For more than 50 years, Canadians have been pouring money into their registered retirement savings plans (RRSPs). For most of that time, it was hard to go wrong. Stock markets steadily climbed for decades. In the 1990s, most equity categories rose, and the value of investors’ nest eggs soared.
Today, it’s a different story. Many RRSP portfolios were decimated during the recession, and countless baby boomers wonder if their investments will recover before they need to draw on them.
If we’ve learned anything during the past few years, it’s that investors need to take a more active approach to their portfolios. We can no longer just scoop up whatever looks good and wait for capital gains. We need to concern ourselves with how our RRSPs are structured.
At a minimum, investors should rebalance their portfolios once a year in response to both their evolving needs and the changing marketplace. Part of the process for most investors is to slowly tilt their portfolios away from stocks and go heavier on bonds and other fixed income investments as they get closer to retirement, so a last-minute crash can’t wipe them out.
If you prefer to forget about your retirement savings the rest of the year, use the approach of the annual contribution deadline (Feb. 29 this year) as an opportunity not just to top up the account and obtain the extra tax receipt, but also to sell off winners that have had their day and duds that will never have theirs. The idea is to get your overall asset allocation—the proportion invested in equities versus fixed income—back to a long-term allocation that fits your penchant for risk and your time horizon.
According to Ken Solow, author of Buy and Hold is Dead (Again), the simple act of rebalancing once a year can add 50 to 80 basis points of extra return (a basis point is one one-hundredth of a percentage point). Assuming now is the time to rebalance, let’s review what some top market minds think you should continue to hold, what you should sell and what you should buy going forward.
WHAT TO HOLD
Generally speaking, an RRSP is a long-term savings vehicle that you don’t want to touch until you’re sporting wrinkles and grey hair. “This is your pension plan and should have the characteristics of one,” says Paul Gardner, partner and portfolio manager at Toronto’s Avenue Investment Management. “You want to own life-long assets.”
A good bedrock for such a portfolio will often consist of large-cap equities that pay a dividend. Because they’re so big, and often multinational, large-caps—companies with a market capitalization of $10 billion and up—collectively have a lower risk profile than smaller companies. The regular dividends they pay out to shareholders can help your portfolio grow even in sideways markets. “You have to own these because you’re getting paid something while you wait for returns,” Gardner says. “If returns were 6%, you wouldn’t need dividends. But they’re not.”
AJ Sull, president and chief investment officer of Vancouver’s Pacifica Partners Capital Management, considers other factors beyond market cap. He looks for businesses that are dominating their industries, have done well over time and have strong balance sheets. Ultimately, he wants to own the business with the best profits.
“They don’t have to be the largest, but they should be the most profitable,” he says. When it comes to yield, he tends to look at the dividend growth rate, rather than the actual percentage payout. For instance, a company with a 3% yield that’s growing by 25% a year is better than a company paying 6% with no growth, he explains. While some investment pros recommend holding dividend stocks outside your RRSP (where they enjoy the dividend tax credit and don’t use up RRSP room), Sull says they belong in retirement accounts too.
Canadians who focus on their home markets don’t have a lot of choice when it comes to the type of large-caps they can buy. The Toronto Stock Exchange is heavily concentrated in two sectors, financials and energy. The result is that the vast majority of RRSPs are overweight in those sectors.
Fortunately, both have generally been good to investors lately. Many banks are currently yielding between 4% and 5%. Oil companies, says Colum McKinley, vice-president of Canadian equities at CIBC, have two things going for them right now: they’re cheap (close to fall 2008 levels) and oil is about $40 a barrel more expensive than it was back then. Another solid choice for the portfolio’s core (though there’s less to choose from) is telecom stocks, which pay yields as high as 5%.
Despite the hardy past performance of such Canadian stalwart sectors, many experts say that a properly balanced portfolio should include foreign holdings as well. Some suggest a 50% allocation to the Canadian market is enough, and investors should also devote a quarter of the equity portion of their portfolios to each of American and international stocks.
Rob Evans, president and portfolio manager with Evans Investment Management, says that when looking at international equities, Canadians should favour brand-name businesses such as Coca-Cola, Pepsi, Microsoft and Exxon Mobil. Not only are they high-quality global companies, but they’re also cheaper than they’ve been in years. “These companies are trading at reasonable multiples compared to 10 years ago,” he says. “They have great balance sheets and risk-return-wise, they’re attractive.”
Every portfolio needs to have some fixed income as well, even in today’s low interest-rate environment. Even a small allocation of bonds and guaranteed investment certificates (GICs) can reduce the volatility of a portfolio substantially. The amount that’s right for a particular investor depends on that person’s age, risk tolerance and net worth. Generally, the younger you are, the less exposure you’ll want to bonds. The closer you are to retiring, though, the more you’ll appreciate the way they preserve your wealth in good times and bad.
With most government bonds currently yielding almost nothing—a five-year Government of Canada bond pays a measly 1.28%—many experts are now suggesting high-quality corporates, which can yield 2% to 4% more than government bonds. In general, the risk of a company defaulting on its debt obligation is much lower today than it was during the recession. Bonds issued by companies rated BBB or above are preferable.
Steven Belchetz, president and chief investment officer with Toronto’s T.E. Wealth, suggests buying bonds through an exchange-traded fund or mutual fund. It can be costly to buy individual bonds yourself, and funds are more liquid. He recommends buying a mid-term bond portfolio, which holds fixed income that matures in five to 10 years. The longer maturity adds some extra yield and, since an RRSP is meant for longer-term assets, you shouldn’t worry about rising interest rates lowering bond prices.
Our Picks: Stocks to hold in 2012
BCE Inc. (TSX: BCE)
The Verdun, Que.-based telecom giant is a favourite of many managers, including Paul Gardner, a partner with Avenue Investment Management. The company has “a ton” of free cash flow and a clean balance sheet and boasts a 5% dividend yield. Trading at 14 times earnings, it’s not the cheapest stock, but it represents a large-cap Canadian company selling a product that consumers will want regardless of economic conditions.
Power Corp. of Canada (TSX: POW)
Montreal’s Power Corp. has all the qualities of a bedrock stock. It owns Canadian and international insurance companies, and has holdings in the communications sector. It’s cheap, trading at around 10 times earnings, and pays a yield of about 5%. Colum McKinley, a portfolio manager with CIBC, says the management team has a long-term focus, and he expects the dividend to grow. “You’re seeing strong results, which will drive asset growth across the business,” he says.
Microsoft (NASDAQ: MSFT)
This Redmond, Wash.–based tech giant isn’t as hot as Apple these days, but that’s a good thing. Since the tech bubble burst, it has become a reliable, dividend-paying company, perfect for RRSP portfolios. Microsoft generates over a billion dollars a month in free cash flow, pays close to a 3% yield and is buying back shares. The stock price was stagnant in 2011, but portfolio manager A.J. Sull says that, with a price-to-earnings ratio of 9, people will eventually see the value.
TD Bank (TSX: TD)
Big Canadian banks should be part of your core position, says Gardner. His bank of choice is TD. He particularly likes its foreign prospects; he says TD has finally built a strong U.S. business with its 2004 Banknorth and 2008 Commerce Bank acquisitions. Gardner also thinks TD will continue to raise its dividend, as it did twice in 2011. TD’s price-to-book is a “reasonable” 1.8 times.
Boardwalk REIT (TSX: BEI.UN)
Boardwalk is a real estate investment trust, not a stock, but it’s “so consistent,” says Gardner. The Calgary-based trust is the largest holder of apartment buildings in the country. Management is the REIT’s largest unitholder, which is always a good sign, and it pays about a 3.5% dividend. Most REITs, including this one, aren’t cheap. It’s trading at 17 times price-to-adjusted funds from operations (P/E for REITs). But its unit price is steadily climbing. It was up 21% in 2011.
WHAT TO SELL
Even though RRSPs are meant for long-term holdings, it’s inadvisable for most investors to buy a few stocks when they’re 30 and hang on to them for the rest of their lives. Periodically selling both duds and overachieving companies is an integral part of building a solid retirement nest egg.
The main reason most people sell is to rebalance a portfolio. If the stock market has a good year, your assets will be more heavily weighted to stocks. If your 60/40 stocks-to-bonds allocation is suddenly 70/30, you’ll want to sell some shares and buy bonds to get your asset allocation back in line. (More likely after a year like 2011, the reverse is true and you’ll want to increase your exposure to equities.)
In fact, you may want to sell stocks more than once a year to take advantage of high valuations. If you really want to boost returns, consider taking profits on companies or funds that have gone gangbusters. After all, the goal here is to buy low and sell high. CIBC’s McKinley buys stock when a company’s valuation ratios, such as price-to-earnings and price-to-book value, are low. That generally means the stock is out of favour. He sells when those metrics reach fair value, 12 to 15 for P/E and 1 to 2 (depending on the sector) for P/B.
“When people love a stock or sector, they can trade well above what is a rational valuation of that company,” he says. “We want to capture that enthusiasm by selling into strength.” One of the ways he determines whether a stock is expensive or not is by looking at the company’s historical valuations. If a business trades below the historical norms, it could be a sign to buy. When it bounces back to its average valuations, he considers selling. Canadian banks, he explains, are currently trading at 10 times earnings. When they reach their long-term norm of 12 times, he may begin to sell and realize some gains.
Selling high isn’t just about making money. Dumping a pricey stock is also a good way to reduce risk. If a company’s valuations get too high, it can become more volatile; even the smallest piece of bad news can destroy share prices. Gardner points to Netflix as an example. Last summer, the movie rental service’s shares were trading at a sky-high 70 times earnings. In the fall, when the company announced that it was going to split its DVD rental and streaming services into two companies, the share price dropped by about 60%. While investors weren’t happy with Netflix’s change in direction (which it has since abandoned), its high price-to-earnings ratio made the plunge that much more dramatic. “If you own something that has a low P/E, there’s some extra protection there,” Gardner explains.
Of course, you’ll also want to sell your underperformers. This is trickier, says McKinley, because you have to decide whether the stock simply hasn’t realized its potential yet or is, in fact, a dud. The first thing to look at, says Sull, is if something’s changed.
“Look at the original reason you bought the company,” he says. “If those reasons no longer hold, then it should be sold.”
In some cases, the market can change so quickly that it’s hard to know you’re hanging on to a loser. Many investors, including Evans, were bullish on Research In Motion even as its price was falling. Evans bought some stock at $60—down from $148—and figured he bought a good company cheaply. “But then the stock price dropped more, there was bad news, the PlayBook wasn’t selling. All of a sudden, competitors were eating RIM’s lunch. We reassessed it and realized we were wrong about this business,” he says. Evans sold it at $40. “It hurts taking losses,” he says.
As a value investor looking for stocks on sale to buy, McKinley loves to see stock prices fall. But he also takes a hard look at why they’re falling. “We want to avoid businesses that have deteriorating fundamentals or financial positions,” he says. “Those are situations when we see a competitive position that’s deteriorating or earnings position declining.”
Another reason to sell is if company insiders, such as the CEO, are dumping stock. “That’s never a good sign,” says Sull. “It shows a lack of confidence and conviction.” Gardner wants to see management own a large piece of the company. If they don’t, he may not buy it to begin with. If the executive stake drops suddenly, he’ll often get out.
At a minimum, investors should realize gains on the outperformers and take losses on the poor players once a year, when it’s time to rebalance. More active investors should assess their portfolio more frequently, especially when news comes out that could affect stock prices. “If the news changes, you want to be on top of it and make a decision whether it’s worth keeping,” Sull explains.
WHEN TO SELL A MUTUAL FUND
Should you hang on and wait for a turnaround or dump your losers now?
With thousands of mutual funds on the market, it’s hard to know which ones to buy and which to sell. Steven Belchetz, president and chief investment officer with Toronto’s T. E. Wealth, says investors need to look at a fund’s long-term track record first. A fund worth buying should be around for at least five years. Watch for consistent performance over different periods of time and different market cycles. Make sure the fund manager was able to preserve capital in down markets. More than anything else, that’s what you’re paying your management fees for.
In general, the fund should be beating the sector benchmark at least half the time. “No fund will always do that well, but you want ones that do it fairly consistently,” he says. So look at annual returns, as opposed to just annualized returns. The latter refers to returns spread over several years, which could be skewed by one incredible year.
When deciding whether to sell, Belchetz says you should decide whether the fund has changed in some fundamental way from what you originally purchased. Has the fund manager’s style changed? Has the fund’s mandate been altered since you first bought units? Has the individual fund manager switched companies? If the answers to these questions are yes, you might want to get out.
Look for selling signals on the upside too, such as when a fund’s price-to-earnings ratio gets too high or the unit price reaches a specific target, adds Belchetz. Conversely, consider selling if the fund’s earnings drop severely. Just like with stocks, these are long-term plays. But if you’ve been waiting years for a fund to bounce back and it disappoints you, there comes a time when you have to cut your losses.
WHAT TO BUY
Once you have built up a core holding of stable blue-chip dividend-payers in your RRSP—say, 80% of the equity portion—you can consider adding some higher-growth prospects. Gardner likes to do this with a value bent, by looking for cheap stocks with more upside than downside. “Non-core sectors are usually something that’s washed out or cheap,” says the Avenue Investment manager. “If you’re wrong, you can get out.”
McKinley suggests that investors look at markets or sectors that are out of favour. The CIBC portfolio manager deals only with Canadian equities, but he’s taking advantage of global economic fears by buying domestic businesses with exposure to overseas markets. For example, Vancouver-based Finning International, the largest Caterpillar dealer in the world, sells equipment in Canada, South America and the United Kingdom. McKinley bought it at 10 times earnings in October, when investors were turning away from anything linked to Europe. It’s now trading around 15 times. “The company faced challenges, and may still have a couple of earnings-depressed quarters, but we see its earnings power, and it was a good buy at an inexpensive valuation,” he says.
There are many European-based multinational companies that have potential too, says Evans. In general, companies based in the eurozone are trading 20% lower than they were during the recession. Each country’s market is trading at about 10 times earnings or less. The American S&P 500, by contrast, is trading at about 14 times earnings. Many European companies also pay healthy dividends. “If it’s a global business, and you can get it at the right price, then it’s a good buy,” Evans says.
Gardner suggests adding some U.S. financials into the mix outside of your core holdings. They’re incredibly cheap, trading at around 10 times earnings and half to three-quarters book value. (Canadian banks trade at twice book value.) Plus, they have long-term potential, as long as you believe the global economy will recover. Of course, Canadians don’t need to own any more banks; most of us are overweight in financials already. But Sull points out that it’s rare to have a sector this big and this vital to the global economy trading so cheaply.
Investors, especially those nearing retirement, may also want to hold some gold in this basket. Most experts suggest putting no more than 5% of your portfolio into the yellow metal. And don’t buy gold because you think the price will climb by another $1,000. Own some as a hedge. Gold typically climbs when the stock market drops. The opposite is also true: it will fall if stocks do well. So consider owning a small percentage in order to preserve wealth should equity markets go awry. One cost-effective way to hold gold in an RRSP is through ETFs that own bullion.
Another way to get precious metals exposure is by buying stock in gold companies. While the price of physical gold went up last year, increasing gold producers’ profits, their stock prices went down. Moreover gold stocks are easier for investors to evaluate, since they produce annual reports, profits and, in some cases, dividends. Gold metal prices, by contrast, largely rise and fall based on speculation. As with any RRSP investment, stick to large-cap names with long-term potential. Kinross and Barrick Gold, says Sull, fit the bill.
Whether you own mutual funds, ETFs or individual stocks in your RRSP—or all three—consider this three-part approach. And whatever you do, don’t panic if the markets fall further in the coming months. “Don’t use any new trading strategies,” says Gardner. The point of rebalancing is to make your portfolio fit the long-term plan, not the other way around.
Our Picks: Stocks to buy in 2012
Wells Fargo (NYSE: WFC)
Investors need to make some assumptions when looking for non-core stocks. Gardner thinks highly of San Francisco–based Wells Fargo, but only because he thinks the U.S. housing market is stabilizing and the American economy will continue to improve. The bank is cheap, 0.75 times book value, and the stock price will rise as interest rates climb, he says. “It will benefit from net interest-rate margin.”
Bank of America (NYSE: BAC)
Bank of America, based in Charlotte, N.C., took a serious beating in 2011, with its share price falling 59%. But Sull still thinks it’s worth considering. The company, he explains, has over a $1 trillion in deposits. That’s about 10% of the retail deposit space in the U.S. Most of its bad assets will have matured by 2013, and the bank has downsized and streamlined to bring expenses under control. Based on tangible book value, the stock should be trading at twice what it is today, says Sull, but don’t expect the price to rise soon. This is a long-term hold.
Novartis AG (NYSE: NVS)
Because it’s based in Basel, Switzerland, Novartis, a global pharmaceutical company, suffered along with the European markets. But the company, which creates drugs, vaccines and consumer health products, is starting to dominate a number of product sectors. Sull likes that it’s still acquiring. It purchased Alcon Inc. last February, which gives it a big stake in the eye-care market. It also pays a 4% yield and is trading at 13 times earnings.
Kinross Gold Corp. (TSX: K)
Sull likes several of Canada’s senior gold producers—“They’re some of the cheapest companies out there in the mining sector,” he says—but his favourite today is Kinross. A series of missteps and overpayments for acquisitions soured investors on this company but, he says, its growth profile is the best of the bunch. “The downside is limited,” Sull says.
Leon’s Furniture Ltd. (TSX: LNF)
While it’s late in Canada’s housing cycle, Gardner likes the Toronto-based furniture retailer because it has no debt, increases dividends every few years—it pays about a 3% yield—it’s priced at a reasonable 12 times 2013 earnings, and has proven it can do well in a tough retail environment. Gardner says the land and cash the company owns is worth at least $8 of the $13-ish stock price. “You’re not paying a lot for the overall business,” he says.