Back on March 5th, I mentioned a proposed portfolio my advisor and I were working on. We finally came to an agreement on my allocation and what to buy, and this is what I bought on March 10, 2006:
|RRSP holding||Type||Account %|
International Stock Fund
|Canadian TSX60 index||Canadian Large Cap||33.7%|
|Canadian Small Cap||3.8%|
|TD Canadian Bond Fund||Fixed Income||25%|
The percentages don’t work out to nice even numbers because we took my advisors original numbers for the equities and multiplied them by 0.75 to make up the equity component of my 75-25 equity-bond split. We will find some nice round numbers to target eventually and then rebalance around those as need be.
You will notice two major differences between what my advisor had originally proposed, and what we ended up getting. The Canadian Energy Index is absent and the TD Canadian Bond Fund is in there as a significant fixed income component. The only change I wanted but I didn’t get, was the use of the Rydex Equal Weight ETF (RSP) instead of CI Value Trust. He seemed to really want to go with that so I let it be. He is interested in RSP though and will look into it some more. He felt it was not much different from a mid-cap index like MDY. If you look at a past performance comparison between MDY and RSP (before dividends) they look pretty similar.
Costs: I paid $75 commision (advised trade to get the iUnits S&P/TSX 60 ETF) and $0 for the mutual funds. As I said in a previous post, mutual funds at Clearsight are all essentially no-load because they buy front-load funds and charge no front-load sales charge.
19 thoughts on “Portfolio Update: Settled In”
Hi, I was wondering why you’re so heavily weighted in Canadian stocks when the Canadian market is 1/15th the size of the US market and 1/8th the size of Japan+Europe. I’m from the US, but my portfolio only has US equities proportional to the US portion of global market cap.
I’ll quote my advisor directly here:
“Exactly where the ‘efficient frontier’ of mix between Domestic and Foreign equity assets is still widely debated – but consensus view is that the right mix of foreign is between 40-50%. At first this is counterintuitive – one would think that if Canada is less than 5% of the Worlds equity markets this is a hugely overweight position – but we buy equity to earn the best possible ‘real return’ above the rate of Canadian inflation – and domestic equities are the likeliest asset type to do that consistently – hence their representation in a typical Canadian’s mix of assets.”
This makes sense to me. Take real return bonds for example. It wouldn’t make sense for a Canadian to buy US TIPS (Treasury Inflation-Protected Securities) or for an American to buy Canadian Real-Return Bonds, or does it? Why buy a product that is adjusted for inflation in another country’s currency if you are making money and spending money in your own country’s currency.
I think the same argument goes for stocks. Your own country’s stocks are more likely to beat the inflation of your own country’s currency.
Phil said: “my portfolio only has US equities proportional to the US portion of global market cap”
Phil, why should the percentage you invest in a certain country should be based on that country’s percentage of the global market cap? If such logic makes sense, then it should also make sense to invest in this way within one country. So essentially, this logic says that one should only invest in large cap companies.
This is a very interesting thing to think about, so thanks for the prompting.
I don’t necessarily think that you should compare stocks and bonds in this way because there is virtually no risk in inflation-protected bonds, while there is in stocks. No matter what the rate of inflation is, the bond price will always have a greater yield (assuming solvency of the issuing agency, and I doubt that Canada or the US are going anywhere anytime soon). However, there is the risk that the market will return less than the rate of inflation or, worse, that the market’s economy will go into a long-term decline. Being diversified across markets will decrease this risk.
If my goal was to get a return _exactly_ the same as the global market, then I would have a portfolio that was proportioned exactly the same as global market, both with regards to country and cap-size. With this, I would be exposed only to market risk, and my fortures would be exactly those of the market. In the U.S. market, this would lead to a cap-size allocation of something around 80/20 large/small (depending on how you define large and small). If I wanted above-market returns, then I would take greater risk (as measured by standard deviation of historical returns) by shifting a greater percentage of assets towards small-cap and value. I have a greater-than-market percentage of my assets shifted this way, but I recognize that my portfolio will behave very differently than the market as a whole. Likewise, I have an slight (~10%) overweight to international stocks.
Overall, I think the inflation risk that is reduced by investing in assets traded in your own currency is replaced with increased risk that having a portfolio disproportionately (7 times larger) concentrated in a single national market. I think that the proper way to hedge inflation is to shift to inflation protected bonds instead of changing the allocation of the stock portion. But, I could be completely wrong about this and would love an argument against it.
I’m glad I was able to “prompt” a reponse from you. 🙂
Your 3rd paragraph starting with “If my goal was to get a return . . .” is a great summary of many of the ideas behind asset allocation.
I agree that “the inflation risk that is reduced by investing in assets traded in your own currency is replaced with increased risk that having a portfolio disproportionately (7 times larger) concentrated in a single national market.” I guess the question is how much should one overweight oneself in one’s own country. At what point does the risk of being too highly concentrated in a single national market become larger than the reduction in inflation risk, if at all?
I wish I had an argument for or against this. Something tells me that I might have a better argument had I read something like a Random Walk on Wall Street. I do know a little about correlation and its effect on risk but it’s the role that inflation plays here that is screwing me up. My gut feeling is that without doing or seeing some quantitative analysis it will be difficult to make much headway on this argument.
I finished A Random Walk last week and I don’t recall anything like this. It’s the inflation thing that’s screwing me up too and your question at the end of paragraph 2 is right on. On correlation, both Canada and US are experiencing the same global deflationary pressures from cheaper labor in India and China. Canada and the US should theoretically have more correlated economies because of NAFTA than they did pre-1990s. Globalization will probably erase a lot of the past benefits of having assets diversified across weakly correlated markets, but who knows.
Just saw an article on one of your funds (E&P) and it made me think of you. Check it out.
Thanks for the link Joe!
Can you buy an international fund that’s hedged back to your currency? That way you don’t have currency risks. I seem to recall that Cundill Value is such.
Also what’s the reasoning of picking Templeton International Stock over other international funds? It has very high MER, low returns and high volatility. Just curious.
I just went with my advisor’s choice on that one because international equities is one area I do not know much about. It has beaten the MSCI EAFE ($Cdn) over the past 15 years. 9.54% annualized return vs. 7.04% for the average fund in the group and 7.52% for the benchmark.
A high MER means nothing to me on its own. Why do you care so much about its high MER?
The MSCI EAFE is a bad comparison because it TEGEX is a Foreign Large Value fund whereas the EAFE is a Foreign Large Blend. For my Foreign Large Value, I use Dodge & Cox International Stock (which is also no-load, unlike TEGEX).
In “A Random Walk”, Malkeil talks briefly about currency-hedged international funds. If I recall correctly, he basically says that the costs incurred by the hedging generally negate any theoretical benefits the hedge would provide.
A high MER also doesn’t mean anything to me in isolation, that’s why I didn’t mention it in isolation. I don’t mind paying higher MER if it performs well, but this fund doesn’t.
Cundill Value had a 15 year compounded return of 11+%, while Templeton International Stock had only managed 9.5% and with higher volatility, so the risk adjusted return is terrible.
Another one on my list is Saxon World Growth which has much lower volatility and still managed to beat Templeton over 15 years with 12.19%. Plus its MER is 1% less!!!
Phil, TEGEX is no load for me as I am buying the front-load fund but my advisor charging no fee so it is essentially no load. Templeton technically classifies it as “value” but everyone seems to compare it again MSCI EAFE. I’ll have to look into this in more detail.
“I don’t mind paying higher MER if it performs well, but this fund doesn’t.”
I can’t agree with that. The fund has a very respectable long-term record.
You can pull out all the figures you want on mutual funds that have done better or worse than the Templeton fund, or any fund for that matter. In the end it doesn’t say anything about what any given fund will do in the future. Chasing performance is a bit dangerous if you ask me.
Here’s a quote from a fundlibrary.com report:
“Templeton International Stock Fund is one of the longest running and best performing international equity funds over the long term. The fund invests in equity securities outside of North America, run by veteran Templeton manager and President of Franklin Templeton, Don Reed. Over the past ten years, this fund had the strongest return given the amount of risk assumed relative to all other international equity funds. The fund is managed with a value investment style that places individual stock selection first and foremost, and strong emphasis is placed on buying and holding strong companies over the long run.”
Sounds like their risk-adjusted return is pretty good according to them. I’m not sure why you think 9.5% is “terrible” by the way.
Morningstar classifies it sas Foreign Large Value:
To my knowledge, there’s no international index like the MSCI US Prime Market Value which most US Large Cap Value index funds track. So, most of the international funds get compared to EAFE, which is usually a bad comparison for a value fund.
You also have to consider that it has an expense ratio of 1.63, which is about a point higher than some equivalent funds (i.e., Dodge & Cox).
“Chasing performance is a bit dangerous if you ask me.”
At least use “chasing performance” in the right context. It generally applies to people buying based on previous short-term performances, not 15-years.
Beside, I brought up volatility a number of times. Although we can’t say the same about returns, funds that had been volatile in the past will generally continue to be volatile in the future. Both Templeton already under performed Cundill and Saxon by about 2+% over 15 years (think compounding), but did it with higher volatility, so the risk-adjusted return is even lower. That’s what I meant by terrible.
Looking at their graphs, Templeton also has high correlation with the TSX compares to Cundill or Saxon. This further increase risks to your own personal portfolio if you follow the Modern Portfolio Theory. Also judging from the 5 year return, it looks like more or less a closet index, so why pay 3% MER just to hold a fund that acts like the indexes? (Another reason why you shouldn’t ignore MER.) Don’t forget, Templeton corrected by around -35% between 2000-2002. If this is truely a value fund, then it’s doing a terrible job, because most value funds outperform during bear markets. The 2 funds I mentioned return about 20% and 40% respectively in that same bear market.
silverm, where did you get the volatility numbers, correlations to the TSX, and return information from? I’ve been checking out Globefund.com and morningstar.ca but neither seem to have all that data available.
You can get the correlation # from http://www.fundscope.com. Most contents aren’t free though. Personally I prefer to compare the graphs instead of having a single correlation coefficient # telling me what to think. For example, what if the 2 investments are uncorrelated during quiet periods but strongly correlated during critical periods such as a major up or down correction? I can’t get that from reading the correlation coefficient #. According to fundscope, this templeton fund had high R-Square number which suggests it’s passively managed, yet you’re paying 3% MER for someone who isn’t doing much work. Finally, the risk-adjusted return is about 2.5% lower then the appropriate index (I think MSCI EAFE), so the manager is actually destroying values. This could be a result of MER.
To be fair, fundscope only has data going back 5 years, so please do your own DD. Good luck.