Financial Jungle

Bye Bye Zero Down and Forty Year Mortgages

Posted by ayong
July 10, 2008

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4 Reasons Why Our Portfolio Has No Bonds

A 20-Year Veteran Reveals His Pragmatic Approach To Real Estate Investing

Renters’ Road To Financial Freedom

Coming Out Of Early Retirement

Posted by Financial Jungle Guy
June 17, 2008

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Biovail - A Possible Value And Yield Play?

H&R REIT Looks Cheap

Model Portfolio: ETFs

Birthday Goodies Challenge in Vancouver

Posted by Financial Jungle Gal
May 12, 2008

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A post by my adorable Financial Jungle Gal.

This year, my birthday falls adjacent to Mother’s Day. While jostling through Mother’s Day crowd presents its own challenges, I’m happy to have uncovered many birthday freebies with some help rummaging the Internet and our Entertainment Book for tips. Here are my findings:

Denny’s – Free meal. The only catch is you need to have a second meal of equal or lesser value and purchase two drinks. Cost: $17 (one Grand Slam Breakfast, tea, coffee, and tips) + $2 for 1 hour of street parking (no free spots in the parking lot after circling for a bit). Save: $9 (one breakfast)
Blenz Coffee – Free beverage. This depends on the independently-owned franchise. The two Robson Street locations honored this special, while I heard the Yaletown location does not. Thanks Miss604 for the tip! Cost: $2.21 (Felt guilty just getting a free coffee, so bought a rice crispy square). Save: $4.10 (one beverage)
Cineplex Entertainment – Free movie at Famous Players, Cineplex Odeon, or Galaxy, Theatres. If you’re lucky to have a connection who can purchase corporate discount movie tickets (thanks FJ’s brother!), you can take advantage of the free movie on your birthday coupon that’s included when you purchase four movie tickets. Cost: Pack of 4 tickets $27.32. Save: $12.50 (one movie ticket)

Honorable mentions:

Entertainment Book – 2-for-1 coupons. If you purchase the Entertainment Book, there are valuable 2-for-1 coupons inside and online. We used the discounted 50% off baked goods to a maximum of $5.00 at Fratelli Bakery on Commercial Drive. They have mini éclairs and individual mini cheesecakes. Perfect as I love cheesecakes and FJ doesn’t! More for me!
Japadog Hot Dogs. Well, there was no discount at this fabulous hot dog stand on the corner of Smithe and Burrard Streets. However, if you get a craving for a Japanese style topping hot dog (try the Terri-Mayo Dog, my favourite) and your best friend wants to treat you out for your birthday, then it could be free! Average hot dog price is $4.50.
eCards – Free greeting cards sent to your email. Environmentally-friendly and a quick way to stay in touch with friends scattered over the world. It brings a smile to my face just knowing that a friend was thinking of me and took a few minutes from their hectic schedule to create and send a card. Of course, phone calls are welcome too! Check out: www.bluemountain.com, www.hallmark.com, www.123greetings.com, www.greetings.yahoo.com

Possible discounts to be investigated later (Sources: Miss604.com and redflagdeals.com)

Dairy Queen → Email coupon for your birthday - possible 2 for 1 16 oz. Blizzard?
Orange Julius → 2 for 1 20 ox. Fruit Smoothie for sign up and receive “special coupon” on your birthday (Must set location).
Old Spaghetti Factory - → Free entrée
Need to fill out an in restaurant registration in advance of birthday and will be sent a complimentary meal coupon for the entire month of your birthday.
Tony Roma’s – join birthday club for coupons.

Last thoughts: We spend my birthday prowling around Vancouver for the freebies and honorable mentions. Highly recommend the movie “Iron Man”. With the thrill of the hunt, we went home happy and satisfied that we saved $30.60.

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Real Professionals Have Skin In The Game, And They Beat The Market Too.

Posted by Financial Jungle Guy
May 7, 2008

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The Public Be Damned… you may quote me: Screw ‘em.

That was the remark from legendary value manager, Marty Whitman, cursing fickle investors for fleeing his Third Avenue fund in favour of the more glamorous technology stocks. The exodus shaved his Third Avenue fund’s assets under management from $50 billion to $38 billion in 1998 and 1999. But guess who’s having the last laugh as the Third Avenue fund is enjoying a 9.95% average 10-year run. Compare that to S&P 500’s 5%!

Marty Whitman has always believed in his value philosophy, which is why he invests the bulk of his wealth alongside investors’. With so much at stake, he can also afford to focus on his long-term objectives in the face of short-term adversities. For Third Avenue, giving Whitman the pink slip is never an option given his revered status. Not to mention Whitman basically runs his own show at the firm.

Other mutual fund managers? Hmm…. not so lucky. Several quarters of persistent lousy performance and you’re out!

So why are mutual fund companies so fixated on short-term returns? Don’t look around. Look at ourselves. We’re the culprits. I once had a colleague, who’s brilliant at what he does, but he said to me, “I pick my RRSP mutual funds based on last year’s performance.” This is how most of us are wired, which is why fund companies are so wildly successful at promoting products catered to our myopic views.

According to an article by Martin Gale, most managers’ interests aren’t aligned with investors’. Judging from how managers are compensated, it’s no wonder why 80% of managers fail to beat the market. They’re not paid to beat the market!

It’s simply not good enough to invest with the manager with the most morningstar stripes. In addition to a strong track record of eclipsing the market, the manager must also “eat his own cooking.” After all, if the manager refuses to eat his poison, why should you?

In 2006, Boston Business Journal surveyed 75 locally based fund filings and discovered that 37 funds had zero dollar invested by their own managers. If a manager doesn’t invest the bulk of his wealth in his own funds, then he’s simply a well-compensated employee whose paychecks depend on MER and assets under management (AUM), not investors’ return. The easiest way to grow AUM is by selling the hottest trends; the ones that made the most money last year. Think back at the height of the Internet bubble. What attracted weak money? Nortel or oil stocks? Fast forward 8 years, which one enriched investors handsomely?

I recently came across an interesting article on Reaping What They Sow. The Denver Business Journal came up with a list of US fund companies where managers were investing heavily in their own funds. The article doesn’t go into performance, so I decided to do a little digging on the top 3 firms: Marsico Capital, Jenus Capital, and Cambiar Investors.

Marsico Capital has 6 funds under managment: Focus, Growth, 21st Century, International Opportunities, Flexible Capital, and Global. All have beaten their respective benchmarks. 2 funds have 10+ year histories. Managers invest an average of $900k in the funds.
Jenus Capital has too many funds to list. But their 38-year-old flagship fund, Jenus Fund, has beaten S&P500 by 2.4% a year. Managers invest an average of $675k in Janus mutual funds.
Cambiar Investors has 3 funds under management: Large-cap, Small-Cap, and International. All have beaten their respective benchmarks. Managers have an average of $559k invested.

If you don’t recognize these U.S. firms, I’m sure you have heard of Warren Buffett, Jim Rogers, Eddie Lampert and George Soros. They, too, have their skin in the game.

Robert Rodriguez was voted by CNN Money as the best manager of our time. Since the mid-1984, his FPA Capital has shattered the S&P 500 with a 3.9% winning margin. He’s a smart dude, but guess what. He’s also the largest shareholder of his fund.

You might recognize value-investing firm, Tweedy Browne. Their flagship $6.7 billion Global Value fund has beaten the MSCI EAFE index by 4.5% a year since 1993. The current managing directors, retired principals and their families, and employees have $91.6 million locked up in the Global Fund.

MorningStar International-Stock Fund Manager of the Year winner, Hakan Castegren, invests over $1 million of his money in his Habor International fund, which commands twice the EAFE index’s 20-year annualized return.

Looking north of the border, there’s Irwin Michael, whose Fundamental Value fund trashed the TSX by a whopping 6% a year since 1990. He invests his family’s savings in his funds.

Don’t forget Francis Chou, whose Chou Associates and Chou RRSP have compounded returns of 12.4% and 10.6% respectively, despite being somewhat of balanced funds.

What about Wil Wutherich? He’s a new to SteadyHand, but not new to wealth management. His Small-Cap fund annualized 17% over a short history so far. Wil Wutherich is also stuffing his money where his mouth is.

Although 80% of “professional” money managers underperform the market, keep in mind that real professionals have skin in the game. While picking a manager with a large stake in his own funds alone doesn’t guarantee extraordinarily results, at least it weeds out the uncommitteds; the ones not paid to beat the market.

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Picking Up Hard Real Estate The Soft Way

Bought Inter Pipeline Fund And Boston Pizza Royalty Income Fund

Debunk Passive Investing As The Holy Grail

Dividend Increases: Steady Income Without Market Volatility

Posted by Financial Jungle Guy
April 24, 2008

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This is the sixth post in the Dividend Increases series.

I think dividend-investing is one of the few free lunches left in investing. Most people looking for higher returns are often confronted with persistent market volatility, but it doesn’t always have to be that way. The strongest driver behind my investing in dividend-paying stocks is the steady and growing income stream that accompanies the strategy, but without the baggage of market volatility.

Take Johnson and Johnson for example. Today, the Board is delivering, yet, another mundane pay raise to shareholders by boosting dividends for the 46th consecutive year. 46 years is a long time. The best part about being a Johnson and Johnson shareholder is that your income is immune to the jittery stock market awash with doom and gloom prognoses in every corner. The stock may be up 5% today and down 5% tomorrow, but as long as dividends are flowing in, investors have no reason to panic and sell low. For this reason, I feel that the dividend investing strategy does a terrific job at stimulating good investment habits for certain individuals.

Below, I have charted Johnson and Johnson’s historical share prices followed by dividend payments from the past decade. When you retire, would you rather live off of the capital gains or dividends?

Dividend increases since my last portfolio update:

TD - 3.5% (11.3% from last year)
North West Company - 18.5% (45% from last year)
Johnson and Johnson - 10.8% (10.8% from last year)
Husky Energy (non-core) - 21% (60% from last year)

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Carnival Cruising To Dividend Growth Territory

Posted by Financial Jungle Guy
April 24, 2008

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I used to think that since it was a capital intensive business, Carnival (CCL) wouldn’t qualify as a classical dividend growth story, but I stand corrected.

Carnival is the most dominating global cruise company in the world generating revenues in excess of $13 billion; trouncing the $6 billion eked out by distant second place, Royal Caribbean. The company didn’t become this big for no good reason: it has the most recognizable brand and the fattest profit margin (17.5%) in the cruise line business. For comparison, Royal Caribbean’s profit margin is only a meager 9.8%.

Carnival is also spinning out lots of cash, and it’s not afraid to share the wealth with investors. In 2007, the Miami-based company garnered an astonishing $4.07 billion of cash from business operations. Out of which, only $0.54 billion was needed for ship improvements/refurbishments, and developments to various tour assets and port facilities.

With $3.53 billion of free cash flow in hand, Carnival chose to reward shareholders with $990 million in dividends and buy back $275 million worth of shares. They reinvested the rest of $2.26 billion as part of the ongoing new shipbuilding program, including final delivery payments on 5 brand-new ships: Carnival Freedom, Emerald Princess, AIDAdiva, Costa Serena and Queen Victoria. (Carnival owned 85 ships by end of 2007.)

This 36-year old company delivered its first dividend payment of 2.5 cents a share back in February 1989. Today, the quarterly dividend balloons to 40 cents a share. In fact, payments have accelerated in recent years quadrupling over the past 8 years.

Carnival is about 20% off its high. I haven’t pinned down an entry price, but at 4% yield, less than 25% payout ratio based on free cash flow, 13.5 PE ratio, and a good growth profile, I think a reasonable entry price is near.

I don’t own the stock. I’m not a certified investment adviser. Please conduct your own research.

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Posted by Financial Jungle Guy
April 21, 2008

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Conventional wisdom jibes with the notion that bonds cannot outperform stocks over a distant horizon unless you’re toying with junk bonds. But there’s much more beneath the surface. I feel very fortunate to have *BondGuy, a securities broker, who promises to debunk this investment myth, but he’ll first warm us up with some background information on a special type of bonds that large institutions and the ultra wealthy invest in, namely Collateralized Mortgage Obligations (CMO.) This article is technical and lengthy, but fascinating. BondGuy is available for questions if you’re interested to learn more about CMO. Emphases in the article are mine.

* Replaced with an alias to comply with regulations.

Most of the world’s investors believe the myth that they can’t get a high yield on bonds unless they invest in Junk bonds. They take the risk of losing their initial investment if the issuer goes into default for only 2 or 3% more in interest that they receive for taking that risk. In this post we are going to bust that myth.

Where do we find the strongest credit quality?

First we need to look into finding bonds of the strongest credit quality that will give us a high level of comfort when it comes to the return of our principal. Remember folks, the return of your investment is far more important than the return on your investment. I’ll take an investment that makes a low return over a losing investment any day. Thus, we should stay away from the Junk bonds.

The United States Government and United States Government sponsored agencies hold some of the strongest credit qualities in the world. If we look at corporate bonds you will be hard pressed to find a bond that has received an AAA credit rating for 70 years continuously. Fannie Mae has been around since 1938 and has been AAA rated ever since. Freddie Mac was created in 1970 and has also been AAA rated since inception. Genie Mae is another government agency that was granted full faith and credit of the United States government in 1969 by then attorney general William Rehnquist.

AAA credit ratings are, of course, the safest available. Any credit rating below BBB is considered Junk. There are 3 major credit rating agencies that issue bond ratings in the United States Moody’s, Standard and Poor, and Fitch.

I know that many of the readers of this forum are in Canada. You can be assured that the cities that you live in invest in Fannie Mae and Freddie Mac. Not only municipalities all over the world invest in these bonds, so do pension funds, insurance companies and banks. When I started working in the bond field, some of the largest clients of my first company were banks in Europe. Freddie Mac, Fannie Mae, and Genie Mae make up the system that gives the United States mortgage market its Liquidity. If there was no Fannie, Freddie, or Genie you could go to the bank to borrow money for a home and the banker would probably say they were sorry, but they have no money to lend to you even though your credit is perfect.

When a bank gives a person a home loan they turn around and sell that mortgage to Fannie, Freddie, or Genie at a slightly lower interest rate than they lent the money at. This way the bank has a small piece of interest from the mortgage and Fannie, Freddie, or Genie has given them all of their principal back. The bank can then lend out the same money again.

Freddie, Fannie, and Genie then package these mortgages into bonds and guarantee on time payment of principal and interest. These agencies are allowed to buy very few sub prime loans and have extreme legal oversight from the United States Government. Why such tight regulations on government sponsored enterprises? If Fannie Mae, Freddie Mac, or Genie Mae were to go bankrupt it would cause world wide financial turmoil. Many of the municipalities in the world would go broke. All of the municipalities in the United States would go broke. Your pension plan would be no more (even in Canada). Banks worldwide would go under. These agencies issue and are responsible for making principal and interest payments on trillions of dollars in debt every year and have never missed or been late on a payment. They issue and pay principal and interest on more debt every year than the GDP of many counties. I think we get the idea. The credit quality is extraordinarily strong.

Genie Mae is full faith and Credit of the United States Government. Fannie and Freddie hold what we often refer to as implied full faith and credit of the U.S. Government. We just watched the U.S. Federal Reserve give a large bail out to Bear Stearns because of the negative world wide financial implications. Bear Stearns is tiny in comparison to Fannie or Freddie. The United States government would have no choice but to bail out Fannie or Freddie if they got into trouble. Thus, the term Implied full faith and credit applies to them. I think we now know how strong the credit quality behind these bonds is. Here is a credit rating chart.

Moody’s	S&P	Fitch	Definition
Aaa	AAA	AAA	Prime: Maximum Safety
Aa1	AA+	AA+	High Grade High Quality
Aa2	AA	AA
Aa3	AA-	AA-
A1	A+	A+	Upper Medium Grade
A2	A	A
A3	A-	A-
Baa1	BBB+	BBB+	Lower Medium Grade
Baa2	BBB	BBB
Baa3	BBB-	BBB-
Ba1	BB+	BB+	Non-Investment Grade

Why on earth would a bond issuer with such a high credit rating pay a high rate of return?

The answer to this question is…. they don’t. The high coupons, or interest passed through to the investor in these bonds is paid through cash flow engineering. Cash flow engineering is the slicing and dicing of interest payments on the cash flows from mortgages. It’s a very complex process so we’ll give an example with some simple numbers just to make it easier for me to explain.

A bank will make mortgages at 6 ½ % to the home buyer. They will turn around and sell these mortgages to Fannie, Freddie, or Genie at 6%. So far the mortgage holder will pay the bank 6 ½ % interest plus principal due and the bank will pay Fannie, Freddie, or Genie the principal received and 6% interest keeping ½ % for their profit.

After this takes place Fannie, Freddie, or Genie will group these mortgages into what they call pools and form bonds that pass through interest from those pools. Some of these pools are in the billions of dollars. They will take 90% of these now 6% mortgages and make bonds that yield 5.5% to the investor. So what happened to the extra ½ %? They take that excess interest and pile it on top of the other 10% of the available mortgage pool giving them 51% yield on that small portion; the original 6% that the mortgages naturally pay and 45% that come from the ½ % excess off the other 90% of the mortgages. Understanding how cash flow engineering is done is not really of importance to the investor. You need to know how it works and what it does to bond coupons. You can use a car without knowing how to make one. We’ll get into what the investor needs to understand next.

Why don’t they just sell the bonds that yield 51%?

Sorry guys, it’s an efficient market that operates on the same risk return principals that every investment operates on. But, one of those risks does not have to be losing your initial investment. These bonds take interest rate risk. If rates go up, the coupon will go down and can go to zero on many of them. That’s why I buy these bonds when it looks like rates are going to go down. It’s a lot easier to speculate on rate moves than it is on stock price moves. Interest rates are in the news almost every day. The U.S. LIBOR floats right along with Fed Funds. Fed Funds is the rate that U.S. banks use to lend each other U.S. Dollars overnight. U.S. LIBOR is the rate that European Banks use to lend each other U.S. Dollars overnight. Just wait for the U.S. Federal Reserve to lower Fed Funds, the U.S. LIBOR will follow, and you can make money with these bonds.Thus, the name of these bonds is Inverse Floating Rate Collateralized Mortgage Obligations or CMO’s. Not all CMO’s are inverse floating rate, some are fixed rate and give much lower returns due to the lack of interest rate risk. Not all CMO’s are backed by government agencies like Fannie, Freddie and Genie. CMO’s that are not backed by Fannie, Freddie, or Genie are subject to losing money due to defaults in the sub prime market.

If we want to take risks to get a higher return we should take interest rate risk and always buy the CMO’s that are backed by government agencies. I have bonds in my client portfolios that float inversely to the 1 Month U.S. LIBOR anywhere from 2% to 25% for every 1% that the index moves. This percentage is called the lever. The Federal Reserve has lowered rates from 5.25% to 2.00% since October 2007. Thus the bonds that have the higher levers are getting about 60% coupons currently.

As rates go up the coupons on these bonds will go lower at the same rate that they went up. All inverse floating rate bonds have what we call a strike. The Strike is the point on the LIBOR Index where the bonds coupon will hit zero. If you have a bond with a 4.5% strike and rates are at 4.75% this bond is considered out of the money and will not begin to pay interest again until rates are lower than 4.5%. After rates fall below 4.5 the coupon will increase by the lever amount. For example: If we have a bond with a 4.5 strike and a 15 lever and rates fall from 4.75 to 3.5% over the next several months the interest rate paid to the investor will go from 0% to 15%. If rates go back up over 4.5% the coupon will go back to 0%.

What are the Maturities on these bonds?

We never know what the maturity on a CMO will be. They are made up of 30 year mortgages and the principal and interest payments are passed through to the investor every month. Usually, they take 7 - 12 years to come to maturity.

If they are 30 year mortgages how do they only take 7 -12 years to come to maturity? The average U.S. family lives in a house for 7 years and the home is sold, effectively ending the mortgage contract. The investor receives their principal on that portion of the bond every time a mortgage contract comes to an end. We have what we call the 4 D’s in this market: Divorce, Death, Destruction, and Default. If a couple gets a divorce the home is usually sold. The same happens when someone dies. If a home is destroyed the insurance company pays off the remainder of the mortgage and the contract is over passing that principal on to the investor. If someone defaults, that mortgage contract is done, the bank takes the house, and the investor in the CMO is paid their portion.

Let’s not forget that on time payment of principal and interest is guaranteed by the U.S. government or a U.S. government agency when you buy bonds issued by Fannie, Freddie, or Genie. Another big factor that causes these bonds to pay down faster is refinancing. If a mortgage holder refinances their mortgage the contract is over and the investor in the bond gets that portion of their principal back. Refinancing happens when rates go down and mortgage holders are given the opportunity to refinance it into a lower interest rate.

There are several factors that an investor looks at to estimate when the bond will come to maturity. The first number they would look at is the weighted average coupon, which is the average rate to the mortgage holder. If they have a higher rate they will be more likely to refinance when interest rates go down and the bond will pay off more quickly.

We look at which states the where the mortgages are located. Some states like California and Florida tend to pay down much faster due to real estate speculation. Another factor we look at is which banks made the mortgage loans. The larger banks tend to actively contact there mortgage holders for refinancing purposes. The banks make fee income and the client saves money investing at a lower rate. This also causes these bonds to pay down more quickly. Since refinancing plays a big part in the prepayment of these bonds, and most people don’t want to reinvest in a higher rate mortgage, you run the risk that rates could go through the roof and stay there for 20 years.

Let’s remember that these bonds have an interest rate paid to the investor that floats opposite interest rates. If rates did go through the roof for 20 years you could be holding a non-performing asset for that amount of time. It’s never happened before but the possibility does exist.

How does Bond pricing work with the inverse floating rate CMO?

If interest rates rise, the price on bonds goes down. If interest rates fall, the price on bonds goes up. Since the coupons on inverse floating rate CMO’s can float so far from where market rates are, they have much higher price volatility than normal bonds. If rates are down, I’ve seen some of the higher leveraged bonds priced at 175 cents on the dollar when I only paid 100 cents on the dollar for them several months before. When rates go up I’ve seen these bonds priced at 50 cents on the dollar.

Investing with a bond investor mentality is far different from that of a stock investor. You know that if you hold your bonds to maturity you will get all of your money back as long as we are using government or government agency bonds. If your stock portfolio is down for the month you feel bad, you don’t know when your stock will come back to the price that you paid for it. When you are investing in bonds you have a contractual agreement to give you all of your money back at some point in the future. Not to say I don’t sell on some highs but I don’t worry at all about the lows. The price will come back when rates go back down and we always receive our principal at 100 cents on the dollar. Many of these bonds can be bought at 50 cents on the dollar if rates have gone up and when rates fall the price will go up making a nice buy and sell play. Let’s not forget that when the price goes up, this means we are being paid interest again. If we sell we get the interest up to the point when we sell the bond and the gain form the sale of the bond. I’ve seen 80% returns with this play.

There are other bond plays that can make nice returns.

CMO’s come in many different varieties. We can use Two Tiered Index Bonds (TTIBs) which are CMO’s that will give us a return higher than most junk bonds with AAA credit ratings. Again we will take interest rate risk. With TTIBs we will receive an interest payment until the 1 month LIBOR reaches a certain rate. As of late I have been seeing bonds that will give the investor 7.5% until the 1 month U.S. LIBOR reaches a 6% strike price and then it will start to go down, 8% until the 1 month U.S. LIBOR reaches a 5.5% strike and some that will give the investor 9% until the 1 month U.S. LIBOR reaches a 5% strike. The coupons could fall to 0% if the U.S. LIBOR goes over the strike price.

Another play that many retirees make is in floor bonds. They are inverse floating rate bonds that will give you a minimum coupon and will float up and down inversely 1% for every 1% that the 1 month LIBOR moves. Why would we buy a 6% bond if we could buy one that will give us a 5% minimum but has the potential to give us 10 – 12% at times.

I understand that many of the readers on this site are from Canada. If you invest in this type of bond you will also be subject to currency risk. I am not a currency trader nor do I believe that I have the expertise to inform you about currency risk. I know that currently the U.S. dollar is sliding against foreign currencies. If you plan to invest this type of bond make sure you speak in detail with your financial advisor about inverse floating rate Collateralized Mortgage Obligations before hand. I would be surprised if there is not an equivalent to CMO’s for the Canadian bond market. Unfortunately I don’t know anything about Canadian government issuers but I can’t see a country like Canada doing without them. If you wish to invest in the U.S. bond markets please wait until the price of oil comes down and the U.S. Dollar stabilizes. For those readers who live in the U.S. you have no foreign currency risk.

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Who’s Benefiting From Your Asset Allocation?

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Smith Manoeuvre - Hidden Treasure In Your Mortgage

Canadian Dividend Stocks Are Flexing Muscles Too

Posted by Financial Jungle Guy
April 16, 2008

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As mentioned in my High Yielding Dividend Stocks Flexing Muscles post, 12 independent studies concluded that investing in high yielding dividend stocks was a winning strategy for much of the previous century. Despite the overwhelming evidence, all the studies were predominantly US and UK based, so I decided to roll up my sleeves and conduct my own research in Canada.

To begin, I queried for all Canadian dividend mutual funds with at least 15-years of historical data from GlobeFund. I then manually weed out funds with too much bond or foreign content; so, only dividend funds with at least 75% common stocks, and 80% Canadian contents made the list.

Here are the final 7 funds along with their 15-year compounded return and Management Expense Ratio (MER):

Not surprisingly, lower MER funds tend to churn out stronger performance over time. However, I don’t see the benefit of paying for MER when an investor can easily emulate these dividend funds with a handful of core holdings, and then build on them as the portfolio grows.

The average annual return for the group is 10.95%, but if I remove the MER component, gross return jumps to 12.87%. It’s worth reiterating that a typical dividend fund has a bond allocation, so a pure dividend play would see over 13% in return. For comparison, TSX’s total return over the same period is 11.27% before tracking error, or a difference of 1.60+% compounded over 15 years. Over the next 3 years or so, I anticipate financial stocks to rebound and resource stocks to cool, which would widen the lead even more.

For other benefits of dividend investing, please check out my post on Top 10 Reasons For Dividend Investing.

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A Diversified 4.69% Yielding Portfolio

Want Success? Be A Ruthless Pig!

What Are Your BNN Top 3 Picks?

Posted by Financial Jungle Guy
April 15, 2008

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Since all BNN guests are having so much fun with their top picks, I don’t see why we can’t have ours. Here are my top 3 picks:

Scotiabank (BNS) - Canada’s most international bank is trading at a cheap 11.7 PE and yielding an attractive 4.2%. The market is hurting the bank even though it has no exposure to US subprime. Risk of a dividend cut is virtually non-existing, and the distribution will head higher over the horizon.

Artis REIT (AX.un) - Retail, office and industrial landlord who has a knack for acquiring undervalued properties with in-place rents significantly below-market rent rates in the booming Western provinces. Currently sports a 6.6% distribution yield, a conservative 75% payout ratio, and a healthy 49.2% debt-to-GBV. For comparison, debt-to-GBV are 55% for Calloway REIT and 61% for HR REIT.

Boralex Power (BPT.un) - Management recently cut distribution from their long-term assets due to USD depreciation and below average hydrology; both of which were outside of management’s control. Odds are in favour of US dollar and hydrology to revert to their historical average. Boralex’s current plight is more than priced in to the 13.9% distribution yield.

What are your BNN top 3 picks?

Disclaimer: This is a fun post. Please conduct your own research before making any investment decision.

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CommunityLend To Cut Fat Middlemen With Social Lending

Posted by Financial Jungle Guy
April 11, 2008

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Today, I was approached by Dave Coleman who is a lead Community Advocate from a new social lending player, CommunityLend.

The whole concept of social lending is relatively new to me. In a nutshell, CommunityLend is an online marketplace that brings ordinary lenders and borrowers like us onto an efficient and nimble platform, thus bypassing most of the overheads from traditional banks and credit unions. This would ultimately leave a lot of money on the table.

“Share the wealth,” CommunityLend pledged.

Borrowers stand to benefit from the best possible rates with multiple lenders competing against each other to bid down the interest rates. Once an auction hammer strikes, the unsecured loan is directed to borrowers’ account, and repayments are automatically deducted every month. To learn more about becoming a borrower, visit I Want To Borrow.

Lenders also benefit because according to CommunityLend, “To keep things as safe and secure as possible we will use virtually the same processes and service providers as banks and credit card companies use for validating identity, sourcing credit information, moving money between parties and enforcing collections.” You can visit the I Want To Invest page to learn more about becoming a lender.

As far as I know, CommunityLend is the first of its kind in Canada, and they’re not even open for business until mid-2008. But apparently, social lending is proving to be a smash hit in countries such as UK and US. UK-based social lending mogul, Zopa, has a member base 190,000 strong across UK, Italy and US, and they’re marching into Japan. According to Zopa, the average return for lenders is 8.1% with a stunning 0.1% default rate.

Since CommunityLend’s website isn’t fully functional yet, you can get an idea of what the auction screen might look like at US-based Prosper. Here you’ll see a list of loans each describing the purpose of the loan, borrower’s credit rating, current bid, and amount funded so far. If you need another example, check out Lending Club.

Dave wanted to know my first impression of social lending. I think it’s a good idea to have new competitors against banks to fight for our dollars, but I still have the following questions/concerns:

How does CommunityLend get paid?
What happens when a loan defaults? Will CommunityLend fight for the lenders?
Can lenders diversify by slicing their money into different loans?
How do lenders and borrowers determine what’s a justifiable interest rate for a particular credit score? Is there a primer available for lenders and borrowers to educate themselves prior to an auction?
Can a lender back out before the term is over? Can he sell the loan to another lender?
What’s the anticipated ratio between the number of borrowers and lenders?

[Edited Apr 12, 2008]

Disclosure: I’m not affiliated with CommunityLend. This is not a paid post.

Additional readings:
* Social lending the next Web 2.0 phenomenon
* Social lending set to soar
* Looking to become ‘an Ebay for loans’

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High Yielding Dividend Stocks Flexing Muscles

Posted by Financial Jungle Guy
April 10, 2008

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The Dividend Guy recently touched on a research paper that revealed a surprising result about dividend investing; stocks that generously distribute larger percentages of their earnings to shareholders tend to outperform their stingy counterparts. This is counter-intuitive considering that the more earnings a company distributes to shareholders, the less retained earnings remain to grow the business. For more on this finding, download Does Dividend Policy Foretell Earnings Growth? from Papers.SSRN.com.

As if that wasn’t a head-scratcher, renowned value-investing firm, Tweedy Browne, compiled a series of studies suggesting another firmly held conventional wisdom is about to come crumbling down. It’s widely believed that one law of dividend investing is to buy lower yielding stocks if you want to accelerate portfolio growth. Beware of such assumption as the paper begins eloquently with a quote from T.H. Huxley.

The deepest sin against the human mind is to believe things without evidence.

As far as I’m aware, this is the very first time that someone gathers not one, not two, not three, but twelve independent research studies using empirical evidence to reinforce the claim that the highest yielding stocks trash their low-yielding counterparts consistently over a variety of periods and geographies.

Here are some quotes from each research:

Triumph of the Optimists: 101 Years of Global Investment Returns (2002) - Over 101 years, [Elroy Dimson, Paul Marsh, and Mike Staunton] found that a market-oriented portfolio which included reinvested dividends would have generated nearly 85 times the wealth generated by the same portfolio relying solely on capital gains. (1900 to 2000, US & UK.)
Dividends and the Three Dwarfs - [Robert D. Arnott] concluded that dividends were far and away the main source of the real return one would expect from stocks, dwarfing the other constituents: inflation, rising valuations, and growth in dividends. (1802 to 2002, S&P500.)
Taxes, Dividend Yields and Returns in the UK Equity Market - Using data from the London Share Price Database (LSPD), [Gareth Morgan and Stephen Thomas] examined the relationship between dividend yields and stock returns from 1975 through 1993 in the UK. Database companies were ranked by dividend yield at the end of each month and divided into six groups, including a zero dividend group (companies that did not pay dividends). … they find a strong [positive] correlation between the size of the dividend yield and the average monthly return. (1975-1993, UK.)
Market Anomalies: A Mirage or a Bona Fide Way to Enhance Returns? - Using a sample of 4,413 companies which were listed on the London Stock Exchange during January 1955 through December 1988, Lenhoff ranked all listed companies each year according to dividend yield and sorted the companies into deciles. …there was almost a perfect correlation in the decile returns between higher dividend yields and higher annualized returns. The top decile, in terms of high yield, produced an average annualized return over 34 years of 19.3% versus 13.0% for the Financial Times Actuaries All Share Index. (1965 - 1998, UK.)
The Importance of Dividend Yields in Country Selection - Michael Keppler examined the relationship between dividend yield and investment returns for companies throughout the world. … The study indicated that the most profitable strategy was investment in the highest yield quartile. The compound annual investment return for the countries with the highest yielding stocks was 18.49% in local currencies (and 19.08% in U.S. dollars) over the 20-year period, December 31, 1969 through December 31, 1989. The least profitable strategy was investment in the lowest yield quartile, which produced a 5.74% compound annual return in local currency (and 10.31% in U.S. dollars). (1969-1989, world.)
Dogs of the Dow - [Michael O’Higgins] discovered that by investing in the 10 highest yielding securities in the Dow Jones Industrial Average of 30 industrial companies, and rebalancing annually, one could substantially outperform the average itself. (1973-1998, Dow Jones Industrial Average.)
Triumph of the Optimists: 101 Years of Global Investment Returns - Higher dividend yield stocks outperformed their lower-yielding counterparts and the index by 180 and 160 basis points annualized from year end 1926 to year end 2000 (a basis point is one-hundredth of a percentage point). This translated into 2.29 times the wealth generated by the lower-yielding stocks. (1926-2000, US.)
The Future for Investors - In Jeremy Siegel’s study, on December 31 of each year, the S&P 500 stocks were sorted into five quintiles ranked by dividend yield. He then calculated the returns of the stocks and quintiles over the next year, re-sorting at year-end. He found that better results were directly correlated with higher dividend yields. The highest yielding quintile (top 20% of S&P 500 based on yield) produced an annualized return of 14.27% versus an annualized return of 11.18% for the S&P 500 Index, which resulted in three times the wealth accumulation of the index. (1957-2002, S&P 500.)
Contrarian Investment Strategies: The Next Generation - David Dreman analyzed the annual returns of price-to-dividend strategies using data derived from the Compustat 1500 (largest 1500 publicly traded companies) for the 27-year period ending December 31, 1996. As indicated in the table below, he found that the highest yielding top two quintiles of the Compustat 1500 stock universe ― as reflected by low prices in relation to dividends ― outperformed the market by 1.2% and 2.6% annualized, respectively, and outperformed the stocks with low-to-no yield by 3.9% and 5.3% annually. (1970-1996, US.)
Lehman Brothers Equity Research - High dividend yield stocks were found to have produced more return with less risk than their low-yield counterparts. The Lehman analysts studied the one thousand largest of U.S. firms ranked by market capitalization, and rebalanced these securities quarterly, starting in January 1970. They found that the top-yielding quintile produced a 13.7% equal-weighted total return per year with a 15.5% standard deviation of return. The bottom-yielding quintile, in comparison, returned 9.0% with a 29.1% standard deviation. (1970-2006, US.)
High Yield, Low Payout - Over the 26-year period, [Credit Suisse Quantitative Equity Research] found that stocks with higher dividend yields generally outperformed those with low dividend yields, but the highest yield decile did not produce the best overall return. As their chart indicates, deciles 8 and 9 outperformed decile 10, the highest yield decile. … However, the best returns have not come from those with the highest yields ― higher yields coupled with low payout ratios have produced the best returns. (1980-2006, S&P 500.)
When The Bear Growls: Bear Market Returns - The Compustat 1500 database (1500 largest publicly traded stocks) was used, and the performance of four value strategies ― low price-to-earnings, low price-to-book value, low price-to-cash flow, and high dividend yields ― were measured and averaged for all down quarters and then compared to the index itself for the 27-year period. All of the value strategies outperformed the market, with the high dividend strategy (low price-to-dividend) performing the best of all the value strategies, declining on average only 3.8%, or roughly half as much as the market. (1970-1996, US.)

Note that the yield is only one facet of a sound stock selection process. Although the typical high-yielding stocks have overwhelming astounded investors with superb total performance, others have slashed or halted their juicy yields due to unsustainable dividend policies.

Just to be on the safe side, we should also examine other financial figures abreast including, but not limited to the price-to-earning (P/E) ratio, free cash flow, payout ratio, debt-to-equity (D/E), return on invested capital (ROIC), revenue growth, and earning growth. One of my favourite sites to look up financial numbers is MSN Finance. Here’s an example link to Saputo’s historical cash flow statements.

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Financial Stocks: Dead Cat Defies Gravity

Posted by Financial Jungle Guy
April 9, 2008

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The investment saying, “dead cat bounce”, has been thrown around recently to warn investors about the nasty surprises prowling right behind the beguiling recovery of fallen financial stocks.

While I don’t know where the financial sector is headed in the short run, as a dividend and long-term investor, I try to block these little price squiggles off my mind and focus on my long-term views and investment philosophies. Without the benefit of hindsight, no one can predict where the stock market will go over the next few days, weeks or months.

I remember reading a few doom and gloom posts in the Canadian Business forum just days after the near collapse of US investment banker, Bear Sterns. Pundits plead investors to sell financials as the whole sector was being crippled by subprime, ABCP, derivative, credit, and liquidity crisis. Many critics were combing for and cherry picking web articles that supported their point of views. One of the articles even recommended the following:

“If your only nest egg is your IRA, then I suggest taking half of your money out, and paying the penalties, and buying physical silver or gold immediately from your local coin shop.”

Having radical recommendations like this displayed in a public forum is disturbing. I hope no one actually followed up on this recommendation and parked half their nest eggs in one precious metal. That would go against the principle of diversification. A wrong bet could send investors into a financial tailspin.

Sure enough, over the next 2 days, the Vanguard Financial ETF surged 5.6% and gold slid 5.9%.

“Enjoy the dead cat bounce while it lasts !!”, one critic trumpeted.

But, apparently the dead cat had 8 lives remaining as the Vanguard Financial ETF subsequently rose 4.4% and gold fell another 2.9% as of closing today. Even the two most hated Canadian banks, Bank of Montreal and CIBC, jumped nearly 20% since the March 18th low. The other 3 big Canadian banks (RY, TD, BNS) are also up a respectable 7% on average.

I’m not suggesting everyone to flee their gold investments and plunk 100% into financials. That would defeat the purpose of this post. If you believe a particular sector will stumble in the foreseeable future, why not prune gently instead of pulling out the root system entirely? The best way to keep portfolio risks in check is to maintain a reasonably diversified portfolio across all sectors, and avoid keeping a finger on the buy/sell trigger while reading these sensational forecasts from financial forums no matter how convincing or colourful they may be.