Baby Buffett loses 4 Billion on Valeant shares

Hedge fund manager Bill Ackman first came to my attention when he invested in Canadian Pacific railroad. As an activist investor, Ackman started a lengthy proxy battle with the board of directors to remove Fred Green as CEO and appoint Hunter Harrison in his place. Not only was Ackman successful but it was very profitable for his hedge fund since the value of CP shares more than doubled under Harrison’s leadership.

In early 2015, Bill Ackman invested in Valeant, another Canadian company. His hedge fund purchase shares around $196 and recently sold all of them at $11 a share. He accelerated his losses by buying call options and selling put options.

Hindsight is of course 20-20, are there any investment lessons that we can use?

 Lesson: Intelligent people are capable of doing very dumb things.

Bill Ackman is clearly a smart man otherwise his Pershing Square hedge fund wouldn’t manage pension fund money. But if you asked the average investment professional /your grandmother whether it is a good idea to stick over a quarter of your assets into a highly levered pharma roll up the answer would tend to be a firm “no”.

Lesson: Position sizing is very, very important.

Always be aware of your risk of ruin, no matter how much you are convinced the odds are in your favor. Regardless of how amazingly smart and brilliant you are and how many hundreds of hours of research you have done, it is perfectly possible that you will lose money on any given investment. Pershing Square had too large a position to simply sell its stake and walk away when things started to go wrong.

Lesson: Highly incentivized management teams can still blow themselves up, and take you down with them.

Part of the original appeal of Valeant to the hedge funds that backed it was how the CEO’s stock options had been structured to make him highly incentivized to get the share price as high as possible. Having management teams with “skin in the game” is clearly important but this does not mean they will not do something very stupid.

Lesson: Auctions are not usually very good places to find bargains.

Ackman admits that he now believes Valeant “substantially overpaid” for Salix, its last big acquisition before things fell apart. A big problem with a role up strategy is paying high prices for third rate assets that no one else in the world is willing to buy.

Lesson: Beware of political risk.

Valeant used aggressive drug pricing to help pay for their acquisitions which got the attention of American lawmakers. Bill Ackman had to testify at a hearing held by the U.S. Senate aging committee which was reviewing escalating drug prices. It also became a big issue during the U.S. 2016 presidential election.

Lesson: Take a loss, don’t let your Ego get in your way.

There is no doubt that billionaires tend to have large egos. Being labeled “Baby Buffett” on the cover of Forbes is quite the ego booster. But there is an old saying, “the bigger they are, the harder they fall”. Ackman’s buying call options and selling put options on a losing position is a clear sign that his ego wouldn’t accept taking a loss on Valeant shares.

Postscript: The share price of CSX railroad jumped up 35% on rumors that Hunter Harrison would be the new CEO. Harrison got the job but can he deliver another turnaround? It may be too early to tell. However, I bought some shares of CSX for my investment club. 

 

Active or passive investing? Why I now use both approaches

There is perhaps no controversy in the investing world more contentious than active versus passive equity investment management. Members of both camps constantly argue that their way is unequivocally the best, despite real-world results that support one side’s argument one year and the other’s the next.

Blackrock, the world’s largest money manager, is overhauling its actively managed equities business. They are cutting jobs, dropping fees and relying more on computers to pick stocks. This is a clear indication how difficult it has become for humans to beat the market.

“BlackRock  CEO Larry Fink has sometimes expressed disappointment in the performance of the company’s actively managed stock funds, and he has pivoted increasingly to focusing on the company’s data-driven “Scientific” equity teams.”

Most investors seem to be in either the active or passive camp, few use both methods. For years, I have been in the active camp because I use options to make money during up and down markets. However, providers of exchange traded funds (ETF’s) have evolved beyond just offering low cost sector and index funds.

The growing popularity of ETFs have increased competition among providers to attract investors to purchase their products. I have notice an increase in the number of products that include covered call and also some put right options.

                               A Partial list of Covered Call ETFs

Advisor Shares STAR Global Buy-Write ETF (VEGA)
CBOE S&P 500 Buy Write Index ETN (BWV)
Credit Suisse Gold Shares Covered Call ETN (GLDI)
Credit Suisse Silver Shares Covered Call ETN (SLVO)
First Trust High Income ETF (FTHI)
First Trust Low Beta Income ETF (FTLB)
Horizons S&P 500 Covered Calls ETF (HSPX)
Recon Capital NASDAQ 100 Covered Call ETF (QYLD)
S&P 500 BuyWrite Portfolio ETF (PBP)
BMO Covered Call Canadian Banks ETF (ZWB-TSX)listed on the Canadian TSX stock exchange
BMO Covered Call Dow Jones Industrial Average Hedged to CAD ETF (ZWA-TSX)listed on the Canadian TSX stock exchange
BMO Covered Call Utilities ETF (ZWU-TSX)listed on the Canadian TSX stock exchange
BMO US High Dividend Covered Call ETF (ZWH-TSX)listed on the Canadian TSX stock exchange
First Asset Can-60 Covered Call ETF (LXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Energy Covered Call ETF (OXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Financials Covered Call ETF (FXF-TSX)listed on the Canadian TSX stock exchange
First Asset Can-Materials Covered Call ETF (MXF-TSX)listed on the Canadian TSX stock exchange
First Asset Tech Giants Covered Call ETF (CAD Hedged) (TXF-TSX)listed on the Canadian TSX stock exchange

A key advantage of ETFs with covered call option writing is investors have some downward protection during these uncertain times. Plus you don’t have to be approved by your financial institution to trade options. Keep in mind that the management expensive ratios are going to be higher than index funds and these ETFs are also fairly new so it may be difficult to evaluate their past returns.

 

Disclaimer: These are not recommendations, do you own research before investing.

 

 

 

 

A reality check on Trump’s tax reform agenda

Still etched in my brain was the great income trust debacle that took place on Halloween of 2005. The Canadian conservative government won re-election promising not to change the tax preferred treatment of income trusts. That promise was broken and Canadian investors lost billions of dollars overnight. The value of my income trust holdings fell by 40% instantaneously.

Needless to say, as an investor in U.S. stocks, failure to appeal and replace Obamacare (ACA) makes me very nervous. Trump’s promise of massive tax cuts and infrastructure spending will need support from the Freedom Caucus (tea  party) who want a border adjustment tax to offset some of the loss revenue.

There is also a complicated Senate rule that would prevent Democrats from blocking the tax bill. Under the rule, the bill cannot add to long-term budget deficits. That means every tax cut has to be offset by a similar tax increase or a spending cut.

‘‘Yes this does make tax reform more difficult,’’ said Ryan. ‘‘But it does not in any way make it impossible.’’

Nevertheless, Treasury Secretary Steven Mnuchin said Friday the administration plans to turn quickly to tax reform with the goal of getting an overhaul approved by Congress by August.

House Republicans have released a blueprint that outlines their goals for a tax overhaul. It would lower the top individual income tax rate from 39.6 percent to 33 percent, and reduce the number of tax brackets from seven to three. The House plan retains the mortgage interest deduction but repeals the deduction for state and local taxes.

However, nearly 34 million families claimed the mortgage interest deduction in 2016, reducing their tax bills by $65 billion. Also, more than 43 million families deducted their state and local income plus personal property taxes from their federal taxable income last year. The deduction reduced their federal tax bills by nearly $70 billion.

On the corporate side, the plan would repeal the 35 percent corporate income tax and replace it with a 20 percent tax on profits from selling imports and domestically produced goods and services consumed in the US. Exports would be exempt from the new tax. (border adjustment tax)

The general goal for Republicans is to lower income tax rates for individuals and corporations and make up the lost revenue by reducing exemptions, deductions and credits. Overhauling the tax code is actually hard because every tax break has a constituency and the biggest tax breaks are among the most popular.

Over the past week, some investors are starting to doubt that the tax cuts will get passed. The value of the U.S. dollar has weaken and ten year bond yields have fallen  from 2.62% to 2.4%. Eight of the ten sectors that make up the S&P 500 were negative for the week. The biggest losers were U.S. financials (-3.72%), energy (-1.78%) industrials (-1.75%) and materials (-1.3%).

There is a lot of money on the sidelines that missed the Trump rally and are waiting for a stock market correction. I took some profits before the Canadian federal budget that hinted at tax increases so I also have some money to re-invest. The Canadian conservative government taught me a valuable lesson back in 2005. What government promises to do and what they actually do can have a negative affect on your investments.

 

20 Seconds of fame on the National News from a blog post

rico-dilello

One of my blog posts that I wrote back in September of 2015, caught the attention of a T.V. producer at CBC News which is a division of the Canadian Broadcasting Corporation. On Feb 24th I received the following email:

Rico,
I`m a National TV News producer at the CBC and I just read your article “Why I quit being a financial Advisor” we are working on story about the trend away from “active investing” to more “passive investing” and think you might be a unique and interesting voice in our item. Can you give me a quick ring so we can have a chat?

I immediately gave him a call and answered some questions about my views on both active and passive investing. He asked if I was willing to be interviewed at my home which I agreed to but I wasn’t given a confirmed date.

To my surprise, I received a phone call while I was at an indoor golf driving range to do an interview. Not actually camera ready, but they were willing to send out a senior writer and cameraman to the driving range. They couldn’t wait because it was going to air the next day before the RRSP contribution deadline of March first. The producer was kind enough to send me a copy of the story. Click on the link below to view my 20 seconds of T.V. fame:

https://drive.google.com/file/d/0B62hJdYjW6psU3Iwam5JTzRKN0k/view?usp=sharing_eil&ts=58b6e6d5

 

Please reframe from making any comments on my golf swing! It has been three months since I swung a golf club.

 

Gold as a hedge against Trump’s Border Tax

Talk of a “border adjustment tax” has gone from the sidelines to center stage in Washington, which has a lot of people asking: What is it exactly?

Currently, U.S. corporations are taxed on their worldwide profits at 35 percent. The House GOP plan would change that radically. The new tax formula would tax domestic revenue (minus domestic costs) at a much lower rate of 20 percent. The net effect would be one that favors exports over imports.

The change would convert the country’s tax system to a “territorial” system rather than a worldwide tax system. It’s meant to create incentives for domestic production because companies also would no longer be able to reduce their taxable income by deducting their overseas expenditures.

The plan would essentially subsidize exports and lead to a 20 percent tax on imports for corporations.

Retailers are very opposed to a border adjustment tax because a large percentage of the products they sell are imported. The end result is Americans will pay higher prices for consumer goods including imported fruits and vegetables.

Now economists who support the tax say the policy would lead to a sharp rise in the value of the dollar. As a result, retailers’ costs will go down so much that it will be a wash to consumers. However, many CEO’s worry whether the economists are right in that assessment.

In the past, gold and gold stocks have been used by money managers to hedge against inflation, currency risk and world chaos. For years, financial advisors recommend having 5% to 7% of your portfolio in gold or gold stocks.

Unfortunately, we have been living with deflation so gold as an investment has not performed very well over the past five years. The chart below compares three ETFs – gold bullion GLD, large cap gold miners GDX and junior gold miners GDXJ

gold

The border adjustment tax could change all that. It could cause mayhem in world trade, leading to higher inflation and extreme volatility in currency markets. The chart below illustrates the 2017 year to date price movements in the above mention ETF’s

gold-1

The biggest risk to owning gold or gold stocks is if the Fed’s interest rate policy changes and they are more aggressive in raising rates. This could cause the value of the U.S. dollar to increase which would be bad for gold.

Fed watchers believe that the June meeting would be the earliest date for an increase in interest rates. The stock market has only priced in two rate hikes for all of 2017. President Trump’s immigration ban and talk on renegotiating trade deals will be in the news for the next few months making investors nervous.

I am considering three short-term trades in gold

  1. Dollar cost average: Buy 300 shares of GDX  at 24.50, Sell 3 Apr 26 call options for $1.20 & Sell 3 April 24 put options for $1.50 (Total investment = $6540.00 U.S.) 
  2. Covered call: Buy 100 shares of GLD at $116.20, sell 1 April $118 call for $2.25 (Total investment $9,370.00 U.S)
  3. Call spread: Buy 5 GLD April $110 calls for $7.10 & Sell 5 GLD April $118 calls for $2.25  (Total investment =$2,425.00 U.S.)

 

The problem with using options in these trade choices is the VIX that measures volatility is quite low. Having to wait until the April 19 expiration date reduces the profit potential. That being said, I think that the first trade is less risky, if I am wrong on the direction of the price of gold. I would own 600 shares of GDX at an average price of $ 22.90 but could then sell more call options.

Do you own any investments in gold stocks or gold ETF’s?

 

Disclaimer: These are not recommendations, please do your own research before investing.

 

 

 

 

 

 

Tips on rebalancing your retirement portfolio

rebalance-moneyunder30

Many investors are in for a rude awakening when they open their year-end retirement plan statements. The bond portion will probably show negative returns. It could even wipeout a good portion of their positive returns from owning equities.

Now, the most common method used in rebalancing your established asset allocation mix would be to reduce the holdings that are up in value (sell stocks) and buy assets that have fallen in price (buy bonds). This practice may have worked very well in the past but interest rates are going up forcing bond prices down.

The chart below compares the S&P 500 with the IShares 20 plus year Treasury bond ETF

tlt

“The decades-long bull market in U.S. Treasuries has finally drawn to a close following Donald Trump’s surprise presidential election victory, according to mutual-fund manager Bill Miller.”

“Miller isn’t the first to call time on the bond bull market. Economist Henry Kaufman, the original “Dr. Doom” who is credited with calling the last bond bear market in the 1970s, told the Financial Times this week that the current bull run is at an end.”

In the past, when the Federal Reserve decided it was time to unwind its easy monetary policies, it would raise the federal funds rate fairly quickly. The Fed believes a neutral stance on monetary policy is reached somewhere above the 4% level. The current Federal Reserve is moving slower than normal. Based on an average of three rate hikes per year, it will take the Fed a little over 4 years to normalize interest rates.

Tip # 1

Short-term, reduce or eliminate investing in target date mutual funds since they automatically rebalance from equities to bonds. Plus they increase your bond exposure the closer you are to retirement.

Tip # 2

During a period of rising interest rates, the prudent strategy is to reduce the duration of your bond portfolio. That could mean using a short-term bond ETF or a ladder of GICs both of which would allow you to benefit from an increase in rates.

Tip # 3

If you’re comfortable with a little credit risk, use short-term investment-grade corporate bonds to get a little more yield.

Tip # 4

Cash is by far the safest asset class. Move some of your equity allocation and some of your fixed income allocation to cash. I have my doubts that President Elect Trump can get congress to pass all his stimulus agenda and even economists are unsure if these policies will actual increase economic growth.

Corrections in the bond market are not as uncommon as you think. Most have been short in duration. See the chart below:

lt-treas-losses

Keep in mind that in the past, rate hikes were implemented  at a much faster pace than what the current Fed has purposed. Losses in the bond market could continue for longer than expected.