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The PFP GroupWealth Management Team
Market VolatilityFight or Flight?
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No one likes uncertaintyEveryone predicted the right outcome – in hindsight
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Presentation Agenda
1. What is Volatility?• Financial Definition and common beliefs• What’s wrong with volatility
2. Historical Perspective• The last 70 years• Volatility and return• The next few years• Strategies to deal with volatility
3. What are we doing?• Asset allocation• Income generation • Security selection• Effective use of derivatives• Tax-based investments
4. Wealth Planning• Wealth Management – a holistic approach• Retirement and Estate Planning using insurance solution• Investment Policy Statement and peace of mind
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What is volatility?
Dictionary: instability, unpredictability, explosive nature
Common beliefs: Prices go lower, fear factor
Financial Definition: Uncertainty of returns provided by a security/asset
Statistical Definition: A measure of the probability distribution of the future returns of an asset
Assume both Asset A &B have expected return of 15%,; S.D. of A is 5%, S.D. of B is 10%
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TSX Composite vs. market volatility – last 5 years
TSX: -5%; Volatility: +200%
Annual dividend: approx 2%
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TSX Composite vs. market volatility – last 10 years
TSX: +50%; Volatility: +50% Annual dividend: approx 2%
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TSX Composite vs. market volatility – last 20 years
TSX: +250%; Volatility: +50%Annual dividend: approx 2%
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What does that mean?
Volatility is cyclicalVolatility tends to go up in down market – fear factorVolatility has increased in general
• High frequency, low cost trading
• Uncertain macro/global environment
• Government/political risk premium
• More financial players globally
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What’s wrong with volatility?
Hurts investors’ confidence Difficult to plan and anticipate return Send wrong message to genuine investors Cyclical market can bounce 20-50% anytime. Market entry after bounce is risky Encourage investors to stockpile too much cash
• Opportunity cost and potential inflation risk
• Inadequate return for retirement Misled investors risk/reward of public securities vs. other asset classes
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Historical perspective
Secular vs. Cyclical market trends• Secular Bull Market (US): 1942-1966; 1982-2001• Cyclical Markets (US): 1932-1942; 1966-1982; 2001-?
Secular: fundamental trend: global growth, inflation, interest rates, technological advancement
Cyclical: greed vs. fear, monetary/fiscal policies, business cycles, inflation/deflation, bubbles, policy responses
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Index Value: 11,231.94
25.61 (0.23%
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The next few years?
Change in leadership follows the bursting of a bubble?• Energy/commodities, technology, financials, health care• And the winner is……..
• Developed countries vs. emerging markets• Net debtor nations vs net savers countries
• Secular trend vs. cyclical trend vs. political headwinds How long is deleveraging process going to continue?
• Tell tale signs What about Europe, US and the BRICS countries? How does Canada fit in?
• Fiscal and political stability• Is global demand for our resources going away?• Is currency level a good predictor of economic performance?• What about the continue in-migration of human and financial capital
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What are we doing?
1. Being more cautious and adjusting our asset mix
2. Repositioning our portfolios Continue to focus on quality/income right across the board Employ institutional hedging/volatility dampening strategies Focus on tax effective strategies
3. Continue using high yield/corporate bonds, preferred shares, fixed income ETF’s and International Funds to compliment our portfolios
4. Continuing to communicate with you to make sure we are aligned with your expectations, goals and comfort levels
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What are we doing?Repositioning portfolios:Continue to focus on quality income generating companies and
securities Utilities, REIT’s and High dividend paying companies S&P Income Trust Index is +12.1% as of 25Nov11 S&P Utilities Index is -2.30% as of 25Nov11 S&P TSX is -14.6% as of 25Nov11
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Examples
1. Inter Pipeline - LP with interests in crude pipelines and nat. gas extraction facilities in Western Canada. Great cash flow with moderate payout ratio of ~75% and has increased distribution 6 times since 2004 keeping steady in 2008/2009. Current yield ~5.8%
2. Rate Reset Preferred Shares – Issued by various companies with investment grade credit qualities.
Enbridge 6.3yr Reset Preferred Share at 4.00% with 237bps spread (interest equivalent of 5.36%)
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Dividends vs. S&P/TSX Composite IndexDividend paying stocks outperform the market
Canadian Annualized Portfolio Performance by Dividend Attribute
S&P/TSX Composite Index, Equal WeightedTotal returns Dec 1986 - July 2011
12.2%10.5%
7.0%
2.9%2.0%
0%
2%
4%
6%
8%
10%
12%
14%
DividendGrowers
DividendPayers
Index DividendCutters
Non-DividendPayers
Source: RBC Capital Markets Quantitative Research
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Dividends vs. S&P 500 Composite IndexDividend paying stocks outperform the market
U.S. Annualized Portfolio Performance by Dividend Attribute
S&P 500 Composite Index, Market Weighted10 year total returns ending March 31, 2011
3.6% 4.0%3.3% 3.5%
-5.3%-6%
-4%
-2%
0%
2%
4%
6%
Source: RBC Capital Markets Quantitative Research
Dividend Payers
Index Non-Dividend
Dividend Cutters
Dividend Growers
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Dividends vs. S&P/TSX Composite IndexAn important part of total market returns
S&P/TSX Annualized Total Returns Breakdown of Dividend Returns and Capital Gains
3.6% 4.2%
2.9% 2.4%
2.5%
7.3%
0%
2%
4%
6%
8%
10%
5 Year 10 Year 20 Year
Capital Gains Dividend Returns
Returns as a percent of total
5 Year 10 Year 20 Year
Dividend Returns 45% 36% 25%
Capital Gains 55% 64% 75%
Dividends have comprised between 25% and 45% of total returns over the last 20 years.
Source: RBC GAM, data as of Dec. 31, 2010. An investment cannot be made directly into an index. Chart and table do not reflect transaction costs, investment management fees or taxes which would lower returns. Past performance is not a guarantee of future results.
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What are we doing?Employ institutional volatility dampening strategies
Puts/Calls (Portfolio insurance and income generation)
Example: Covered call on Dollarama to generate additional income
Example: Puts on TSX and S&P 500 indices – insurance against portfolio
Customized Structured notes (both Principal Protected and Principal at Risk)
Example: Alerian MLP index note and USD S&P 500 Note
Alerian MLP Index has a 6.5% ROC income with a currency hedge
USD S&P 500 Note is a pure play on the index but with a twist….if index is above 1285 on Jan 12, 2012 investor gets 7% return
Upcoming Gold Note
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Why High Yield/Corporate bonds?
5 Reasons to own High Yield/Corporate bonds1. Higher return potential than other fixed income investments
2. Higher current yields / higher coupons than investment grade debt and
dividend-paying equities
3. Defensive features relative to dividend-paying equities
• Secured and unsecured investments rank senior in the capital structure
• Tighter covenant protection afforded to investors against deteriorating credit
profile
4. Lower interest rate sensitivity
• Senior secured floating rate high yield bonds have no interest rate duration
• When interest rates rise, high yield bonds tend to have a negative
correlation to government bonds
5. Credit cycles give active managers an opportunity to add value
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Why Invest In High Yield/Corporate Bonds?
FIVE BEST/WORST YEARS: HIGH YIELD & INVESTMENT GRADE CORPORATE BONDS (1987 – 2010)
5 Worst Years
5 Best Years
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WHY INVEST IN CORPORATE BONDS ATTRACTIVE RISK/RETURN PROFILE
5-YEAR RETURN ANALYSIS: CORPORATE BONDS AND OTHER MAJOR ASSET CLASSES
ANNUAL RETURN
STANDARD DEVIATION
SHARPE RATIO
High Yield Bonds* 7.9% 14.1% 0.50
US Corporate Bonds** 6.7% 7.3% 0.72
BMO Small Cap Blended
3.8% 23.0% 0.20
S&P/TSX Composite 2.7% 17.2% 0.13
Russell 2000 0.7% 24.5% 0.09
S&P 500 0.25% 18.9% 0.03
MSCI World -0.5% 20.5% 0.01
*BofA Merrill Lynch US High Yield Master II Index. **BofA Merrill Lynch US Corporate Master Index.As of October 31, 2011
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Higher yields offer downside protection when rates are rising - Period 1994 – June 2011
5.9%
-0.3%
9.7%
6.6%
0.4%
10.4%
7.5%6.3%
8.3%
-2%
0%
2%
4%
6%
8%
10%
12%
Total Returns over entireperiod (%)
Returns in a rising rateenvironment (%)
Returns in a falling rateenvironment (%)
U.S. Government Bonds U.S. Investment Grade Bonds U.S. High Yield Bonds
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Why Fixed Income ETF’s and Funds
Better liquidity and higher yieldsDiversificationBreadth and depthTransparentEfficient way to get immediate access to specific areas that would
be difficult for us to get access toCompliments our individual security strategy
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Examples
iShares XGB – All Government Bond Index 3.166% yield with 6.75yr Duration and 218 holdings.
RBC Global High Yield Fund – Mainly US/Emerging Market High Yield Bonds with 5.6yr Duration, hedged back to CAD and a running yield of ~5.00%
Mackenzie International fund Pairing – 50% Mac Cundill Value and 50% Mac Ivy Foreign Equity. Upside capture of 77% and downside capture of 61% with a very low 0.32 correlation to the MSCI Index over 10yrs. 55% US and rest scattered among UK, Japan, France, Netherlands, Switzerland, Canada, Italy.
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Investor Emotions
“Be fearful when others are greedy and greedy when others are fearful” -Warren Buffet
“A bear market is a temporary interruption of a permanent uptrend
-Nick Murray“You’ve got to be careful if you don’t know where you are going because you might not get there”
-Yogi Berra
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The Cycle of Market Emotions
Point of maximum financial opportunity
Optimism
Excitement
ThrillEuphoria
Anxiety
Denial
Fear
Desperation
Panic
Capitulation
Despondency Depression
Hope
Relief
Optimism
Point of maximum financial risk“Wow, I feel
great about this investment.”
“Maybe the markets just aren’t for me.”
“Temporary setback. I’m a long-term investor.”
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Patience will be rewardedBy staying invested you will not miss the best days
26.3%
14.5%
24.3%17.3%
9.8%
-33.0%
35.1%
17.6%
8.9%
-1.6%
7.6%-0.3%
-7.1%
-63.1%
-4.0% -2.0%
-80%
-60%
-40%
-20%
0%
20%
40%2003 2004 2005 2006 2007 2008 2009 2010
Annual return Annual return minus the 10 best daysSource: RBC Global Asset Management Inc. An investment cannot be made directly in an index. Graph does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results. Performance data as of December 31, 2010.
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The need for a well defined plan
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Philanthropy (Charitable
Giving)
Trust Solutions
Holding Company Services
Cash Flow Analysis &
Management Retirement Planning
Transfer of Wealth:
(Corporate & Personal)
Insurance Analysis
Estate Planning
Tax Planning
Investment Management
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The PFP
Group
WEALTH MANAGEMENT: Our Holistic Approach
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Wealth Management Plan: Tools to reduce/manage Risk & Volatility
Money has a different meaning to each client • Retirement, Estate and Legacy management• Income and Capital requirement• Tax minimization & Liability reduction• Capital growth
Determine your Appetite for Volatility • Asset Allocation • Investment objectives
• Needs, wants, must haves• Cash Flow requirements
Develop your Road Map
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Wealth Management Tools: Creating a Road Map
Risk Questionnaire: • Review existing or complete a new Risk Questionnaire. Better understand what Risk and Volatility means to
you and your situation. Investment Policy Statement:
• Ensure your “Investment Policy Statement” is clear on the asset allocation and the type of securities that will be held within your portfolio. This will help you understand the quality of the securities that are held and the maximum or minimum exposure you will have to any volatile securities.
Will & Estate Review: • Update Wills & Power of Attorneys (Including Business Will if required)
• Taxes upon death- Income tax (Deemed Disposition) & US Estate Tax (if applicable)
• Probate Taxes- .5% on first $50,000, & 1.5% over $50,000.
• Transferring your Estate: Trusts, Hold Co’s, Gifting, Joint Ownership, Beneficiaries, Insurance.
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Wealth Management Tools: Creating a Road Map
Personal Financial Plan
• Begin the process of having your needs, wants and objectives built into a comprehensive financial plan that can be used to monitor and review on an annual basis.
• Goals and Objectives: Be clear and concise.
• Your Current financial situation vs. Projected financial situation (Net Worth)
• Cash Flow needs: determine most efficient way to receive income, i.e.: Hold Co, Insurance, RRSP, Pension Fund, Investment Portfolio.
• Tax Planning: Income splitting, types of securities or investments held, transfer of wealth.
• “Asset Allocation”- Rate of return required.
• Risk Management: Estate Shrinkage- do you have enough to meet your needs in the future.
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Wealth Management Tools: Creating a Road Map
Holistic Wealth Management Approach • Combining a Wealth Management Plan as part of your Investment Solution creates a a clear and
concise road map to address your needs and objectives as well as the path that is required to obtain them:
Our experience has shown the following• Clearer understanding on return requirement• Minor changes to “asset allocations” to better meet your comfort levels.• More efficient estate structure leading to more efficient after tax returns resulting in lower risk and
volatility from investment portfolio.• Tax efficient and capital guaranteed solutions to reduce volatility and deal with future tax
obligations. • Greater understanding of the Investment Process and the quality of investments held leading to less
anxiety around volatility.• Sense of comfort knowing that all facets of Wealth Management have been addressed
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The outcome of a well defined plan.
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