Ryan Bushell

All three major US equity market indices hit new all-time highs last month while the Canadian market remains stubbornly below its all-time high set last August following a sharp downturn in oil prices.  As we have detailed before while share prices and the widely quoted equity market indices based on them make for great headlines, they are only half the story when it comes to an investor’s long term total return since they ignore dividends.  The two charts below detail the difference between the total return indices and the more popular price only indices quoted in the daily headlines.  As you can see while share prices have gone on round trips (2000 – 2013 for the S&P 500 and 2008 – 2014 for the S&P TSX Composite) the total return indices have ground steadily higher.

Charts 1 and 2 – Benchmark Price vs. Total Return Comparisons since 2000


Source: Thomson Reuters as at Apr 30, 2015

The gap between the blue and grey lines in each chart represent the value accumulated from compounding dividends not captured in headline market index quotes.  Another interesting point is the degree to which the Canadian market’s total return outpaces its price return owing to the higher average dividend yield of Canadian companies.  Leon Frazer portfolios have an even higher dividend yield so the gap between our “price index” and total return would be even wider, not to mention the fact that our equity composite has significantly outperformed both markets for the period, regardless of currency as shown below.  (We don’t track an LFA “price index” because it’s meaningless to our clients… makes you wonder why markets are tracked this way)

Chart 3 – Relative Performance of LFA Composite vs Benchmarks since 2000


Source: Thomson Reuters/LFA as at Apr 30, 2015

LFA Composite (see disclaimer below) results above are shown gross of fees in order to compare them to the market indexes which are also gross of fees, however even after netting out the maximum fee level the LFA Composite would still handily outperform for the CTD (Century to date).  The point is not to show off, the point is to show the sustainable performance lift from a credible dividend based investment strategy over a longer timeframe.  If you look to the far right hand side of the chart you can see where the pull back in our performance was not mirrored by the indices below.  In fact if we run the exact same chart above for a shorter period, since Dec 31, 2012 the results look quite different:

Chart 4 – Relative Performance of LFA Composite vs Benchmarks since 2012


Source: Thomson Reuters/LFA as at Apr 30, 2015

Wow!, amazing performance for the US market, especially for Canadian investors, and drastic underperformance of the Leon Frazer Equity Composite.   What is going on?  Is it over for dividend paying stocks?  Is it time to abandon Canada?  Has Leon Frazer lost their way? These types of questions and more come to mind when evaluating the past few years.

Our answer, of course, would be no to all of the above.  Over shorter periods relative performance comparisons can be misleading.   The key to the Leon Frazer dividend investing strategy is the compounding and reinvestment of the dividend income over time.  If you again look at charts 1 and 2, you can see the value added from the reinvestment and compounding of the dividend is represented by the distance between the total return series and the price series and grows wider as time passes.  This is because dividends get paid regardless of the market’s direction, adding a little bit to the return every year.   If you look at the first few years of those charts you can see that they pretty much mirror the market’s movement exactly.  This is just the math of compounding; it starts slow but grows exponentially as time passes.  (For a good example of how compound growth works click here)

For those unfamiliar with the Legend of the Chessboard, a humble servant (and brilliant mathematician) asks his king for just one grain of rice on the first square of the chessboard and for that amount to be doubled for each subsequent square.  His wish, seemingly benign, is granted.  There are 64 squares on a chessboard so the servant is entitled to 1, 2, 4, 8, 16, 32, 64 grains for the first few squares which seems quite modest, but by square 64 he is entitled to 18,446,744,073,709,551,615 grains which is enough to cover the earth’s surface several inches deep.  Now if we take this example to an investment context the squares on the chessboard are like years going by.  For those clients that have been with us only a few years, the returns seem fairly modest.  Those clients are still in the 1,2,4,8 area of the chessboard.  As you can see from all the charts above the income compounding performance gap doesn’t really appear until around the 10-year mark.  Most investors, even seasoned investors, have never employed a clear compounding investment strategy in one place for long enough to see the benefit of the later squares on the chessboard.  Leon Frazer is lucky enough to have several clients who have reached some of the latter squares of the chessboard who couldn’t care less about chart 4, because in some cases just the income they earn on their investments every year is multiples of the amount they initially invested.

This brings us back to trying to answer those troubling questions above about what is going on today.  Recently lower dividend paying sectors have led the market.  In the last 24 months Consumer, Health-Care and Technology shares have been the best performers despite paying paltry dividend yields while higher yielding sectors have underperformed:

Chart 5 – 2-year S&P TSX Composite Total Return Sector Performance vs. Current Sector Dividend Yield


The same general relationship holds in the United States as well:

Chart 6 – 2-year S&P 500 Total Return Sector Performance vs. Current Sector Dividend Yield


Based on the above it’s pretty clear that higher yielding stocks have been underperforming but why?  The answer lies in market psychology that repeats throughout history.  As returns increase investors become more aggressive.  Safer stocks are bought/held at the beginning of the market cycle.  As the market begins to run, investors must move out the risk spectrum to “catch up”.  This happens for a period of years and the cycle feeds off itself.  The quality dividend paying names like the ones we own start to level off first, as they proportionately get purchased more at the beginning of the cycle.  Additionally in the current cycle there is concern about an increase in interest rates negatively affecting dividend paying equity valuations in the short-term, which we have discussed before here.  Towards the end of the cycle market returns get harder to match so investors take even more risk to outperform short-term, leading them to sectors with lower dividend yields and higher volatility. Right now these sectors are experiencing upside volatility, returns of 20% or more per year are clearly not sustainable, the downside volatility will follow at some point but for now owners of these sectors are flying high.

The Leon Frazer composite has underperformed its benchmark by over 8.5% over the last three years gross of fees.  I went back to 1960 and plotted our performance against the benchmark on a rolling 3-year basis to find other such periods in our history, the results below are pretty interesting:


Looking at chart 7 you can see 6 periods where the Leon Frazer composite underperformed the benchmark for a period of more than a year.  In 5 of those 6 instances (the red circles) the 12 months that immediately followed peak underperformance for our composite were negative for the market.  The data is summarized in the table below.

Table 1 – S&P TSX Total Return Index and LFA Composite Performance following

LFA Composite Underperformance Peak:

Following 12-month total return for the TSX Composite:

Following 12-month total return for the LFA Composite:

September 1969



September 1980



September 1987



August 2000



October 2007






Source: Thomson Reuters/LFA as at Apr 30, 2015

As you can see this indicator does a pretty good job of predicting some pretty nasty markets, meaning that if we are underperforming by a significant margin there is usually some excess to be corrected in the market.  The last time our performance dipped negative at all was briefly in 2010, which was followed by a year where the market was down over 8% in 2011 and the LFA Composite was up slightly.  That was a relatively benign correction, 2008, the next closest incidence, was not.  It remains to be seen how this period will resolve, but suffice it to say that this indicator does not bode well for the market at large.

So based on the information above why wouldn’t we cash out our clients and wait for the impending doom?  Frankly we are not that arrogant, we have no idea where the market is going and our clients get paid nothing to sit in cash.  Going back to the Legend of the chessboard the dividends we collect year in and year out are the grains of rice that accumulate on the squares.  If the client is not withdrawing funds they get reinvested and earn more dividends the next year and so goes the miracle of compounding.  For those living off their portfolio; the portfolio is the engine that delivers the dividends that pay most of the bills, stop the engine, and the machine breaks down.  Even in the worst downturn we’ve endured as a company (2008-2009) 40% of the holdings in our portfolio increased dividends and portfolio values recovered in less than 3 years.

Unfortunately the stock market is not the simple math of the chessboard; it is a psychological animal that preys on all investors emotional weaknesses.  With a credible dividend investing strategy you leave less to chance with the latter and have a more clear view to math eventually working in your favour as you make your way around the chessboard.  As it happens our flagship portfolio: the IA Clarington Canadian Conservative Equity Fund, has just over a 65 year track record which is very close to the 64 squares on the chessboard.  Here is a chart showing the value of $10,000 since inception in 1950:

Chart 8 – Value of $10,000 invested in the IA Clarington Canadian Conservative Equity Fund since inception

Source: LFA as at Apr 30, 2015

The raw numbers look like this:  If you had invested $10,000 in 1950 it would be worth a little over $3 million today with over 1/3 of that value being represented by reinvested dividends, net of mutual fund management fees (Currently 2.49%).  That means every dollar invested initially is worth over $305 today having compounded at ~9%/year.  Not quite the same as the astronomical 18 gazillion grains of rice you would get compounding at 100%/year but I think most investors would take it.

Many investors marvel at investment results like this or the more famous Warren Buffet but there are reasons both track records are rare in the business.  Both strategies focus on quality and fundamentals rather than emotion.  Both strategies rely on patience rather than greed.  Both strategies occasionally make mistakes but the victories more than compensate.  And above all else both strategies involve discipline and common sense, qualities that few market participants possess.   We strive to put every client of our firm is on a compounding curve, it just takes time to see it.

The information contained in this presentation that is attributed to sources other than Leon Frazer & Associates Inc. (‘Leon Frazer’) or is derived by Leon Frazer from such other sources, is from sources that Leon Frazer considers reliable. Leon Frazer cannot be held responsible for any errors and omissions contained in such sourced information. Leon Frazer, a professional portfolio manager, recommends that its clients and anyone considering investments seek investment related tax, legal and accounting advice from their own professional advisers.
The purpose of Leon Frazer’s (LFA) Equity Composite (the ‘Composite’) is to provide a reasonable indication of asset weighted historical performance of our institutional mandates, which include the IA Clarington Canadian Conservative Equity Fund (which has been managed by Leon Frazer since 1950), the JOV Leon Frazer Dividend Fund (which has been managed by Leon Frazer since 2007) and the Counsel Canadian Dividend Fund (which has been managed by Leon Frazer since 2009) and 4 other institutional mandates. The Composite is intended to indicate the relative performance of Leon Frazer’s investment selections in the Composite portfolio, compared to the S&P/TSX Total Return Index.
The data provided is the Composite’s annual performance and/or cumulative average annual performance for each of the years shown, and illustrates the performance of the institutional assets under management by LFA. The Composite portfolio invests primarily in securities that generate income, which provides the basis for both fund distributions and long-term capital appreciation.
To ensure comparability to the S&P/TSX Total Return Index, the indicated rates of return in the Composite is the historical annual compounded total returns including changes in value and reinvestment of all distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable that would have reduced returns. The Composite performance results are presented before management, custodial and portfolio management fees. 
The value of an investment is not guaranteed, may change frequently and past performance may not be repeated. The investor may not get back the amount invested. Actual returns in a managed account will be reduced by fees, costs and taxes applicable to the account. © 2015 Leon Frazer & Associates Inc.



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