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Value Update II, 2009:

The first quarter of 2009 has finished and although equity markets are up from their lows the economic landscape hasn’t changed dramatically for investors or businesses. Unemployment continues to rise, the cost of capital has remained relatively high and transparency in corporate earnings has been inadequate at best. Companies will begin reporting their numbers soon, but with GDP contracting by a significant amount in the past two quarters investors are going to be looking for stability rather than erosion or growth in earnings.

Companies with strong defensive balance sheets and cashflows have weathered the storm well so far. Companies suffering from an abundance of debt and poor management have moved in the predictable direction of continued deterioration. After nearly every stock suffering through the decline in equity markets this is an environment of corporate survival. We are in an environment where corporate fundamentals will reign and the strong will survive. If a company has low debt, strong margins, can maintain profitability and can gain market share against competition then these are the investments an investor wants to target for their portfolio.

An investment portfolio, properly constructed for risk, should be balanced in a number of areas. Having an adequate exposure to different assets, diversification (amongst countries, sector and businesses) of those assets and avoiding cyclicality goes a long way to protecting your capital (capital preservation) from significant events in equity markets. While I would like to be able to take full credit for the better returns of my portfolios against broader indexes the real reason I’ve faired well is more to do with how my portfolios have been constructed and by maintaining a focus on risk.

I’m going to provide insight into my overall portfolio (all invested assets combined) to give a sense of how I’ve positioned myself now and for the future.

First, here is a list of my investing activities in March:

CDN Buys:

Power Financial Preferred Series H (PWF.PR.H), Russel Metals (RUS), Manulife Financial (MFC), Canadian Tire (CTC.A), Husky Energy (HSE), Fortis (FTS)

US Buys:

Exelon (EXC), Eaton (ETN), Whirlpool (WHR), Berkshire Hathaway (BRK.B), General Mills (GIS), Smuckers (SJM), United Parcel Service (UPS)

Sell:

PowerShares DB Crude Oil ETF (DTO)

The only new addition to any portfolio was Canadian Tire (CTC.A). This is a stock I’ve watched with interest for some time after selling my position in Reitman’s (RET.A) prior to December of 2008. Although my Canadian portfolio has adequate exposure to consumer stocks the price I paid for CTC.A was difficult to ignore given their long-term growth prospects, retail presence in strongly anchored real estate and well recognized brands.

My other purchases follow my discipline of adding to stocks I want to own for the long-term. As I add to certain stocks I’m forced to rebalance in other names to keep my equity exposure to individual companies within each portfolio between my targeted 3-5%. At times this leads to purchasing stocks at a slightly higher valuation than I would normally like (FTS, EXC & SJM) but over the longer term I believe that making purchases today rather than tomorrow will reward my conservative discipline both through dividend growth and share appreciation.

The one surprising sell might be DTO which at first glance doesn’t fit into my strategy of long-term value and dividend investing. DTO was placed in my RSP as a hedge against the potential decline of the CDN$ last summer and performed very well in achieving its intended purpose. I’ve slowly taken profits in DTO over the past nine months to offset to drop in the CDN$ value of my US investments as the price of crude oil bottomed out. This is a strategy I still intend to outline in a future post and at this point I see limited downside to the CDN$ with conditions in the US as they are.

Overall Portfolio Breakdown:

I was asked by a reader recently if it was possible to give some insight into the breakdown of my overall portfolio; all investments. This is something that I closely monitor in a spreadsheet on a monthly basis and it shows me whether I am adequately diversified in any number of areas.

At first glance an investor might scratch their head at my choices for asset allocation and diversification. With nearly 50% of my assets in Canadian common equities and another 12% in Canadian preferred shares and bonds I’m really heavy on Canadian exposure. The reason for this is fairly simple and straightforward.

My main goal at the moment is to construct a portfolio of investments that create a growing tax-efficient stream of income for early retirement. I’ll be turning 28 next month and currently pay into a pension (HOOPP) that could potentially fund a portion of my retirement at age 65 or earlier. My current taxable income doesn’t offer a huge incentive to contribute the majority of my savings into an RSP and I would rather save contribution room for when my income begins increasing at a faster rate over the next few years. The fact that I’m young with the potential of having a sufficient pension at retirement complicates my potential taxable income after retirement. This is one situation where compound interest can work against an investor. If I didn’t have any potential pension income then the incentive of placing the majority of my savings within an RSP makes sense. But if I were to have a pension income of $35,000 in retirement and an RSP of significant size when converted to a RRIF I could be looking at being placed in the highest marginal tax bracket without ever taking a voluntary withdrawal. Conservative contributions to my RSP (or spousal RSP) are planned for the future, but with the dividend tax credit in Canada and my investing horizon of over twenty years to compound my investments being heavy in non-registered equities now makes more sense.

The TFSA that I’ve recently opened will be balanced with my RSP portfolio as funds are added in future years, but for now the account will stand as a high interest savings account with some basic TD index funds.

My fixed income exposure (all Bonds, Preferreds and Cash) currently stands at 33.75% which for my age provides an adequate 70/30 breakdown to equities. Once I purchase my first home in the next year or so my bond exposure will go down to less than 5%. I view the investment in a home, over the long-term, as a giant bond that appreciates at 4% (at best) per year after consideration of all costs.

For my sector allocation it shouldn’t be a surprise with the extent of my Canadian exposure that financials are the highest weighting at 17.68%. Consumer discretionary and staples stocks, a group of Enduring Value favourites, come in a close second at 17.32% followed by utilities, industrials and healthcare which make up another 20% of my portfolio. Energy and telecom are two groups that I intend to increase the relative weighting to as well as shifting a heavy financial exposure to industrials and utilities over the next few years.

I wrote about the fundamentals of leveraging dividends recently and one lesson learnt by many investors is that leverage used aggressively is a very dangerous practice. The rewards can be high, but the risks are even higher if not properly managed. Maintaining my overall exposure to leverage at less than 15% of all invested assets is an important objective because it allows me to repay the interest and principal owning within a conservative time period.

SAML Reader Choice Analysis:

There were a total of 162 readers who voted for the next stock analysis in the SAML program with the following results:

Bank of Montreal (BMO): 21% (35 votes)
Bank of Nova Scotia (BNS): 32% (52 votes)
CIBC (CM): 3% (5 votes)
Royal Bank (RY): 12% (20 votes)
TD Bank (TD): 30% (50 votes)

BNS and TD were the clear leaders amongst voters and from private requests. Taking Stock in Bank of Nova Scotia (BNS) will be the next stock analysis released (date still pending), but I’ll likely decide to do an analysis on TD Bank this year as well.

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{ 3 comments… add one }
  • Scott April 6, 2009, 6:51 am

    Hi Brad,

    I’m curious as to why you have a cash allocation when you are currently on margin? They cancel each other out, yet there is a net interest expense to you to do things in this way.

  • Nurseb911 April 6, 2009, 7:34 am

    That one’s easy and I should have explained that better in the post.

    Cash represents what I have in a high interest savings account for the downpayment of a home within the next 12 months. I keep it separate from my invested assets, but consider it in the overall portfolio because I would have access to it for investment purposes if I decided I didn’t need a home.

    Basically the leverage I use (margin) is for my long-term investments and cash is for my short-term (housing). I considered using the cash for further investing, but at my current cost of capital I felt that having something separate from my equities was important for the short-term purchases I will need to make over the next 12-24 months (house, wedding, new car, etc).

    The cost is one of peace of mind in my case knowing that if I decide to move on a home in the short-term I have the funds available for 20% down plus closing costs without having to sell assets.

  • Jay Profeit April 10, 2009, 10:11 am

    I was just going to ask you the same cash question but you just cleared it up in the comments. Like the portfolio though, good luck!

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