Much talk has ensued in past months, around the time of quantitative easing by central banks, about the concept of real estate being a so-called "inflation hedge". What is meant by this?
The concept of "hedging" is pretty straightforward: take a position in an investment that limits the possible losses when summed with another investment. Generally one gives up some return for doing this but one can prevent against an investment being wiped out. Of course in the context of real estate, there is no hedge per se. What is meant is that real estate returns generally track inflation. Therefore if you have investments that would be hit hard if inflation increased, real estate is purported to generally increase its total return in an inflationary environment and you would at least have something, all said and done.
It helps to remember, when it comes right down to it, why real estate has any value at all. Simply, real estate is a capital asset that generates income from rents. Without that income or potential income (tangible or intangible), real estate would have no inherent value. It so happens that rents generally increase with inflation so the future value of the asset would tend to increase with inflation as well, minus depreciation of course.
The problem with blindly touting real estate as an "inflation hedge" is that the cash flows eventually determine prices. If prices are out of line with cash flows, what fundamentally justifies prices increasing with inflation? Often it is taken on blind faith that real estate prices increase with inflation as a law but prices are dependent upon the cash flows -- prices do not rise in and of themselves without cash flows rising as well. Unless there is speculation.
In a speculative bubble, where yields from cash flows are poor compared to other similar investments, it is not true that prices generally appreciate with inflation. In such an environment the balance of probabilities will have prices trail inflation at least until the underlying income streams are competitive again. You would be better off investing in real return bonds or perhaps some of the countless other investments whose income streams track inflation as well, many of which may well have better risk-adjusted returns than that condo with a 4% cap rate.
Showing posts with label risk management. Show all posts
Showing posts with label risk management. Show all posts
Thursday, July 2, 2009
Saturday, November 15, 2008
"Boring" Canada's Financial Tips for the World
Ottawa, November 13, 2008
From Finance Canada.
The following guest column by the Honourable Jim Flaherty, Minister of Finance, appeared in today’s Financial Times. In it, Minister Flaherty outlines Canada’s five-point plan to restore stability to the international financial system.
"The financial crisis that began 14 months ago in the US has intensified and spread around the world, threatening to roll back economic progress that has been made over the past two decades. Governments have been responding in a co-ordinated fashion and will continue this work in the lead-up to the summit of the Group of 20 leading economies.
"Few countries are as dependent on trade or as integrated into the global financial system as Canada. Yet our financial sector continues to weather the turbulence better than many other countries. This did not happen by chance. Canadians by nature are prudent and our financial system has been characterised as unexciting. Canada’s regulatory regime ensures that stability and efficiency are balanced. As a result, Canadian taxpayers have not had their money put at risk in response to this crisis. If Canada’s financial system is boring, perhaps the world needs to be more like Canada.
"Before we examine grand designs for global regulatory regimes, we need to recognise that good regulation begins at home. Effective national regulatory regimes could have prevented this crisis and must be our first line of defence against any future one. We all need to draw lessons from those systems that worked well and apply them to our national regulatory regimes.
"First, we need to regulate all pools of capital that rely on leverage. The crisis has demonstrated the devastating impact that unregulated entities can have. Transparency requirements must be the price of admission to global markets. Different financial services may have different regulatory requirements, but we need to bring them all under a regulatory umbrella.
"Second, capital and liquidity buffers need to be large enough to handle big shocks. Moreover, regulators must restrain overall use of leverage. Some have criticised high Canadian capital requirements for banks as being too conservative. But the strong balance sheets of Canada’s banks through this period speak for themselves.
"Third, it is not enough for regulation to look at individual institutions. It needs to look at the system as a whole. Risks that may appear sensible in isolation can be unsustainable from a systemic perspective. This systemic vantage point must be used to mitigate any tendency to underestimate risk when times are good. This requires co-ordination across the government, central bank and regulatory agencies.
"Fourth, we need to make market infrastructure more transparent and resilient. Non-transparent over-the-counter trades and naked short-selling reduced the stability of the system.
"This crisis has demonstrated that even countries with strong financial systems can feel the effects of inadequate regulatory regimes elsewhere. Countries may hesitate to impose new requirements on their own institutions if these measures will create a competitive disadvantage. This points to the importance of the fifth step: strengthening international co-ordination, review and surveillance to create a better second line of defence. Canada was a pioneer of the joint International Monetary Fund-World Bank financial sector assessment program. This independent review of domestic financial systems should be mandatory and public. We need to strengthen the role of international colleges of supervisors to ensure better understanding of systemic risks and to co-ordinate national actions. We need IMF surveillance with teeth. Countries must live up to their responsibilities to support global financial stability and growth. Nowhere is this more important than in correcting global imbalances through appropriate exchange rate and macroeconomic policies to support growth.
"The process of how we make decisions is equally important. In two decades of unprecedented growth, we have seen the emergence of dynamic new economic players that must be full participants at the global table. Canada took one of the largest share cuts of any country in the recent IMF reform exercise to ensure that emerging economies are better represented. This broader range of voices must be heard in other venues such as the Financial Stability Forum.
"Together, these reforms must ensure that incentives are aligned to support stability and that resilience is built into the financial system.
"The open market system did not fail in this crisis. However, some forgot Adam Smith’s maxim that the invisible hand needs to be supported by an appropriate legal and regulatory framework. We need to work together to strengthen those frameworks, and that work must begin at home."
From Finance Canada.
The following guest column by the Honourable Jim Flaherty, Minister of Finance, appeared in today’s Financial Times. In it, Minister Flaherty outlines Canada’s five-point plan to restore stability to the international financial system.
"The financial crisis that began 14 months ago in the US has intensified and spread around the world, threatening to roll back economic progress that has been made over the past two decades. Governments have been responding in a co-ordinated fashion and will continue this work in the lead-up to the summit of the Group of 20 leading economies.
"Few countries are as dependent on trade or as integrated into the global financial system as Canada. Yet our financial sector continues to weather the turbulence better than many other countries. This did not happen by chance. Canadians by nature are prudent and our financial system has been characterised as unexciting. Canada’s regulatory regime ensures that stability and efficiency are balanced. As a result, Canadian taxpayers have not had their money put at risk in response to this crisis. If Canada’s financial system is boring, perhaps the world needs to be more like Canada.
"Before we examine grand designs for global regulatory regimes, we need to recognise that good regulation begins at home. Effective national regulatory regimes could have prevented this crisis and must be our first line of defence against any future one. We all need to draw lessons from those systems that worked well and apply them to our national regulatory regimes.
"First, we need to regulate all pools of capital that rely on leverage. The crisis has demonstrated the devastating impact that unregulated entities can have. Transparency requirements must be the price of admission to global markets. Different financial services may have different regulatory requirements, but we need to bring them all under a regulatory umbrella.
"Second, capital and liquidity buffers need to be large enough to handle big shocks. Moreover, regulators must restrain overall use of leverage. Some have criticised high Canadian capital requirements for banks as being too conservative. But the strong balance sheets of Canada’s banks through this period speak for themselves.
"Third, it is not enough for regulation to look at individual institutions. It needs to look at the system as a whole. Risks that may appear sensible in isolation can be unsustainable from a systemic perspective. This systemic vantage point must be used to mitigate any tendency to underestimate risk when times are good. This requires co-ordination across the government, central bank and regulatory agencies.
"Fourth, we need to make market infrastructure more transparent and resilient. Non-transparent over-the-counter trades and naked short-selling reduced the stability of the system.
"This crisis has demonstrated that even countries with strong financial systems can feel the effects of inadequate regulatory regimes elsewhere. Countries may hesitate to impose new requirements on their own institutions if these measures will create a competitive disadvantage. This points to the importance of the fifth step: strengthening international co-ordination, review and surveillance to create a better second line of defence. Canada was a pioneer of the joint International Monetary Fund-World Bank financial sector assessment program. This independent review of domestic financial systems should be mandatory and public. We need to strengthen the role of international colleges of supervisors to ensure better understanding of systemic risks and to co-ordinate national actions. We need IMF surveillance with teeth. Countries must live up to their responsibilities to support global financial stability and growth. Nowhere is this more important than in correcting global imbalances through appropriate exchange rate and macroeconomic policies to support growth.
"The process of how we make decisions is equally important. In two decades of unprecedented growth, we have seen the emergence of dynamic new economic players that must be full participants at the global table. Canada took one of the largest share cuts of any country in the recent IMF reform exercise to ensure that emerging economies are better represented. This broader range of voices must be heard in other venues such as the Financial Stability Forum.
"Together, these reforms must ensure that incentives are aligned to support stability and that resilience is built into the financial system.
"The open market system did not fail in this crisis. However, some forgot Adam Smith’s maxim that the invisible hand needs to be supported by an appropriate legal and regulatory framework. We need to work together to strengthen those frameworks, and that work must begin at home."
Friday, August 15, 2008
Whoddathunk!
Due to the pressure of falling commodity prices the TSX has fallen from 15,000 points only a couple months ago to around 13,000 points today.
Oil has fallen from nearly $150/bbl to $112/bbl today.
Gold has fallen from its lofty heights around $1000/oz to $780/oz today.
Most other commodity prices have fallen dramatically over the past two months.
For anyone unfamiliar with market volatility in a commodity based economy, you just got your first lesson. It's possible to make and / or lose a lot of money very quickly.
For any long term investment strategy, diversification is important, otherwise you need near perfect timing to avoid the dramatic ups and downs. Diversification doesn't mean holding 5 different energy trusts either, I mean truly non-correlated assets.
Oil has fallen from nearly $150/bbl to $112/bbl today.
Gold has fallen from its lofty heights around $1000/oz to $780/oz today.
Most other commodity prices have fallen dramatically over the past two months.
For anyone unfamiliar with market volatility in a commodity based economy, you just got your first lesson. It's possible to make and / or lose a lot of money very quickly.
For any long term investment strategy, diversification is important, otherwise you need near perfect timing to avoid the dramatic ups and downs. Diversification doesn't mean holding 5 different energy trusts either, I mean truly non-correlated assets.
Friday, September 14, 2007
Dollar Cost Averaging
Here is a financial planning tidbit to think about over the weekend - dollar cost averaging into an investment portfolio. Dollar cost averaging is an ideal method to build portfolios over time.
What is it?
Rather than make a lump sum investment purchase, dollar cost averaging involves the regular purchase of a small amount of an investment on a weekly, monthly, or quarterly basis.
Why does it work?
The theory is that, over time, financial markets fluctuate, and a fixed dollar amount will yield varying units of a security - such as a mutual fund. The result is that more of the security will be purchased when prices are low, while less of the security will be purchased when prices are high.
What are the advantages?
Three important advantages of dollar cost averaging are:
a) minimizing market timing concerns
b) eliminating concerns over investing possibly large lump sum amounts, and
c) disciplined savings.
c) disciplined savings.
How can you do it?
The strategy can be implemented easily by setting up a systematic investment plan that transfers funds from your bank account into your investment account on a regular basis.
An example involving an initial investment of $1,000 in the CI Portfolio Series Balanced Portfolio starting in November 1988 and subsequent contributions of $200 per month until August 2007. This modest start and contribution schedule would have resulted in a $104,000 portfolio value today. This method is quite conservative and the returns far outstripped inflation, Canada Savings Bonds, and 5 Year GIC returns.
I like dollar cost averaging because it eliminates a lot of the emotion from investment decisions and is very disciplined. Have a great weekend.
Thursday, August 16, 2007
Who took the 'fun' out of fungible?
fungible
"Of or relating to assets that are identical in quality and are interchangeable. Commodities, options, and securities are fungible assets. For example, an investor's shares of Xerox left in custody at a brokerage firm are freely mixed with other customers' Xerox shares. Likewise, stock options are freely interchangeable among investors, and wheat stored in a grain elevator is not specifically identified as to its ownership."
Related stories:
Bank of Canada Provides Liquidity
Banks and Pension Funds Band together to provide liquidity to ABCP market
Notably, the TSX is down over 4.5% so far today in what I would term panic selling at this point in one of the most volatile days that I can remember. From the year's highs in July, the TSX is down approximately 14%. For comparison purposes, the Canadian Value Index is down approximately 11%.
"Of or relating to assets that are identical in quality and are interchangeable. Commodities, options, and securities are fungible assets. For example, an investor's shares of Xerox left in custody at a brokerage firm are freely mixed with other customers' Xerox shares. Likewise, stock options are freely interchangeable among investors, and wheat stored in a grain elevator is not specifically identified as to its ownership."
Related stories:
Bank of Canada Provides Liquidity
Banks and Pension Funds Band together to provide liquidity to ABCP market
Notably, the TSX is down over 4.5% so far today in what I would term panic selling at this point in one of the most volatile days that I can remember. From the year's highs in July, the TSX is down approximately 14%. For comparison purposes, the Canadian Value Index is down approximately 11%.
Tuesday, August 7, 2007
Thursday, July 26, 2007
Markets are Down, Down, Down!
Mohican is doing a quiet little cheer this Thursday as markets around the world, overvalued by many measures for a while now, are coming back down to more prudent valuations this week. I don't take pleasure in losing money or my client's money but I have had money on the sidelines now for many clients and the satisfaction of protecting them from this market correction is fantastic. It will also provide us with some great buying opportunities once the dust settles.
The TSX is down over 6% on the week so far as the resource and financials heavy S&P TSX Composite Index is feeling the selling pressure. The US markets and overseas markets are declining even more. Emerging markets and especially Latin American markets are being hit the hardest. The Brazil and Mexico stock indices were down over 5% today alone.
All in all, the Canadian market is fairing better than other world markets although it never reached the same lofty valuations as many others - especially those emerging markets. In contrast, with the TSX Composite down nearly 6% on the week the Canadian Value Index is down less than 5% indicating that, even over short term corrections, value is the safest place to be.
The TSX is down over 6% on the week so far as the resource and financials heavy S&P TSX Composite Index is feeling the selling pressure. The US markets and overseas markets are declining even more. Emerging markets and especially Latin American markets are being hit the hardest. The Brazil and Mexico stock indices were down over 5% today alone.
All in all, the Canadian market is fairing better than other world markets although it never reached the same lofty valuations as many others - especially those emerging markets. In contrast, with the TSX Composite down nearly 6% on the week the Canadian Value Index is down less than 5% indicating that, even over short term corrections, value is the safest place to be.
Saturday, July 7, 2007
Kim Shannon - Home in the range
Bull markets are rarer than you think
by Mark brown http://www.advisor.ca/images/other/aer/aer_0207_homeintherange.pdf
Markets have been range bound for the past seven years and, if history is correct, they will stay that way for at least another eight years, according to Kim Shannon, value manager and founder of Sionna Investments. “Typically after a major mania condition, the market capitulates, consolidates and goes sideways for a minimum of 15 years and once as long as 30 years,” she told an audience attending an event to promote Shannon’s move to become a partner with Brandes Investment Partners & Co. “Markets are more often range bound,” she says.
When bull runs do occur, they’re generally short and over before most people have a chance to enjoy it. In fact, markets have been range-bound for 100 of the past 134 years. The telltale sign that markets are moving sideways is the average price-to-earnings ratio. According to Shannon, P/E ratios creep up during a bull run before the market levels off. In subsequent years, that ratio is slowly eroded away in one of two ways: The price comes down or the earnings catch up to the price. The last sideways market began in the middle of 1965 when the P/E ratio was pulled down into single digits. Over the next 18 years investors returns flat-lined with an average return of 0.6%. Dividend yields were the main income generator over that period with an average yield of about 4.5%. The two combined produced an average return of 5% per annum. The single digit P/E ratios set the conditions for the next bull run, which took off in 1982.
Currently, the average P/E ratio in Canada rests at about 15. “People don’t want to think that our market could go single digits,” Shannon says, but to her that likely means we are not done with the recovery and capitulation stage. Generally, the commodities index falls during a bull market and rises during a sideways market. This obviously bodes well for Canada, she says. The data available seems to support that assertion. Shannon notes Canada has outperformed most markets during these range bound periods. While she thinks this will continue, she warns investors not to become compliant. “Keep in mind, through these sideways markets you can have individual fabulous rallying years, but you get much more frequent bear markets,” she says. And while it’s possible to set new record highs on the market, they almost never sustain them. This is one of the reasons why Shannon doesn’t like to make year-to-year predictions for the market. It also says something about how this successful long-term value manager invests.
The key theory for value managers is reversion to the mean, she says, that is, a stock companies trade will do nothing more or nothing less that what it has tended to do before. By looking at how the stock has performed relative to the market in the past, Shannon can make a prediction on how it’s going to behave in the future. “In simple terms,” she says, “what we do is search the investable universe looking for dollars that happen to be trading at $0.70 or less and, if the risk factors are acceptable, patiently waiting for them to go back to a dollar.” In a recent interview she talks about her reluctance to make broad market predictions. “What happens in a year is more noise than anything else,” she said. Overall, when it comes to the market Shannon has always been something of a pessimist when it comes to setting predictions for the market. “My clients know that I tend to wear bear coloured glasses all the time,” she said. “When I make predications and forecasts, if they add a dose of optimism, they’ll probably get it about right.”
by Mark brown http://www.advisor.ca/images/other/aer/aer_0207_homeintherange.pdf
Markets have been range bound for the past seven years and, if history is correct, they will stay that way for at least another eight years, according to Kim Shannon, value manager and founder of Sionna Investments. “Typically after a major mania condition, the market capitulates, consolidates and goes sideways for a minimum of 15 years and once as long as 30 years,” she told an audience attending an event to promote Shannon’s move to become a partner with Brandes Investment Partners & Co. “Markets are more often range bound,” she says.
When bull runs do occur, they’re generally short and over before most people have a chance to enjoy it. In fact, markets have been range-bound for 100 of the past 134 years. The telltale sign that markets are moving sideways is the average price-to-earnings ratio. According to Shannon, P/E ratios creep up during a bull run before the market levels off. In subsequent years, that ratio is slowly eroded away in one of two ways: The price comes down or the earnings catch up to the price. The last sideways market began in the middle of 1965 when the P/E ratio was pulled down into single digits. Over the next 18 years investors returns flat-lined with an average return of 0.6%. Dividend yields were the main income generator over that period with an average yield of about 4.5%. The two combined produced an average return of 5% per annum. The single digit P/E ratios set the conditions for the next bull run, which took off in 1982.
Currently, the average P/E ratio in Canada rests at about 15. “People don’t want to think that our market could go single digits,” Shannon says, but to her that likely means we are not done with the recovery and capitulation stage. Generally, the commodities index falls during a bull market and rises during a sideways market. This obviously bodes well for Canada, she says. The data available seems to support that assertion. Shannon notes Canada has outperformed most markets during these range bound periods. While she thinks this will continue, she warns investors not to become compliant. “Keep in mind, through these sideways markets you can have individual fabulous rallying years, but you get much more frequent bear markets,” she says. And while it’s possible to set new record highs on the market, they almost never sustain them. This is one of the reasons why Shannon doesn’t like to make year-to-year predictions for the market. It also says something about how this successful long-term value manager invests.
The key theory for value managers is reversion to the mean, she says, that is, a stock companies trade will do nothing more or nothing less that what it has tended to do before. By looking at how the stock has performed relative to the market in the past, Shannon can make a prediction on how it’s going to behave in the future. “In simple terms,” she says, “what we do is search the investable universe looking for dollars that happen to be trading at $0.70 or less and, if the risk factors are acceptable, patiently waiting for them to go back to a dollar.” In a recent interview she talks about her reluctance to make broad market predictions. “What happens in a year is more noise than anything else,” she said. Overall, when it comes to the market Shannon has always been something of a pessimist when it comes to setting predictions for the market. “My clients know that I tend to wear bear coloured glasses all the time,” she said. “When I make predications and forecasts, if they add a dose of optimism, they’ll probably get it about right.”
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