Acting in the best interests of clients

by James Parkyn

Some of Canada’s big banks took quite a lot of criticism recently for their decision to stop selling mutual funds from outside companies through their financial planning arms.

CIBC, RBC and TD claim the decision to allow financial planners to sell only inhouse funds is in response to new regulations that come into effect at the end of this year. Those regulations are known as know your product (KYP) and are part of a larger package of client-focused reforms (CFRs) being brought in by the country’s securities regulators.

The KYP rules are designed to ensure investment firms and their advisors have a deep knowledge of the products they recommend to clients.

For firms, this means having policies, procedures and controls in place to monitor investments offered to clients and providing training to advisors on them. For advisors, it means recommending only firm-approved investments and demonstrating they understand what they are recommending and ensuring they are suitable for a client’s portfolio.

The overall goal of the client-focused reforms is to create a higher standard of advisor conduct that will put clients’ interests first. Essentially, it could be viewed as a codification and enhancement of industry best practices that many firms and advisors are already incorporating—from gathering detailed client information to demonstrating product knowledge to revealing potential conflicts and putting clients’ interests first.

The decision by the three big banks to stop selling third-party mutual funds sparked an outcry from critics in the media and the financial industry who say the banks are not acting in the best interests of their clients. They argue the banks are using the new rules as an excuse to sell only their own funds, which are more profitable for them, through financial planners in branches. (Third-party funds will still be sold by the banks’ full-service brokers and their online discount brokerages.)

Globe and Mail columnist Rob Carrick noted the banks are depriving investors of the opportunity to choose better alternatives available from third-party fund companies and said the three big banks are “effectively turning their planners into sellers of bank products.”

For my part, I hope the actions of these three big banks will lead clients to reflect on what they want and should expect from their investment advisor.

The country’s securities regulators introduced the new client-focused reforms after resisting calls to bring in the more rigorous fiduciary standard for investment firms in the face of stiff opposition from the industry.

At PWL Capital, we have long adhered to a fiduciary standard in our client dealings and have argued it should be applied throughout our industry. Under a fiduciary standard, a firm must put its client’s interests above its own and act strictly in a client’s best interest.

For many years, our firm has been accredited by the Centre for Fiduciary Excellence (CEFEX), a global organization that audits and certifies the processes of investment advisory firms.

CEFEX-accredited firms adhere to the Global Fiduciary Standard of Excellence. To obtain this accreditation, PWL was required to undergo an extensive “best interest” review—and, to maintain this status, we must undergo annual audits by CEFEX.

At PWL, we don’t have any in-house products. We have a list of approved securities that includes only investments that have been researched by the firm and approved by our investment committee.

These investments are all low fee and tax efficient. They offer no compensation to PWL, or the firm’s advisors, and they reflect our philosophy that passive portfolios and broad diversification are the keys to long-term investing success.

In all these ways, we demonstrate our steadfast belief that investment advisors must always act in the best interests of their clients. It is the bedrock upon which our firm is built.

Why worry about whether we’re in another speculative bubble?

by James Parkyn

It’s been almost a year since the World Health Organization declared a global pandemic in response to the spread of COVID-19. As we discussed in our recent portfolio performance review 2020, no one could have predicted the extraordinary events of the past year or the markets reaction to them.

The market crash in February and March 2020 was the worst since 1929 as the gravity of the pandemic crisis became clear. Then, the markets came roaring back with extraordinary speed and ended the year at all-time highs.

It was a year like none other in memory and provided a remarkable lesson on the importance of disciplined asset allocation and the danger of trying to outguess the markets by jumping in and out of investments in hopes of cutting your losses or maximizing your gains.

That’s called market timing and researchers have found it to be one of the worst wealth-destroying mistakes you can make. For example, the Dalbar research firm found that poor trading decisions caused the average U.S. equity fund investor to earn annual returns that were 4.7 percentage points below those from the S&P 500 index in the 20 years to the end of 2015.

People who try to time the market are often driven by a fear of losses or a desire to make big profits, but as we’ve seen in dramatic fashion this year, it’s impossible to forecast where the markets are headed.

The danger becomes clearer when we dig a little deeper into recent market trends. Growth stocks in general—and big tech stocks in particular—produced by far the best results in 2020. In the U.S., large and mid-cap growth stocks returned 36% versus just 1% for value stocks—the largest divergence ever recorded.

Skyrocketing prices have captured the imaginations of many investors who have bought into tech stocks and other hot investments like electric car maker Tesla and cryptocurrency Bitcoin. Meanwhile, others are dumping their stocks because they fear a speculative bubble has inflated of the kind seen during the dot.com era of the late 1990s.

Which side is right? A rational investor doesn’t have to engage with either. The antidote to the stress of worrying about current market conditions is a portfolio that is broadly diversified across asset classes and geographies and a patient, long-term perspective.

We make no judgment about whether U.S. growth stocks are in a bubble, but we do observe that value stocks and markets in other parts of the world are currently trading at far lower valuations. The beauty of diversification is that when one market is falling, others will be performing relatively better.

The real danger in investing is not missing out on a hot sector bet or suffering through a market correction. It’s making poor decisions in the heat of the moment that can lead to a permanent loss of capital.

Our discipline of sticking to diversified asset allocation may not produce the excitement of jumping on the latest zooming tech stock or cryptocurrency, but it has been proven to be the prudent way to build wealth over the long term.

Last year was a high-speed test in managing our emotions

by James Parkyn

In year-end retrospectives over past few weeks, we’ve been reminded just how extraordinary 2020 was on so many fronts.

From the COVID pandemic to the Black Lives Matter movement to the fraught U.S. election and many other momentous events and devastating outcomes, it was a year that challenged our emotional resilience like none other in recent history.

It was no different in the markets. The stock market crash in March gave way to a lightening fast recovery. For investors, 2020 was a real-time, high-speed test of our risk tolerance and how well we’re able to control our emotions in the face of exceptional volatility.

To learn the investment lessons of 2020, it’s instructive to think back to how we all felt at various points during the year. The initial market plunge understandably provoked fear in many, especially because it came at a time of great uncertainty in other areas of our lives, as we navigated a health and economic crisis.

When the markets rallied, many investors were still processing the crash and were distrustful the recovery could be sustained. As it became clear, massive governments and central banks interventions were supporting the economy and markets, investors became increasingly confident in the rally’s durability.

The remarkable market gains since March have once again been concentrated in the technology sector where enthusiasm has been fuelled by the economic effects of the pandemic, including remote work and online shopping. And then there’s Tesla—a phenomenon unto itself.

When fear fades, regret often takes over. How much money could you have made by betting on a few big tech names rather than broadly diversifying your investments?

How about the strength of the U.S. stock market versus developed and emerging markets elsewhere in the world? Wouldn’t it make more sense to concentrate on the U.S. market.

However, if 2020 taught us anything, it’s just how unpredictable the markets can be. Our portfolios must be designed to both weather unexpected developments and take advantage of favourable outcomes.

As investment author Larry Swedroe observed in his review of the book, The Psychology of Money by Morgan Housel, these are not easy psychological waters to navigate.

“Unexpected events and random luck can lead to good decisions having bad outcomes and poor decisions having good outcomes,” Swedroe writes. “Success is a lousy teacher because it can seduce us into thinking we cannot lose. Thus, we should not become overconfident in our judgments when things turn out well. Similarly, failure is a lousy teacher because it can seduce smart people into thinking their decisions were poor, when failure was just the unforgiving reality of risk showing up.”

It’s not easy for bright, successful people to accept their inability to outsmart the markets. However, sticking with a well-engineered portfolio through good times and bad is the hallmark of intelligent investing.

Helping clients manage their emotions is an important part of what we do here at PWL Capital. In that sense, we see our role as advisors helping people make good decisions, not facilitators of risky moves driven by passing emotions.

The coming year will no doubt hold more surprises, but there is much to be hopeful about with the roll-out of vaccines around the world. We will be here to keep your investments and personal finances on track, and the whole PWL team wishes you a happy, healthy and prosperous 2021.

Look beyond the headlines: Patience is the key to building wealth

by James Parkyn

In the spring of 2008, the New York Times published an article with the headline: An Oracle of Oil Predicts $200-a-Barrel Crude.

The oracle in question was Goldman Sachs equity analyst Arjun Murti who was predicting a “super spike” in the price of oil, continuing a run that had brought it to $130 a barrel at the time the article ran in May 2008. (All figures in U.S. dollars.)

“The grim calculus of Mr. Murti’s prediction…is enough to give anyone pause: In an America of $200 oil, gasoline could cost more than $6 a gallon,” the article says.

As the piece noted, Murti was far from alone in forecasting a further surge in oil prices. In Canada, former CIBC World Markets chief economist Jeff Rubin also called for $200 a barrel oil and even wrote a book describing all the implications for the economy.

Sadly for these analysts, the stage had already been set for the collapse of oil prices. The 2008-09 financial crisis and accompanying recession sent prices to below $40 a barrel. But it wasn’t long before prices were climbing again and the oil bulls were back at it, only to be disappointed when the fracking revolution helped flood the world with crude.

It’s been a quite a rollercoaster. Now, think what would have happened to your investment portfolio had you actually taken these headlines seriously and loaded up on the stocks of energy producers and other companies that benefit from high oil prices.

Every day you can find predictions from stock analysts, professional investors and economists about what’s going to happen in the markets.

These forecasts are often persuasively argued, pointing to “fundamentals,” market history and various data points. And they are often wrong.

In fact, the evidence is that the experts are no better at seeing into the future than you and me. Their predictions have been proven wholly unreliable as demonstrated in another Times article. It reports on research into the forecasts made by Wall Street strategists between 2000 and the end of 2019.

“The gap between the median forecast and the market return was 4.31 percentage points, an error of almost 45 percent,” the article says. “The median forecast was that stocks would rise every year for the last 20 years, but they fell in six years. The consensus was wrong about the basic direction of the market 30 percent of the time.”

Actually, market predictions are worse than useless because they generate media commentary that can throw your investment plan off track.

To better understand the danger to your financial health, you only have to think back to the dire headlines at the time the market was falling in February and March in response to the pandemic crisis. For example, a headline in the Globe and Mail on March 12 warned A significant bear market is just starting.

We know in hindsight the market would bottom just 11 days later. On that day, a powerful rally began that saw stocks rise 38% in Canada and 40% in the U.S to the end of June. By the end of August, client portfolios we manage had returned to close to their opening value at the beginning of the year. If the negative headlines had scared you out of the market in March, you would have missed out on that rally.

Of course, we might be headed for another market downturn if there’s a serious second wave of the pandemic or some other negative event in the weeks ahead. And that’s the point—we just don’t know what’s going to happen and neither does anyone else.

However, we do know that $1,000 invested in world equity markets in 1985 would have turned into $28,000 by the end of 2019. That’s why it’s so important to tune out the day-to-day noise and focus on long-term returns.

It may not be exciting, but the only investing news that matters is that patiently holding a broadly diversified portfolio that reflects your tolerance for risk through good times and bad is the best way to build wealth.