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Investment Review – 2008:

In one of my concluding posts for 2007 I used the line Cash is King to describe my thoughts on investment opportunities for 2008. What I didn’t know at that time was the accuracy of the prediction that cash would play throughout parts of the year for equity and debt markets.

The past twelve months have seen a flurry of activity as I collapsed my Value Portfolio, concentrated on increasing investment cashflow and decided to utilize a line of credit for investment purposes. Each substantially helped me to avoid the critical losses that many other investors have experienced and while I would like to attribute my stock selection skills and portfolio construction for my ability to avoid significant downside I remain humble in how fortunate I was to make it fairly unscathed. One dominant theme played out in the market during this past year that very few could have predicted…everything got hit.

Nearly every stock, every asset class and every economy was hit with a wave of fear, panic and uncertainty that lead to global markets posting losses that went well over what previous bear markets have brought. Some stocks or asset classes held up better than others, but for the majority of investors it appeared for a time that the rules of investing fundamentals was turned upside down and don’t currently appear to matter over the short-term.

Lessons Learnt:

While global diversification might have been useless as markets around the world followed each other into the dark abyss sector diversification, for my portfolios, helped considerably to protect from critical losses. Consumer stocks such as Metro (MRU.A), Empire (EMP.A), Kraft (KFT), Colgate-Palmolive (CL), Smuckers (SJM), Saputo (SAP) and Shoppers Drug Mart (SC) held up relatively well in the face of severe pessimism in equity markets. My healthcare holdings in Sanofi-Aventis (SNY), Baxter (BAX) & Johnson & Johnson (JNJ) buffered the storm from a defensive position and a venture in preferred shares has added some additional cashflow to my Canadian dividend-growth portfolio despite my initial hesitations about this asset class. The big disappointments this year came from the performances of General Electric (GE), Exelon (EXC), Banco Bilbao (BBV), Manulife Financial (MFC) and my core positions in three Canadian Banks (RY, TD & BNS). I decided in July as oil prices and the Canadian dollar began their initial slide that I would hedge my US positions with DTO (double short oil ETF) with the high correlation between oil prices and our loonie in order to protect from the short-term downside I anticipated from a bursting commodity bubble. I’ve maintained that hedge after trimming my position by half and still believe it to be a worthwhile activity despite the long-term holding period of this portfolio. While a gain of over 540% may seem incredible the hedge was only a small portion of my portfolio and the value of my RSP, in Canadian currency, has remained virtually the same.

Looking back on the performance of various equities I hold I realize that not having all my investments in one category helped to provide gains when others were lagging. Exposure to industrials, utilities, financials, consumer stocks and energy helped to buffer the losses that I could have experienced if I were exposed to one more than another and demonstrates to me the importance of sector diversification as much as asset or global diversification.

Dividends make a big difference and while I’ve advocated for the importance of dividends in an investment portfolio 2008 showed you why you want to get paid as an investor. There are a lot of investors jumping onto the Dividend Express in recent years and I have to admit that while I favour dividends over pure gains my two portfolios (DivG & RSP) currently yield very respectable cashflow that has helped to fuel new purchases of shares I might not have had access to otherwise. In an environment where capital comes at a premium I think investors need to expect a form of compensation for the equity they provide to a public corporation. Attention needs to be paid to a company’s payout in the event that it’s not sustainable but there is a clear case to be made that companies need to offer investors an incentive to continue to hold their equity in times such as these. Investors need to realize that equity is used by companies to make loans, buy equipment and conduct their business. When the cost of capital is at such high levels and if markets trade sideways for a prolonged period of time I want to ensure that I have the resources available to me as an investor to continue buying companies at depressed prices. The current amount of dividends paid out from DivG nearly matches my targeted annual contributions from savings I intend to contribute to that portfolio for 2009. Essentially the dividends act as an equal partner in growing my portfolios over the long-term by doubling what I can invest through savings left from my income over the next twelve months. This acts as a second or third earner in my household and contributes meaningfully now and over the long-term in the future cashflow I create from my investments.

Part of being a young investor is the continued struggle to stay grounded in your outlook on investments. For some time I’ve felt I had a good grasp of how far an individual equity could fall based on a valuation of the company that was reflected in the intrinsic value of the business. Essentially I felt there would always be a floor on the market price of an investment based on rational fundamentals of the business. In 2008 I learnt that equities, bonds and preferred shares can fall much further than any long-term fundamentals may dictate regardless of how deeply I found them to be discounted. Some stocks initially resisted the abundant negativity of the market and were range bound in their valuations, but I quickly witnessed that selling pressure can act as an avalanche which left me in awe. In my assessment of some of my bluest blue chip stocks I witnessed valuations and yields of astounding levels and valuations that knocked on the door of book value that I never envisioned seeing.

I like to attribute the equity and credit markets of 2008 to walking into a trauma in the emergency department twenty minutes late and expected to jump into the middle of things without knowing much about what might be going on. There’s always anxiety as you attempt to make sense of your surroundings but experience teaches you that patients, just as markets, still need the basic fundamentals to survive. Just as each of us need oxygen to breathe and energy to fuel our metabolism; a company needs access to capital, products or services in demand by markets, a margin of safety in its operations to weather a significant storm and leadership to provide direction when the ride gets rough. Staying composed and able to think critically in the midst of a meltdown offers some intriguing perspective that can assist any investor. When the markets become dysfunctional the basic principles of business take over.

2008 provided the perfect environment for an investor to realize the importance of having a plan. Whether you had simple goals or a specific investor policy statement (IPS) 2008 was the environment where you needed the discipline to stick with a well designed investing strategy regardless of how far investments fell. If your goal was capital preservation and you leaned towards a higher risk tolerance in recent years with the allure and promise of commodities and globalization than likely you’ve learnt an important and expensive lesson. A plan helps to take out the emotions that always seem to plague investors and lead them to market timing mistakes. If you invest in an indexed investment strategy and were fearful to commit your regular monthly contributions you may have saved some money on the downside, but might end up regretting those decisions through this period for accumulation prospects if the markets recover 20-30% from these levels. Although many pundits are advocating that old investing strategies are worthless in this market environment I still believe that a well executed plan will serve an investor well over the long-term.

Volatility was nasty in 2008 and you had to stay focused to capitalize on opportunities. Whether investors were jettisoning investments because of fear, margin calls, preservation or capitulation a keen investor could do well by placing orders below the bid/ask and of an investment and securing that company when others rushed in to sell.

My short-term plan, a ten part series I published in the fall, was likely a better investment tool than I had noticed at the time and helped me avoid some very serious losses that I could have experienced if I hadn’t revisited that short-list of criteria on a weekly basis. While this list might not have been the only factor in helping my portfolios from weathering this storm it did help me on multiple occasions to avoid investments that failed those criteria and fell precipitately from where I had originally looked at them.

My final two lessons don’t offer any new insights but provide some very important lessons for investors: 1.) Debt kills companies & 2.) Traditional sources of safety can no longer be blindly held as safe without further investigation.

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{ 3 comments… add one }
  • Anonymous January 7, 2009, 1:21 am

    I want to thank you for sharing your ideas and hard work and allowing others (like me) to learn from you. I am very much a newbie investor – have only been investing from august 2008 and your thought-provoking blog with a clear and logical thought process together with the other bloggers from the Div-Net, has helped guide me through a very difficult period. I am down about 7% in absolute terms (bad choices) but you have helped me discover dividend based investing and I am grateful because I feel comfortable doing it.
    Have a good new year!

    amagqira

  • Mark January 7, 2009, 11:53 am

    Solid post as usual Brad – clear and concise. Great call on your DTO hedge this summer btw.

    For myself, as another young investor, 2008 was an outstanding learning opportunity. While the portfolio took a bit of a hit, I feel I was able to gain immense hands-on training that classroom learning simply can not teach. The shear force of market waves this year was a wake-up call.

    Mark

  • Nurseb911 January 7, 2009, 12:38 pm

    Amagqira & Mark,

    It's great to see that both of you, despite experiencing losses, have the right frame of mind for learning from the mistakes of the market. Investing is very similar to anything else: you can read about it, study it and observe it but until you actually take the step of doing it on your own those lessons aren't as valuable. Take stock in the risk your portfolio is exposed to and act accordingly.

    Best of 2009 to you both.

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