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Table of Contents
Put your financial adviser on a leash
February 11, 2000
100% Foreign content for your RSP
December 22, 1999
Tax Loss Selling or Dealing With Your Mistakes
November 26, 1999
Life Stages of your RRSPs
November 12, 1999
Just give me boring (but great) rates of return
November 3, 1999
De-mystifying Demutualization - part Two
October 25, 1999
De-mystifying Demutualization - part One
October 19, 1999
Seg funds for the simple minded
September 14, 1999
The interest rate game Part 2
August 12, 1999
The interest rate game Part 1
July 30, 1999
Choosing funds: Five for the long run
July 14, 1999
New Funds: To buy or not to buy
July 2, 1999
Making sense of momentum investing
June 18, 1999
Rating the fund managers
June 4, 1999
Resource recovery hinges on supply and demand
April 30, 1999
Tech funds draw strength from favourable trends
March 24, 1999
Withdrawing from your RRSP
March 9, 1999
The economic implications of the euro - An interview with Ranga Chand
February 12, 1999
Underperforming small-cap funds have strong upside potential
January 29, 1999
How to pick a winning equity fund portfolio
January 15, 1999
View the Weekly Insight archive

Just give me boring (but great) rates of return

Wednesday, November 3, 1999

So many investors are approaching the stock market today as if it were a visit to the race track, standing in line at the lottery wicket or visiting Atlantic City or Las Vegas, looking and hoping for the next big hit that will propel them into a financial dreamland. Nothing exemplifies this contorted approach to participation in the stock market than the mania currently going on in the high tech sector, especially the Internet craze.

Speculators in these technology businesses are operating on a hope and a prayer that their stock pick, which they buy at the stock "wicket", will be the winning ticket. It surely isn't based on any hard numbers of what or where these companies will be in the future because most investors with any common sense will admit they simply don't know. And there's no doubt that purchases aren't grounded on past history or performance of the companies, or on any kind of reasonable valuations. In most cases, purchases are not based on any kind of reasonable analysis of valuations, because quite frankly, there is nothing to value-no earning and in lots of cases, no revenues either. Pure, naked speculation in my humble opinion with the same potential for success as playing a video lottery terminal.

Let's go to the other end of the investment spectrum, from pure speculation to almost perfect certainty-the arena of bonds. What are one's objectives when buying a bond-government or high-grade corporate bonds? The answer is simple -there is an expectation of a set coupon rate, say 6%, interest payments every month, quarterly, yearly or whatever the terms of that bond spells out. And, when the bond reaches maturity, it is expected that the principle will be paid back. Simplicity, boredom and most importantly, guaranteed rates of return. There's no guesswork and, in most cases, no surprises. And that's what most fixed income investors are looking for-nice boring rates of return without any nasty surprises. Most of these bond owners don't look at the price of their bond on a minute by minute, daily or evenly monthly basis because they don't care what the market is saying about their investment. It's the same way they think of their house-they don't have a price for it being flashed up on some ticker constantly and they didn't buy it to resell it tomorrow or even six months from now. They know what they have bought and they know what they will get. If they own a 2, 5, 10 or 30-year bond, they are true long-term investors.

But somehow, when investors turn their attention to owning equities, they lose this perspective completely. Guaranteed rates of return is the furthest subject from their minds. Some magical metamorphosis takes place whereby humans are at times, transformed from rational, calm, long-term investors with the capacity for independent decision-making into a thundering herd of buffalo rolling from one province to another as one thoughtless mind. They measure returns from their stocks, some on a second-by-second scale. But as different as these two worlds of bonds and equities appear, the truth is they have more in common than at first glance.

When you buy a common stock and you take possession of the share certificate (another rare event these days), you can search that piece of paper until you turn blue but nowhere will you find a coupon printed on the certificate promising or guaranteeing a particular rate of return. The job of the analyst, portfolio manager or you (if you take that responsibility) is to try to determine what coupon you can print on your stock certificate in order to give them bond-like characteristics-what Warren Buffett, the great Omaha based investor labels "equity bonds". What Buffett is searching for are companies that are as predictable as solid bond instruments, that will deliver consistent and growing, and yes, boring rates of returns. The problem is finding companies with bond coupon-like returns. In most cases, it's difficult if not impossible. When you really start to examine most companies, you'll find most of their returns will remain a mystery until we can look back in retrospect. You won't find much future predictability in most basic industries (a hefty chunk of Canada's economy, unfortunately), and it's the last thing you'll find in Internetland. And then, if you're fortunate enough to find a company with a predictable coupon, the problem is further compounded by trying to pay a price for that equity that gives you, the investor, a reasonable rate of return. That's particularly difficult given the inflated prices we, as investors, face these days.

The good news is that if you wait long enough, these sorts of equity investments do appear from time to time, even in overpriced markets. If a company's prospects are predictable within a significant margin of safety and the price is attractive, who cares what price the market is? After all, you're not buying the "market".

The relentless search continues. What is required is patience by individual investors and portfolio managers. Unfortunately many investors ignore the whole idea of trying to find consistent coupon-type companies and instead place their money in instruments in a fashion no different than spinning a roulette wheel. You want excitement?--go to Vegas.

You want safety and growth?-look for consistency and predictability.

By Larry Sarbit, Senior Vice President at AIC Group of Funds.

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