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Why You Should Beware of First Dates

Imagine that you’re the marketing director for MegaAlpha Investments and you want to advertise two of your mutual funds. In the September 2011 issue of Performance Chaser magazine, you place the following ad:

Are stocks still worth the risk? Not anymore. Over the last three years, the S&P/TSX Composite Index delivered an annualized return of just 0.2%. Meanwhile, the MegaAlpha Awesome Income Fund earned 6.4% a year. Rather than relying on a disappearing equity premium, our managers delivered reliable yield and significant growth with a portfolio of the highest quality government and corporate bonds.

Three months later, in the December issue, you run a different ad:

Are stocks still worth the risk? You bet. Over the last three years, the MegaAlpha Awesome Equity Fund  delivered an annualized return of 12.5%, dramatically outperforming the DEX Universe Bond Index, which returned just 7.7%. Rather than relying on the perceived safety of bonds, our managers took advantage of generous dividends and capital growth in a portfolio of leading Canadian companies.

Do you think I made those numbers up? Nope. Both the index returns and the funds’ performance are real—except the “MegaAlpha Awesome Income Fund” is actually the iShares DEX Universe Bond Index Fund (XBB),

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Can the Pros Time the Market?

I never meant to make you cry
And though I know I shouldn’t call
It just reminds us of the cost
Of everything we’ve lost
Bad timing, that’s all
Bad Timing, Blue Rodeo

One of the promises made by active managers is that they can move to cash before the markets tank and then get reinvested before they recover. When markets are as volatile as they have been in recent years, a manager with this skill would be something of a hero.

I recently looked at the record of actively managed mutual funds during bear markets for an article just published in Canadian MoneySaver. I found that there were indeed periods where managers were able to protect investors from losses. The problem was that defensive mangers were usually late to the recovery party. As a result, over an entire market cycle most investors are usually better off staying fully invested all the time.

Shortly after the article appeared, I heard from a member of the investing club I belong to. He told me that one the other club members,

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ETF Risks in Perspective: Securities Lending

This is the final post in a series of three looking at the potential risks that ETFs may pose to the stability of financial markets. The previous two discussed synthetic and leveraged ETFs. Now we’ll take a look at the practice of securities lending.

Many active traders, including hedge funds and prop traders at investment banks, engage in short selling when the they believe a stock is about to fall in price. For example, if a company is trading at $20, a short seller might borrow shares and sell them on the open market for that price. If the stock falls to $18, the trader can then buy it at this lower price, return the shares to the lender, and pocket a profit of $2 per share (before costs).

Firms that borrow shares need to get them from somewhere, and the most common lenders are mutual funds, ETFs and pension funds, who use securities lending agents as intermediaries. When a fund lends shares to a short seller, it collects a fee for doing so.

The problem

The main concern about securities lending is common to all funds,

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Couch Potato Live in Toronto

Looking for something to do on Wednesday, November 9? ING DIRECT is hosting a public event to discuss personal finance with four panelists, including yours truly. The other three are:

Rubina Ahmed-Haq, a financial journalist and blogger who has worked with the CBC, Rogers Media and Moneyville.
Ellen Roseman, the Toronto Star’s intrepid consumer advocate and columnist, whose work also appears on CBC Radio and Moneyville.
Preet Banerjee, an obscure former blogger with no public profile.

The event, hosted by Andrew Zimakas, VP Marketing of ING DIRECT Canada, will give live audience members an opportunity to ask questions of the panel. We’ll also be taking additional questions through social media.

Everything kicks off at 7 pm EST at the ING DIRECT café at 221 Yonge Street in downtown Toronto. It will also be streamed live at the other café locations:

Calgary
600–6th Avenue SW

Vancouver
466 Howe Street

Toronto (north)
111 Gordon Baker Road

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If you prefer to sit at home and participate in your pyjamas, the event will be available through a live webcast: register here.

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Why Staying the Course Isn’t “Doing Nothing”

On Tuesday I linked to a poll of some 200 institutional investors who were asked about their outlook for global equity markets. The smart money seems to be evenly split between buyers, sellers, holders, and those who “are confused and doing nothing.”

It’s funny that investors who don’t react to market swings are said to be doing nothing. This is one of the enduring myths about index investing: that carefully building a diversified, all-weather portfolio for the long term makes you a naive fool because you’re not constantly “repositioning.”

Staying the course is not “doing nothing.” On the contrary, it’s doing something thoughtfully and productively rather than constantly reacting to the market. The first three quarters of 2011 have been a marvellous example of how diversifying and ignoring forecasts can work so well during times of market stress. To see this idea in action, let’s do a Q3 check-in with the Complete Couch Potato.

No, everything does not go down together

Dumping bonds was supposed to be part of the “reposition your portfolio for today’s market” strategy—actually it’s been a refrain for about three years now. And once again,

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Globe and Mail Best Blog Award

I’m pleased to announce that Canadian Couch Potato has been selected as the top investing blog in Canada by the Globe and Mail. The article appears in today’s issue of the paper and online here.

I’d like to thank Rob Carrick and Dianne Nice at the Globe for nominating the blog, and I want to express my gratitude to all of my readers. I believe that one of the strengths of this blog is the number of smart, sophisticated readers who leave insightful comments and engage in intelligent debates. Let’s all continue the effort to make Canadian Couch Potato the best source for information on index investing.

If you’re visiting for the first time, I encourage you to read the Couch Potato FAQ for the lowdown on index investing.

Book draw winners

Many thanks to all of the readers who weighed in the questions of whether index investors need an advisor. I’ve randomly selected five names from those who posted a comment or Tweeted the post, and these winners will receive a copy of Tony De Thomasis’s book,

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Finding the Right Advisor

One of my favourite financial authors, William Bernstein, used to recommend that investors ditch their financial advisor and handle their portfolios themselves. But in his 2010 book, The Investor’s Manifesto, Bernstein recanted that advice: “I was wrong. Having emailed and spoken to thousands of investors over the years, I have come to the sad conclusion that only a tiny minority will ever succeed in managing their money even tolerably well.”

I’m not quite as pessimistic as Bernstein, but I agree that most people would benefit from professional financial help, even if they use an indexing strategy. The problem is that too many advisors focus on products rather than process, and their compensation models often create conflicts of interest. I discussed these ideas last week in a guest column for the Toronto Star about what you should expect from a financial advisor.

Many of my views on this issue were shaped by Warren Mackenzie of Weigh House Investor Services. I first met Warren three years ago, when he was part of MoneySense’s 7-Day Financial Makeover. The magazine invited three couples and one single woman — all self-confessed financial messes — to Toronto,

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A Case Study in Currencies

In my last post, I explained that US-listed ETFs that hold overseas stocks do not expose Canadians to fluctuations in the US dollar. This is an important idea to understand if you’re comparing ETFs that hold international equities.

Vikash Jain, portfolio manager at the Toronto investment firm archerETF, was kind enough to dig into the data and provide a real-world example of this principle. In 2009 and 2010, the MSCI Brazil Index returned a total of 51% in its local currency, the Brazilian real (BRL). During that same two-year period, the following currency movements took place:

The BRL strengthened against the US dollar (USD) by 38%

The BRL strengthened against the Canadian dollar (CAD) by 14%

The CAD strengthened against the USD by 21%

Jain explained how all of this would have affected the returns of investors who held the iShares MSCI Brazil Index Fund (EWZ), which is traded in US dollars:

An American holding EWZ would have received the 51% index return, plus a big boost because the BRL shot up 38% against the greenback. In USD terms, he would have earned 109%.

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Couch Potato Takes Manhattan

This will be my only post of the week, as I am currently on a family vacation in New York City. I spent today in the Financial District, approaching bankers and other well-dressed individuals on Wall Street and asking them if they had considered embracing a low-cost indexing strategy. Most ignored me. Some swore colourfully. My children were frightened.

During quieter moments, I’m rounding out my summer reading this week with John Bogle’s Enough: True Measures of Money, Business, and Life. Bogle, as long-time Couch Potatoes will know, is the founder of The Vanguard Group and the father of index investing. This book contains no practical advice for investors; rather, it’s a reflection on everything that has gone wrong in business and finance in recent years. In the world of investing, Bogle sums things up like this:

Too much cost, not enough value
Too much speculation, not enough investment
Too much complexity, not enough simplicity

Amen to all three points. It’s hard to overstate the influence that Vanguard and Bogle himself have had on investing in the United States. Not only is Vanguard now the largest mutual fund company in the world,

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