Ryan Bushell

Headline:  The S&P 500 Total Return Index is up 157% in Canadian dollars over the past 5 years

Implications:  If you’re not in the US market as a Canadian investor, you’ve totally missed out; look at all the return you are missing; you are falling behind your retirement plan; you are losing; everyone else is doing better than you; you should switch your investment strategy.

Backstory:  For the 10-year period prior to this, the S&P 500 was down 40% in Canadian dollars. If you had invested in either market for the past 20 years, your returns would be roughly equivalent – 8.36% per year for the S&P 500 Total Return Index and 8.19% per year for the S&P/TSX Total Return Index.

Headline:  Oil prices plunge over 50% from previous year, leaving producers to feel the pinch

Implications:  It’s over for oil, get out now; if you hold oil or any other commodity-based investments, you should sell them because they are going to zero; move to safer investments.

Backstory:  Oil prices are up ~100% from 20 years ago. Chinese gasoline demand is up 12% year-over-year, and China’s crude oil imports have grown 160% in the last 10 years, equivalent to 10% per year. US gasoline demand is back to all-time high levels not seen since before the great recession of 2008. Oil prices have been as high as $140 and as low as $35 in the past 10 years, but the average price has been $81/barrel.

Headline:  Nasdaq surpasses Internet bubble peak to set a new record

Implications:  It’s different this time; technology stocks are for real, this is where the returns are; GET IN

Backstory:  Technology companies are notoriously difficult to own as long-term investments and pay only nominal dividends. There are lots of good technology companies, but the cycles can be more boom/bust. When one technology cycle ends, the next cycle usually begins with new companies. The yield on the Nasdaq is currently less than 1.5%. Over the last 20 years, the Index has returned 9.07% per year, which is modestly higher than the TSX or S&P 500, but with more volatility and turnover.

So what’s the real story?

We like to measure things in the now, and indexes quantify how well or poorly a specific stock market is doing in the moment. We all want that 157% return in 5 years, but unfortunately, investing isn’t that simple, or immediate.

If we go back 5 years to August 31, 2010, the United States was a very scary place to invest. The US government had a deficit to GDP ratio of over 10%, the US Federal Reserve balance sheet had more than doubled in 3 years to ~$2.5 trillion, the US dollar was at an all-time low, a government debt downgrade was on the horizon and people were seriously talking about the Chinese yuan replacing the US dollar as the world’s reserve currency. As a Canadian investor, all you had to do to get your 157% return was sell your Canadian assets, including bank stocks, which held up remarkably well during the financial crisis, and put your faith directly in the US economy by investing in every company in the S&P 500 Index, without hedging the currency. Simple, right?

Now the opposite is seemingly true. The Canadian economy is on shaky ground, the world is worried about our housing market and our economy, thanks to the price of oil dropping more than 50% in the last 12 months. Our market has underperformed the US market by nearly 100% in the past 5 years, so who would want to invest money here?

This post is not meant to be a commentary on relative market performance or oil prices. I have already written plenty about that here , here and here. What I want to explore is the question of what we can realistically expect to earn from equities over the long-term, and how the Leon Frazer strategy is designed to achieve that goal.

Investing is a marathon

In today’s era of immediate gratification, investing is the ultimate marathon. Endurance athletes will tell you the key to running a marathon involves the 3 P’s: Preparedness, Patience and Perseverance. I found this great article on running a marathon that could just as easily be applied to long-term investing. It lists 13 tips, including: set healthy expectations, go with what you know, avoid unnecessary stress, and walk a minute every mile. Experienced marathoners know there are rough patches in every race. The key to overcoming them is to rely on your training and maintain a consistent pace/approach. Too many investors try to run a series of 1-5 year sprints, but similar to a 26-mile marathon, most investor’s time horizons stretch out 25 years or more.

Set Healthy Expectations – Preparedness /Patience

To run your investing marathon, you need to have a reasonable expectation of what the finish looks like. A good financial plan includes the long-term return assumptions necessary for reaching your goal. It is imperative to rely on these long-term assumptions and the planning that goes into constructing a portfolio, and not to deviate for short-term performance. One of the great quotes of the article is “Run for the finish rather than the time.” In investing, it is easy to get caught up in what other people are seemingly making from their investments. Your investment goals are individual and your success will only be determined at the finish. Much like gamblers, investors always talk big about their wins and ignore their losses. Stay focused on your plan and pace yourself. All that should matter to you is getting to the finish.

So what is the best way to set a reasonable long-term return assumption? Investment returns are largely dictated by interest rates. With today’s ultra-low interest rates, it would seem that investment returns over the next 30 years should be lower for all asset classes than they were in the past 30. Equity returns are more consistent over the long-term than fixed income and are less dependent on prevailing interest rates; however, in return for this extra return, you get more short-term fluctuation in values. Dividend yields in Canada have remained remarkably consistent, around 3-4% annually, save for a brief distortion by Nortel at the turn of the century. It seems reasonable to conservatively assume a 7% net of fees return from Canadian equity portfolios over the long-term as the midpoint of a 5% (conservative) to 9% (optimistic) range, based on both historical and forward looking data. All of this assumes constant inflation at the Bank of Canada’s 2% target, which is where inflation currently resides. If inflation were to rise, so would returns, and vice versa, such that real returns (after inflation) should stay fairly constant for a multi-decade time horizon.

Go With What You Know – Preparedness/Perseverance

Competitive marathoners are creatures of habit. They rely on their extensive training and experience to get to the finish line. An experienced marathoner is highly unlikely to change shoe brands on a whim or alter their race day routine based on a hot tip from a friend. That is not to say that they don’t make changes as they go along, but those changes are likely to be well thought out and slow to develop. Investing should be the same.

We go to great lengths to educate our clients on what they own and develop a great deal of familiarity with the holdings. We like the Canadian market not only because it is home to a host of solid dividend-payers, which helps satisfy our long-term return objectives, but more importantly, because it is familiar. Any investment horizon will have its challenges and when those challenges come, it causes investors to doubt. Am I in the right strategy? How do I know my investments aren’t going to zero? Do I need to sell or should I hold on? All of these questions are natural human behavior in the face of uncertainty, but know this: the key to successful long-term investing is staying invested, and the key to staying invested is understanding what you own. Being able to commit more funds when prices are down is the real secret to earning even better returns.

We have always felt that a portfolio of Canadian dividend-payers is an ideal fit for Canadian investors because the above average dividend yield tends to smooth volatility and supplement return over time. Being familiar with many of the company’s business models lends confidence to the long-term viability of the portfolio holdings, allowing clients to trust their holdings even when they are down. A hot tip from a friend on a hedge fund sounds great until there is panic in the market and you have no idea what you own so you sell at an inopportune time. Familiarity is key. Don’t underestimate the detrimental effect our inherent psychological weaknesses can have on investment returns. They extend from the most knowledgeable investors to the uneducated. At Leon Frazer, we’ve also made some bad decisions in our 75+ years, however, the best decision we ever made was to rely on what we know and not deviate. It is a special thing to survive 75 years in this business and consistently earn returns for clients.

Avoid Unnecessary Stress – Patience/Perseverance

Once you have a portfolio/strategy that you feel good about, stick with it. You can’t control the conditions of a race, so don’t bother. Excessive worrying can lead to bad decisions. There will always be problems and there will always be solutions, but the stock market does not wait for risk to exit before producing the reward. Over the course of 16 months in 2008, Canadian banks (a great investment over pretty much any significant stretch during our 75-year tenure) lost over 50% of their value, on average, as the global financial crisis spiraled downward. As long-term investors, we understood Canada had a very different housing market from the US and that our banks had minimal exposure to the factors that were causing the global angst. Less than a year after the banks bottomed in March of 2009, they were back to all-time highs, including dividends. Panic at the bottom is an investor’s worst enemy since stock market moves are exacerbated on the downside and tend to reverse quickly. Losses crystalized at the bottom have a lasting negative impact on long-term total returns. Our strategy is designed first and foremost to keep clients invested. You need to be invested to earn dividends, and dividends make up roughly half of our long-term total return assumption.

Walk a Minute Every Mile – Perseverance

This advice is intended to help marathoners ensure they finish by resting regularly throughout the race. Stocks go up and stocks go down, but over the course of time, the path is clearly up. Since the inception of the S&P/TSX Composite Total Return Index in 1956, there have been 278 negative months, however look what happens when the time horizon extends past 3 years on a rolling basis:

Investing is a marathon-not a track meet - Chart 1

This means that no matter when you buy equities, you have a >95% chance of positive returns after 5 years, but YOU MUST STAY INVESTED. According to Dalbar, who does a great job tracking investor returns relative to index returns, the average investor got just over half the index return over the last 20 years. A lower average return significantly increases the odds of more negative periods than listed above, and shows the detrimental effect of human emotions in the equity market. Markets can be difficult to take sometimes, especially when headlines blasted from multiple media sources need to be sensationalized to stand out, but there is great reward for staying the course. The difference between the average investor’s 5.19% annualized return over the last 20 years and the market’s 9.85% annual return results is a difference of $3,795,380 on an initial $1,000,000 investment. It is important for markets to correct and take a rest once every 3-4 years in order to rest up for the next stage of the marathon. No one likes it when shares decline, but we find it helps keep our clients (runners) focused on the finish when they see the dividends continue to roll into their accounts. In case you were wondering, here are our comparable numbers to those listed above (Note: Quarterly returns for periods prior to September 1984, *gross of fees):

Investing is a marathon-not a track meet - Chart 2

The Bottom Line

A marathoner is only judged at the finish. Sure, there are intervals along the way, but they mean nothing if the race is not completed. Short-term investing is hard; nearly 40% of months have negative returns. Long-term investing is easy: there has never been a negative 10-year period in the market and Leon Frazer has never had a negative 5-year period. The most important thing is to keep running/stay invested. We find it is easier to keep clients invested in companies they are familiar with, which pay them income as long as they own the shares. Anyone can do the investing math, but few can conquer their emotional weaknesses. We cannot predict the future with certainty, but history tells us there is value in our discipline. Remaining invested in businesses that primarily provide the needs of society, while compensating shareholders with a portion of quarterly profit, is what we have done, what we are doing and what we will continue to do. The race is a long one, but we are well trained and conditioned for the task.


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