National Post (National Edition)
Why fear of the different is dragging down your investment returns.
Iwas recently in New York with my son, and we visited Ellis Island. This terrific museum tells the immigration story of the 12 million people who came to the United States through Ellis Island between 1892 and 1954. One of the most interesting parts of the museum was how Americans viewed these immigrants. The message was very consistent. They were not wanted. The only thing that changed over those 62 years was which country and its people were being maligned and targeted. The message boiled down to a fear of the different.
How is this relevant to a personal finance column? It is because I see this same fear of the different hurting investment returns. Specifically, those who invest only in stocks, bonds and cash, are missing out on better riskadjusted portfolios. They are missing out on new asset classes of private debt and ‘uncommon’ securities because they are different.
Another fear of the different can be seen in our heavy bias to Canadian stocks, when the TSX has underperformed the rest of the world for the past decade, and we are just three per cent of the global market capitalization. As a simple example, how many Canadians own a stock called Generac Holdings? There are dozens like it, but this is a company that has gone up 80 per cent over the past three years, and is up 13.5 per cent over the past year. How many Canadians have ever heard of the company?
Generac is a Wisconsinbased designer and manufacturer of power generators. It isn’t a small company. It has a value of $3.5 billion. As a point of comparison, here are some Canadian names that you might own and have certainly heard of. These companies all have a market capitalization much smaller than Generac — Crescent Point Energy, Westjet, Cineplex, Aecon Group. By the way, none of these more ‘common’ names have performed anywhere close to as well as Generac.
We see many prospective clients where 100 per cent of their stock investments are Canadian. To see how one of the top Canadian investors builds a portfolio, take a look at the Ontario Teachers’ Pension Plan. This top ranked pension plan has some differences in their investment mandate to you or me, but fundamentally the plan is invested for the purpose of funding a large group of Canadian retirees. Only a small fraction of their assets are directly invested in Canadian publicly traded stocks.
While I do understand that there are some tax differences and size differences for Teachers than what you or I face, the general message is quite powerful. We need to change the way we invest and to embrace the different. Here are three ways to do this (in addition to more global investing).
ADD PRIVATE DEBT TO YOUR PORTFOLIO
This is an asset class that has been largely made possible by changes to bank regulations that came into effect after 2008. As large banks focused their lending increasingly on large companies or on only ‘A’ risk mortgages, many smaller and medium-sized businesses needed to find other
sources of financing. We have looked to firms like Mortgage Investment Corporations (MICS), other firms that lend to businesses with loans that are secured in a number of different ways, or those doing factoring with high-quality companies. There are several ways to find investments in these areas that are generating returns of seven per cent to 10 per cent a year that are not correlated to the stock market. The key is to find those lenders who have exceptional risk management processes from the beginning to the end of a loan, and who have a long track record of experience so that the risks of problem loans are small, and the ability to recover any losses is very high.
INVEST IN LIFE INSURANCE
While most view life insurance
as something to cover off risks when you have a mortgage and children, for wealthier individuals who will have a decent sized estate, permanent life insurance is a means to generate tax-free returns that are not connected with the ups and downs of the stock market or real estate. In many cases, permanent life insurance can provide a tax equivalent return of more than eight per cent a year. Would you buy an eight-per-cent GIC today? With a few specialized strategies for high-income individuals under 50, there are sometimes ways to generate these returns in a way that you can benefit financially without the obvious downside of dying.
LIFE SETTLEMENTS AND PERSONAL INJURY LAWSUITS
Here is an area that is getting a little more outside of the mainstream, but is worth looking at. Life settlements are legal in some provinces and states, but not all. They allow someone to sell their life insurance policy to another person or group while they are still alive. An investment would go toward purchasing a pool of life insurance policies and collecting the return when the insured dies. With personal injury lawsuits, one can either invest in the ultimate payout of a lawsuit, or one can essentially lend money to the injured party or even the lawyer, with the loan being paid out from the proceeds of the insurance company payout. The key with investments like these is that they have the ability to pay high returns on something that is completely diversified from the returns of stocks, bonds and real estate.
When I look at what smart and wealthy people are doing with their investments, I see a small but meaningful shift of some investment dollars outside of Canada and outside of traditional asset classes. Canadian stocks, bonds and preferred shares all have their place in an investment portfolio, but today I would suggest that it should be smaller than before, and be augmented by some of the ideas in this column. Do not fear the different.