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In this Episode, James Parkyn & François Doyon La Rochelle will be reviewing the performance of capital markets for the first half of 2024. It is a subject they cover twice yearly to help their listeners better understand and evaluate their portfolios’ performance.
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Fehlende Folgen?
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In this Episode, James Parkyn & François Doyon La Rochelle present James’ latest eBook called “The New Retirement”
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In this Episode, James Parkyn & François Doyon La Rochelle will start the new year by covering the global capital markets performance for 2023.
Then, they tackle how to measure your portfolio performance. Which goes hand in hand with the first topic.
Links to share:
Episode 48: 2022 Investing Lessons & 2023 Outlook — Capital Topics By James Parkyn & François Doyon La Rochelle https://www.capitaltopics.com/listen-here/episode-48-2022-investing-lessons-and-2023-outlook
- Market Statistics - Parkyn Doyon La Rochelle - December 2023 - PWL Capital By Raymond Kerzérho https://www.pwlcapital.com/resources/market-statistics-parkyn-doyon-la-rochelle-december-2023/
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In this Episode, James Parkyn & François Doyon La Rochelle will first discuss year-end tax planning strategies for investors in Capital Market Securities
Then, they will chat with Raymond Kerzerho, PWL’s Senior Researcher, about his latest blog regarding Canada’s major pension plans.
Links to share:
Episode 56 : RESP Withdrawal Planning and Investor Home Market Bias — Capital Topics By James Parkyn & François Doyon La Rochelle
Episode #52 : The New Tax-Free First Home Savings Account FHSA — Capital Topics By James Parkyn & François Doyon La Rochelle
Twelve Observations About the Big Canadian Pension Managers and Eight Takeaways for Individual Investors - PWL Capital By Raymond Kerzérho -
In this Episode, James Parkyn & François Doyon La Rochelle will address why we prefer using total market ETFs or mutual funds to build our portfolios rather than other investments solutions.
They also share their thoughts on a real hot button issue for all Canadians, Taxes!
Raising taxes on top income earners is often proposed as a solution for generating a lot of extra revenues and at the same time reducing inequality in Canada.
Links to share:
Raise taxes on high income earners? Let’s try another approach — Capital Topics By James Parkyn - https://www.capitaltopics.com/blogue/raise-taxes-on-high-income-earners-lets-try-another-approach US Total Market or S&P 500 ETFs? - PWL Capital By Raymond Kerzérho - https://www.pwlcapital.com/us-total-market-or-sp-500-etfs/ -
In this Episode, James Parkyn & François Doyon La Rochelle give a brief overview of how registered education savings plan works and what are the best strategies to tap into your RESP savings most efficiently.
They also drill down into the stock component of your portfolio and on how much global exposure you should have.
Links to share:
- The Debate About the 60/40 Balanced Portfolio and the Review of the RRIF Mandatory Withdrawal Rules — Capital Topics By James Parkyn & François Doyon La Rochelle
- Capital Topics episode 23: The High Cost of Investing in Hedge Funds - PWL Capital By James Parkyn, Raymond Kerzérho & François Doyon La Rochelle
- Canadian Home Bias: A Case for Global Equity Diversification | Vanguard Canada By Bilal Hasanjee - Vanguard
- Global equity investing: The benefits of diversification and sizing your allocation (vanguard.com) By Scott J. Donaldson, Harshdepp Ahluwalia, Giulio Renzi-Ricci, Victor Zhu & Alexander Aleksandrovich – Vanguard
-The Canadian Equity Market Isn’t as Canadian As it... | Morningstar By Dan Lefkovitz
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In this Episode, James Parkyn & François Doyon La Rochelle review the Market Statistics as of June 30,2023 and update their listeners on Inflation.
Market Statistics – June 2023 : Market Statistics - Statistiques de marché (pwlcapital.com)
Read The Script:
1) Introduction:
François Doyon La Rochelle:
You’re listening to Capital Topics, episode #55!
This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
In this episode, we will discuss the following points:
- For our first topic, we will review and comment the market statistics for the first half of the year.
- And for our next topic, we will give you an update on inflation.
- Please note before we move on to our topics that we will take a summer break. We will be back for our next episode on September 28th.
Enjoy!
2) Mid-Year Review of Markets:
François Doyon La Rochelle: I will start today with a review of the market statistics as of June 30, 2023. So, after a very difficult year in 2022 when pretty much all asset classes posted big losses, I’m sure our listeners will be relieved and happy to hear that in the first half of 2023 stocks and bonds are generating positive returns. These positive returns are across the board as all the asset classes we follow, except for one, are in positive territory. As a reminder, you can find our Market Statistics report on our Capital Topics website in the resources section or on the PWL Capital website in our team section. We will provide the link for the market stats on the podcast page.
James Parkyn: Indeed François, after the historical devastation where both stocks and bonds were hammered with double-digit negative returns, investors should be quite pleased with the returns so far this year.
François Doyon La Rochelle: Totally James, particularly given the fact that most market pundits were skeptical about the outlook for markets entering the year. Many of them were forecasting a recession that has not yet materialized.
James Parkyn: Correct it has not materialized yet, GDP growth continues to be positive, personal consumption remains stubbornly strong and jobs are still being created at a strong pace both here in Canada and the U.S. Market Pundits are however expecting GDP growth to slow and even contract in the coming months on the back of the historic interest rate tightening cycle imposed by the central banks. As a reminder to our listeners, to tame inflation that had risen to multi decades highs last year - 8.1% here in Canada and 9.1% in the U.S., the Bank of Canada increased its overnight rate from 0.25% in March 2022 to 5% in July 2023. In the U.S., the Federal Reserve increased the Fed fund rates from 0.25% to 5.25% over the same period.
François Doyon La Rochelle: I must say that this tightening cycle had the desired effect on inflation since it has come down here in Canada and the U.S. to 2.8% and 3% respectively which is close to the long-term target of 2% set by both central banks. This said, the tightening cycle caused collateral damages particularly in the U.S. regional banks as the sharp interest rate increases left some banks in delicate positions prompting the intervention of the Federal Reserve.
James Parkyn: Regional banks were not the only worry for the markets in the first half of the year, there was, yet another debt ceiling political crisis in the U.S. that dominated the headlines for several weeks until an agreement to raise the debt limit was reached in June.
François Doyon La Rochelle: Despite all this noise, the stock markets have had a strong first half, particularly in the U.S. and the internationally developed markets. Those equities are now in the bull market territory and have risen more than 20% from the lows reached in October 2022. We will look at the details a bit later, but the S&P500 Index in the U.S. is up, in U.S. dollars, by 27.5% since the lows, and the index for internationally developed equities, the MSCI EAFE (Which is the acronym of Europe, Asia and the Far East) is up roughly 32.8% since the lows. Here in Canada, we are not yet in a bull market since the S&P/TSX Composite is up only 12.8% from October’s 2022 lows.
James Parkyn: This may be surprising for some investors who are still emotionally caught up in the recency bias of last year. Capital market history teaches us that strong bull markets most often follow painful bear markets.
François Doyon La Rochelle: Absolutely James and there is a good chart from Dimensional in their mid-year review that shows, based on data from the Fama/French Total US Market Index extending from July 1926 to December 2022, that historically, after a market decline of 20% or more, the average return one year later is 22.2%, the cumulative average return after 3 years is 41.1% and the cumulative average return after 5 years is 71.8%.
James Parkyn: Yes, this data is very powerful as it is a stark reminder that you need to stay disciplined in bear markets by staying invested and sticking to your long-term plan. You can’t afford to be out of the market when it turns positive.
François Doyon La Rochelle: Despite this nice rally from last year’s bottom, it must be mentioned that the main indexes have not fully recovered to where they were at their all-time highs.
James Parkyn: Effectively, the S&P500, the MSCI EAFE, and the S&P/TSX Composite are still between 5% to 7% off their previous peaks as of June 30th.
François Doyon La Rochelle: With this being said let’s now look at the market statistics as of June 30th. Let’s start with the Canadian fixed income. 2022 was a historically difficult year for bonds as it was the worst year in many decades. Canadian short-term bonds in 2022 were down 4.04% and the total bond market, which holds longer-dated maturities was down by a whopping 11.7%. Year-to-date as of June 30th, despite an increase in the interest rate of 1% by the Bank of Canada, the Canadian short-term bonds are up 1.01% and the Canadian total bond market is up 2.51%.
James Parkyn: It’s nice to see positive numbers in the bond market again, however, the performance you are quoting Francois is total return numbers, which includes interest income. If we look at bond prices, remember bond yields and bond prices move in opposite directions, short-term bonds on a price basis were down slightly. Longer-duration bond prices were up a bit.
François Doyon La Rochelle: You are right James, bond prices are down but especially in the short end because of the impact of the latest interest rate increases from the BOC. As an indication the yield on the benchmark Government of Canada 2-year bond was 3.82% at the beginning of the year and it now sits at 4.21%, so the price went down. The yield on the Government of Canada 10-year bond was 3.30% at the start of the year and it was 3.26% on June 30th, so the price went up.
James Parkyn: For those looking for the safety of GICs, there are some juicy rates available now. For example, you can get over 5.5% for a 1-year GIC and about 5.2% for a 5-year.
François Doyon La Rochelle: Now let’s look at equities, stock markets around the globe were up everywhere year-to-date. Canadian equities were up by 5.70% led mainly by growth stocks since the large and mid-cap growth stocks had a performance of 8.1% versus 4.0% for large and mid-cap value stocks. Small-cap stocks also delivered a positive return with a performance of 3.0% year-to-date as of June 30th. In the U.S., the total stock market is up 16.2% in USD but because the Canadian dollar gained relative to the US dollar the performance in Canadian dollars was 13.5%. Year-to-date, large and mid-cap growth stocks vastly outperformed value stocks with a performance in Canadian dollars of 26% versus only 2.7% for value stocks. Small cap returned 5.6% in Canadian dollars with small growth again outperforming value with a performance of 10.9% versus 0.1% for small value.
James Parkyn: This is a complete reversal of what happened last year when large and mid-cap growth stocks were down significantly more than large and mid-cap value stocks. What is significant this year, is that a handful of mega-cap stocks are dominating the returns in the U.S. stock market. According to Morningstar, as of May 31st, 97% of the return on the Morningstar U.S. Large and Mid-Cap Index, which performs closely with the S&P500 Index, came from the 10 largest stocks in the index. This means that only 3% of the return came from all the over 700 stocks.
François Doyon La Rochelle: Yes, year-to-date performance in the U.S. market is very concentrated in a few stocks and a few sectors. Just looking at the top 5 holdings of the S&P500, which includes Apple, Microsoft, Amazon, NVIDIA, and Alphabet (Google) they have a performance year-to-date as of June 30th ranging from positive 36% for Alphabet to a whopping 189% for NVIDIA. In terms of sectors, 4 out of 7 sectors are experiencing negative returns in the first half. The sectors that are performing well are the technology, communication services, and consumer discretionary sectors. According to an RBC Global Asset Management report, since January 1st, 2020, only seven stocks in the S&P500 Index have produced more than half its cumulative return and these stocks are Meta, Apple, Alphabet, Microsoft, Amazon, NVIDIA and Tesla.
James Parkyn: Wow, this is impressive, but it means that if you are a stock picker and you did not hold any of these stocks in your portfolio you probably did poorly compared to the index. Remember there are thousands of stocks in the U.S. market and even more globally and research shows that most stocks, over very long periods, underperform one-month U.S. Treasury bills. This capital market history fact comes as a major surprise to most investors.
François Doyon La Rochelle: That’s correct and that’s one of the reasons why stock pickers have trouble beating indexes and why we use broadly diversified portfolios to make sure we have the winners in our clients’ accounts.
Finally, looking at internationally developed equities, large and mid-cap stocks were also up year-to-date, they were up by 12.1% in local currency. In Canadian dollars, international developed equities were up 9.1% since the Canadian Dollar appreciated against the basket of currencies included in the MSCI EAFE Index. Here again, large and mid-cap growth stocks have outperformed value stocks with a performance of 11.5% in Canadian dollars compared to 6.7% for large and mid-cap value stocks. Similarly, in the U.S. and Canada, the small-cap stocks trailed large and mid-caps with a performance of 3.1%, that’s also in Canadian dollars.
To conclude, emerging markets lagged compared to developed markets with a year-to-date performance of 2.6%, and contrary to developed markets' value and small-cap stocks fared better than growth and large-cap stocks.
So this wraps up the review of what happened in the Markets during the first half of the year.
3) Update on Inflation:
Francois Doyon La Rochelle: Our Main Topic today is an Update on Inflation. We have covered Inflation a lot since the spring of 2022. James, maybe we can start with a summary of where are we at now with Inflation Rates?
James Parkyn: Francois, Inflation cooled last month to its lowest pace in two years. As indicated earlier in the podcast, in the U.S., the consumer-price index or CPI climbed 3% in June from a year earlier, sharply below the recent peak of 9.1% in June 2022. The index for core inflation, which excludes volatile food and energy prices, in June also posted its smallest monthly increase in more than two years. The annual rate of inflation is now at the lowest it has been in just over two years. While the rate of inflation in the June CPI report remains above where the Fed wants it to be, the data suggests clear progress in getting price pressures down toward more acceptable levels.
François Doyon La Rochelle: In Canada, the news was even better. The latest Inflation number came in at 2.8% in June. What about Europe and the UK James?
James Parkyn: In Europe, inflation has eased to 5.5% in the 20 countries using the euro and to 7.9% in the U.K., but that’s still far above the Central Banks’ 2% target.
François Doyon La Rochelle: Does there appear to be a consensus among economists? Can Central Banks declare victory over Inflation?
James Parkyn: Nick Timaros in the WSJ reported in a recent article that: “Some Fed policymakers and economists are concerned that the easing in inflation will be temporary. They see inflation’s slowdown as long overdue after the fading of pandemic-related shocks that pushed up rents and the prices of transportation and cars. And they worry underlying price pressures could persist, requiring the Fed to lift rates higher and hold them there for longer.” So their biggest fear François is about whether wages and price growth can slow enough without an economic downturn.
François Doyon La Rochelle: Karen Dynan, an economist at Harvard University is quoted in that article. She states, “While things seem to be heading in the right direction with inflation, we are only at the start of a long process”. So, James, what are economists on the other side of the debate saying?
James Parkyn: Nick Timaros goes on to state: “Other economists say that thinking ignores signs of current economic slowing that will gradually subdue price pressures. They also argue inflation will slow enough to push “real” or inflation-adjusted interest rates higher in the coming months. That would provide additional monetary restraint even if this week’s rate increase is the last of the current tightening cycle”.
François Doyon La Rochelle: So, the debate is really around wage inflation. The first camp of economists is nervous that there is too little slack and too much demand in the economy. They are not confident that inflation will return to the Fed’s 2% inflation target in the coming years.
James Parkyn: Exactly. Many of these economists worry that wage growth is too strong. Without a recession, they see a tight labor market pushing up core inflation next year. Since an overheated labor market is likely to show up first in wages, many see pay gains as a good proxy of underlying inflation pressure. The thinking is that 3.5% annual wage growth would be consistent with inflation between 2% and 2.5%, assuming productivity grows around 1% to 1.5% a year.
François Doyon La Rochelle: According to the U.S Labor Department’s employment-cost index, wages and salaries rose 5% in the January-to-March period from a year earlier. The Fed watches this index closely because it is the most comprehensive measure of wage growth.
James Parkyn: The second camp of economists believes there is ample evidence that the labor market is cooling, in turn reducing inflationary pressures. They point out that the amount of time it takes unemployed workers to find new work has been growing. Increases in hours worked by private-sector employees have slowed along with the number of unfilled jobs. Benjamin Tal, the deputy chief economist at CIBC World Markets, is quoted in the Global Mail that: “He expects the economy to be bleeding vacancies as opposed to jobs. Namely, companies will not be hiring but not be firing.”
François Doyon La Rochelle: The encouraging news about inflation falling is that it has created space for the Central banks to be more patient and take their time about any further rate hikes.
James Parkyn: To support that point François, the Fed in the U.S. last month held its benchmark federal funds rate steady in a range between 5% and 5.25%. This was the first pause after 10 consecutive increases since March 2022, when officials raised it from near zero. As a reminder for our audience, the conventional thinking is that Interest-rate increases slow the economy through financial markets by lowering asset prices and raising the cost of borrowing. As we can see by what has happened in the financial markets and the economy, this has yet to transpire.
François Doyon La Rochelle: On July 27th, the Fed increased the Fed Funds rate by 25 Basis points to a target range between 5.25% and 5.50%. This was widely expected by the markets. This matches the prior peak reached over 2006-07. You’d have to go back to 2001 to find a period when rates were higher than today. The speed and size of the hikes (over 500 basis points in 16 months) are unmatched by any Fed tightening campaign since 1980. That said, CPI inflation is getting close to the Fed’s 2% target. What are Central Bankers saying about the latest inflation numbers James?
James Parkyn: They are all staying on message insisting the pain will only get worse if inflation slips out of control. The governor of the Bank of England Andrew Bailey was quoted in the Financial Times: “Our job is to return inflation to target, and we will do what is necessary. I understand the concerns that go with that, but I’m afraid I always have to say – that it is a worse outcome if we don’t get inflation back to target.” Despite the risk of recession François, I feel the central bankers are emphasizing that they expect to keep rates at their peaks for some time – likely longer than stock and bond markets expect. They also appear to me to be very synchronized.
François Doyon La Rochelle: I agree James. The Bank for International Settlements (or BIS), the Switzerland-based global organization of central banks appears to agree as well. In a recent report, the BIS highlighted that since early 2021, almost 95% of the world’s central banks have raised rates. Even more than during the inflationary oil price shocks of the 1970s. The BIS called it “the most synchronized and intense monetary policy tightening in decades.”
James Parkyn: I think there is increasing acknowledgment that Policy mistakes were made during the Pandemic. That in turn requires that interest rates be normalized at much higher levels than the ultra-low rates in effect during the pandemic.
François Doyon La Rochelle: James, what are economists saying about the impact of fiscal policy or government spending on Inflation?
James Parkyn: David Parkinson writing in the Globe & Mail recently, asked the following question: “How much of Canada’s nagging inflation problem can we blame on government spending?” In his article in the wake of the Bank of Canada’s latest interest-rate increase, he highlights the fact Governor Tiff Macklem noted in the bank’s latest economic projections, government spending growth is running at about two percent. This is on par with the estimated rate that the economy’s potential output is growing. This implies that the government’s contribution to the economy’s supply-demand balance is neutral. In other words, it’s not helping the excess demand problem that continues to fuel inflation pressures, but it’s not compounding the problem, either. But he also goes on to make the case that if you compare government spending to pre-pandemic levels, fiscal policy is stimulative.
François Doyon La Rochelle: Intuitively, governments could also help fight inflation by reducing deficit-funded spending to cut demand. This would lower the pressure on Central Banks to raise interest rates further.
James Parkyn: To that point Francois, Gita Gopinath deputy executive director of the International Monetary Fund, in a speech at the European Central Bank’s (ECB) annual conference in Sintra, Portugal, last month argued “Some side effects of fighting inflation with monetary policy could be reduced by giving fiscal policy a bigger role. Indeed, economic conditions call for fiscal tightening,” She went on to say: “Given the economic conditions we have, both because of high inflation and record high debt levels, the two would call for a tightening of fiscal policy. If you look at projected fiscal deficits for many G7 countries, they look too high for far too long.”
François Doyon La Rochelle: She also warned and I quote her: “Central banks must accept the “uncomfortable truth” that they may have to tolerate a longer period of inflation above their 2 percent target to avert a financial crisis.” James, is there good news for Investors with lower Inflation?
James Parkyn: Yes, I believe there is good news for Investors in rates staying higher for longer. I also think that the real news is that we are now starting to get positive Real Interest rates. Finally, many Economists are forecasting lower Central Bank rates as early as 2024 and as far out as 2025. Morningstar chief economist Preston Caldwell stated in a recent report that “Inflation is now showing broad-based signs of deceleration,” says “The Fed is still likely to hike in its July meeting, but today’s CPI Inflation report supports our view that the Fed will pivot to aggressive cutting in 2024 after inflation falls.” François, we now know that the Fed effectively increased their Fed funds rate after July’s meeting.
François Doyon La Rochelle: For investors who have been avoiding fixed income because they’re afraid of rising rates, now is the time to revisit their fixed income portfolio. Investors are getting compensated on a real basis, meaning after inflation, from their bond investments, and that hasn’t been the case for quite some time.
James Parkyn: The perfect example is we are now getting much better rates on GICs. Recently, the GIC rates were 5.5% for 1 year, and about 5.2% for 5 years. These rates are significantly higher than our Estimate for Expected Return on Bonds of 4.26%. Our listeners can find our latest PWL Financial Planning Assumptions paper published on our PWL Website. Despite rising bond prices generally, yields are now higher than they have been for most of the past decade.
François Doyon La Rochelle: Right now, you’re getting a good income out of a fixed income. Rates look attractive. On a “real” basis, rates also look attractive when compared to inflation expectations for the coming years. For example, the PWL estimate for inflation is 2.2% a year, meanwhile, an investor buying a 5-year GIC, like you mentioned James, would get 5.2% or a real yield of 3%.
James Parkyn: In Conclusion Francois, the key for Investors is that even if the Fed raises rates a bit further, the end of the current cycle of increases is on the horizon unless there is a dramatic resurgence in inflation. As we have said many times, we do not preach market timing about stocks AND bonds. Specifically for bonds, don’t try to time the peak in interest rates.
I want to share with our listeners an interesting quote from Dimensional in their Mid-year Review report: “What investors do know is that markets will continue to quickly process information as it becomes available. A long-term plan, one focused on individual goals and built on confidence in market prices, can put investors in the best place for a good experience, whatever may be in store”.
François Doyon La Rochelle: In other words, James, don’t try to guess the end of the hiking cycle. As a reminder to our Listeners, our discipline is to invest with “The Investor Mindset, focused on the long term”. We don’t want to be led astray by short-term noise in the financial media and recent financial market volatility. This challenge is daunting and applies to all Investors including us Professionals. We have said it often on our Podcast: “It is simple to say but not easy to do: We must always be cognizant that we can fall into a trap of trying to “Forecast the Future”.
4) Conclusion:
François Doyon La Rochelle: Thank you, James Parkyn for sharing your expertise and your knowledge.
James Parkyn: You are welcome, Francois.
François Doyon La Rochelle: That’s it for episode #55 of Capital Topics!
Do not forget, if you would like to submit questions or suggestions for the show, please email us at: [email protected]
Also, if you like our podcast, please share it when with family and friends and if you have not subscribed to it, please do.
Again, thank you for tuning in and please join us for our next episode on September 28 exceptionally as we are taking a break for the summer.
Enjoy your summer and see you soon!
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In this Episode, James Parkyn & François Doyon La Rochelle review the latest eBook authored by James Parkyn titled Investing Life Skills for Early Savers.
This eBook is available on the Capital topics website and in our Team’s section on the PWL Capital website and will provide important life skills that will serve early savers on the road of making smart money decisions.
eBook:
Investing Life Skills for Early Savers - PWL Capital
Read The Script:
Introduction:
François Doyon La Rochelle: You’re listening to Capital Topics, episode #54!
This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
In this episode, we will review the latest eBook authored by James titled INVESTING LIFE SKILLS FOR EARLY SAVERS.
Enjoy!
Investing Life Skills for Early Savers :
François Doyon La Rochelle: In today’s Podcast, we will cover only one Topic which is a Review of the latest eBook Authored by you James titled INVESTING LIFE SKILLS FOR EARLY SAVERS. This ebook is available on the Capital Topics website and in our Team’s section on the PWL Capital website. This has been a major effort and, in our Team, we made a strategic decision a few years back to add Next Generation clients to our Practice which includes the children of our current clients.
James Parkyn: Yes, this has been a major undertaking as these younger clients are, in many cases, in the early stages of learning about saving and investing. In some cases, their thinking and experience are surprisingly advanced. In the case of the children of our clients, the parents were very happy we are undertaking this initiative. For them, it is part of their family values to help them develop what they consider to be an essential life skill going forward in their lives. Many of them also realize they wish they had started much younger than they did.
François Doyon La Rochelle: For our Listeners, this is an eBook format, so it is relatively short at 28 pages with a lot of pictures and graphic illustrations and, is meant to be an easy jargon-free read. James, what is the main message you are trying to get across to Early Savers?
James Parkyn: My main message is about the importance of starting early.
It is a life skill that will serve you well on the road of life and will give you the confidence to make smart money decisions. Just to be clear for our listeners, what we mean by 'Life Skills' are the skills you need to make the most out of life. Any skill that is useful in your life can be considered a life skill. Early savers need to make this a high priority.
François Doyon La Rochelle: You have had a lot of meetings with Early Savers over the last few years and what did you learn?
James Parkyn: First off, I had to connect with them, so I decided to start the conversation from the vantage point of “Start with Why”. The idea comes from Author Simon Sinek who wrote a highly regarded book on the topic.
François Doyon La Rochelle: What else resonates for them?
James Parkyn: Well, I always like to connect with anecdotes about music. I mention the song “Time” by Pink Floyd from the seminal album “Dark Side of the Moon published in the early 1970s”.
François Doyon La Rochelle: Ok, but this music is from their Parents' generation.
There is another song on that album called “Money”, but the lyrics are mostly political.
James Parkyn: To my surprise, many know Pink Floyd and the song. What I like about the lyrics from the song “Time” is that they convey a key message about the importance of starting early. I suspect the Band probably did not realize it when they wrote the words but somehow, they related a fundamental lesson about learning Investing Life Skills early.
François Doyon La Rochelle: What do the lyrics say?
James Parkyn: “Ticking away the moments that make up a dull day. Fritter and waste the hours in an offhand way. Kicking around on a piece of ground in your hometown. Waiting for someone or something to show you the way. Tired of lying in the sunshine, staying home to watch the rain. You are young and life is long, and there is time to kill today. And then one day you find ten years have got behind you. No one told you when to run, you missed the starting gun.”
François Doyon La Rochelle: Wow, that’s incredible how relevant the message is to our Topic. This new eBook is trying to help Early Savers to understand the importance of starting now. There will be no one to fire a starting gun to tell you to start learning and investing.
James Parkyn: Exactly Francois. For me personally the joy of seeing the light go on about Investing in Life Skills is because they realize the concepts are really “accessible”.
François Doyon La Rochelle: I like your choice of the word “Accessible” because it is very empowering to know and really feel “I can do this!”. So, James let’s get into the meat of the eBook content. What are the Life Skills Early Savers need to develop?
James Parkyn: We cover seven Investing Life Skills. The first Life Skill is Getting started. Investing in some Early Savers can be scary: “Where do I start? It is so complicated!” Even worse, some Early Savers may wonder “Why do I need to pay attention now? I have all my life ahead of me!” When you’re starting, it’s not easy to find the best route to achieving the financial goals you have set for yourself and your family. There are so many competing priorities to consider and only limited resources to commit to any one of them.
François Doyon La Rochelle: Adding to the challenge in today’s wired world with the internet and social media ever present, Early Savers have way too much information at their fingertips and in fact, what they are seeking is real knowledge and practical information that they can use to get started and to help them on this new journey they are starting.
James Parkyn: I agree which is why we explain key concepts to help Early Savers take the first critical steps on their financial journey. And yes, Francois, we hope they will learn how to make good decisions and avoid major mistakes.
François Doyon La Rochelle: Getting started is all about explaining the magic of compound interest. Maybe you can explain to our listeners what compound interest is.
James Parkyn: Compounding is no small thing. Albert Einstein is reputed to have called it the eighth wonder of the world. It’s the interest on the interest you’ve already earned. In other words, compounding is the money you earn on your original investment, plus the money you earn on the returns already accumulated over time.
François Doyon La Rochelle: There’s another important reason for getting started early on your investing journey. You will be getting into the habit of saving while learning the principles of investing and building your confidence.
James Parkyn: Precisely! When you have lived through many bear markets and as you know Francois, we have had four since 2000, then your experience as an Investor with a Long-Term Mindset you will be less likely to panic sell because you have a well-engineered diversified portfolio is that you will recover and go on to grow in value.
François Doyon La Rochelle: What’s a good way to get started?
James Parkyn: Early Savers should set up an automatic withdrawal from their bank account that goes directly to an investment account. That’s called paying yourself first (before all your other expenses), and it works because you naturally adjust your spending to the amount of money you have on hand.
François Doyon La Rochelle: James let’s discuss the second Life Skill Early Savers need to develop: Managing your Human Capital.
James Parkyn: Many people are unaware of their most valuable asset. It remains hidden in plain sight because it’s taken for granted. What is this asset? Your potential to generate income over your lifetime. It’s called your human capital and can be defined as the present value of all your future earnings. For most people, that works out to a huge number, especially if you’re young. Your human capital is even more valuable because it’s a hedge against inflation. Earnings tend to rise with the cost of living.
François Doyon La Rochelle: James the term “present value of all your future earnings” is jargon for many Listeners and Early Savers.
James Parkyn: Human capital is the present value of all future wages from working. You can increase your human capital by continuing your education or going for on-the-job training. Think of all your future expected earnings that you will take home as compensation up to the time you will retire from working. Then, estimate what it would be worth as a lump sum of investment capital.
François Doyon La Rochelle: As it grows, you also need to protect your human capital in the same way you safeguard other important assets.
James Parkyn: If you’re like most people, you’ll be rich in human capital when you start out in your working life, but poor in financial capital. As you move through your career, your goal should be to convert your human capital into financial capital by earning, saving and making good investment decisions. Both forms of capital are important, give them both the attention they deserve.
François Doyon La Rochelle: When you add into the mix the compound return on both Human and Financial Capital that is how you get to financial independence however you may define it. James let’s now discuss the third skill Early Savers need to develop: Cultivating an Investor Mindset.
James Parkyn: Many people approach investing as if it were a game of chance that can be won by placing bets on the latest hot stock or investment fad. Blackrock Asset Management surveyed in 2015, 51% of Canadians said at the time that they believe investing is like gambling. While investing and gambling both involve risking money in hopes of realizing a financial gain, that’s where the similarity ends. Investing – when done right – is about buying assets that have a positive expected return thanks to the income they pay and/or their long-term capital appreciation.
François Doyon La Rochelle: We have covered this concept in a past Podcast. The difference between Investing and Speculating sometimes is a question of perspective and timeline. Speculation often means you expect short-term easy gains. This is a question that challenges even us professionals.
James Parkyn: I agree. But for Early Savers, the Life Skill to develop is patiently sticking to a broadly diversified portfolio that reflects their risk tolerance and accepting that it may not produce the excitement of trying to hit the jackpot on a hot stock or a cryptocurrency. But they shouldn’t be investing for thrills. Your aim should be to achieve your long-term goals, and that’s not something to gamble on. I have heard the expression it is ok to lose money when you are young you can make it up later in life. I hate that and tell Early Savers to beware as if you look at the loss based on the effect of compounding over multiple decades of your lifespan then the loss is massively larger.
François Doyon La Rochelle: Next up is the fourth Life Skill Early Savers need to develop: Keeping Your Eye on the Long Term. What is your message about this Life Skill?
James Parkyn: Successful investors make consistent, smart money decisions and stick with them through market ups and downs over a period of decades. That requires discipline, an essential skill to learn early in your investing life. Develop your Plan and stick to it.
François Doyon La Rochelle: This is about not falling prey to the noise in the financial media and trading based on short-term capital market events and economic news. We have talked often on our Podcast about avoiding “market timing”. Researchers have found it’s one of the worst wealth-destroying mistakes you can make. A sharp downturn in the markets can be particularly difficult for some people to stomach. They talk themselves into the idea that they can pull out now and get back in when things get better.
James Parkyn: However, trying to time the market presents at least two problems. First, if you sell now, when will you know it’s safe to buy back into the market? Second, you risk missing out on gains while you’re on the sidelines and that can have a huge impact on your long-term returns. While it can be challenging, the best investment strategy – as supported by decades of academic research – is to hold a portfolio of broadly diversified, passively managed investments through good times and bad. Why passively managed? Because research clearly shows that most active fund managers underperform their index benchmark in any given year.
François Doyon La Rochelle: The fifth Life Skill Early Savers need to develop: Understanding Human Biases. James, what do you say to Early savers about the psychological aspects of Investing?
James Parkyn: I tell them they need to understand how their basic human instincts can cause them to make poor financial decisions. We all fall prey to mental and emotional biases that can lead to serious investing errors.
François Doyon La Rochelle: To control the influence of mental and emotional biases, you must first be aware of them and then guide yourself back to rational thinking and good decision-making processes. What are some of the key biases?
James Parkyn: Behavioral economics has been a huge growth area with two major Nobel Prizes being awarded to academics for their work in the past 20 years or so. There is an amazing amount of research that deals with Behavioral biases. I highlight the top 4 that I believe Early Savers should watch out for in your thinking about investments.
Recency Bias: This is the tendency to give greater importance to events that have occurred in the recent past. Recency bias can cause you to depart from your investment plan to jump on a hot market trend or sell during a market downturn.
Over-Confidence: It’s common for people to develop unwarranted confidence in their abilities, including their ability to make exceptional profits in financial markets. Overconfidence can lead investors to make risky bets based on a misguided belief in their ability to predict the future.
Confirmation Bias: This occurs when investors seek out information that confirms their point of view and discount divergent opinions.
Loss Aversion: Behavioral finance researchers have determined that people feel the pain of a loss about twice as strong as the pleasure they get from an equivalent gain. Loss aversion is another bias that can distort your decision-making by causing you to prioritize avoiding losses over earning gains.
François Doyon La Rochelle: Good investment advice and processes such as annual portfolio reviews, automatic contributions, and periodic portfolio rebalancing can help Early Savers keep their emotions in check and keep them on track with their Long-Term Investment plan. The sixth Life Skill Early Savers need to develop: Diversifying to Reduce Your Risk. This is another topic we address often on our Podcast. What is the message of this Life Skill?
James Parkyn: Diversifying your portfolio by holding many investments in different markets is a fundamental strategy for successful investing. Noble Prize-winning economist Harry Markowitz famously described it as “the only free lunch in finance.”
François Doyon La Rochelle: Markowitz demonstrated that when you combine assets that perform differently over time you lower the overall riskiness of your portfolio without reducing expected returns.
James Parkyn: It comes down to not putting all your eggs in one basket. When you own just a few stocks, the failure of any one of those companies can lead to a permanent loss of your savings. But when you own many stocks—ideally all of them in a given market— the poor performance of some will be offset by the better performance of others.
François Doyon La Rochelle: A word of caution: This doesn’t mean you will never lose, but your gains and losses will reflect those of the overall market. You’ve removed what’s known as unsystematic risk – the risk unique to a specific company or industry.
James Parkyn: The same principle applies to holding different asset types such as stocks, bonds, and real estate. Each produces different returns in any given period and by combining them in a portfolio you reduce its riskiness.
François Doyon La Rochelle: It may come as a surprise, but research shows that many investors hold woefully under-diversified portfolios.
James Parkyn: Fortunately, Early Savers can avoid this basic investing error by owning passively managed funds that allow you to broadly diversify at a very low cost.
François Doyon La Rochelle: The seventh and last Life Skill Early Savers need to develop: Controlling Your Emotions. James, how is this Life Skill different compared to learning about Human cognitive biases?
James Parkyn: Great Question Francois. As you said earlier, here is the message I want to convey is to pay attention to how you react emotionally to market volatility. Among the most important of these is to tune out media noise about the day-to-day movements in the markets and focus instead on your long-term Investment plan. It should have asset allocation targets that reflect your objectives and risk tolerance. As markets move up or down, you periodically rebalance your portfolio back to your target asset allocations and keep your faith that the process works overtime.
François Doyon La Rochelle: As we have stated before, The Financial Services industry and the Financial Media promote active management which pushes us to do a lot of trading. Think of all the industry advertising showing someone in front of a trading screen of stock quotes. Unfortunately, many Investors equate trading with adding value.
James Parkyn: I have a great quote from a longtime collaborator of Warrant Buffett, Louis Simpson, who oversaw investments at Berkshire Hathaway’s giant GEICO insurance subsidiary. He once said: “We do a lot of thinking and not a lot of acting. A lot of investors do a lot of acting and not a lot of thinking.” For me, this, in a nutshell, reflects how we manage our clients’ money and how we are different from most of the financial services industry. We buy very carefully; we hold and defer tax and rebalance when it makes sense to do so. We do this all while sticking to the Clients’ well-thought-out plans.
François Doyon La Rochelle: I love this quote too. Louis A. Simpson was one of Warren Buffett’s favorite fund managers and a one-time potential successor. He was much lesser known than Buffett or Charlie Munger. Sadly, he passed away at the beginning of 2022 at age 85. We should point out to our Listeners that by acting a lot he means trading a lot. So now, let’s get back to the Investing Life Skill of Controlling Your Emotions. When markets go up it’s relatively easy to keep your emotions in check for most investors when your portfolio goes up every day.
James Parkyn: Down markets are a fact of life when you invest. Taking a controlled amount of risk is what allows you to earn returns and build your wealth. However, falling markets can create anxiety and pressure to act which can feel overwhelming at times. This is when investors must control their emotions to avoid making errors that will lead to a permanent loss of capital.
François Doyon La Rochelle: All Investors must guard against the fact their thoughts can deceive them. You may think you’re making rational decisions when in fact your actions are being driven by fear. That’s why you should prepare yourself for market downturns by striving to recognize when you’re feeling under stress and cultivating strategies to deal with unhealthy emotions. James, you also provide recommendations for Books. What do you recommend?
James Parkyn: First, I recommend that the Early Savers read our eBook “7 Deadly Sins of Investing” that we published in 2021. It is in some ways a companion piece to this new eBook.
I also recommend two must-reads for Early Savers who want to develop a deeper level of knowledge:
The Psychology of Money by Morgan Housel: This is a very popular book and it is very useful to both Professional Investors and Individuals. award-winning author Morgan Housel shares 19 short stories exploring the strange ways people think about money and teaches you how to make better sense of one of life’s most important topics.
Think, Act, and Invest Like Warren Buffett by Larry E. Swedroe Think, act and invest like the best investor out there: Warren Buffett. While you can’t invest exactly like he does, Think, Act, and Invest Like Warren Buffett provides a solid, sensible investing approach based on Buffett’s advice regarding investment strategies.
François Doyon La Rochelle: James, you also provide recommendations for Books for Parents. What Books do you recommend for them?
James Parkyn: I recommend two very good but different books:
It Makes Total Cents by Tom Henske. He is an American author. Some material in this book is specific to Americans Investors and reflects US tax laws. It Makes Total Cents (spelled with a “c” as a play on words) is a short, easy-to-read bite-size guide to help parents. This concise book is meant to be read a chapter per month covering the 12 most important money topics that a child should understand before going to university or college.
The Wisest Investment by Robin Taub. She is a Canadian and her book is about teaching your kids to be responsible, independent, and money smart. Robin Taub lays out a roadmap for teaching your kids about money.
Financial literacy has been a long-ignored subject and the result has been generation after generation entering adulthood without a grasp of money basics. This eventually leads to unnecessary stress in adulthood and ultimately causes stress leading to health issues.
François Doyon La Rochelle: James, you also provide recommendations for Books for Parents. What Books do you recommend for them?
Conclusion:
François Doyon La Rochelle: So, this is it for today’s podcast Investing Life Skills for Early savers. Thank you, James Parkyn for sharing your expertise and your knowledge.
James Parkyn: You are welcome, Francois.
François Doyon La Rochelle: That’s it for episode #54 of Capital Topics!
Do not forget, if you would like to submit questions or suggestions for the show, please email us at: [email protected]
Also, if you like our podcast, please share it when with family and friends and if you have not subscribed to it, please do.
Again, thank you for tuning in and please join us for our next episode to be released on August 2nd.
See you soon!
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In this Episode, James Parkyn & François Doyon La Rochelle discuss a recent report from the C.D. Howe Institute that highlights the need to revamp the rules surrounding Registered Retirement Income Funds (RRIFs) withdrawals.
They also tackle the current debate over the classic way of building a balanced portfolio which is an allocation of 60% stocks & 40% bonds.
Links to share:
- Episode #52 : The New Tax-Free First Home Savings Account FHSA — Capital Topics by James Parkyn & François Doyon La Rochelle
- Episode 50: 2023 Update on Expected Returns — Capital Topics By James Parkyn & François Doyon La Rochelle
- The silver lining from a tough year in the markets is higher expected returns. — Capital Topics by James Parkyn
- A look back and forward at the 60/40 portfolio | Vanguard Canada By Vanguard Canada
-Live Long and Prosper? Mandatory RRIF Drawdowns Raise the Risk of Outliving Tax-Deferred Saving By William B.P. Robson & Alexandre Laurin at The C.D. Howe Institute
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Description:
In this Episode, James Parkyn & François Doyon La Rochelle revisit the basics of the recently launched Tax-Free First Home Savings Account (FHSA) and give their listeners some planning ideas.
They also perpetuate their annual tradition and review of the 15th edition of The Credit Suisse Global Investment Returns Yearbook 2023, Summary Edition.
Read The Script:
INTRODUCTION:
François Doyon La Rochelle:
You’re listening to Capital Topics, episode #52!
This is a monthly podcast about passive asset management and financial and tax planning ideas for the long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
In this episode, we will discuss the following points:
For our first topic, we will review and comment on the recently launched Tax-Free First Home Savings Account (FHSA)
And next, for our main topic, we will Review the Credit Suisse Global Investment Returns Yearbook 2023
Enjoy!
In the news: The New FHSA
François Doyon La Rochelle: In our first topic today, we will review and comment on the recently launched Tax-Free First Home Savings Account (FHSA). This is a topic that we covered in episode #45 of this podcast back in October 2022 but since then, as of April 1st, the legislation governing these types of accounts has taken effect, so we thought it was a good time to revisit the basics and give you some planning ideas.
James Parkyn: Yes, for many of our clients and our listeners, this is a hot topic that deserves our attention since it’s probably the most significant tax break ever offered to help Canadians save money tax-free for the purchase of their first home.
François Doyon La Rochelle: I totally agree, so let’s start and remind our listeners of the basics of how an FHSA works. The first question to ask is, who can open a First Home Savings Account? So, to be able to open an FHSA, you must be a tax resident of Canada aged between 18 and 71. Furthermore, you or your partner cannot have owned a home in the current calendar year or any of the previous 4 calendar years.
James Parkyn: One interesting nuance here to highlight is, although you can only participate once in the program, if you are now renting, but you were a homeowner let’s say 6 years ago, you could still qualify as a first-time homeowner and open an account.
François Doyon La Rochelle: Correct, once you have opened your account, you can contribute up to $8,000 per year to a lifetime maximum of $40,000. If you don’t contribute the full $8,000 in a given year you can carry forward the unused portions of your contribution room up to a maximum of $8,000. This means that if you contribute less than $8,000 in one year, you can contribute your unused amount in a future year. For example, if you open an FHSA in 2023 and you only contribute $4,000, in 2024 you would be allowed to contribute $12,000. That is the $8,000 for 2024 and the $4,000 for your unused contribution room for 2023. Also, like with the RRSP, your contributions are tax-deductible, meaning that any amount you put in will be deducted from your taxable income, therefore reducing your income tax.
James Parkyn: An interesting planning strategy here, especially for younger folks that are just starting their careers and that may not be earning a lot of money, is that you don’t have to claim a deduction in the tax year you have made your contribution. Your contributed amount can be carried forward and deducted in a later year when your income will be higher. This way you can get a bigger tax deduction for your contribution. For parents wanting to help their adult kids buy their first home, since attribution rules don’t apply, they can give money to their kids for their contributions.
François Doyon La Rochelle: Also, contributions to a FHSA doesn’t have any impact on your regular RRSP contribution room so, if someone is fortunate enough and has the funds available, he could contribute to both type of accounts and use the tax refund to contribute to their regular TFSA. There is an important caveat however, once you open your FHSA, it can only remain open for up to 15 years or up to the end of the year when the account holder turns 71. At that point, if the funds have not been used to buy a first home, it can be transferred on a tax-free basis to an RRSP or RRIF or it can be withdrawn.
James Parkyn: We would not recommend withdrawing the funds as the amount withdrawn would be added to your income and taxed. This said, since the transfer to an RRSP would not impact, nor would it be limited to someone’s RRSP contribution room there is another planning idea here for renters. Lifetime renters that don’t intend to ever buy a house and that have maximized their RRSPs could open an FHSA and maximize their contributions to it. This way, since the funds accumulated in an FHSA can be rolled over tax-free to a regular RRSP the renters would effectively be generating an extra $40,000 of RRSP contribution room.
François Doyon La Rochelle: Yes, this is effectively one of the loopholes of this new program. Even then, if you are unsure whether you will be buying a house in the future, there is not much downside in opening an account and making the contributions because in the end if you don’t buy a house, you can rollover the funds accumulated tax-free to your RRSP or RRIF. So, if you don’t have the funds to make contributions to both the FHSA and the RRSP it would make sense to put money in the FHSA first. Talking about RRSPs, if you were planning to use the funds accumulated in your RRSP to buy your house with the Home Buyers Plan (HBP) you will be happy to hear that you will now be able to use the funds from both types of accounts to purchase your home. As a reminder, at first, when the legislation was introduced, you could not combine both plans.
James Parkyn: This is huge since prospective first-time home buyers could add another $35,000 in down payment.
François Doyon La Rochelle: Yes, this is very interesting, however unlike with the FHSA, the amount withdrawn from your RRSP with the HBP must be repaid within 15 years, starting the second year after the year of the first withdrawal. So, the HBP is essentially only a way to borrow money from your RRSP.
James Parkyn: Correct, in any case, I would recommend anyone to open a FHSA as early as possible to benefit from tax-free compound growth. If you open your account early and you make the maximum contribution each year, you can invest your funds more aggressively since the account can remain open for up to 15 years before you need to cash it out to buy a home or roll it over to your RRSP or RRIF. If you wait too long before opening and contributing to the account, you are giving up on growth since you will need to invest your funds more conservatively.
François Doyon La Rochelle: Yes, investing the maximum early, that is $8,000 per year for the first five years for a total of $40,000 at a 6% annual growth rate could result in approximately $85,000 in 15 years. If you combine this amount with the HBP of $35,000 that’s a total of $120,000 in down payment. If you have a partner that has been as diligent as you that’s $240,000 that could be available for a down payment.
James Parkyn: Yes, and again whatever your investment goals, the key is to let the magic of compounding work for you.
The sooner you start the better you will end up in the long term.
François Doyon La Rochelle: James, many Early Savers ask themselves when they are starting what should I prioritize? The TFSA, the FHSA, or the RRSP, and for those starting a family we can add the RESP. What do you recommend for Early Savers who have competing needs for their savings and can’t contribute to all of them?
James Parkyn: Great question Francois. The answer to me is likely to do your TFSA first because it has the most flexibility in that there are no tax consequences on funds withdrawn and you can put the amount taken out back in but you have to wait the following tax year. There is going to be a lot of FHSA promotion about the tax deductibility but if for any reason you would need to withdraw the funds it will be fully taxable, and you will not have the option to put the funds back in. So, there is no one size fits all answer. If you are sure of buying a home and have sufficient income to claim the deduction, then the FHSA will be a great option. You could even consider withdrawing from your TFSA and contributing to your FHSA and then using the tax savings to put money back in your TFSA.
François Doyon La Rochelle: Finally, for the moment there is only a handful of financial institutions that are presently offering these types of accounts. When I verified, Questrade, the Royal Bank, and the National Bank were the only ones offering it, but you can be sure that other institutions will follow suit in the coming months.
James Parkyn: Lastly, if you are currently in the process of buying a house since there is no holding period before you can withdraw funds from your FHSA to buy a house, you could technically open an account and make the maximum contribution for the year to get a tax refund and then withdraw the money the following day if needed.
François Doyon La Rochelle: Yes, that’s a good point James, thank you!
Main Topic: Review of The Credit Suisse Global Investment Returns Yearbook 2023 – Summary Edition:
François Doyon La Rochelle: Our Main Topic today is a Review of the 15th edition of The Credit Suisse Global Investment Returns Yearbook 2023 Summary Edition. Our regular Listeners will know we make this an annual tradition. Last year, we put a lot of effort into preparing our Podcast #38 in which we reviewed the 2022 edition of the Credit Suisse Global Investment Returns Yearbook, and we recommend our Listeners to go back and listen to it as the content (The impact of High Inflation on Stocks and Bonds and Update on the benefit of International Diversification) is still very relevant to what is happening in financial markets now. That being said, James, could you give our Listeners an Intro about the Yearbook and explain its purpose?
James Parkyn: Absolutely, I will quote directly from the Introduction: “The Credit Suisse Global Investment Returns Yearbook documents long-run asset returns over more than a century since 1900. A key purpose of the Yearbook is to help investors understand today’s markets through the lens of financial history.” The Yearbook details the returns and risks from investing in equities, bonds, cash, currencies, and factors in 35 countries and five different composite indexes. The Global Investment Returns Yearbook is produced in collaboration with renowned financial historians from the London Business School Professors Elroy Dimson, Paul Marsh, and Mike Staunton who produce the DMS Database. They are also the co-authors of the book “The Triumph of the Optimists” published in 2003.
François Doyon La Rochelle: Reviewing the Yearbook is an annual must-read for us. I would add that it is also a core part of our Podcast mission to share with our Listeners relevant evidence-based research. OK so now James, I’m going to start today’s review by asking you the same two questions as last year. First, why do you as a Portfolio Manager find the Yearbook useful?
James Parkyn: Francois, our discipline, as our regular Listeners know well is to invest with “The Investor Mindset, focused on the long term”. We don’t want to be led astray by short-term noise in the financial media and recent financial market volatility. This challenge is daunting and applies to all Investors including us Professionals. We have said it often on our Podcast: “It is simple to say but not easy to do: We must always be cognizant that we can fall into a trap of trying to “Forecast the Future”. This is why the Yearbook is so useful to us as portfolio managers. The Yearbook helps put current financial market events into context and compare them to long-term capital market history.
François Doyon La Rochelle: I agree, after all the major economic and geopolitical events of last year, it is crucial to take time out and look at financial market history to appreciate the importance of risk management.
James Parkyn: The 2023 Yearbook, like the ones before it, addresses this topic of why a long-term perspective is needed to understand risk and return in stocks and bonds. The events of 2022 should have reminded investors to fear complacency. Larry Swedroe said it well in his article “Lessons from the Markets in 2022. His Lesson #1 for 2022 was: “Just because something hasn’t happened doesn’t mean it can’t or won’t.”
François Doyon La Rochelle: Now for my second question to you James: what are the highlights of this year’s Report?
James Parkyn: I will share my Five Highlights of this year’s Yearbook.
My first highlight is they make the case for the importance of a long-term perspective and with it an appreciation of the laws of risk and return in stocks and bonds. This starts with explaining how even 20 years of data is too short a period to help make asset allocation decisions.
I quote from the Yearbook: “The volatility of markets means that even over long periods, we can still experience “unusual” returns. Consider, for example, an investor at the start of 2000 who looked back at the 10.5% real annualized return on global equities over the previous 20 years and regarded this as “long-run” history, and hence guiding the future. But, over the next decade, our investor would have earned a negative real return on world stocks of −0.6% per annum.”
François Doyon La Rochelle: This is very true and that’s why it’s so important to be careful about “Recency Bias”. The Yearbook also talks about having a long-term perspective on Bonds. What does it say, James?
James Parkyn: I remind our Listeners that for most Investors Recent bias is based on what happened in the last year. The Yearbook makes the case for a much longer time frame. So, to answer your question about Bonds I share another quote from the yearbook: “Long periods of history are also needed to understand bond returns. Over the 40 years until end-2021, the world bond index provided an annualized real return of 6.3%, not far below the 7.4% from world equities. “I believe and the Yearbook concurs that extrapolating bond returns of this magnitude into the future would be foolish. The rapport goes on to say: “Those 40 years were a golden age for bonds, just as the 1980s and 1990s were a golden age for equities. In fact, the real return on world bonds in 2022 was −27%.”
François Doyon La Rochelle: It is so difficult if not impossible to forecast and successfully time big market directional shifts. In our last Podcast #51, we addressed the Active vs Passive results in 2022. The worst category out of the 20 was Global Real Estate with a success rate of only 20%, it was slightly surpassed by the corporate bond category with a success rate of 22.6% and by the diversified emerging markets category with a success rate of 23.4%. So, the vast majority of Active Managers missed the boat and performed poorly in these Asset Classes compared with the passive funds.
James Parkyn: Exactly. My second highlight of the 2023 Yearbook is linked to the first one: “A historical risk premium in equity and bond returns relative to T-bills exists for a reason, that being a necessary payment for the risk of volatility and drawdown.” As our Listeners well know, we have experienced four equity bear markets since 2000 and we need to be paid for such a risk.
François Doyon La Rochelle: This makes total sense when you think that in 2020 with the Pandemic, the world experienced its third bear market in less than 20 years. Markets then staged a remarkable recovery and volatility fell once again. However, in 2022, volatility again rose, and both stocks and bonds fell sharply on inflation and rate hike worries and concerns over the Russia-Ukraine war. This was the fourth bear market since 2000. The Yearbook addresses how portfolio diversification can mitigate such risks.
James Parkyn: Yes, but reaping the benefits of diversification is also a long-term concept and can let you down in the short term. The historically extreme negative returns in 2022 of the classic balanced 60/40 equity/bond allocation are the perfect example.
François Doyon La Rochelle: To me, this point was also made in last year’s Report, specifically that the negative correlations between stocks and bonds were not the long-term norm. The Yearbook makes it clear that stocks and Bonds have a historically positive correlation and that the last 20 years of negative correlation before 2022, were not the norm.
James Parkyn: We have addressed this topic a lot in recent Podcasts. Again, Investors must have a Long-Term Mindset.
My third highlight of the 2023 Yearbook is the topic of stagflation.
François Doyon La Rochelle: For our listeners, it might be good to clarify that stagflation is a term from the 70s, and early 80s, which characterizes an economy with low growth, high unemployment, and high inflation.
James Parkyn: The Yearbook warns there is a “growing consensus that conditions will return to normal with low inflation re-established.” They quote academics Arnott and Shakernia: “A keener look at history would highlight how rare this happens”. They state this would in their view be a “best quintile” outcome with the “worst quintile” being inflation persistence for a decade.
François Doyon La Rochelle: To me, this point is about forecasting the future or trying to guess “the markets’ prevailing psyche.”
James Parkyn: Agreed, but the Yearbook makes the case that inflation and interest rates may not come down as fast as expected based on the very long-term perspective of the data in the DMS Database. My fourth highlight is when they tackle the big question: “What does it mean to be an Inflation hedge?” For instance, most Investors believe that Equities are a hedge against Inflation. The Yearbook provides extensive evidence that stocks, as well as bonds, tend to perform poorly when inflation is higher. It also makes the point that both stocks and bonds perform worse during hiking cycles.
François Doyon La Rochelle: Stocks are not, as is often claimed, the best hedge against inflation. The Yearbook makes a great case that “returns deteriorate for both” stocks and bonds as inflation rises. The Yearbook also makes the case that “Equities performed especially well in real terms when inflation was low.” In periods of deflation stocks actually “produced lower returns than on government bonds.” We discussed this in last year’s Podcast #38.
James Parkyn: Yes, we did, and the 2023 Yearbook makes the point very clearly again this year about the long-run evidence on equity returns. I quote: “While equities have enjoyed excellent long-run returns, they are not and never have been the hedge against inflation that many observers have suggested. Despite this, it is widely believed that stocks must be a good hedge against inflation to the extent that they have had long-run returns that were ahead of inflation. However, their high ex-post (after the fact) return is better explained as a large equity risk premium. The key nuance is that: “It is important to distinguish between beating inflation and hedging against inflation.”
François Doyon La Rochelle: Financial Market returns in 2022 proved the point. Stocks went down in a year of high inflation. The Yearbook makes the case that “Most finance professionals are too young to remember high inflation, bond bear markets, and years when stocks and bonds declined sharply together.”
James Parkyn: The Yearbook provides the long-run analysis needed to place the events of 2022 in context. Now I will share my fifth and final highlight when the Yearbook tackles the topic of Commodities as an asset class and the benefit of holding it in periods of inflation.
François Doyon La Rochelle: We hear a lot of noise about investing in Commodities as an Inflation Hedge and the fact that they are not correlated to Equities and Bonds. What does it say about the role that commodities play as an asset class? Do they offer a hedge against inflation that equities do not?
James Parkyn: To answer your question, I will quote from the Yearbook: “A key conclusion to take away, and highly pertinent today as 60/40 equity/bond strategies have let investors down, is that commodity futures do prove a “diversifier” from an asset allocation perspective, being negatively correlated with bonds, lowly correlated with equities and statistically a hedge against inflation itself.” They go on to say that: “The problem is that the limited size of the asset class cannot solve all the asset allocator’s prevailing inflation-induced dilemmas.” So, it’s nice in theory but not realistically investable for both Institutional and Retail Investors.
François Doyon La Rochelle: James, you refer here to commodity futures but it’s also interesting to raise that the Yearbook also looked at direct investing in commodities.
James Parkyn: The Yearbook finding is that direct investing in Commodities does not provide a hedge against Inflation. I Quote “We find investing in individual commodities have themselves yielded very low long returns.
François Doyon La Rochelle: There is more in the Yearbook that is significant: As we point out to our Listeners regularly on our Podcast, history can provide clues to the future, so we should be cautious about any forecasts.
James Parkyn: Yes, the Yearbook results are long-term averages spanning many different economic conditions. As discussed at the beginning of this podcast, this is because stocks and bonds are volatile, with major variations in year-to-year returns. We need a very long time series to support inferences about investment returns. The Credit Suisse report shows us that even 20 years is often not long enough.
François Doyon La Rochelle: So, James, to wrap things up, given the insights from this Yearbook, and given the backdrop of higher rates and high but slowly declining inflation, how should investors be thinking about their portfolios today?
James Parkyn: François, I think it’s appropriate to repeat our Conclusion from Podcast #38 when we covered the 2022 Credit Suisse Yearbook. I think it's also important to remember that rising rates and high inflation are just two risk factors that investors face. Equity investors have experienced periods when safe assets, for example, bonds and cash, have been good counterweights to the volatility of stocks. Remember, there are many different risks that you are trying to defend against. There will be times when bonds will be really helpful. I recommend that our listeners always consider their long-term goals, their risk profile, their ability to take risks, and their time horizon. In addition, they should consider the decumulation plan of their portfolios. All these elements should be considered when thinking about the structure of their portfolios.
François Doyon La Rochelle: In conclusion, I quote from the Yearbook: “Bad years happen and, when they do, it is consoling to remind ourselves of the long-run record from global investing. For investors in risky assets, especially equities, the long-run record truly does represent the triumph of the optimists.”
James Parkyn: That is a great quote Francois and hopefully, our Listeners will take inspiration from it. On another note, we hope the recent merger of UBS with Credit Suisse into a mega bank will mean that the tradition will continue, and we will see a 2024 edition.
Conclusion:
François Doyon La Rochelle: Thank you, James Parkyn for sharing your expertise and your knowledge.
James Parkyn: You are welcome, Francois.
François Doyon La Rochelle: That’s it for episode #52 of Capital Topics!
Do not forget, if you would like to submit questions or suggestions for the show, please email us at:[email protected]
Also, if you like our podcast, please share it when with family and friends and if you have not subscribed to it, please do.
Again, thank you for tuning in and please join us for our next episode to be released on June 8th.
See you soon!
Links:
- Episode 51: Update on Active Vs. Passive & Global Banking Solvency — Capital Topics by James Parkyn & François Doyon La Rochelle
- Episode 45: Bond Investing A New Landscape — Capital Topics by James Parkyn & François Doyon La Rochelle
- Episode 38: Review of the Credit Suisse 2022 Global Investment Returns Yearbook — Capital Topics by James Parkyn & François Doyon La Rochelle
- First Home Savings Account (FHSA) - Canada.ca by Government of Canada
- Global Investment Returns Yearbook 2023 – Credit Suisse (credit-suisse.com) by Credit Suisse
- Triumph of the Optimists: 101 Years of Global Investment Returns: Dimson, Elroy, Marsh, Paul, Staunton, Mike: 8601416069784: Books - Amazon.ca by Elroy Dimson, Paul Marsh & Mike Staunton
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In this Episode, James Parkyn & François Doyon La Rochelle discuss the following subjects:
In the news: Global Banking Solvency
Main Topic : Update on Active Vs. Passive
In this episode, we invite our listeners to check our latest feature below. For the first time we share the Podcast Script which was a request from some of our audience.
Links:
- The Grumpy Economist: How many banks are in danger? (johnhcochrane.blogspot.com) by John Cochrane
-The Non-Bailout Bailout – Foreign Policy by Adam Tooze, Podcast “Ones & Toozes”
-How Bank Oversight Failed: The Economy Changed, Regulators Didn’t - WSJ by Andrew Acherman, Angel Au-Yeung & Hannah Miao
-Chief Risk Officer: The Most Thankless Job in Banking - WSJ by Ben Cohen
-Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe: Ip, Greg: 9780316286046: Books - Amazon.ca by Greg IP
-The Price of Time: The Real Story of Interest: Chancellor, Edward: 9780802160065: Books - Amazon.ca by Edward Chancellor
-Episode 44: Central Banks and Recessions — Capital Topics by James Parkyn & François Doyon La Rochelle
-When Headlines Worry You, Bank on Investment Principles | Dimensional by Dimensional
-What Gets Lost When You Rescue Markets - WSJ by Jason Zweig
-It Wasn’t Just Credit Suisse. Switzerland Itself Needed Rescuing. - WSJ by Margot Patrick, Patricia Kowsmann, Drew Hinshaw & Joe Parkinson
-SPIVA U.S. Year-End 2022 - SPIVA | S&P Dow Jones Indices (spglobal.com) by Tim Edwards, Anu R. Ganti, Craig Lazzara, Joseph Nelesen & Davide Di Gioia
-Active Funds Continue to Fall Short of Their Passive Peers | Morningstar by Bryan Armour
Read The Script:
Introduction:
François Doyon La Rochelle: You’re listening to Capital Topics, episode #51!
This is a monthly podcast about passive asset management and financial and tax planning ideas for long-term investor.
Your hosts for this podcast are James Parkyn and me François Doyon La Rochelle, both portfolio managers with PWL Capital.
In this episode, we will discuss the following points:
For our first topic, we will discuss news on bank solvency.
And next, for our main topic, we will give you an update on the results of active management versus passive for 2022.
Enjoy!
In the news: Global Banking Solvency:
François Doyon La Rochelle: Our first topic today is news about Bank Solvency. James, you will address the major news story of the failure of Silicon Valley Bank, also known by the acronym SVB, in the US and the fear of contagion spreading to other US and International banks, especially after the news of the forced merger of the Credit Suisse bank with UBS in Switzerland. Credit Suisse bank was among the top 30 globally systemic important banks. Now, many of our Listeners are wondering: Is this the beginning of a major Banking crisis as we saw 15 years ago in 2008-2009 with the Global Financial Crisis?
James Parkyn: I can understand why our Listeners and indeed most Investors would be very worried about this news. It is everywhere in the financial press. You can’t escape it. In this segment, we will try to summarize what happened and what is important for Investors to know and what is noise so they avoid making bad decisions that could negatively impact their Long-Term Investment Plan.
François Doyon La Rochelle: So, let’s start with SVB in the US. What happened and why did it fail so quickly?
James Parkyn: The story of what happened is not yet fully known. What we do know so far is that the collapse of Silicon Valley Bank was driven in part by assets it held (mostly high-quality US Treasury Bonds) that lost value when interest rates rose from near zero.
A mismatch between its assets and liabilities caused a liquidity trap. Events moved so rapidly that it kind of resembled the storyline in the classic Christmas Movie “It’s a Wonderful Life” by Frank Capra starring Jimmy Stewart. Most Listeners know the storyline where Jimmy Stewart’s brother in the movie lost the deposit money of the Bailey Building and Loan in a deposit-envelope mix-up at the bank owned by the dreaded Mr. Potter. Very quickly news spreads in the small town that the Bailey Building and Loan were insolvent, and customers rushed to withdraw their deposits.
François Doyon La Rochelle: Yes, this movie is one of the most loved of all time. It also perfectly illustrates a classic bank run.
James Parkyn: Economist John Cochrane in his Blog titled “How many banks are in danger?” on March 14, 2023, explains it best: “SVB failed because it funded a portfolio of long-term bonds and loans with run-prone uninsured deposits. Interest rates rose, and the market value of the assets fell below the value of the deposits. When people wanted their money back, the bank would have to sell at low prices, and there would not be enough for everyone. Depositors ran to be the first to get their money out.” And there you have it, that’s what happened to SVB, a classic run on the bank.
François Doyon La Rochelle: To better understand, we must remember the economic picture prevailing in 2022 and what precipitated this. Last year, the key issue for both the economy and the banks was inflation, which jumped above 5% after decades of around 2%. The Fed had until mid-2021 to signal it would hold rates near zero for years then shifted gears dramatically and raised them at the sharpest pace since the early 1980s. Many investors, including SVB, were caught unprepared for this new reality of higher rates.
James Parkyn: The mechanics of Bond investing is that rising rates cause bond prices to fall, especially bonds that don’t mature for many years. It has been widely reported that SVB favored longer-term bonds for their additional yield. A fall in the value of a bank’s bond holdings could in theory reduce their capital, the cushion between assets and liabilities that absorbs losses.
François Doyon La Rochelle: How did the Regulators let this happen?
James Parkyn: In the WSJ on March 24th, 2023, in an article entitled “How Bank Oversight Failed: The Economy Changed, Regulators Didn’t”. The article states: “As interest rates surged after years of quiescence, regulators didn’t fully anticipate the hit banks would take to the value of their bond holdings.
The Fed as late as mid-2021 expected the era of ultralow rates to continue. Not until late 2022, when rates had already risen substantially, did regulators warn SVB that its modeling of interest-rate risk was inadequate.”
François Doyon La Rochelle: So, can we say the Regulators were not doing their job?
James Parkyn: A second factor was the failure to appreciate the danger where SVB became dependent on very large deposits. and these deposits could be withdrawn virtually any time with today’s technology.
The WSJ article goes on to say, “Banks had come to depend more on such deposits. Regulators acknowledge they didn’t stress such a concern because the big deposits were from SVB’s and Signature’s core customers, who, it was thought, would stick around.
François Doyon La Rochelle: The WSJ article goes on to say: “… deposits fled far faster than had ever happened before, aided both by social media-fueled fear and by technology that allowed people to move vast sums with a few taps on a smartphone.” I find it hard to believe that a large Bank with a reported USD 209 Billion in Assets would fail at such elementary risk management. Can we say it was a sort of perfect storm of events?
James Parkyn: I don’t believe it is. We often say in our Podcast, we don’t know what we don’t know, and a Black Swan type of event is not forecastable. But this is just a case of bad risk management.
François Doyon La Rochelle: The economist John Cochrane in his March 14th Blog seems to agree. He stated: “In my previous post, I expressed astonishment that the immense bank regulatory apparatus did not notice this huge and elementary risk. It takes putting 2+2 together: lots of uninsured deposits, and big interest rate risk exposure. But 2+2=4 is not advanced math”.
James Parkyn: The storyline gets better. Bank regulations in developed countries like Canada and the US require that they have a senior executive in a role called Chief Risk Officer or CRO. It is unbelievable but at the time of failure, SVB had no CRO.
Journalist Ben Cohen of the WSJ wrote an Article on March 23, 2023, titled “It’s the Most Thankless Job in Banking. Silicon Valley Bank Didn’t Fill It for Months.” He wrote: “Silicon Valley Bank’s lack of an executive in that role for eight critical months is a reminder that risk doesn’t have to be excessive or exotic to be existential. SVB’s alarming exposure to rising interest rates wasn’t hard to see coming and should have been easy to hedge against. It remains flabbergasting how a bank that served the most innovative corner of the economy could have been doomed by a basic mismatch of assets and liabilities. But tech’s favorite bank failed because its risk management did first.”
François Doyon La Rochelle: But the SVB would’ve had other risk-reporting regulatory obligations. Ultimately, would the Board of the Bank be accountable?
James Parkyn: Yes, I agree even with no Chief Risk Officer, at the very least there should have been an acting CRO, and regulations would require regular reporting to the board on Risk management. Ben Cohen of the WSJ said it best: “Of course, the presence of a Chief Risk Officer isn’t necessary to know when the Federal Reserve hikes rates and regulatory filings suggest SVB was aware of its vulnerabilities long before the run on the bank: The board’s risk committee met nearly as many times last year (18) as it did in the previous three years combined (19).” So here again we see a big-time failure of basic governance processes.
François Doyon La Rochelle: So, what about the Credit Suisse Bank and the merger with UBS? Is the situation like SVB? What’s the impact of Credit Suisse and UBS merging?
James Parkyn: Economic Historian Adam Tooze in his Podcast Ones and Toozes on March 17th, 2023called it a “Confidence shock that killed Credit Suisse”. Regular listeners will remember from Podcast #44 that he wrote the highly regarded book “Crashed” detailing what happened in the banking system during the global financial crisis. Unlike SVB it was not a liquidity crisis but a counterparty crisis. Other global banks and large customers were losing faith in Credit Suisse’s ongoing viability.
This is a major issue for Switzerland and its role in the global banking system. A recent WSJ Article titled “It Wasn’t Just Credit Suisse. Switzerland Itself Needed Rescuing”. For any country, it would be a financial emergency. For Switzerland, the stakes verged on existential. Its economic model and national identity, cultivated over centuries, were built on safeguarding the world’s wealth. It wasn’t just about a bank. Switzerland itself needed rescuing.
François Doyon La Rochelle: The Credit Suisse bank crisis added the Global contagion dimension to this crisis. For the Swiss, it threatens an economic model and national identity built on safeguarding the world’s wealth.
James Parkyn: Credit Suisse, the second-largest Swiss bank, and Top 10 Global Bank, has had risk management issues for over a decade. Adam Tooze in his March 17th Podcast called it a “Confidence shock that killed Credit Suisse”. Now that Credit Suisse and UBS, the larger Swiss bank, have merged, the question is the combined bank, with over 50% of the Swiss banking market, too big to bail?
The WSJ reported on March 22nd, 2023: “Its banking system is five times the size of its gross domestic product and larger than in most economies. UBS combined with Credit Suisse has a balance sheet twice the size of the Swiss economy.”
François Doyon La Rochelle: It is clear to me that all this turmoil will have an impact on the Central Bank’s Policymaking and their inflation-fighting maneuvers of raising interest rates. The bank collapses in the United States and the emergency rescue of Credit Suisse is likely to force central banks to weigh the trade-off between systemic risks and inflation risks.
James Parkyn: Higher rates will continue to weigh on banks’ balance sheets. They will also cause problems in other parts of the economy. Economic Historian Adam Tooze in his Podcast on March 17th, 2023 said “when Central banks increase interest rates, they are trying to impact inflation thru negative events. With such a rapid rate hiking cycle engineered by Central Banks, it was to be expected that negative economic shocks would happen. It was only a question of what would bend and what would break.”
François Doyon La Rochelle: What is the role of Bank Regulators in this mess?
James Parkyn: Well! you know, it seems they’re always fighting the last battle with the last battle strategies and so, if you recall in our Podcast #44, we quoted Mervin King, the former governor of the Central Bank, that said: “Central Banks have to come up with new ideas and we got to forget about the mistakes of the recent past and focus on what needs to be done.” So, let's go back to Jason Zweig, who wrote in the WSJ article on March 17th “Over the past couple of decades, the Fed, the Treasury, and other authorities have stepped in time after time to stabilize the financial markets, as if failure were no longer an option. This all goes to illustrate an even bigger problem: Central authorities aren’t omniscient and omnipotent, and their efforts to wring risk out of the system may make it more dangerous, not less. Even as rules have proliferated and bailouts multiplied, the U.S. stock market has suffered four crashes of least 20% since the year 2000.”
François Doyon La Rochelle: Well now we are talking about Moral Hazard.
Another quote from Jason Zweig of the WSJ: “The attempt to eradicate failure from the financial system, of course, is part of modern society’s broader push to make life itself riskless and idiot-proof, with indestructible baby strollers, child-resistant drug packaging, almost self-driving cars and shoe removal at airport security.”
James Parkyn: Another WSJ Columnist Greg Ip pointed out in his 2015 book “Foolproof,”: “…making an environment feel safer can lull many people into complacency and excessive risk-taking.” I am also reading a highly recommended book by financial historian Edward Chancellor, called “The Price of Time,” a history of interest rates. This author makes the point “The attempt to control risk by lowering interest rates reduces the cost of taking risk, and so ends up increasing the aggregate amount of risk in the system.” We have talked a lot in our podcast about normalized interest rates. We have had rates that are too low for too long and too many people have taken for granted this would simply continue.
François Doyon La Rochelle: James, what is your advice for our Listener?
James Parkyn: In preparation for this Podcast, I went back to our Podcast #44 on Central Banks that we published in September 2022. The big fear last fall was about recessions and the potential impact on financial markets. We highlighted Dimensional research that showed that Markets around the world have often rewarded investors even when economic activity has slowed. Many now feel that the specter of Bank failures will reduce lending activities by banks further increasing the likelihood of reduced economic activity. We recommend that our Listeners stay disciplined in their LT Investment plan and forget about all the noise of the moment such as Inflation, Interest rates, recession, and now we can add to the list of bank failures.
François Doyon La Rochelle: Yes indeed, our regular Listeners know, this is one of our mantras as a disciplined Investor with a Long-Term Mindset you can’t forecast the future.
James Parkyn: In conclusion Francois, we turn to our friends at Dimensional, they produced a great article entitled “When Headlines worry you, bank on Investment Principles.”
“While every investor’s plan is a bit different, ignoring headlines and focusing on the following time-tested principles may help you to avoid making short-sighted missteps.
1. Uncertainty Is Unavoidable: uncertainty is nothing new and investing comes with risks.
2. Market Timing Is Futile.
3. “Diversification Is Your Buddy” a quote they attribute to Nobel laureate Merton Miller.
François Doyon La Rochelle: I like the following quote from this article: “When the unexpected happens, many investors feel like they should be doing something with their portfolios. Often, headlines and pundits stoke these sentiments with predictions of more doom and gloom. For the long-term investor, however, planning for what can happen is far more powerful than trying to predict what will happen.”
As usual, we will share the link with our Listeners.
Main Topic: Update on Active Vs. Passive:
François Doyon La Rochelle: For our second topic today, we will give you an update on the results of active management versus passive for 2022. I believe that by now, after all the podcasts that we have released, most of our listeners understand that we are strong believers in market efficiency and that our investment philosophy is based on the empirical evidence that using broad-based and low-cost investment passively managed products are the best way to capture market returns and increase the odds of long-term success for our clients.
James Parkyn: Correct and it’s been more than 20 years now that we have adopted this investment approach based on the belief that active investing is a negative sum game. However, this does not mean that we don’t question ourselves and look at the latest research papers and articles to make sure our investment philosophy is supported by evidence.
François Doyon La Rochelle: Yes, and that’s why year after year we analyze the SPIVA report, from S&P Dow Jones Indices which measures the results of the S&P Indices versus active funds, and also the Morningstar Active vs Passive Barometer report which measures the performance of active funds against their respective passive peers, to see if the results for the last year were any different than in the past. Unfortunately for active managers, this year was no different than in the past, since once again active managers were not able to beat their passive comparable.
James Parkyn: This is particularly interesting after a difficult year like 2022 when stock and bond markets unusually sold off at the same time. The old narrative from active managers is that good active management will outperform passive investments during times of market volatility, so what happened?
François Doyon La Rochelle: Well, we would certainly expect given all the market volatility in 2022, that active managers would have plenty of opportunities to beat passive strategies.
James Parkyn: Effectively, we covered the major geopolitical and economic events in our podcast over the last year, but it is worthwhile to highlight some of them for our listeners to get a feel for the opportunities that active management could have exploited to generate better results. The year started with the war in Ukraine and the subsequent geopolitical turmoil, then followed multi decades of high inflation rates, and the subsequent swift and strong reaction from central banks to increase interest rates. Again, I am just highlighting the obvious here but getting back to our topic Francois, how well did active management do against passive last year?
François Doyon La Rochelle: To answer your question, James, I will base myself predominantly on the Morningstar active versus passive barometer report. This report is comprehensive as it covers nearly 8,400 actively managed funds in the U.S. with approximately $15.7 trillion of assets under management. I prefer this report to the SPIVA since it measures the rate of success of active managers against the results of actual passive funds and not benchmarks.
James Parkyn: This is an important nuance. The Morningstar report “benchmarks” reflect the actual, net-of-fees performance of investable passive funds and not simply the performance of an index that is not investible without incurring fees.
François Doyon La Rochelle: Correct James and that’s a very important nuance.
Now let’s look at the results. Again, based on the narrative that active managers will do better in times of market stress I think the results for 2022 are not very conclusive for active management.
Based on the 20 different investment categories reported by Morningstar only 40.5% of active managers were able to beat their respective benchmarks in 2022. This is a weaker result than in 2021, a very good year in the markets when 51.1% of active managers were able to beat their benchmarks.
James Parkyn: As you mentioned this is very interesting as it goes against the active management’s narrative that they will perform better in difficult years. So out of the 20 categories, what were the best ones?
François Doyon La Rochelle: Out of the 20 different categories, 6 of them had a success rate above 50%. Meaning that in each of these 6 categories, more than 50% of the managers were able to beat their benchmarks. By way of comparison, that number for 2021 was 7. That being said, the best-performing categories in 2022 were, one, the US small value category with a 61% success rate, second, the US small growth category with a 56.9% success rate and third the world large blend category with a 56% success rate. I must mention in all objectivity that the U.S. large blend category, which is probably the largest fund category by assets under management, was also amongst the best categories in 2022 with a success rate of 54.1%. This means that 54.1% of the active managers in that category beat their benchmark last year.
James Parkyn: Now which categories fared the worst?
François Doyon La Rochelle: The worst category out of the 20 was Global Real Estate with a success rate of only 20%, it was slightly surpassed by the corporate bond category with a success rate of 22.6% and by the diversified emerging markets category with a success rate of 23.4%.
James Parkyn: What I find interesting in these results is that the highly interest-sensitive categories like global real estate and the corporate bond category were amongst the worst-performing categories last year.
François Doyon La Rochelle: Yes, I was also surprised by these results and by the fact that the other bond categories, the intermediate core bond category, and the high yield bond category have also had poor results with low success rates of 37.9% and 27.2% respectively. Therefore, vastly underperform their passive counterparts.
James Parkyn: Wow, I would have thought that in a year like 2022 with all the talk surrounding inflation, interest rates, and central bank decisions active management would have prevailed. Given the narrative, you would expect that active managers would be able to adjust their portfolios and reap the benefit of predicting interest rate changes.
François Doyon La Rochelle: Indeed James. I also looked at the 2022 SPIVA U.S. and Canadian reports and although they don’t analyze the performance of active versus passive in the same way as Morningstar, there were some very interesting takeaways in their report regarding the inability of active managers to outperform their respective benchmarks. The report highlights that the market conditions for equities and fixed income were uncommonly challenging in 2022, underlying however that these difficult markets gave active managers material opportunities to generate relative outperformance. Opportunities that most active managers were unable to exploit.
James Parkyn: What do they mean by that unable to exploit?
François Doyon La Rochelle: Well, if we examine the example provided in the U.S. SPIVA report, the S&P500 Growth, and the S&P500 Value indices, which are both large-cap U.S. equities indices, were respectively the worst and best-performing equity benchmarks in 2022. The report goes on to mention that more than 20 percentage points were separating their full year’s performance. Our regular listeners will remember that we highlighted in our podcast #48 that value stocks vastly outperformed growth stocks in 2022.
James Parkyn: Wow, this type of dispersion in returns should in my mind been a great opportunity for active management.
François Doyon La Rochelle: Yes, but the active managers were not able to seize the opportunity since most of them, who are benchmarked to the S&P500 Index, failed to beat it. Since large-cap growth stocks were the worst-performing asset class, a large-cap growth manager could have simply purchased stocks of another U.S. asset class to beat its benchmark. Despite this fact, close to 74% of active managers in that asset class still failed to beat their benchmark. Here is a quote from the report, “the prospect for skilled stock pickers in large-cap U.S. equities were above average and the tailwinds for even unskilled managers were unusually favorable” The report goes on to say “An examination of the particular market segments that over and underperformed shows that they should have given the advantage to active managers, in particular thanks to their ability to deviate from broad-based, market cap weighted allocations to large-cap U.S. equities.
James Parkyn: Anything to report on the longer-term results of active versus passive?
François Doyon La Rochelle: Well, for the last 10-year period the success rate for active management in the Morningstar report is at 31.5%, meaning only 31.5% of the active managers were able to beat their passive counterparts. If you look at the 20-year results, the success rate drops even further to a low of 16.2%. In the U.S. SPIVA report what I found interesting there is that it gives the quartile breakpoints for Equity funds in the U.S. The takeaway here is that if you would have bought an S&P500 Index fund or a broader market S&P1500 Index Fund you would have effectively bought a fund that ranked in the first quartile of all active and passive funds in the over the last 5,10- and 20-year periods.
James Parkyn: Well François that’s very compelling evidence because I wrote a blog recently and you got all this financial press “There is a recession coming…you should do this and do that with your portfolio...” and I said “Yeah, but then what? What do you do?” and often the market is going to react before the recession ends. Maybe active managers, as you mentioned earlier, the large-cap blend, 54% beat the benchmark. But then what? What about the second year? And there are taxable events and you have got to guess both events. If you’re riding a horse in active management, it’s got to continuously be at par with the market. When you show only 16.2% over 20 years beat the market and we haven’t even gotten into the tax and efficiency of active management vs. taxes. So again, based on these reports and our experience with client portfolios, we’re very confident that staying the course with our investment philosophy is doing the right thing with our customers and we believe that our listeners would agree as well.
François Doyon La Rochelle: That’s correct, no changes are planned, again it’s proof that over the long term, disciplined passive investors will earn higher returns than active investors.
Conclusion:
François Doyon La Rochelle: Thank you, James Parkyn for sharing your expertise and your knowledge.
James Parkyn: You are welcome, Francois.
François Doyon La Rochelle: That’s it for episode #51 of Capital Topics!
Do not forget, if you would like to submit questions or suggestions for the show, please email us at: [email protected]
Also, if you like our podcast, please share it when with family and friends, and if you have not subscribed to it, please do.
Again, thank you for tuning in and please join us for our next episode to be released on May 11th.
See you soon!
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In this Episode, James Parkyn & François Doyon La Rochelle welcome back their dear colleague Raymond Kerzerho, PWL’s Senior Researcher & Head of Shared Services Research. Together they discuss the update of the Capital Market Assumptions for Expected returns titled “Financial Planning Assumptions”, that he produced with PWL’s Head of Research & Client Education, Ben Felix.
- Financial Planning Assumptions (Market Capitalization Weighted Portfolio) - PWL Capital by Raymond Kerzerho & Benjamin Felix (February 22, 2023)
-Financial Planning Assumptions (Factor Tilted Portfolio) - PWL Capital by Raymond Kerzerho & Benjamin Felix (February 22, 2023)
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In this episode of Capital Topics, James Parkyn and François Doyon La Rochelle discuss the following portfolio management and financial planning subjects:
Main Topic: Ken French: Five things I know about Investing
- « Five Things I Know About Investing » by Kenneth R. French : Five Things I Know about Investing | Dimensional
-Podcast #48: 2022 Investing Lessons & 2023 Outlook : Episode 48: 2022 Investing Lessons & 2023 Outlook — Capital Topics
- « Getting Wealthy vs. Staying Wealthy » by Morgan Housel : Getting Wealthy vs. Staying Wealthy · Collab Fund
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In this episode of Capital Topics, James Parkyn and François Doyon La Rochelle discuss the following portfolio management and financial planning subjects:
In the News: 2022 Market Statistics Main Topic: 2022 Investing Lessons & 2023 Outlook-Market Statistics – Parkyn Doyon La Rochelle – December 2022: Market Statistics - Parkyn Doyon La Rochelle - December 2022 - PWL Capital
-Podcast #45: Bond Investing A New Landscape: Episode 45: Bond Investing A New Landscape — Capital Topics
-Podcast #44: Central Banks and Recessions: Episode 44: Central Banks and Recessions — Capital Topics
-Podcast #43: Retirement Income Planning: Should Your Portfolio Withdrawals Vary with the Market?: Episode 43: Retirement Income Planning: Should Your Portfolio Withdrawals Vary with the Market? — Capital Topics
-Dimensional’s Article: Market Review 2022: After a Down Year, Looking to the Past as a Guide | Dimensional
-Jason Zweig’s Article: Mirror, Mirror on the Wall, Who Knew That Stocks Would Fall? - WSJ
-Larry Swedroe’s Article: Fourth Quarter 2022 Economic Review and Outlook - Articles - Advisor Perspectives
“The Psychology of Money” by Morgan Housel: The Psychology of Money: Timeless lessons on wealth, greed, and happiness: Housel, Morgan: 9780857197689: Books - Amazon.ca
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In this episode of Capital Topics, James Parkyn and François Doyon La Rochelle will discuss the following portfolio management and financial planning subject:
Update on Year-end Tax Planning for Capital Market InvestorsWhy aren’t more Canadians maxing out their TFSAs? — Capital Topics
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