This week's interesting finds

November 16, 2019

Sunday marks the 11th anniversary of the launch of our funds.
Here is a throwback to an early video we shot. We may not look as young anymore – but our commitment to putting our investors’ interests first will never get old.

The price to be paid for listening to Armageddonists
Many famed commentators have made dire predictions of imminent stock-market doom. This has been a recurring theme since the 2008 financial crisis. What if you listened to these talking heads and shifted your money from stocks to the safety of bonds? How would this have protected your wealth? Not very well.

Below is a hypothetical example of what would have happened if you shifted your savings from the S&P 500 Index to the Barclays Aggregate Bond Index during the week these famed commentators made one of those predictions. In the most extreme example, we see losses reach as high as 60%.

Here are some quotes rounded up from these prediction pontificators.

"It really does now look like President Donald J. Trump, and markets are plunging. When might we expect them to recover?  A first-pass answer is never. So we are very probably looking at a global recession, with no end in sight." (Paul Krugman, New York Times, November 2016)

“Trump victory would likely cause the stock market to crash and plunge the world into recession” (Simon Johnson, Former Chief IMF Economist, November 2016)

“I think it’s pretty obvious that the top is in. It’s just waiting for the knee-jerk bulls, robo traders and dip buyers to finally capitulate.” (David Stockman, August 2015)

Kids, money, and process over short term outcomes
The abundance of information today has made us dependant on getting it fast which has translated to the rise of on-line portals enabling parents to check their children’s grades in real-time. There is nothing wrong with making sure your child stays on track, but good intentions can be overwhelmed by unintended consequences, infecting the learning process. Many parents become obsessed with the random bells and whistles alerting them to incoming grades. Children become conditioned to learn something short term, get a good grade, and then forget everything.

There are no shortcuts to learning and investing. Good processes, not temporary outcomes are the keys to positive long-term results.

The same applies to obsessive portfolio checking. Like those compulsive and over-protective parents. What are you expecting to see? The more frequently you monitor your portfolio, the more likely you are to observe a loss. This is likely to cause short-sighted decisions and could hurt your investment performance.

With investing, time is usually on your side. Your kids and money benefit more from a long-term process-oriented approach. Incessantly logging into your computer frequently checking things that don’t need checking never made anyone rich.

Betting on humble CEOs
A new study accepted for publication in the Strategic Management Journal found that analysts tend to significantly underestimate the earnings potential of companies run by humble chief executive officers. That leads to artificially low earnings forecasts from the analysts, which the firms can then more easily meet or beat.

To measure humility, they recruited senior undergraduate students, as well as experts in psychology, to rate videos in which the CEOs appeared, using a scale that includes such characteristics as modesty, fairness and sincerity.

While humble CEOs aren’t any more or less capable leaders than their more brash peers, they tend to benefit from an “expectation discount,” which can lead to increased market returns for their companies following earnings announcement.

The only ones to really gain any valued insight from this study is the analyst. they might be unaware that their own psychological biases can affect how they appraise companies and the CEOs that lead them.

Investing fads
Investment products like any other products are created only because their manufacturers feel they can be sold. In the investment industry what sells is constantly evolving and can depend on anything from demographics to changing consumer sentiment.

Think back to the late 1990s and the dot com boom. Suddenly, anything vaguely connected to the internet and the “new economy” became a license to print money. Investors queued up to sink their savings into IPOs of misty-eyed ventures built on the flimsiest of pretexts.

In the post-dot-com early 2000s, disenchanted with the “new” economy, Wall Street renewed its embrace with the “old” economy through the concept of BRICs, a term coined by Goldman Sachs economist Jim O’Neill.

More recently, the investment du jour has been “smart beta”, a rules-based investment methodology pitched as combining the advantages of low-cost traditional ‘passive’ indexing and high-conviction ‘active’ stock-picking.

Having an adviser who understands your needs, circumstances and risk appetite can help in understanding these swings in investment fashion. 

This week's interesting finds

November 9, 2019

A focus on Canadian energy

Canadian Energy - Solutions for the industry
A great new talk from Chris Slubicki, CEO of Modern Resources. Nationwide discussions regarding energy and the environment in Canada have become increasingly heated and divisive. 

In this talk, Chris explores some of the serious unintended consequences of our current regulatory environment. He then outlines some solutions and a new path forward to economic prosperity, environmental sustainability, and a more cohesive Canada.

We Have Met the Carbon Enemy and He is Us
Your smartphone has enabled enormous hydrocarbon-based energy demand growth – and will continue to. The virtual world has shown a funny way of triggering real-world activity, nearly all of which requires energy – and in turn, causes CO2 emissions.

Decreasing oil and gas investment amid growing global energy demand driven by population growth, coincidental with increasing disposable income enabled by technology and industrialization in developing countries, has a real shot at spiking medium-term oil and natural gas prices to previously unseen levels. Sadly for Canada, our collective response to this astounding global opportunity appears to be self-flagellation, continuous delay and an ever-increasing regulatory burden, rather than building great, well-thought-out projects, of which Canada could have many. 

How best to help save the world from carbon while being honest with yourself? Begin by putting down your phone. Travel locally and walk or bike when you can. Deny yourself the instant gratification of online ordering. Grow more unfertilized food yourself. Sounds a bit rough, doesn’t it?

For your remaining energy use, recognize that Canada is a global leader in environmental stewardship and support the energy companies of this country. They are competing internationally under significantly more stringent domestic rules and practices while ranking 2nd (behind Norway) on environmental and social performance against other energy-rich nations.  The world is moving ahead on energy demand of all types, with or without Canada. We shouldn’t impoverish ourselves to no purpose.

How about some unity?
The world is making the transition to cleaner energy, so why not be a leader? Why not develop Canadian expertise, deploy these technologies and share them with the rest of the world? We believe cleantech will be a $2.5-trillion global market by 2022.

Many Canadian energy companies have already made great progress in prioritizing the environment. Some of us in the industry are committed to bold steps – to being not just cleaner, but to be clean. Net-zero emitters. If the Canadian industry is going to brand itself as an ethical alternative, that’s a must.

Hypocrisy
South Africa, India, the Philippines, South Korea, Japan and China, all signatories to the Paris climate accord, are building a combined 1,800 new coal-fired power plants. Coal plants emit twice as much CO2 as natural gas plants. Meanwhile, international environmental groups campaign against sending Canadian LNG to those countries.

Exporting our cleaner natural gas to global markets would benefit global emissions

This week's interesting finds

November 1, 2019

Value and Growth
Over the past decade, investors holding U.S. value stocks have produced an annualized return of 12.9% compared to a 16.3% annualized return for growth stocks. This difference between value and growth makes many people wonder what’s wrong with value and then try to offer simple explanations for why value has underperformed growth.

Taking a closer look at the data a study found that it's not the performance of value stocks that have been out of whack — rather, the performance of growth stocks has been abnormally high relative to historical levels.

Over the last decade,  value has been more or less in line with its historical returns dating back to 1929.

Growth, on the other hand, has diverged greatly over the last decade compared to its historical average.  Over the 10-year period ending June 2019, growth produced an annualized return of 16.3%, much higher than its 9.7% return since July 1926.

History has also shown that these trends can quickly turn. Some of the weakest periods for value stocks when compared to growth stocks have been followed by some of the strongest. One example in history is during the dot-com era. On March 31, 2000, growth stocks had outperformed value stocks in the US over 1-year, 5-year, 10-year, and 15-year periods. Fast forward one year to March 31, 2001, value stocks had regained the advantage over every one of those periods.

Putting buy and hold to the ultimate test: the crash of 1929

To this day, no one is really sure why stocks crashed in 1929 and no one foresaw how long and terrible the bear market would be. As usual newspapers and economists tried to predict the bottom, but their efforts were in vain. The Dow didn’t surpass its 1929 high until Nov. 23, 1954, a quarter-century later.

Investors fled the stock markets and not many stuck around long enough to break even. A 1954 survey by the Federal Reserve found that only 7% of middle-class households said they preferred to invest in stocks over savings bonds, bank accounts or real estate. 

Investors should always regard the stock market as sailors regard the sea—a means to an end, usually benign, but potentially lethal.

To be a long-term investor in stocks, you have to be prepared to lose more money for longer than seems possible. Anyone who takes that risk lightly is likely to sell out, in the next crash, near the bottom.

Interview with Bernard Arnault of LVMH
The LVMH process has one goal: star brands. According to Arnault, star brands are born only when a company manages to make products that “speak to the ages” but feel intensely modern. Such products sell fast and furiously, all while raking in profits. “Mastering the paradox of star brands is very difficult and rare,” Arnault notes dryly, “fortunately.”

“Our philosophy is quite simple, really. If you look over a creative person’s shoulder, he will stop doing great work. Wouldn’t you, if some manager were watching your every move, clutching a calculator in his hand? That is why LVMH is, as a company, so decentralized. Each brand very much runs itself, headed by its own artistic director. Central headquarters in Paris are very small, especially for a company with 54,000 employees and 1,300 stores around the world. There are only 250 of us, and I assure you, we do not lurk around every corner, questioning every creative decision.”

“I would say that there are four characteristics required. A star brand is timeless, modern, fast-growing, and highly profitable. The problem is that the quality of timelessness takes years to develop, even decades. You cannot just decree it. A brand has to pay its dues—it has to come to stand for something in the eyes of the world. But you can, as a manager, enhance timelessness—that is, create the impression of timelessness sooner rather than later. And you do that with uncompromising quality.”

Interview with Dani Reiss of Canada Goose
“During the IPO roadshow, we fielded questions about whether Canada Goose was a fad and whether we were worried about becoming too popular. I’ve heard such questions probably every year I’ve been at the company, yet they still make me smile. Our brand is 60+ years old, and we’ve been growing every year for at least the past 15 years, but in so many ways we’re just getting started.”

“I hear stories regularly from people who are only now discovering us about how much they love our products. Young, old, local, international, outdoor explorers or fashionistas, they all respond to our commitment to quality, authenticity, and staying true to our DNA. That’s how we remain relevant as we grow and build an enduring brand.”

“And as we do, I’ve made it clear that one aspect of our business is non-negotiable. Canada Goose will forever be a champion for “Made in Canada.” There is simply no better way for us to remain timeless. Our Canadian heritage and commitment to manufacturing our parkas domestically are at the heart of our business and brand. Many companies in our industry outsource to offshore manufacturers, but we will keep aggressively investing in producing premium products in Canada. “

Trick or Treat!

EdgePointers had some fun with costumes

This week's interesting finds

October 26, 2019

Staying the course: Even stars are underdogs at times
Active portfolio management can be like riding a roller coaster at times. Even highly successful active managers often underperform over periods of time.

The chart below shows the performance of active managers over a 15-year period. As you can see most active managers did not even survive and only 14% of them survived and outperformed over the 15-year period. However, if we take a closer look at these most successful managers that outperformed over the 15-year period, we find that 72% of them experienced at least one three-year period of underperformance.

More than one study has shown that the vast majority of successful managers have at times failed to exceed their benchmarks or their peers, particularly over periods of three years or less. And they’ve sometimes lagged by a wide margin, Of course, it’s easy to lose confidence in an investment after suffering through a negative period but selling (or buying) purely based on short-term numbers is one of the worst things you can do as an investor.

Do yourself a favour – after picking the right investment for you, stay loyal. After all, the longer you stay in the game, the greater your chances of coming out ahead. Don’t replace one fund with another simply because it has underperformed lately. Invest in a fund because you believe in the investment approach and understand how it can help you in the long term.

The Ongoing Battle for Pipeline Projects in Canada
Canada has the world's 3rd largest oil reserves and is currently the 7th largest producer of crude oil.  Canada's crude oil production has increased from 2.3M barrels/day in 2005 to 4.6M in 2018. With the proper infrastructure built, the National Energy Board estimates the production will grow to 6M barrels/day by 2030. The critical question facing Canada's oil and gas industry is whether the necessary infrastructure will be built.

Over the last decade, many of the proposed pipeline projects have been cancelled or delayed as a result of regulatory challenges or political decisions. If all of the export pipelines applied for since 2012, which have now been canceled or delayed, were instead approved and completed as per their original proposed in-service dates, 3.4M barrels/day of additional capacity would have been added by 2019. Instead, between 2013 and 2016, only 1M barrels/day in additional capacity was added, and since 2016 no additional capacity has been added. This has contributed to a widening price differential for Western Canadian Select (WCS) compared to Western Texas Intermediate (WTI).

For a review of some of the most high-profile pipeline projects in Canada in recent history click here.

High flying
The combined value of the five biggest companies in the S&P 500 -Apple, Microsoft, Amazon, Alphabet, and Facebook -- has reached 17% of the index's total market cap. That's the highest for the top five companies in any week since the burst of the dotcom bubble at the turn of the century.







Unprofitable IPOs

The percentage of companies going public that have yet to generate positive earnings has reached 70%. This is the highest since the peak of tech-industry excess roughly 20 years ago.

Friday Funnies

This week's interesting finds

October 19, 2019

What's your vintage year?

When did you become an EdgePoint partner? Let's take a walk down memory lane as we recall the major events and fun facts from your vintage year.

Focusing on best ideas

CFA Institute recently released a blog post looking at active managers’ returns by position sizing relative to benchmark. Looks like there’s a relation between best ideas and performance. Another reason it makes sense to run concentrated portfolios of high conviction ideas. 

Negative interest rates are nothing short of a mystery

Negative interest rates are likely to throw off whatever we knew about the financial world and how things worked in the past. Howard Marks discusses why negative rates have become prevalent, what implications they might have, whether they will reach the U.S., and what investors can do as they navigate these uncharted waters.

Why would anyone want to buy a negative-yield bond?
• Fear about the future that causes investors to engage in a flight to safety in which they elect to lock in a sure but limited loss
• A belief that interest rates will go even more negative providing a profit on bonds when they do (as bonds appreciate in price as they would with any decline in rates)
• An expectation of deflation causing the purchasing power of the repaid principal to rise
• Speculation that the currency underlying the bond will appreciate by more than the interest rate

What is there to do?
The most reliable solution lies in buying things with durable and hopefully growing cash flows. Investments with the likelihood of producing steady earnings or distributions that reflect a substantial yield on cost seem like reasonable responses in times of negative yields. The challenge lies in accurately predicting the durability and growth of cash flows and making sure the price you pay allows for a good return. In today’s environment, assets with predictability are often priced too high and investors are unusually willing to extrapolate growth far into the future. While simple in concept, investing is far from easy, especially today.

Leveraged Loans

Barely noticed in a corner of the financial markets, leveraged loans originally worth about $40 billion are staging their own private meltdown.

Loans tied to more than 50 companies have lost at least 10% of face value in just three months. Some have dropped a lot more, with lenders lucky to get back just two-thirds of their investment if they tried to sell.

Morgan Housel on behavioral biases and pitfalls

In January this year Morgan Housel- Partner, Collaborative Fund- gave a presentation on behavioural biases and pitfalls faced by ordinary investors at the India Investment Conference. Through five stories and various examples, he conveys that investing is not just about what you know but also about how you behave and that stocks become less risky the longer one holds them.

“The goal of investing is not to minimize boredom, it is to maximize returns! If you want clients to stick around, then do things simply.”

This week's interesting finds

October 12, 2019

Our Q3 commentaries are available now

This quarter, portfolio manager Geoff MacDonald explains why it's important to invest like a rational business owner, while fixed-income analyst Derek Skomorowski discusses why relying on others to do your credit work doesn't pay off.

America’s middle class can’t afford its cars

Car loans that are increasingly stretched out are a pronounced sign that some American middle-class buyers can’t afford a middle-class lifestyle. For many, the availability of loans with longer terms has created an illusion of affordability. It has helped fuel car purchases that would have been out of reach with three-, five- or even six-year loans. Low rates in effect served as a bailout for the auto industry over the last decade. 

A growing share of car buyers won’t pay off the debt before they trade in their cars for new ones, either because the car is in need of repairs or because they want a newer model. A third of new-car buyers who trade in their cars roll debt from old vehicles into their new loans. 

Americans have been borrowing to buy their cars for decades, but auto debt has swelled since the financial crisis. U.S. consumers held a record $1.3 trillion of debt tied to their cars at the end of June.

So far this year, dealerships made an average of $982 per new vehicle on finance and insurance versus $381 on the actual sale. 

Momentum. After one year of outperformance, the next 9 are usually bad
Momentum strategies show a tendency towards long-term reversal. Starting from around the one year point onward, they underperform. The green column shows the initial one-year annual excess returns of Winner portfolios over Loser portfolios. The blue column shows the excess returns of those same portfolios from the end of the 1st year to the end of the 10th year. 

Free cash flow as a % of GDP is at a record high in the U.S.

There have NOT been big investments by either households or businesses that create misallocations of capital.  Misallocations usually precede/cause a recession.

Source: Empirical Research Partners

Paying for stability

Stable stocks have been more expensive only 4% of the time since 1976. Bank stocks have been less expensive only 5% of the time since 1976.

Source: Empirical Research Partners


Demographics

Artist Profit Sharing

Don't go chasing waterfalls...

…unless you can take a photo of it like this spectacular shot. Our Q3 Photo Contest winner is Ted Chisholm.

This week's interesting finds

October 5, 2019

Warren Buffett's first television interview

Invaluable lessons about investing that haven’t changed to this day. 


Paying for stability

The valuation gap between stocks with stable growth and volatile growth is larger today than at any time in at least the last 35 years. The 20% of S&P 500 stocks with the most stable EBITDA growth during the past 40 quarters currently trade at a median forward P/E of 21x. This represents a 23% premium to the median S&P 500 stock's multiple of 17x. Since 1985, this premium was only exceeded in early 2000 at the peak of the Tech Bubble. The 25% discount carried by the stocks with the most volatile earnings growth (13x vs. 17x) has been deepening for a decade and is now the largest on record.

BUT…
While the valuations of stable growth and volatile growth companies look extreme relative to history, valuations have generally not been a useful signal for predicting the forward returns of these stocks in the past. Exhibit 14 below shows the weak historical relationship between the valuations of stable growth stocks and their forward 12-month returns relative to volatile growth stocks. In the past, large valuation spreads have not indicated above-average risk of a reversal in valuations and performance. In fact, the times in the past when stable growers carried the largest valuation premia relative to volatile growth stocks were often been followed by further stable growth stock outperformance. 


Ever seen a 0.00% R squared before?*
*R-squared is a statistical measure that explains to what extent the variance of one variable (valuation premium in this case) explains the variance of the second variable (forward 12-month excess returns in this case).  

Bond and dividend yields since 2005

Tech IPOs aren't working for the masses
Many of the seemingly hot debuts this year have been much less so for most ordinary investors. Most big new tech issues from this year are trading below their opening prices from their first day of trading. For most new tech issues, the biggest gains come upfront. Relatively few investors get access to new shares at the listing price. But for the majority of investors who have to wait for trades to open, the returns aren’t so glamorous. 

Shale boom is slowing