Acting in the best interests of clients

by James Parkyn

Some of Canada’s big banks took quite a lot of criticism recently for their decision to stop selling mutual funds from outside companies through their financial planning arms.

CIBC, RBC and TD claim the decision to allow financial planners to sell only inhouse funds is in response to new regulations that come into effect at the end of this year. Those regulations are known as know your product (KYP) and are part of a larger package of client-focused reforms (CFRs) being brought in by the country’s securities regulators.

The KYP rules are designed to ensure investment firms and their advisors have a deep knowledge of the products they recommend to clients.

For firms, this means having policies, procedures and controls in place to monitor investments offered to clients and providing training to advisors on them. For advisors, it means recommending only firm-approved investments and demonstrating they understand what they are recommending and ensuring they are suitable for a client’s portfolio.

The overall goal of the client-focused reforms is to create a higher standard of advisor conduct that will put clients’ interests first. Essentially, it could be viewed as a codification and enhancement of industry best practices that many firms and advisors are already incorporating—from gathering detailed client information to demonstrating product knowledge to revealing potential conflicts and putting clients’ interests first.

The decision by the three big banks to stop selling third-party mutual funds sparked an outcry from critics in the media and the financial industry who say the banks are not acting in the best interests of their clients. They argue the banks are using the new rules as an excuse to sell only their own funds, which are more profitable for them, through financial planners in branches. (Third-party funds will still be sold by the banks’ full-service brokers and their online discount brokerages.)

Globe and Mail columnist Rob Carrick noted the banks are depriving investors of the opportunity to choose better alternatives available from third-party fund companies and said the three big banks are “effectively turning their planners into sellers of bank products.”

For my part, I hope the actions of these three big banks will lead clients to reflect on what they want and should expect from their investment advisor.

The country’s securities regulators introduced the new client-focused reforms after resisting calls to bring in the more rigorous fiduciary standard for investment firms in the face of stiff opposition from the industry.

At PWL Capital, we have long adhered to a fiduciary standard in our client dealings and have argued it should be applied throughout our industry. Under a fiduciary standard, a firm must put its client’s interests above its own and act strictly in a client’s best interest.

For many years, our firm has been accredited by the Centre for Fiduciary Excellence (CEFEX), a global organization that audits and certifies the processes of investment advisory firms.

CEFEX-accredited firms adhere to the Global Fiduciary Standard of Excellence. To obtain this accreditation, PWL was required to undergo an extensive “best interest” review—and, to maintain this status, we must undergo annual audits by CEFEX.

At PWL, we don’t have any in-house products. We have a list of approved securities that includes only investments that have been researched by the firm and approved by our investment committee.

These investments are all low fee and tax efficient. They offer no compensation to PWL, or the firm’s advisors, and they reflect our philosophy that passive portfolios and broad diversification are the keys to long-term investing success.

In all these ways, we demonstrate our steadfast belief that investment advisors must always act in the best interests of their clients. It is the bedrock upon which our firm is built.

The bonds in your portfolio are doing their job

by James Parkyn

It’s been another very good year for stocks and another lacklustre one for bonds. That’s led many investors to wonder whether they should be allocating more money to stocks and less to bonds.

To the end of September, Canadian stocks were up 17.5% this year while bonds were down 4% (including interest and dividend income). Despite this performance, our advice is to proceed cautiously when considering increasing the equity weighting in your portfolio at the expense of bonds.

Yes, stocks have had strong returns since the markets bottomed out from the COVID crash in March 2020 while rock bottom interest rates have meant paltry bond yields of little more than 1%.

However, bonds do more work than just contribute to your overall returns. They play a critical role in diversifying your portfolio by acting as a shock absorber when corrections hit the stock market.

This is because bonds—especially the short-term, high-quality ones we favour—are much less volatile than stocks.

That’s important to remember at a time when equity markets have been so strong for so long. Even before the rapid recovery from the pandemic shock, stocks had a great run dating back to the rebound from the 2008-09 financial crisis. The good times have desensitized many investors to risk as we see in the surge of speculative trading in hot stocks, cryptocurrencies and special purpose acquisition companies. But risk hasn’t gone away.

We can see the shock-absorbing effect of bonds through a metric known as the Sharpe ratio. Named for its inventor, Nobel laureate William Sharpe, it measures the performance of an investment compared to a risk-free asset, after adjusting for risk. When comparing two portfolios, the one with a higher Sharpe ratio provides a better return for the same amount of risk.

As economist and market strategist David Rosenberg demonstrates in this article the addition of a meaningful portion of bonds to a portfolio dramatically improves risk-adjusted returns.

Rosenberg calculates that an all-stock portfolio over the last five years had a Sharpe ratio of 1.08 compared to 1.2 for a portfolio composed of 60% equities and 40% bonds and 1.25 for a 50/50 mix. So, despite the low returns of bonds over the last five years, the Sharpe ratio increases because the bonds substantially reduce the volatility of the portfolio. The same pattern can be seen over 10-, 20- and 30-year periods.

Besides being a buffer against volatility in the stock market, there’s another reason why bonds are useful in a portfolio. When the stock market suffers losses, you can use your bond allocation to raise cash to cover your spending needs, while you wait for equities to recover. You can also use it to buy stocks when they are down.

Of course, a 100% stock portfolio will have higher expected returns, but it is also riskier. Good portfolio management involves finding the right balance between risk and reward given your goals and tolerance for risk.

The bottom line is we believe a bond allocation should viewed as a portfolio stabilizer, not an impediment to maximizing your returns. Experience has taught us that a lower volatility portfolio is going to produce better, more tax efficient performance over the long run than a highly volatile one.

So, don’t worry about your bonds, they’re doing their job.

4 essential investing lessons from the last two decades

by James Parkyn

At PWL Capital, we believe it’s crucial to take a long-term view of investing. That’s why I sat down recently with my colleagues François Doyon La Rochelle and Raymond Kerzérho to talk about our investing lessons since 2000 for an upcoming episode of our Capital Topics podcast.

The common denominator in our discussion was the importance of patience for successfully building your wealth over the long term.

You only have to consider the many momentous events that have occurred during the last two decades to understand why patience is so important. The list includes the bursting of the tech bubble in 2000, 9/11, the Afghanistan and Iraq wars, an extended bear market in 2001-03, the financial crisis of 2007-09 and, most recently, the COVID-19 pandemic.

Through it all, the stock market has kept going up. Since September 2001, the S&P 500 has gained an annualized 8.2% per year in Canadian dollars, while the S&P/TSX Composite in Canada is up an annualized 8.1%, and the combined MSCI EAFE and Emerging Markets index is up 6.6%.

If you had let your emotions get the better of you and bailed out of the markets in response to any of the events listed above (or the many others of lesser importance), you would have deprived yourself of those gains.

With that in mind, here are the four most important lessons to take away since 2000.

1. You don’t know what you don’t know

This phrase encapsulates the deceptively simple observation that no one knows what the future holds or what impact events will have on the markets. For example, no one could have predicted the terrorist attacks of September 11, 2001, or the devastation of the global pandemic.

Howard Marks, co-chairman of Oaktree Capital Management, summed up the importance of intellectual humility when investing this way: “No amount of sophistication is going to allay the fact that all of your knowledge is about the past and all your decisions are about the future.”

2. You can’t forecast the future, but neither can anyone else

This lesson is a corollary to the last. Despite the impossibility of predicting the future, many economists, analysts and active investment managers earn their money trying to do just that.

All the noise they create can lead you astray from your investment plan with dire consequences for your wealth.

3. Investor behaviour and discipline are crucial

To avoid pitfalls, it’s essential to develop a disciplined investing mindset. This means filtering out the noise of the moment and sticking resolutely to a long-term view that’s guided by your investment plan.

A well-designed investment plan is a roadmap you can return to when times are tough and you are tempted to stray off-course. Your portfolio should be aligned with your risk tolerance and risk capacity. It should also be tax efficient and broadly diversified. These are the factors you can control.

4. Evidence-based investing works

I recall in 2003 when as a firm we made the decision to implement fully passive portfolios. My experience in the years that followed has confirmed my belief that adhering to scientifically verified principles of sound investing is the best way for our clients to have a successful investing experience.

It has produced solid investment results for them and remarkable growth for PWL Capital as more and more people have embraced the power of low-cost passive investing and the other best practices we follow. It’s an approach to investing that gives clients the confidence to stick with their investment plan through good times and bad.

Be sure to download our podcast to hear more investment lessons from the past two decades. You can also learn more about the fundamentals of evidence-based investing by downloading your free copy of our eBook, 7 Deadly Sins of Investing.

Steps you can take to manage the risk due to cognitive decline

by James Parkyn

Cognitive decline is a topic most people would rather not think about, and that’s the danger when it comes to preparing for this risk.

Diminished mental capacity can lead to a devastating loss of savings built up over a lifetime due to poor bad decisions, unfortunate misjudgement or financial exploitation.

With the large baby-boom generation growing older, it’s a subject that’s starting to gain more attention. Indeed, a recent article in the Wall Street Journal called cognitive decline the biggest financial risk facing baby boomers.

The Canadian Securities Administrators (CSA), the umbrella group for the country’s securities regulators, has published new rules for registered investment firms and advisors to enhance protection for older and other vulnerable clients.

The following rules will come into force at the beginning of next year:

• Trusted contact person—Registrants (firms and advisors including PWL Capital) will be required to take reasonable steps to obtain the name and contact information of a trusted person from clients as well as their written consent for the trusted person to be contacted when there are concerns about financial exploitation or the client’s mental capacity to make financial decisions.

• Temporary holds—A regulatory framework is introduced to guide registrants in placing a temporary hold on transactions, withdrawals or transfers in circumstances where they have a reasonable belief that there is financial exploitation of a vulnerable client, or where there are concerns about a client’s mental capacity to make financial decisions.

The stakes are high for seniors and their families. Canadians who are 65 or older now represent nearly 17% of the population. They control $541 billion in non-pension financial assets, representing 39% of such assets controlled by Canadian households, according to Statistics Canada data cited by the CSA.

The Wall Street Journal article reports that rates of mild cognitive decline and dementia increase from a combined 12% for ages 70 to 74 to 45% for those 80 to 84, according to a report by the Center for Retirement Research at Boston College.

Mental capacity can diminish gradually and may not immediately affect a person’s ability to perform routine financial tasks such as paying bills. However, it can make complex or unfamiliar decisions even more difficult, including buying and selling investments, calculating asset allocations and efficiently managing withdrawals from registered and taxable accounts.

Do-it-yourself investors are of particular concern. The use of discount brokers has rocketed during the pandemic and DIY investors typically have little or no contact with an investment advisor.

The WSJ article notes: “Do-it-yourself boomers may be more vulnerable in some ways because they’re calling the shots solo, without help from wealth advisers. So, if they go off the rails, no one else may know. ‘That’s the danger with do-it-yourself investors—they may be overconfident,’ says Michael Finke, a professor of wealth management at the American College of Financial Services.”

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 At PWL, we believe it’s important to have a long-term plan to mitigate the risk exposure due to the possibility of cognitive decline. In putting your plan together, you should involve your loved ones and professional advisors, so they understand where your assets are located and your wishes for their management.

Here are some steps you should consider when planning in the event of diminished mental capacity.

• Simplify your finances before possible cognitive decline begins. This may include reducing the number of accounts you have, selecting simpler investments and transferring investments from DIY accounts to advised accounts.

• Identify a trusted advocate and an alternate who understand your financial objectives and will act as your trusted contact person. These may be family members, close friends or outside professionals, such as accountants or lawyers. However, it should never be the investment advisor who is managing your investments.

• Regularly review and update any general or limited powers of attorney you currently have and get an enduring power of attorney (or mandate of protection in Quebec) that will be used if you lose the capacity to manage your affairs.

• Collect either in a binder or an internet vault a list of financial goals and all your financial account numbers and passwords as well as a list of regular monthly bills and any other important information and records.

For more information on this subject, please listen to our discussion in episode 22 of our Capital Topics podcast.

We are sensitive to the concerns people have about cognitive decline and the many issues it raises. Please contact us if you wish to discuss how we can help you prepare yourself or your loved ones for this unfortunate possibility.

Should you be worried about high inflation?

by James Parkyn

If you follow the business news, you know there’s been a lot of speculation lately about whether we’re heading into a period of persistent high inflation.

The trigger for these concerns has been a spike in prices that saw May headline inflation hit 3.6% in Canada and 5% in the U.S.

Some economists are concerned that long-term inflation is being stoked by massive monetary and fiscal stimulus to fight the pandemic recession, combined with pent-up demand from consumers and supply chain bottlenecks as the global economy reopens.

Should we be worried? While we don’t make forecasts about where the economy or the markets are heading, there are signs inflation fears may be overblown.

Both the Bank of Canada and the U.S. Federal Reserve insist the current inflation surge is transitory and there remains a lot of slack in the economy. Although disagreement has emerged recently within the Federal Reserve leadership over the seriousness of the inflation threat.

More importantly, the bond market is not signalling high inflation expectations. If the millions of investors who make up the bond market foresaw a sustained bout of higher inflation on the horizon, they would bid up interest rates. In fact, rates did move sharply higher earlier this year, but since mid-May, they have dropped by .10% in Canada and .25% the U.S.

Looking at the longer term, many observers believe high consumer and public debt and an aging populations are secular trends that will keep a lid on inflation. Economist David Rosenberg believes once things settle down towards the end of the year, the focus will shift back to deflation as the real threat.

Certainly, the stock market hasn’t shown any negative effects so far from the upswing in inflation. It remains at or near all-time highs in Canada and the U.S.

While the stagflation period of the 1970s produced terrible equity returns, inflation has historically been good for stock prices when it’s accompanied by economic growth.

The Credit Suisse Global Investment Returns Yearbook looks at the impact of inflation on global stock and bond returns from 1900 and 2020. It shows that real returns turned negative only in the worst 20% of inflation occurrences. It also found that long-term bonds were hit far worse than stocks during bouts of high, sustained inflation.

So, how should investors think about the today’s cross-currents of information and opinion about inflation?

Your first reaction should be to tune out the day-to-day noise in the media. Nobel Prize winning economist Eugene Fama noted in a recent webinar that future inflation movements are even harder to forecast than interest rate and stock movements, which is to say they are impossible to predict.

Nevertheless, we know inflation is an important variable in financial planning and a risk to be considered. To manage it and other risks, it’s critical to have a financial plan and to be disciplined in sticking with it through market volatility.

To protect against inflation, choose high-quality, short duration bonds for the “safe” portion of your portfolio. Shorter duration bonds turn over more quickly and thus avoid the heavier losses that longer-term issues suffer when inflation and interest rates rise.

Allocate the rest of your portfolio to stocks and higher yielding income securities, ensuring you are globally diversified because inflation might not hit all countries at the same time.

Ignoring the noise and focusing on the fundamentals of prudent investing are the best ways to grow your wealth and keep your peace of mind, no matter what happens in the economy and markets.

To learn more about good investing practices, get a free copy of our new eBook, the Seven Deadly Sins of Investing.