WHAT I HAVE LEARNED FROM MY HIGH-TOPS

In­vestors should think Con­verse All Stars, not the hot new sneaker, Tom Bradley says.

Windsor Star - - FINANCIAL POST -

They’re all the rage. Even though they haven’t changed in al­most 100 years, peo­ple of all ages are wear­ing them.

I’m re­fer­ring to Con­verse All Star bas­ket­ball shoes. I had a pair (high-tops) when I played high school ball in the ’70s and bumped around in red, black and blue ones in univer­sity. I still take great pride in telling young peo­ple in the gro­cery line that the ones I’m wear­ing are 40 years old (they mostly look at me like I’ve lost it).

For a fash­ion item, I can’t think of any­thing that matches Con­verse All Stars for longevity. In in­vest­ing, the equiv­a­lent would be a sim­ple port­fo­lio of bonds and stocks. Ba­sic, en­dur­ing and as ef­fec­tive to­day as a cen­tury ago.

Like shoes, how­ever, there’s been a steady flow of new in­vest­ment ap­proaches and fea­tures — prin­ci­pal pro­tec­tion; en­hanced yield; tax-ef­fi­cient in­come; illiq­uid as­sets; cur­rency hedg­ing; dou­ble-lever­age ETFs; notes linked to com­modi­ties and in­dexes; and as­set-backed pa­per. On this list are some use­ful tools for build­ing port­fo­lios, but be­fore you stray from the triedand-true, here are some things to know about the new-and-fancy.

MORE COM­PLEX EQUALS LOWER RE­TURN

When­ever I see a new prod­uct be­ing ad­ver­tised, Bob Hager’s words ring in my ears. Bob was the co-founder of Phillips, Hager & North and a quiet gi­ant in our in­dus­try.

When in­vest­ment bankers came to pitch us on new prod­ucts, he’d in­vari­ably say, “No mat­ter how it’s pack­aged, it al­ways comes down to stocks and bonds. If they don’t do well, the prod­uct doesn’t have a chance.” In other words, the bankers haven’t in­vented a new source of re­turn.

Each ad­di­tional fea­ture added to an in­vest­ment prod­uct brings more peo­ple with it (in­vest­ment bankers, cur­rency and de­riv­a­tive traders, and mar­ket­ing ex­ec­u­tives), and not sur­pris­ingly, they don’t come cheap. No mat­ter what bells and whis­tles there are, the buyer takes all the risk and re­ceives a por­tion of the re­turn from the as­sets. The pro­mot­ers keep the other por­tion while tak­ing no mar­ket risk.

Most struc­tured prod­ucts are de­signed to make the ride smoother or con­vert more of the re­turn into in­come. Both of these fea­tures come with a price — lower to­tal re­turn.

LESS TRANS­PARENCY MEANS MORE SUR­PRISES

If you don’t un­der­stand how an in­vest­ment prod­uct works, then you can’t be ex­pected to an­tic­i­pate all the po­ten­tial out­comes. I learned this from my days as a stock an­a­lyst.

In the ’80s, I cov­ered a num­ber of con­glom­er­ates that of­fered lim­ited vis­i­bil­ity. Un­der­stand­ing what drove Pagurian, Fi­nan­cial Trustco and Hees In­ter­na­tional (I’m dat­ing my­self ) was a chal­lenge.

More re­cently, we’ve had big sur­prises from com­pli­cated, opaque com­pa­nies like En­ron, Bom­bardier and Valeant. In­vest­ment prod­ucts are the same. If you don’t have per­fect clar­ity as to what’s go­ing on be­hind the scenes, then be pre­pared for out­comes not cov­ered in the mar­ket­ing ma­te­ri­als. A decade ago, we had the As­set-backed Com­mer­cial Pa­per (ABCP) de­ba­cle. Cana­dian in­vestors didn’t get what they were owed while lawyers and hedge funds had a field day pick­ing up the pieces.

THEY’RE SOLD, NOT BOUGHT

A sim­ple bond and stock fund or port­fo­lio doesn’t come with a glossy, four-page brochure. It doesn’t need one. For prod­ucts that are more com­plex and dif­fi­cult to un­der­stand, how­ever, it’s de rigueur. In the mar­ket­ing ma­te­ri­als and ad­ver­tis­ing, the terms and lan­guage used of­ten make it dif­fi­cult to com­pare the prod­uct to your other in­vest­ments. For in­stance, in­dex-linked notes ad­ver­tise the best pos­si­ble “cu­mu­la­tive” re­turn (“Earn up to nine per cent”) which means that if ev­ery­thing goes right, you’ll earn a three-year “an­nu­al­ized” re­turn of 2.9 per cent.

There are other tricks to watch for. One of the most com­mon ones is link­ing a prod­uct’s per­for­mance to an in­dex re­turn (i.e. S&P/TSX Com­pos­ite In­dex). While in­dex lev­els are re­ported widely, they don’t rep­re­sent the re­turn of the mar­ket. The to­tal mar­ket re­turn in­cludes both the price change of the in­dex and div­i­dends re­ceived. This dis­tinc­tion is rarely men­tioned in the brochures.

As with ath­letic shoes, there have been plenty of ad­vances in fi­nan­cial prod­ucts, some real and some mar­ket­ing.

If you’re mov­ing be­yond the Con­verse All Star port­fo­lio, make sure you know why you’re do­ing it, what you’re get­ting and if it has what it takes to last 100 years.

Fi­nan­cial Post Tom Bradley is pres­i­dent of Steady­hand In­vest­ment Funds, a com­pany that of­fers in­di­vid­ual in­vestors low-fee in­vest­ment funds and clear-cut ad­vice. He can be reached at tbradley@steady­hand.com.

A sim­ple port­fo­lio of bonds and stocks is like a pair of Con­verse All Stars: ba­sic, en­dur­ing and as ef­fec­tive to­day as a cen­tury ago, writes Tom Bradley. In­vestors can run some hefty risks should they stray from the tried-and-true to the new, more com­plex fi­nan­cial prod­ucts.

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