A made-in-Canada investing strategy
Are you tired of subpar investment returns? Perhaps it’s time to sit back and take the passive approach.
Back in the mists of time — actually, in 1990, passive investing was born with a made-in-Canada product. Awkwardly dubbed Index Participation Units, they numbered just two, TIPS and HIPS.
While sounding like one of the hip-hop styles then surging into popular culture, TIPS and HIPS were quietly revolutionary with ultra-low management fees. Instead of being directed by a mutual fund manager or team focused on buying and selling to beat a given stock market benchmark, these modest inventions simply tracked an index as closely as possible.
TIPS 35 mimicked the then Toronto Stock Exchange 35 or TSE 35, an index of the biggest companies in Canada. HIPS, later TIPS 100, tracked the TSE 100 index. Ten years after their debut, you’d have been lucky to find a single person outside the investment industry who had ever heard of these products.
I first came across them in 1997. I asked a group of experts to create portfolios with $50,000 in imaginary funds for a column I wrote back then. Eric Kirzner, a professor of finance at the University of Toronto’s Rotman School of Management suggested a passive portfolio using TIPS 35.
Passive? Hardly an appealing investment approach in my books. Nor in anyone else’s. There was outright derision at this little portfolio, called The Easy Chair, which would do no trading but merely track two equity indices (the TSE 35 and the S&P 500) and a government bond index with a dollop of cash to round it out.
Here’s how Kirzner set it up:
- 20 per cent cash
- 30 per cent bonds
- 35 per cent Canadian equities
- 15 per cent U.S. equities
The Canadian portion was invested in TIPS 35 while the U.S. percentage was in another new index product called SPDRs, which tracked the S&P 500 Index. It still exists and can be found with the ticker symbol SPY.
The cash was invested in a Beutal Goodman money market account. That move elicited sniggers all round as the stock market was booming and who on earth would “invest” in cash earning a measly six per cent when there was oodles more to be made in equities? The same argument was levied against the bond decision.
Seventeen years later, the rationale for the Easy Chair has held up brilliantly. As Kirzner predicted, it didn’t outperform many mutual funds in times of hot stock market runs. But most of the time the Easy Chair shone with the ballast of cash and bonds.
All Kirzner did over the years was rebalance now and then to keep to his original asset allocation or percentages.
Through currency, technology, real estate and financial crises the Easy Chair sailed along. Even though interest rates plunged to historic lows during the recession following the 2008/2009 market crash, those regular payments from cash and bonds were welcome as all-equity portfolios lost 40 or 50 per cent of their value.
Kirzner predicted the Easy Chair would return around eight per cent annually over time. And it has. Some years it posted a 13 per cent gain, and once it came in as low as 1.3 per cent. But, it has averaged out around eight per cent.
A portfolio of 50 per cent in cash and bonds is considered very conservative. Nonetheless, the long-term return has been anything but meagre.
For those who enjoyed a 25 per cent gain on U.S. investments in 2013, eight per cent seems hardly worth the effort. But one year does not make for a reliable investment plan. I’d love to be a big winner every year on the stock market but history tells us that no one is, including Warren Buffett.
Over the past years, Kirzner has said he might trim his cash portion to 10 per cent but he’s still comfortable with the percentages.
Fortunately, new products make this portfolio very easy for do-it-yourself investors. They are now called Exchange Traded Funds (ETFs) and the field has grown to hundreds listed on the Toronto Stock Exchange. The majority of these ETFs follow the passive tradition, which Kirzner built upon with the Easy Chair portfolio.
In other words, there is no active trading, just the tracking of a given index.
Beware the fancy footwork of the relatively recent leveraged and inverse ETFs. They are far riskier and difficult to understand.
The beauty of the Easy Chair is that it can be tweaked for any risk tolerance. For example, someone with a defined benefit pension plan might choose a mix such as 5/20/50/25 for an RRSP.
Next week, I’ll write about what the Easy Chair could look like today and how the passive approach can beat the pants off most portfolio strategies.