A couple of weeks ago, we released Our Voluntary Code of Conduct for the Stewardship of Your Wealth. Click here to read the full, signed document: highrockcapital.ca/uploads/3/4/2/5/34254660/our_voluntary_code_of_conduct_as_stewards6.pdf
This Voluntary Code of Conduct is, largely...voluntary. There are items in there that we do NOT need to do or have in there from a regulatory point of view. Things like: "be transparent with fees/costs, respect our client's money is theirs, make ourselves available, forming an IRC, manage our own personal money exactly the same as our clients", etc, etc. At High Rock, we go "above and beyond the regulatory requirement" and take every item in Our Code very seriously. The very fact we have a Code of Conduct, in and of itself, goes above and beyond the regulatory requirement.
However, some of our Voluntary Code of Conduct items are not...voluntary. For instance, and most importantly, our very first Code of Conduct states: "We will always put our client's interests ahead of our own". We didn't have the space in the document to elaborate, so I will do it today, but this Code is a regulatory requirement, and so it should be.
Putting our client's interests ahead of our own should be self-explanatory. Scott put it best in a real-life blog two days ago: highrockcapital.ca/scotts-blog/whos-money-is-it-anyway
Without me going on, have a read and you will get part of the picture of how we, High Rock, not only saved our clients some $ (and didn't keep it for ourselves) but also did not try to talk them out of their dreams just so we could increase our own revenue.
Herein lies the difference between a simple Standard of Care and a Fiduciary Duty.
A Standard of Care simply means that an Advisor just needs to treat you "fairly, honestly and in good faith". If that means selling high-fee mutual funds to the client, so be it. If it means keeping the "spread" on a foreign exchange trade, so be it. If it means collecting a commission for selling clients structured products or various funds, so be it. All "fair (not really), honest (not really) and in good faith (not really)"...get the picture?
A Fiduciary Duty, on the other hand, states that we (High Rock) are "REQUIRED to act in the best interests of our clients at all times". If that means we can cut their fees and expenses by not buying them high-fee mutual funds, then that is what we MUST do. And we do...High Rock clients will never own a mutual fund...EVER! We have the intellectual capital in-house to manage money directly.
Here is the difference on a slide:
It may seem like a subtle difference to you but to us, it's a big deal. So much so, that you will see that Scott, Bianca and myself have all signed our Code and commit to following every line item at all times. Anyone out there have an Advisor that has produced and signed such a Code?
According to the Small Investor Protection Association (SIPA..the group that uncovered what has been going on at the big banks and alerted the CBC's Go Public), there are 121,000 people in Canada registered as "financial professionals" and only about 4,000 of them have a fiduciary duty...the other 117,000 have a simple standard of care. In Canada, I believe the only professionals who owe their clients a fiduciary duty are: lawyers, accountants and portfolio managers. High Rock is registered with the Ontario Securities Commission (and BC, Alta and Sask) as a Portfolio Manager and, as such, owes it's clients a Fiduciary Duty at all times. We would have it no other way...it is in our DNA.
And on top of that, Bianca is a Certified Financial Planner (CFP) so is governed by their internal Standards of Professional Responsibility and Code of Ethics and I am a Charted Financial Analyst (CFA) and am governed by the CFA Institute's Code of Ethics and Standards of Professional Conduct along with an annual certification stating, among a long list of items, that I have not been charged, arrested, investigated or under the influence of narcotics (no, I will not utilize the legalization of marijuana in Canada).
Scott says it most Tuesday's during our Weekly Webinars but I will say it again, "Government bond markets lead all capital markets". So paying attention to the government bond market is a big part of our job in ascertaining the risk inherent in all the other asset classes we have investments in.
Someone asked me recently, "why is is that government bonds lead stocks"? The main reason is that the government bond market is massive, not all that transparent (BNN doesn't even show yields on the right side of their screen) and heavily traded by massive macro hedge funds (who one would think are reasonably bright). Regardless, the fact is, the bond market is almost always right and foreshadows most moves in other risk assets.
So here is what the 10yr US Treasury Bond has done (in yield) since the US election 11/09/16:
What you should notice is that the yield on the 10yr has now retraced about 38.2% from the entire move from 1.72% (bottom left) the day of the election to 2.64% (mid Dec). This is now the lowest yield since mid-Nov. And this in the face of the Fed having raised rates 2 times (Dec and Mar .25% each) and talk over the past few weeks about them reducing the size of their balance sheet. So we sit at 2.30%. Why?
Could be geopolitical risks like Russia/Syria and/or North Korea. Could be Trump is having a hard time with a Republican-controlled Congress on getting his health care plan in play and just today he said he needs to get the health care plan complete before he can push through his tax plan. Any and all of these issues are leading to rising risk for risk assets, like stocks. And when risk rises for risk assets, there is a natural flight to quality (FTQ) into safe havens like government bonds. Makes sense?
So given what is going on in the world and in the USA, one would expect that the S+P 500 might be under a similar amount of pressure as yields have been under for that FTQ...but not quite so fast. Have a look first at the same retracement timeline on the S+P:
Note that the S+P has come no where close to retracing to that 38.2% retracement level which is the top green line at 2305.
Strange? With all this geopolitical and risk associated with Trump's plan, one would think that stocks would be following lower.
And if we look at the VIX (the Chicago Board Options Exchange Volatility Index) which is simply a good measurement of what market participants think of risk, we see that it is now higher than it was at the election date:
We are pretty confident about are two things:
So what do we do with this view/observation? Nada, nothing, zero. Yes, we wait and protect our capital. We still have some strategic risk assets on but the risk we are taking has been muted by the increase in volatility in most asset classes...save for US stocks!
Something I track at least once a quarter is US Bank Assets. Their assets include such things as government securities, a host of different loans (commercial and industrial, real estate, loans and leases) and the largest catch-all, Bank Credit.
Today, we will look at the overall Bank Credit metric (reported once per week) to see what is happening. The reason why this is so important is because when banks lend (as you will see) the economy grows and the stock market follows higher. When banks slow down lending, the opposite occurs. Cause and Effect.
Bank Credit (white line) and the S+P 500 (yellow line) over the past 10 years with a reasonably high correlation to the naked eye:
All good? Well if we shorten the Bank Credit chart up a fair bit from 10 years to two years, we see a different picture forming. Note how Bank Credit, although still at it's all time highs, is not only decelerating, but actually decreasing?:
And now we can look at the same chart overlayed with the S+P 500 across the last two years:
Something to start watching a little more often than once per quarter.
Here is a chart of the Federal Funds Rate (the o/n rate the Fed charges large banks to borrow money from them at) and as you can see, the Fed hiked the rate on March 15th (which is obviously in the 1st Quarter of 2017):
And here is what the Federal Reserve Bank of Atlanta estimates the 1Q17 US GDP will be in their Atlanta Fed GDPNow Forecast:
As you can see, even the overly optimistic ivory towered economists starting dropping their estimates by late Feb (blue wave moving lower). So this week, after weak Vehicle Sales, ISM Manufacturing and today's Unemployment, the Atlanta Fed cut their estimate on 1Q17 GDP by 50% from 1.2% to 0.6%.
I would conclude by saying that clearly Janet Yellen and other voting members of the Fed's FOMC (the committee that decides on the path of short term interest rates) don't value the Atlanta Fed or at least their economist Paul Higgins who invented this thing. Let's see who is right...Paul Higgins or Janet Yellen.
Given we just finished another quarter, and all of our clients will receive their quarterly packages from us, including a letter sent from our Independent Review Committee (IRC) member, I thought I would take the time to explain more about what our IRC is, what the IRC does and why it is so important to us.
First of all, an IRC MUST be established for ALL Prospectus-based funds. A Prospectus-based fund is a fund that has been approved, ironically, by the Ontario Securities Commission (OSC) for sale into retail systems (that is to say, through the Investment Advisor network). Think: mutual funds, Exchange Traded Funds (ETF's), Closed-end Funds, etc. I say ironically because, in the case of mutual funds, the fees associated with these things are ridiculously high in most cases. Isn't this where retail investors actually need protection from the regulator? Anyway, enough about my pet-peeve...all of these types of prospectus-based funds MUST have an IRC.
An IRC is, in effect, comprised of at least three Independent Members. These Independents are responsible for the overall governance of the operations of the fund. The IRC is put in place to ensure that the Fund Manager follows all of the protocols and effectively "does what they say they are going to do". Things like: approving the annual audited reports, ensuring the Fund or Portfolio Manager invests according to the mandate of the fund with regards to investments and restrictions, etc.
Now an interesting point is, who pays for the IRC? Guess?? You do. The IRC fee (usually around $15,000 to $50,000 per year) is paid out of fund expenses. Who pays for fund expenses? You do. The IRC, like all of the other fund operating expenses, (auditor fees, management fees, IRC fees, trade settlement costs, etc) form what are called the Management Expense Ratio (MER), which you have probably heard about. MER's are those hidden or embedded fees that the fund charges you to invest in their fund. Most MER's on prospectus-based funds run around 2+% per annum. Make no mistake, you pay when you own a prospectus-based fund. So the Fund Manager picks the IRC Members of their choosing (they typically pick folks they know well) but you end up paying for the IRC through the MER you pay! How crazy is that? One could even argue there is an inherent conflict of interest by the Fund Manager choosing the IRC but then having you pay for them..
All-in-all, the reason all of these prospectus-based funds are mandated by the securities regulator to have an IRC is to protect the retail investor. And from first-hand experience, I can tell you that the IRC Members on the two funds High Rock manages for Scotiabank are real due diligence folks. They do their job and hold my feet to the fire on every quarterly Board call. Keeps me sharp and ensures the investors in those Scotiabank funds are protected on several levels.
Now onto High Rock's IRC.
When we started our Private Client Division (two years ago) to manage our own money and that of some family and friends, I said to Scott, "what about forming an IRC to give our clients the knowledge that someone with experience is looking out for their best interests?". Scott thought it was an interesting concept and one we quickly agreed was the right thing to do.
The first thing to understand is that, we do NOT need to have an IRC within our Private Client division. The reason we don't is because we don't manage our Private Client accounts on a prospectus-fund basis...we manage all of our private client accounts on what is called a Separately Managed Account (SMA) basis. (The two funds we manage for Scotiabank are prospectus-based funds and therefore, Scotiabank being the Fund Manager, has hired and formed the IRC for those funds).
Next up is explaining what a SMA is. An SMA means that you own the account and all of the securities in it and, because it is always yours, you are free to transfer out of High Rock any time you want with no fees or deferred sales charges, like on some mutual funds). All you do when you sign up with High Rock is sign an Investment Management Agreement (IMA) that gives High Rock the authority to manager your account on a fully-discretionary basis (which we are registered to do by the securities regulators in Ontario, BC, Alberta and Saskatchewan).
There are two main benefits to managing all of our private client accounts on a SMA basis:
Did you catch that in point 2 above? That's right, High Rock pays for our IRC out of our Management Fee. Technically, yes, you are paying us, so you could argue that you are in fact paying for the IRC. BUT, we are NOT required to have an IRC (SMA vs prospectus-based funds), so we could pocket that money that we pay the IRC. But we choose to have an IRC and are happy paying the IRC fee each quarter. High Rock formed our IRC two years ago on a Voluntary basis...not something we were required to do.
Who is our IRC and what exactly does it do?
We chose Wychrest Compliance Services to be our IRC Member. Wychrest is a third party Compliance firm founded by Jonathan Heymann (a former OSC staffer). Jonathan does do some compliance reviews for High Rock to ensure we are fully up to date on the ever-changing and highly-complex requirements put on us by the OSC acting in our capacity as a registrant Portfolio Management company. Because of these reviews, Jonathan is pretty familiar with High Rock. Things like: our registration is up to date, our cybersecurity platform is robust, etc.
Wychrest reports to our clients at the end of each quarter (coming soon to existing clients). When we contracted this out to Wychrest, we asked that he write a formal letter to all of our private clients at the end of each quarter. We asked them to set the bar pretty high and hold our feet to the fire on a few items, like:
We have this letter from the 4th quarter of 2016 at the bottom of each page on our website so feel free to have a read for yourself: highrockcapital.ca/uploads/3/4/2/5/34254660/hrcmi_ircreview_december2016.pdf. And I can tell you, Wychrest is very happy for existing or, even prospective clients, who want more information, to contact Jonathan directly to discuss.
This IRC is a very important part of High Rock's Private Client division and is for the sole benefit of our private clients.
I had a discussion about two years ago with a senior lawyer at the OSC where I told him that the new "disclosure rules" on what fees Advisors were receiving just didn't go far enough. I told him that 99% of the retail investors I talk to didn't fully-understand what MER's were and how they can erode a portfolio over time. He was shocked. (You can read some of what I discussed with the OSC in an article in the Financial Post written by Barry Critchley on June 2, 2015:business.financialpost.com/news/fp-street/high-rock-capital-management-leads-the-charge-on-fee-disclosure:
When I told this lawyer at the OSC that we had, voluntarily, formed an IRC, he thought that was a very interesting and novel approach, so novel in fact, that he stated (at the time, but we believe we still are) that High Rock is the only Portfolio Management company in the country, managing accounts on a SMA basis, to have voluntarily formed an IRC.
We could have kept more of the money you pay us but we see our IRC as extremely important to us (and our clients) as we build trust amongst our existing clients and hope to do so with prospective and new clients.
As the old saying goes, a picture is worth a thousand words.
That being said, here is a picture of the S&P 500 (yellow line) and the US Gross Domestic Product (GDP) on an annual bar chart basis. The short horizontal red line is the GDP for 2016 which matches the GDP for 2011, both at a paltry 1.6%.
Not much to say here other than, something has to give. One can only stretch an elastic band so far before it snaps.
Either GDP rises towards the 4% range (noted by the red arrow upwards) or the S&P 500 needs to drop (noted by the yellow arrow downwards), or a combination of the two, in fact.
Not much else to say.