Thursday, October 28, 2010

Looking For Mr. GoodFund - The Search for the Perfect Hedge Fund - Prologue

Finding a hedge fund with supersized returns and tiny correlations, is my mission. Is it mission impossible or merely mission difficult? Of course, with perfect hindsight finding a hedge fund that historically had superior performance with a low correlation to the markets is easy.  Finding a hedge fund that can outperform in the future is a different matter all together.

I plan to write a series of blogs about the process as I search for  those hedge funds. It is October 28, 2010 and I hope to have finished my assignment by the end of November. In the next blog I will discuss some of the criteria I will be screening on, and some observations about the hedge fund industry in Canada.

Wednesday, October 27, 2010

Commodity Fundamentals Look Positive

iShares S&P 500 (IVV) Vs SPDR Gold Trust ETF (GLD), Power Shares DB Agriculture Fund (DBA) 

Not only have stocks enjoyed a rally since the summer but so have commodities. Gold surged to an all-time high of $1,387.35 an ounce. Tin is at a record high and so is cotton. Soy beans have rallied 16 percent this year and corn has surged 37 percent.

There are a number of cyclical, and event driven factors that are at play. Stronger corn prices are a result of lower corn production forecasts, due to poor weather in the U.S corn belt. A drought in Russia, leaves wheat supplies at 25 year lows. A strong economic rebound in the developing countries, has caused a dramatic improvement for commodities. The causes of the current strong prices are many, and some may be temporary. However, the underlying fundamentals of a constrained supply, a weak U.S. dollar, and surging demand from  emerging markets particularly China are likely to result in stronger prices in the future. 

PowerShares DB US Dollar ETF (UUP) Vs 
PowerShares DB Commodity ETF(DBC) 
Commodities prices are mostly denominated in U.S. dollars and a falling dollar translates into rising commodity prices. The U.S. government has spent large amounts to keep the U.S. economy afloat during the financial crisis and is soon expected to see a $1.8 trillion gap between revenue and expenditure. These massive federal deficits undercut the dollar's value. A simulative  monetary policy does as well. Quantitative easing (i.e. printing money) in the U.S. is expected to further flood the financial system with cheap dollars raising a concern for higher inflation in the future. The possibility of currency wars as many countries try to get  competitive by devaluing their currency, will likely play an increasing role in rising commodity prices as well.

The demand for commodities in the emerging markets is the biggest reason for higher commodity prices. In 2006, the emerging markets' share of world output outpaced developing markets in nominal GDP terms. As those economies try to catch up to the developed, the the use of commodities intensifies as  the  standard of living improves and the countries become more urbanized.

As these nations become increasingly more industrialized, the sheer number of workers who will be buying their first house, their first car, and their first television are raising per capita consumption and demand of commodities. The world's urban population is growing by 70 million people per year and soon over half of the world's population is expected to live in urban areas. As populations migrate from rural areas into urban settings, additional schools, roads and other infrastructure will be required to accommodate them. This building boom of essential infrastructure is expected to propel demand for commodities like steel, concrete, oil and copper for years to come.

Bottom Line
Commodities have a place in a portfolio as as a means of improving diversification and reducing risk. The possibility of strong prices in the next few years, makes the use of commodities even more compelling.

Sunday, October 24, 2010

Should You Join The Tiger-21 Club?

Image Source: Hollingsworth, John Karen  , U.S. Fish and Wildlife Service

The Tiger is on the prowl and I do not mean Tiger Woods. Tiger-21, (The Investment Group For Enhanced Returns for the 21st Century)  is opening up for business in Canada and is looking for new members. If you are a decamillionaire (have $10,000,000 in investments),  “Tiger Worthy”,  and willing to spend the  $30,000 per year membership dues, you can join this exclusive club.

According to their website Tiger-21 ”is a peer-to-peer learning group for high-net-worth investors. We help members build the skill set to successfully transition from focused entrepreneurs to disciplined managers of wealth. Participating in professionally-facilitated, 12-14 person groups, our members meet monthly to harness the varied expertise and collective intelligence of their peers in high-energy, day-long sessions.”

Since Thane Stenner, has been appointed Managing Director  for Tiger-21 in Canada, they have been actively recruiting new members. They plan to have 56 members in total in Canada with groups in Vancouver, Calgary, Toronto and Montreal. In a recent interview with Jon Chevreau of the Financial Post , Mr. Stenner, discussed the plans for Canada, some of the criteria for joining, and the benefits of being part of this exclusive networking group.

Would I ever join the Tiger -21?  That is a moot point  because I am definitely not Tiger Worthy,  with a net worth closer to 0 than it is to their minimum requirement of $10,0000,000.

Should an investor join the club? If the purpose of joining was to improve the performance  of their investment portfolio or looking for new investment ideas then there are cheaper and more direct ways of accomplishing that goal. For $30,000 a year, an investor can buy a lot of expertise to improve their investment performance. If an investor wanted to hear investment  ideas from  speakers like David Rosenberg or Bill Gross, much can be found for free on the internet.

The value in joining, in my opinion is the networking possibilities with like-minded, successful businessmen. Meeting with a dynamic group of investors could  be worth the  $30,000 a year in membership fees. I also believe the ideas coming from the group,  will be more valuable than the ideas that come from the investment experts brought in to speak.

Bottom Line  

Will Tiger-21 reach their 56 member limit? I believe it is quite likely. According to BMO there are about 27,000 households with over $10,000,000 in investments. If only 0.207% join or  1 in every 482 Decimillioniares then their goal will be reached.

Thursday, October 21, 2010

Ten Commandments of ETF Investing

I have been following, investing in, and recommending ETFs since they first came on the scene. Much is written about them daily, but very few articles and blogs provide any new advice or insights into them. However, a recent article titled 10 Commandments of ETF Investing published by ETF Database - The Guide to ETF Investing provided 10 well written commandments, that all ETF investors should follow. They are:

  • Honor Thy Expense Ratio
  • Consider The Total Cost Of ETF Investing
  • Thou Shall Not Use Market Orders Recklessly
  • Thou Shall Not Covet Your Neighbors Weighting Methodology
  • Thou Shall Not Bear False Witness Against ETFs
  • Thou Shall Not Make Wrongful Use of The Name "ETF"
  • Thou Shall Not Use Liquidity Screens
  • Not All ETFs Are Created Equally
  • Thou Shall Buy Commodity ETFs (But Only If You Truly Understand Them)
  • Thou Shall Take Advantage of Free ETF Resources

Wednesday, October 20, 2010

Do Commodities Have a Place in Your Portfolio?

Most investors are well diversified within the equity asset class, both domestically and globally. Once diversified, trying to reduce risk further will have little impact as individual stocks, the different equity markets, and investment styles are highly correlated with each other. Moreover, correlations has been increasing in the last few years. Bonds traditionally have been used to diversify, but with record low rates, the prospects for decent returns are poor.

In order to reap the benefits of diversification, the investor needs to add non-correlated assets to  their portfolio.  The use of commodities can offer this improved diversification to an investor's portfolio. Commodities, like oil, gold, copper, wheat or cattle are impacted by factors considerably different from those that influence stock and bond returns and volatility. This makes commodities intrinsically different from stocks and bonds, resulting in a low correlation.

The prices of commodities respond more to current supply–demand conditions, whereas the prices of equities and bonds, respond more closely to the longer-term outlook. Commodities will react to events that in most cases are not related to the underlying economy. As an example a poor harvest of corn in the U.S can have signification price ramifications not only to corn but other agricultural products as well. We have all seen what happens to the gold price in time of any international crisis.

In addition, commodities can hedge against unanticipated global growth. As emerging countries  move up the development chain they consume commodities more intensely on a per capita basis, placing upwards pressure prices of those commodities.
 Risk Return Profile of Adding Commodities

Not only do commodities have low correlations with traditional asset classes and the overall business cycle but correlations are also low between the different commodity sectors. Historical data indicate that their long term have been similar to those on equities, and the volatility of commodities is only modestly higher than that of equities. But when commodities are combined with a traditional portfolio the overall risk is reduced.

Another option of investors is to buy the  common shares of companies that produce commodities as a proxy for the underlying commodity. As an example an investor can buy energy stocks instead of oil. The problem with this strategy is that the return is affected by factors other than the commodity’s price. The investor is buying the management talent and financial structure of the companies, but management, based on sound reasoning, may decide to hedge production, limiting the upside move in commodity prices. Generally returns on the stocks of commodity producers are not as highly correlated with the returns on the commodity as they are with the returns on the stock market as a whole.  In other words, commodity-related stocks behave more like other stocks than their underlying commodity.

Until recently, commodity exposure was usually  through commodity futures making it out of reach to all but the most sophisticated investors and institutional traders. These barriers are eliminated for the investor with the advent of diversified commodity fund and exchange traded funds and exchange traed notes. 

There is no question that adding commodities, will improve the diversification of a portfolio. More over the arrival of ETFs and ETNs make it easy for an investor to gain broad commodity exposure. However, if using ETFs fully understand, how they are constructed and ensure they are used properly in your portfolio. 

Monday, October 18, 2010

Big Banks Pursue Big Bucks

Big banks that formally were  known by names like the Royal Bank of Canada, but now are better known as letters and logos want you as clients - if you are a very high net worth individual with assets greater $5,000,000 and especially the uber-wealthy with assets north of $30,000,000.

RBC, BMO, and UBS have all announced recently, that they are making organization changes to target and provide more customized services to the very high net worth and ultra-wealthy  Canadian families.

Their belief is that high net worth people have more complex needs than just managing the investments.  Therefore, rather than an individual using different organizations and advisors, they can get all their advice and service under one roof. The private bankers will offer a full collection of bespoke services including investment management, legal, accounting, estate planning, trust services and philanthropy in an upscale atmosphere.

Depending on the account size and the complexity, each client might work with several advisers, and generate significant fees for the banks. The business of dealing with wealthy families is not only prestigious, but quite lucrative. It is likely that other banks in Canada, will make announcements in the near future that they too, will be targeting the same group of wealthy Canadians.

Competition should be heating up for those investor with significant assets. As a consumer, competition is always good as there will be more options and choices available. Some of those services might even trickle down and become available to a broader client base. The competition  will not likely result in lower costs and fees. It has been my observation that the Canadian banks do not try to attract  more business by chopping prices. They would rather compete on based on “service” and the “brand promise” they make to clients.

We do expect more direct marketing to those very high net clients, as the banks try to retain their own customers and aggressively pursue other bank's clients. As I write this blog, it is likely that they are building a dossier on many potential targets as they try to make a connection with them.

If you are looking for a new investment relationship or a private banker comes knocking at your door, it is important to have a clear understanding your objectives and current requirements. What services do you currently need and are you  properly serviced by your current advisers. As an example, if you have a good lawyer and accountant, do you need one of their lawyers or accountants.
If you want to choose a new relationship with one of the big banks, it is important to get them to compete for your business rather than decide after hearing one sale's presentation. Prepare a  request for proposal and have 3 different banks make their presentation on what specifically they can do to meet your requirements. This process will assure that each participant puts their best foot forward. Also, the proposals can be compared easily. The likelihood of making a good choice improves dramatically. Often hiring an investment consultant  like Ohow Investor Consultants can help manage this process for you and will work with you to ensure you make the correct decision. Often their fees can be recouped through a negotiated discount with the manager.
The Bottom Line
As the big banks  focus is placed on the ultra wealthy, there will be more and more services available to them and other less wealthy investors. Also they are likely to be more aggressively pursued. If you are looking for a new investment relationship, it is important to have a clear understanding your objectives and current requirements and ensure that the potential suitors compete for the business.

Friday, October 15, 2010

Flattening Yield Curve: Good For Stocks But Bad For Banks

As the concerns about the economy have lessen, the Bank of Canada has moved to a more neutral monetary policy resulting in a gradual rise in short term interest rates. At the same time, long term rates have dropped reflecting  a re-emergence of deflationary fears in the U.S. This has caused a flattening in the yield curve as the spread or the difference between short and long term rates has narrowed.

Government of Canada Interest Rates

91 Day Tbill
10 Year Bond
April 28,2010
October 13,2010

The change has been significant. The current difference between long and short rates is 1.83% compared to 3.27% less than 6 months earlier. This phenomena has been happening the U.S. as well.

In a recent article Is the Flattening Yield Curve Good For Stocks?,  Liz Ann Sonders, Chief Investment Strategist for Charles Schwab & Co., Inc., discussed the implication for the stock market when the yield curve flattens. Her conclusion was: “Historically, a narrowing of the yield curve has been tied to stocks performing reasonably well.” In the 10 periods they studied when there has been a sharp decline in the yield  curve, the S&P was up on average 5.21% 3 months later,  and 17.97% 12 months later.

Although a flat yield curve might be good for stocks, it is generally considered  to be negative for bank stocks -  certainly compared to the rest of the market. Banks will typically borrow money at the short end and lend out money at the long end of the yield curve. The profit margin will shrink as the spread between long and short term rates narrows.

In the chart below, the S&P/TSX Composite is higher than it was  6 months ago yet the Financial sector is still below. The Financial sector has underperformed the overall market by 10% in the last 6 months. This under performance is similar in the U.S. and EAFE countries.
iShares S&P/TSX Composite (XIC) versus S&P/TSX Financial Sector Index (TTFS)
Bottom Line
As of October 14, 2010, the Financial Sector is the largest Industrial sector in the S&P/TSX Composite with a 29.1% weight. Most Canadian investors will have significant portion of their Canadian equity portfolio in Financials. It is important to  check  the sector weight in your portfolio and if it represents  more than 30%, then reducing the exposure could mean better performance and lower risk for your portfolio over the next 6 to 12 months.

Thursday, October 14, 2010

Are You Rich, Uber Wealthy or Just Affluent?

most expensive cars in the world 2010 Ferrari Enzo
Ferrari Enzo

In marketing a product or service it is important for a business to define their target market and then define a strategy to sell to that specific market segment. As an example Ferraris are marketed differently than Kias, It is no different in the Investment Management and Advisory business.

As a marketing man would say, a well defined target is the first principle to a successful marketing strategy. In the investment business the most common way of defining the market is based on the amount of investible assets an individual or family owns. There is no precise definition as it will vary depending on the financial institution.  Wealthy  and affluent investors  will have assets of between $100,000 and $1,000,000; high net worth individual have between $1,000,000 and $5,000,000; a very high net worth client  is defined as  between $5,000,000 and  $30,000,000 and ultra high net worth  investors have greater than $30,000,000.

In the The Merrill Lynch – Capgemini World’s Wealth Report  of 2009  it is estimated to that in  2008 there were 8.6 million High Net Worth Individuals (HNWI) worldwide representing total wealth of US$32.8 trillion, and that by  2013 HNWI wealth will be valued at $48.5 trillion. In Canada, according to the financial research firm Investor Economics,  there were 544,000 high-net-worth households in Canada. By estimates of BMO’s market research estimates there are about 27,000 homes in Canada with investment asset of greater than of $10-million.

Bottom Line
As an investor, the investment opportunities, advice and service offered to you is based to a large degree on your wealth. As the level of wealth rises, so does the quality of advice and service. It is important therefore to assure that you have the quality of investment advice you deserve.

Please Allow Me To Introduce Myself

Ken Hawkins is the founder of Ohow Investor Consultants, a private investment office, set up to help high net worth investors effectively manage their investment portfolios. Ohow is the Cree Indian word for “Owl” and the Owl has become to symbolize, wisdom, prophecy and prosperity.

As a seasoned investment professional Ken has gained considerable knowledge in the many facets of investment management including portfolio management, investment consulting, quantitative research, investment strategies and the unique challenges of working with high net worth private investors.

Prior to founding Ohow Investor Consultants, Ken was  the Chief Investment Strategist at Weigh House Investor Services, a Portfolio manager with Ontario Teachers’ Pension Plan,  A Quantitative Analyst/ Strategist with Scotia Capital and Deutsche Morgan Grenfell and as an Investment Advisor with ScotiaMcleod and BMO Nesbitt Burns.

The objective of this blog is to provide information, insights, about the implementation of investment stratifies and the process of managing the investment assets specifically for the high net worth investor. This blog will also discuss the unique characteristics of the high net worth investors and those who provide the service, products and advice to them.

Our philosophy for the investment management is as follows:
  • The optimal approach to investment management, involves a mix of both passive and active investment strategies utilizing the strengths of both approaches and minimizing their weakness.
  • Costs and fees are an inevitable part of managing investment assets. Minimizing cost is important, but more important is assuring you get the best value out of the fees that are paid.
  • A simple, eloquent, easily understood, but well diversified portfolio is always preferred to a complex, overly diversified portfolio.
  • Developing and following the correct investment policy and asset mix, understanding and managing risk, and the proper rebalancing of asset classes and investment managers are most important factors for investment success.
  • Investors should think of themselves as the CEO of their investment portfolio, like being a CEO of an operating company.