 months, 1 year, 3 years, 5 years, or 10 years). You can vary how often you make changes, and you can add in other criteria such as the reader’s friend did with manager persistence. So, there is no study that specifically looks at the exact strategy described above.

When someone looks at past data and tries out different strategies, this is called data mining. Even if 90% of funds fail to match their benchmark index over 10 years, you can always use data mining to find a strategy that would have chosen mostly funds in the winning 10%. Even if the strategies are just random, eventually one of them will happen to choose past funds that outperformed.

Perhaps the reader’s friend didn’t do any data mining and just happens to have a strategy that has performed well recently. The problem we’re now faced with is that we can’t distinguish skill from luck. Maybe this new strategy will perform consistently well for the next 20 years. But more likely, it will perform randomly, and because most funds underperform, a random strategy is likely to underperform. If this turns out to be the case, then the 3% MERs will become quite painful.

In the end it’s impossible to tell if an active strategy is a winner or if the investor is simply lucky. But just going by the track record of supposedly winning strategies, I’m not optimistic about this one. A further problem is that even winning strategies don’t work forever. I can’t say for certain that the reader’s friend is simply lucky, but I won’t be betting any of my money on this strategy.

Monday, September 23, 2013


Nassim Taleb’s latest book Antifragile is hard for me to describe succinctly. It contains a number of interesting ideas that made me think, which is a very good thing. On the other hand Taleb sets a new standard for incomprehensible meanderings. Taleb sees himself as part philosopher, but I can usually understand the writings of philosophers.

Two of Taleb’s previous books had messages important in shaping a sound investing strategy. Fooled By Randomness teaches that we tend to mistake skill for luck and see patterns when there is just randomness. Most sensible investors should conclude that they do not have the skill to trade against investing professionals even if they feel like geniuses in a rising market.

Taleb’s The Black Swan teaches that extreme events are much more likely to occur than standard theory based on the Gaussian bell curve predicts. However, I preferred the treatment of this subject in Benoit Mandelbrot’s earlier book The (Mis)Behavior of Markets. Investors should conclude that they need to consider how their finances would be affected by extreme events such as equities dropping by 50% at the same time as losing one’s job. Considering such a possibility seriously dampens enthusiasm for leverage.

I can’t say that Antifragile adds much to these two investor lessons. Perhaps it reinforces the need for investors to protect themselves against extreme events.

Taleb labels anything that tends to be harmed by random events as “fragile”. For the opposite, he does not use “robust” because he is not looking to describe things that are not harmed by randomness; he wants a word for things that are actually helped by randomness. For this he coins the term “antigfragile”.

Readers can be forgiven for thinking that all things fragile are bad and antifragile good. This is not the case. For example, lottery tickets are antifragile because the downside is very limited and extreme randomness gives a huge upside. However, lottery tickets are still bad because the expected return is so low.

Giving examples of the incomprehensible sections of this book would require unreasonably long quotes, so I’ll just give a few amusing short quotes:

Risk “is both predictive and sissy.” Antifragility is “nonsissy.”

“We have managed to transfer religious belief into gullibility for whatever can masquerade as science.”

“Science is an anti-sucker problem.”

Taleb is no fan of newspapers “with their constant supply of causes for things.” I read newspapers but understand what he means whenever I read an inane headline like “markets drop amid Syria concerns.” We seem to yearn for explanations, even when there is no reason to believe they are correct.

“Risk is in the future, not in the past.” This is a great criticism of data mining. If you build an investing strategy that can handle all the shocks seen in some stretch of the past, you may be leaving yourself wide open to new types of shocks or larger shocks.

Taleb is no fan of people who make economic predictions but aren’t held to account. “Overconfidence leads to reliance on forecasts, which causes borrowing, then to the fragility of leverage.”

The people that Taleb most dislikes are labeled “fragilistas”. This seems to mean someone who advocates economic policies that make our economy more fragile. If a given shock causes some amount of damage, a more fragile economy would suffer more damage from the same shock.

In a diatribe against the metric system Taleb says “A meter does not match anything; a foot does.” He goes on to go through several British units claiming they are all natural in some way, but that metric units are not. This is all nonsense. The only virtue of British units is that they are familiar to some.

Apparently, applying ice to injuries is a “naive version of an interventionism,” and “there is no empirical evidence in favor of reduction of swelling.” I’ve played a lot of sports in my life and I estimate that I’ve used ice to control swelling perhaps 1000 times. This may seem like a lot, but it’s only 3 times per month for about 30 years. Of the perhaps 100 times I was too lazy to apply ice I regretted it almost every time. There may be good examples where medical intervention has questionable benefit, but using ice to control swelling is a terrible example. I think this is a case where Taleb is able to come up with a very intelligent-sounding reason to avoid doing something he doesn’t want to do.

“Corporate managers have incentives without disincentives.” This is very true. Stock options give corporate managers huge paydays if their risky leveraged strategies pay off. If the strategies flame out, investors eat the losses (or taxpayers for too-big-to-fail businesses).

One of the most coherent parts of the book is Appendix II on economic models and how they blow up. Unfortunately, I didn’t understand any of the remedies discussed in Table 12.

Overall, I’m glad I read this book because it made me think about a number of subjects in a new way. However, I have a hard time recommending it to others.

Friday, September 20, 2013

Short Takes: Renting Out a Room, Floating Rate Notes, and more

Here is my post for this week that drew quite a few reader comments:

One Thing Investors Must Do for Themselves

Here are my short takes and some weekend reading:

Potato does some analysis to show that renting out part of your house doesn’t help all that much to make Toronto’s high house prices more affordable.

Dan Hallett points out problems with floating rate note (FRN) funds that some investors like because they don’t have to lock in long-term fixed rates and suffer if interest rates rise. The trouble is that these funds carry significant risk that isn’t properly reflected in fund risk ratings.

Big Cajun Man had some post-dated cheques stolen from his son’s school which led to him paying several stop payment charges. A fee of $12.50 seems manageable until you have to pay it 10 times, but not 11 as his bank tried to charge him.

Million Dollar Journey answers a reader question about which type of investment account is best for holding Canadian index ETFs.

Tuesday, September 17, 2013

One Thing Investors Must Do for Themselves

Despite my enthusiasm for do-it-yourself investing, I understand that most people need help. The problem is that far too many investors who seek help end up just being sold expensive mutual funds. This got me thinking about what is the minimum that investors need to do for themselves; what one thing can they not afford to leave to their advisors? Here is my suggestion:

All investors should be able to work out for themselves how many dollars they pay per year in fees across their portfolios, including management expense ratio (MER) costs, fund loads, commissions, and any other costs.

Instead of focusing on the “top ten things to look for in a financial advisor,” investors would do well to learn enough to be able to protect themselves from bad advisors and recognize good advisors. I think the knowledge required to add up portfolio costs is a great starting point for learning how to evaluate advisors.

Reasonable financial advisors should be able to help their clients understand how to add up costs. Investors who don’t know what they pay in fees and don’t know how to work it out for themselves have no idea if they are being taken for a ride or not.

I’ve been told by several people that they have a “great financial guy,” but many of these people aren’t even aware that this great financial guy gets paid out of their savings. Instead, these people should be able to say “I paid $2850 in total portfolio costs last year and the service I got for this money was worth it.”

No doubt we could all come up with a lengthy list of things people should understand about investing, but given that so many investors start with so little knowledge, I recommend learning how to identify costs as a starting point. I’m open to opinions on other starting points, but I’m not interested in making a list. If there is something better than my suggestion, then let’s replace it rather than add to it.

Friday, September 13, 2013

Short Takes: Efficient Markets, Pound Foolish, and more

My posts for this week:

Getting Some Money Back from Tyco Stock

Mystery of the Missing Month of Savings

Here are my short takes and some weekend reading:

Potato tells the amusing story of an article making fun of traders who seemed to confuse stock tickers on different exchanges. However, these traders didn’t seem so confused after all.

The Blunt Bean Counter explains how CRA could hit you with a 20% penalty on unreported income.

My Own Advisor explains why he isn’t a fan of mortgage life insurance.

Big Cajun Man has his wife give a turbulent account of trying to get a cheap hotel room.

Wednesday, September 11, 2013

Mystery of the Missing Month of Savings

If you save $1000 per month and earn no interest, you’ll have $12,000 at the end of one year. What if this goes on for two years? You might naively think you’d have $24,000 saved, but an authoritative source says this isn’t right.

According to the Globe and Mail’s Pay Yourself First calculator, you’d only have $23,000 saved after two years of saving $1000 per month.  (As of 2016 Nov. 2, the Globe and Mail finally dropped this calculator from its web site.) To see this, punch in an annual salary of $100,000 with 0% for the salary increases and 0% rate of return, and set the “pay yourself” rate at 12%, with one year of saving. The result is a retirement fund of $12,000 as you would expect. Now bump it up to 2 years of saving. The retirement fund jumps to $23,000.

I’m not sure where the missing month goes, but apparently every year after your first year of saving you lose a month. After 3 years of saving you have $34,000, and after 10 years you have $111,000.

I first wrote about these surprising results almost 7 months ago. I received a message from the Globe and Mail saying “Thanks for drawing the problem to our attention. We are investigating.”  However, the calculator remained online for a long time.

Monday, September 9, 2013

Getting Some Money Back from Tyco Stock

When Tyco stock cratered a little over a decade ago, I was one of many investors who lost a lot of money. Tyco was sued for allegedly overstating their financial results and paid a $50 million settlement. A couple of years ago I was invited to share in the spoils of this settlement.

I had thought that my claims were rejected but was pleased to receive a small cheque in the mail recently. My share of the settlement was only 0.18% of my losses on Tyco stock, but somehow it felt good to get this token amount. At $18 returned for each $10,000 I lost on Tyco stock, this settlement doesn’t make up for much, but it gave me a warm feeling anyway.

I don’t miss my days of poring over company financial statements looking for stocks to buy. I don’t expect to participate in any more investor lawsuits.

Friday, September 6, 2013

Short Takes: Profiting from Telemarketers, Your “Enough” Number, and more

My posts for this week:

More Buy-High and Sell-Low Advice

The Physics of Wall Street

Here are my short takes and some weekend reading:

Freakonomics has a great story about someone in the U.K. who found a way to profit from telemarketers.

My Own Advisor takes a run at calculating his “enough” number – how much he needs per month in retirement.

Million Dollar Journey finally answers the question of how the blog will change once Frugal Trader hits the magic million-dollar net worth mark. It turns out that the blog won’t simply shut down :-)

The Blunt Bean Counter clarifies some of the new T1135 reporting rules on foreign investments.

Big Cajun Man seems to have a talent for prompting CRA to ask for proof of some of his tax slips. Maybe when I don’t get reviewed by CRA it’s a sign that I’m not taking enough deductions.

Thursday, September 5, 2013

The Physics of Wall Street

The book The Physics of Wall Street, by James Weatherall, is a fascinating account of the advances in understanding financial markets made by physicists. The book delves into the personal lives of physicists who made their fortunes on Wall Street and gives an overview in clear language how they made their money.

It’s possible to get something out of this book even if you don’t know much about the mathematical side of investing, but it is primarily for readers interested in advances in the math used by quants over the years to beat the market.

For example, the book explains the difference between normal and Cauchy distributions and the range of other stable distributions between these two. Benoit Mandelbrot showed that the pattern of investment returns are wilder than the normal distribution and are better modeled by the more complex distributions between normal and Cauchy.

Over time, each physicist had to come up with progressively better methods to beat other investors who quickly learn about past techniques. The description of fairly recent genetic algorithms should be enough to convince most investors that they are far out of their league in trying to beat the market. As Weatherall says, “there is still a place for sophisticated investors to profit. You just need to be the most sophisticated investor.”

I highly recommend this book to anyone with an interest in the mathematics of investing. Others may choose to take a pass.

Tuesday, September 3, 2013

More Buy-High and Sell-Low Advice

Here’s a quote from Andrew Allentuck in this weekend’s Financial Post:
“If you are paying more in management expenses and commissions than you get in dividends and capital gains over a period of three to five years, consider changing portfolio mix or managers who created the mix.”
Basically, this means “if your portfolio goes down over three to five years, make a change.” This is bad advice in a couple of different ways:

1. During most three to five-year periods, this is a very low standard. If the markets rise by 5% per year over three years and your investment fees consume this entire gain and more, you’re paying wildly excessive fees.

2. Most times that stock markets have a serious correction, the three-year return will be poor. Allentuck’s advice has you making a change when markets are down. Investors tend to seek safer investments when stock markets are down. This advice drives buy-high and sell-low behaviour which is devastating to long-term returns.

Investors would be much better off to minimize fees during good times and bad. They also need to choose an asset allocation with volatility they can stomach and then stick with it through market drops.