In this meaty, beaty, big and bouncy edition:
- Welcome to new readers
- Feature: How I Won the Department of Psychology’s Olympic Hockey Pool
- Market Guy Mailbag: Getting started; Market Call on ROB-TV; Gold; Asset Allocation
- The Market Guy’s Closing Bell: The Pride of the Inbox
Welcome to new readers
Welcome to all the new folks who’ve signed up after reading about the column in the December/January edition of Moneysense Magazine. It’s good to have you aboard. I should mention that I’m not a financial advisor and so I don’t provide any financial advice. I just enjoy writing about the markets and what I’m doing to make a few extra bucks. If you find something in the column that can serve as a springboard for your own research, fantastic! If you end up regarding the column as a burden you have to bear and a bear you have to cross, then you have plenty of company.
How I Won the Department of Psychology’s Olympic Hockey Pool
Like most Canadians, I look back on the 2006 Turin Olympics with a sense of ambivalence. On the one hand, there was Cindy Klassen and her 5 medals, the women’s hockey team, and the fact that our country finished third in the overall medal count. On the other hand, there was the men’s hockey team, over a dozen fourth-place finishes, and the CBC’s Brian Williams. Ordinarily hockey, and even Team Canada for that matter, ranks far down on my sports hierarchy below baseball and the Toronto Blue Jays. I suppose this makes me the antithesis of the stereotypical Canadian. In any event, I found my interest in the men’s Olympic tournament much higher than usual, owing almost exclusively to the fact that I was playing along in the Carleton University Department of Psychology Olympic Hockey Pool. More importantly for you, what the heck does this have to do with investing in the financial markets? Patience, my young padouan. As Grandpa Simpson said of his revitalizing tonic, “all questions will be answered, all fears will be allayed” (or something to that effect).
Participating in an Olympic hockey pool is not unlike assembling an investment portfolio. Here are some of the similarities:
- Past performance heavily influences your decision-making. The players most likely to be selected in the pool are apt to be the players who are leading the scoring tables in the NHL. The stocks and mutual funds that attract the most attention are those that are currently the top performers.
- Judgements are made under conditions of considerable uncertainty. Hockey has injuries, penalties, and a variety of intangibles such as team chemistry. The markets have scandals, world events, and organizational culture.
- All decisions are influenced by your own level of risk tolerance. I’m relatively risk-averse, so I’m not interested in gambling on Peter Forsberg’s health in the same way that I’m not interested in gambling on Nortel’s balance sheet or RIMs chances of retaining market share.
- There’s added pressure due to social comparison processes. Simply, we’re not only curious about how we’re doing, but we also want to know how others are doing (especially if we deem such others to be similar to ourselves). Given that I was a first-time participant in the pool, I didn’t want to embarrass myself. I suppose the same thing goes when it comes to investing.
- Feedback on your decisions can be obtained almost instantaneously. Hockey has box scores, while the markets have stock quotes. Hockey has TSN and Sportsnet, while the markets have CNBC and ROB-TV. I watch all four, much to the chagrin of the Market Gal.
- The decision-maker is faced with a dizzying array of choices. Olympic hockey has players from different countries; the markets have stocks in different sectors.
However, given the short duration of the Olympic hockey tournament, it more accurately resembles a stock-picking contest rather than the construction of an actual portfolio. Let’s break this down: Both are events of short duration and therefore playing it safe is typically not a winning strategy. More often than not, one has to assume a considerable amount of risk in order to obtain the highest return. You don’t win a hockey pool by having a player from every single country and you don’t win a stock contest by picking an index fund. Now if we’re talking about a multi-year approach (or even a hockey pool that’s based on a complete season), that’s a different story. So what is a participant to do?
Well, it makes sense to place most of your eggs in a very small number of baskets. To win a hockey pool, you have to bet on the performance of a small number of teams. So if you think Team Canada is going to the finals, then selecting a heavy percentage of players from their roster would represent a logical strategy. For a stock-picking contest, a similar approach makes sense. If you believe that energy names are going to be the top performing sector, then you’d overweight the contest portfolio in favour of energy names. There’s little incentive to diversify.
OK, but most of you aren’t going to be joining a stock-picking contest anytime soon, so let’s keep the discussion focussed on the construction of an actual portfolio. Investing guru Warren Buffett suggests that if you want to outperform the market, then you need to adopt overweight positions from time to time. He’s done this quite successfully, as much of his portfolio is based on insurance and consumer products. He also suggests that if you diversify too much, then you’re going to end up with market returns. When you factor in trading fees, this means that a completely diversified portfolio won’t even match the performance of the markets on which it’s based. That’s depressing. So in my own portfolio I try to stay diversified but will overweight certain sectors and markets from time to time. I decided to apply this approach to the Olympic hockey pool. That is, adopt a modest overweight position in the team that I thought would score the most goals and reach the tournament final. However, I also wanted to include representation from each of the teams that I thought had the best shot at moving beyond the preliminary round.
Figuring that Canada , Russia, the Czech Republic, Sweden and Finland had the best chances at a medal, I wanted a player from each of these teams on my roster. Similarly, I believe that dividend-paying stocks, companies with solid cash flow and low debt give me the best chance at investing successfully over the long haul. So I overweight these stocks in my portfolio. In the Olympics, I was prepared to forego Slovakia, Latvia, Kazhakstan, Germany, Switzerland, and the United States. Similarly, I tend to forego stocks that don’t pay me anything, have high debt, and are expensive.
With stocks, I generate a list of companies that fulfill my criteria and monitor them closely. In hockey, I prepared a list of the top forwards from each of the favoured countries and decided to overweight Team Canada. It seemed like the logical and most psychologically-satisfying thing to do. With that, I headed for the draft. Here’s what transpired:
|Even Warren Buffett would have been overweighting Team Canada.|
A few days before the tournament, we all gathered in an office overlooking the Rideau River in Ottawa. Here were the ground rules: In the first round, we had to select a goalie; round two had to involve drafting a member from the Italian team; rounds 3-8 were open and you could draft any player, provided he hadn’t been drafted in an earlier round. Let’s examine my picks and how each can be related to my portfolio.
Round 1: I opened up with Marty Brodeur (CAN), which seemed to be an obvious pick. It’s like pizza, sex, and investing in one of the big-five banks…all are good even when they’re bad.
Round 2: Tony Iob (ITA), mainly because he’d played some junior in Canada. The fact that he was lighting up the Austrian League was, strangely enough, a plus. This pick was like a high-interest savings account: you don’t want to rely on it for very long and you wish there were better alternatives. Now let’s move on to what most of us considered the “real” part of the draft:
Round 3: Joe Thornton (CAN). A couple of us went with him, although Jagr, Heatley, Iginla, and Lecavalier also went. Thornton was having a strong NHL season, played well in the World Cup, and is a perennial All-Star. Simply, he’d been doing well in both the short and long term and seemed like a solid pick.
Round 4: Simon Gagne (CAN). Nobody else got him, preferring Alfredsson, Sakic, Nash, Bertuzzi, Satan and St.Louis, among others. After this round it seemed like a perfect opportunity to talk smack. However, this was a room full of research psychologists, so I exercised caution. I can only imagine what a poker tournament would be like. In any event, the overweight in Team Canada is analogous to my overweight in the income trust sector. However, all good overweights must come to an end; and so began my effort at diversification.
Round 5: Ovechkin (RUS). This was a popular pick here, along with Kovalchuck and Selanne. Picking a Russian in the pool is like owning a bond until maturity…where’s the downside?
Round 6: Mats Sundin (SWE). Nobody else picked him. My reasoning was that I needed a Swede, Alfie was already gone and perhaps Sundin would flourish when surrounded by some actual talent. Other people went with Zetterberg, Richards, Smyth, Cole, Hossa, among others. It’s like when I cycled out of Riocan because it was too expensive. I still wanted exposure to the REIT sector so I looked for some cheaper alternatives.
Round 7: Straka (CZE). Again, I was flying solo with this pick. I wanted a Czech and believed there was a decent shot that Straka would be playing alongside Jagr and Rucinsky (his linemates in New York). Others went with Datsyuk, McCabe, Modano, Hejduk, and Yashin, among others. Being a Senators fan, I have to note that picking Yashin for the pool is like hiring Kenneth Lay to run your company. Another random note: I was surprised by how many Americans were selected. It’s like overweighting precious metals; you may be right, but I just can’t bring myself to understand or accept it.
Round 8: Olli Jokinen (FIN). Kovalev, Prospal and Malkin, also went. My choice here was determined almost exclusively by the fact that I needed a Finn to round out the roster. The last pick in the draft is like the last purchase in a diversified portfolio: you know the least about it, but have to make it anyway. These are the international equities in my portfolio.
So there you have it. I’d created a diversified roster with a modest overweight that nicely mirrored my diversified portfolio with a modest overweight. So I sat back and assumed that one of those assuming a heavily over-weighted roster (e.g., mainly Russians) would walk away with the top prize. Through the preliminaries I stayed in the top-three, and as we entered the medal round, I was hoping that my Canadians would come through in the clutch. Well, my overweight became just plain over…and did so in a hurry, as Canada was promptly bounced by the Russians. However, my diversified approach meant that I had a whack of forwards still playing. Heading into the final, I was tied for first, with two players still alive (Sundin and Jokinen). The competition had only one (Alfredsson). Well, my guys fetched a couple of assists, Alfie was shutout, and that was the end of that.
So I won the pool and walked away with a prize that has yet to be determined! Even though my overweight to Team Canada was a colossal failure, the fact that I was still relatively diversified saved my Canadian bacon. I was surprised to win because diversification rarely means that you’re the top performer over a short period of time. In fact, you’re rarely the top performer over any period of time. However, I believe that my approach gives me the best chance at succeeding over the long haul without undertaking undue risk. And who knows? The fact that I won the pool illustrates that it’s at least possible to finish on top from time to time. However, I don’t recommend playing too many games against a room full of psychologists.
|What happens when two Canadians, a Swede, a Finn, a Czech, and a Russian skate onto a rink? The Market Guytakes home the hardware!|
The Market Guy Mailbag
Letter #1: Tomasz in London (grade 11) writes:
I’m hoping that you may address the following topic in your future column:
How to begin investing with a relatively small amounts of money, (ex. $1000), especially when it comes to diversification?
Getting an early start on your investing career is to be commended, so nice going. All that I can do is talk about how I started out. I had roughly the same amount of money as you and began investing in mutual funds (after a brief time spent with GICs…they were yielding double-digits at the time). I began with a balanced fund and contributed to the fund as often as I could. It was a great place to throw my lawn-mowing money. After that, I had compiled enough cash to branch out into a Canadian equity fund, a US fund, and a bond fund. After that, an international equity fund was added. Around that time I started dating, so obviously there wasn’t much cash left over for investing. So I started working at Zellers and this gave me some extra money to throw in the portfolio. As these positions grew and I had a few more bucks for investing, I started looking at individual stocks. In other words, it took a few years to get the ball rolling. The first few years didn’t seem very glamorous, but it’s in the early years when compounding does its heavy-lifting. The important thing is to keep learning and having fun. Thanks for your wonderful letter, Tomasz…and thanks to all of those who consider themselves to be “newbies” who took the time to write in with their stories.
Letter # 2: Navdeep in Toronto writes:
What do you think about Market Call on ROB-TV? Do you ever use it as a source of investment ideas?
Ah, Market Call. The show involves ordinary investors calling in to ask questions of a money manager or analyst. I must confess that yes, I do occasionally watch the program and yes, I do occasionally fetch an idea or two. Lately I’ve been more interested in the Friday edition of Market Call, which is devoted to a consideration of income trusts. Permit me a tangent, as I have a bone to pick with the host, Jim O’Connell. He seems to ask the same questions each week and usually receives the same answers.again and again and again. I thought it might be fun to offer his usual questions, the obvious answer that we hear each week, and some alternative responses that would spice things up a bit.
Jim’s question #1: “What makes for a good income trust?”
Obvious answer, the one we hear each week:
“A company with decent market share, some pricing power, a steady and predictable stream of cash, low capital requirements, sufficient liquidity, the potential for modest growth, proven management, a strong track record, operating in a relatively boring sector of the market (or some combination of the above).”
What someone should say to spice things up:
“A company on the edge, Jim. Purchase companies that are extremely sensitive to even the slightest change in economic conditions or currency valuations. Weakening cash flow, high debt and no competitive advantage whatsoever are also good attributes.”
Jim’s question #2: “Are there some companies that should not be income trusts?”
Obvious answer, the one we hear each week:
“Not all companies represent good candidates for the trust model. We choose to invest only in the companies that meet the criteria that we’ve already discussed.”
What someone should say to spice things up:
“More importantly Jim, let’s talk about the sectors that should be joining the income trust market. I’m talking about porn and the world of adult entertainment. You know what I mean, Jim? Sure you do. What sector has a more reliable stream of cash flow, sufficient liquidity, and just think about all those analysts tripping over themselves to cover the sector, I mean those conventions in Vegas can get pretty.um.what’s wrong Jim? You look pale.”
Jim’s question #3: “Is there a bubble in the income trust market? Some say it’s getting too pricey.”
Obvious answer, the one we hear each week:
“Yes, some names are getting overextended, but it really depends on what name your talking about. It’s more important to approach the income fund sector on a trust by trust basis. In this respect, it’s just like any other sector of the market.”
What someone should say to spice things up:
“Hell no. Everything is a screaming bargain Jim. Buy them all. Every last one of them. Go into mind-numbing debt if you have to.”
“They’re all crap, Jim. Avoid with extreme prejudice. Can we go home now?” (This is known as the Ross Healy response).
At least Jim dropped the “what exactly is an income trust?” question that he’d been asking for 5 straight years. I can’t tell you how glad I am to see that out of the rotation. Oh, and feel free to “Play the Jim” next Friday and try to guess when he’s going to ask his favourite three questions. I’m guessing that all will make an appearance before the halfway mark of the show.
|The Market Guy can understand the need to educate…but “what is a trust?” eventually became like fingernails on a blackboard.|
Letter #3: Paul in Ottawa writes:
I was reading the latest issue of MoneySense and was fortunate to have come upon your blog site. You spoke at length on topics such as oil and gas trusts, REITs and select mutual funds, though I was curious as to your take on precious metal and gold investments.
Of the ‘golds’ in my portfolio, I presently own Goldcorp, which does pay a small dividend, but whose story is largely based on aggressively growing through acquisitions at this early stage of the gold bull run. I also have a mid-tier company, Yamana, which follows the same strategy, though likely will not have a dividend for some time yet. Both have done well relatively recently, so I am just parking these and holding for the long term. I believe golds will one day be on the cover of newspapers on a daily basis, though we’re still some time away from that.
Thanks for the note and congrats on doing so well with Goldcorp and Yamana. I have to confess that my knowledge of the gold market wouldn’t fill a thimble, so you’ve hit on one of my glaring inadequacies. Thanks! The fact is that I don’t understand the case being made by the gold bugs. In the early 1980s, gold was trading over $800 and now it’s in the mid-$500s. I was reading in the Globe and Mail last week that in order to approach the old highs in present dollars, gold would have to exceed $2000. Yet each and every year, the gold bugs tell us that now is the time to buy, the metal is going to move big-time, and all those who disagree are misinformed or naïve. I recently had lunch with a gentleman who told me that we’re headed for a worldwide economic collapse and so its time to begin hording precious metals in our basements. Eventually, the bugs may be right..but I could also be dead for 50 years when that happens. Now if only these companies would start paying some hefty dividends, then I’d consider joining the congregation. Otherwise, I’ve found gold to be an interesting trade rather than a long-term investment.
If I were to adopt a gold position, I’d limit it to 5% of the portfolio. In terms of specific names, I’d probably go with the available SreetTracks gold ETF (GLD on the NYSE). It invests in actual bullion, rather than gold stocks and carries an MER of 0.4%. If the thought of buying a $US ETF was freaking me out, I might consider the iUnit ETF (XGD on the TSX). However, 46% of the fund consists of only two names, Goldcorp and Barrick, so this is highly dependent on a limited number of names. On the plus side, the iUnit pays a modest dividend and has a decent MER of 0.55%. My preference for ETFs in the sector owes much to my lack of confidence in picking specific names. In any event, your prediction of gold as front page news may very well be realized.and if that happens, what a perfect selling opportunity!
|Yosemite Sam always wanted the gold. Stay away Sam, because theMarket Guy doesn’t have any. Why don’t you try asking that long-eared galoot?|
Letter #4: Margaret writes:
How about a suggestion of what diversification one should have within their equity portfolio?
Your question is one that I receive quite frequently, and it’s a question that I continue to struggle with. Asset allocation decisions should be based on many different factors, including our risk preference, financial goals, time horizon, age, and financial situation. A starting point might involve trying an on-line asset allocation tool. Most brokers provide this service. For example,
I found these links on the Financial Webring Forum, which is located at:http://www.financialwebring.com/forum/
The Market Guy’s Closing Bell
With apologies to Lou Gehrig, I must be the luckiest man on the face of the Earth. I don’t have to tell you that fun follows me around, and I don’t want to brag.but over the past few weeks I’ve received unsolicited emails from complete strangers offering the following wonderful things:
- Discount prescription drugs, most of which promise to enhance my sexual pleasure.
- Huge discounts on the software titles that I use every day.
- A substantial sum of money from the direct descendants of a wealthy African businessman, if only I agree to join in a certain business venture.
In other words, so long suckers!
The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets…so do your homework before making any investment decisions. Basing any decisions on his column would be really, really stupid. He predicts the Toronto Blue Jays are going to win 95 games this year, the Dallas Cowboys are going to sign a decent kicker, and that Arby’s will eventually open a restaurant in Eastern Ontario. Send your slow-roasted, marinated beefs to email@example.com