This all encompassing chart, straight from Deutsche Bank, summarizes the YTD returns up to this week with all major asset classes including stocks, government and corporate bonds, currency markets, gold, and commodities.

From our perspective, there are a few things worth noting.

Firstly, despite the bearish undertones of the market from those investing in precious metals, gold is actually flat on the year. The current sentiment is not really warranted based on actual performance, so this could be an overshoot of negativity that doesn’t reflect market realities. In other words, this could be yet another sign of the bottom.

Next, the chart really shows some of the stories of the year. The USD strength rings loud and clear with all foreign currencies and commodities uniformly dropping. However, nothing has dropped as much as the Russian ruble which is the worst performing asset class of the year.

Click Image for Larger View (& more charts)

Click Image for Larger View (& more charts)

“I’m no genius. I’m smart in spots – but I stay around those spots.”
Tom Watson Sr., Founder of IBM

“What an investor needs is the ability to correctly evaluate selected businesses. Note that word ‘selected’: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
– Warren Buffett (Trades, Portfolio) 1996 Letter to Shareholders

In the world of value investing, one of the most important concepts is the concept of “Circle of Competence,” which came from and has been used over the years by Warren Buffett(Trades, Portfolio) as a way to focus investors on only operating in areas they know the best. In one of my previous articles, I wrote that, by understanding the business, Buffett means understanding the business model, not necessarily the products or services provided by the business. You can drink Coca-Cola (KO) every day yet not have the faintest idea why it is such a great business. On the other hand, you may have no idea of Valeant’s pipeline of drugs, but you can understand the business model without understanding most of its drugs.

There are a lot of discussion points on this important topic of “Circle of Competence.” In this article, I want to discuss what I call the “Circle of Competence Trap,” and especially three sectors that investors are especially subject to this trap. These three sectors are retails, energy and metals. I intentionally exclude the technology sector because it is well known that value investors tend to shun this sector anyway.

Let’s talk about the retail sector first. When I first started investing, I naively thought retail was one of the most understandable business because it is so closely related to our daily lives be it general retailers or specialty retailers. They are everywhere in our lives. Because I could see and visit those retailers in person, I assumed that I could understand how they make money and observe the trend in the retail business. Boy, was I wrong. It didn’t take that many mistakes and observations for me to realize that retail is one of the toughest businesses out there and as value investors, we have to be very careful with this sector. Look at what happened to Borders, JC Penney (JCP), Aeropostale (ARO) and Tesco (TSCO). Borders and JC Penney were high-profile mistakes made by Bill Ackman (Trades, Portfolio), who has a fabulous batting average and Tesco was a mistake made by great Warren Buffett (Trades, Portfolio). Let’s not forget about Buffett’s early investment in this department store called Hochschild, Kohn and Co. The reality is, the business model of retailing is inherently tough. It is a challenging business because shopping habits and sales channels are constantly changing, making it difficult for businesses to build and maintain competitive advantages. Moreover, your competitors can copy your best practices in no time, making it even harder for everybody to compete in this business. Some retailers are also subject to rapid technology changes, which make their business models deteriorate very rapidly (RadioShack [RSH], Borders etc.). It is just very tough to assess the business model in the next 5-10 years in retail.

Energy and metals are another two sectors where many value investors claim false “Circle of Competence.” If you ask a typical analyst what the business model of an energy E&P company is, he or she will probably tell you that you make all these capital investments in machines and equipment so you can drill oil or gas wells, then you extract them out of the ground and sell them to somebody else, hopefully at a price that not only covers your extraction and development cost but also makes you nice little profit. Similarly, for metal miners, they invest in the mines, extract the metals and sell them to someone else. Of course there are many other sub-industries in this sector such as oilfield services, offshore drillers, steel mills, etc. But if you ask me what is the most important factor that affects almost all businesses in this sector, I would say it is the price of the commodity, be it the price of oil or gas or gold, the future price of which I would argue very few of us can forecast with a reasonable amount of confidence. I was looking at some onshore rig services companies recently and stumbled onto the 2001 and 2002 annual report of this one company. I was shocked to find out that, at one time during that period, oil was below $20 a barrel. That was merely 12-13 years ago and just recently, many people were freaking out because oil dipped below $80 a barrel. Incidentally, during the same period, gold was trading below $300 per ounce, which is about one-fourth of where it is today and one-sixth of what it was two years ago. If we were in the middle of 2002, instead of 2014, could any of us imagine the price of oil and gold would quadruple within the next 12 years? I doubt many of us could. And if we couldn’t, we should think twice if we think energy and metal businesses are within our “Circle of Competence.”

In the end, I want to clarify that I am not discouraging the readers. My intention is barely to remind us that these three sectors are very tough for us to come up with reasonable forecast on what is going to happen to the business in the next 5 to 10 years. Therefore, we should be more careful if we claim these businesses within our “Circle of Competence.” Although it might seem obvious that investors should stick to what they know, the temptation to step outside one’s circle of competence can be strong. By reminding ourselves of the perils in investing in retail, energy and metals, we are better guarded against the folly that may come from an incomplete understanding of the business model.

….related:

• Seth Klarman Buys Big Stakes in 3 Companies by Holly LaFon
• A Complete List of Books Written By the Gurus by Sheila Dang
• Multiple and Customizable Investment Checklist: New and Much Improved Feature by GuruFocus

If you’re a keen follower of Michael Campbell’s Money Talks, than you probably understand the missed opportunity by solely investing in public markets like stocks, bonds and funds. Last week’s article explained the basics of alternative investments and the three main areas that retail investors can likely invest in: real estate, private companies and commodities. Before investing one should know the risks as salespeople will always show you the reward – but a real advisor takes the time to explain the risk. I can tell you that at TriView we’ve reviewed hundreds of Business Plans and my partners probably thousands, and to this date we’ve never seen a pro forma that doesn’t make money! So why do so many fail?

Alternative investments can improve your portfolio diversification, can be profitable in any economic environment, can improve long-term risk adjusted returns and can preserve capital in volatile markets. So based on the above factors, why wouldn’t you invest all of your wealth into alternative investments? The above is only one side of the sword, the other side that should concern you is less liquidity than public markets, valuation based on book value than market value, less regulation that can lead to fraud and longer capital lockout periods that can extend your investment more than anticipated.

Simply put, alternative investments should be a piece of your portfolio pie and the size of that piece depends on your own risk tolerance and timeframe.

What are five risks that a retail investor should consider before making an investment:

–  Management risk

–  Financial risk

–  Transparency risk

–   Liquidity risk

–   Less Regulatory risk

Management risk is probably the biggest with alternative investments as you’re investing in a private company that is generally controlled by one or a few people. Hundreds of millions of dollars have been raised and lost due to the lack of experience, knowledge and integrity of management in alternative investments. Many of these failures tend to be gifted sales or marketers that are very good at selling an idea but have no experience to execute their idea. They tend to see a trend and take advantage of investor greed to pry money out of their hands. The old saying is “even turkeys can fly in hurricanes”. But once the wind stops, there’s a giant thud when your investment hits insolvency. Before investing in any company, try and get a background check on the management team (google them). Another thing to look for is “investor alignment”. Investor alignment is comparing how management get compensated (front is bad, back is good), and how do you get paid (front is good, back is bad). Also find out what penalties management face if they don’t hit targets on time and on budget?

Financial risk is an important factor when investing in a private company that can’t raise money on the public markets. Many deals have failed due to lack of capital. For example, what happens if a company needs to raise $10 million to complete their business plan and only raise $7 million? Sometimes they can get some bridge money (borrowed money at high interest) or need to dilute shares to vulture capitalist that reduce the original investors significantly. The worst case scenario – the business fails and the investors’ money disappears entirely to insolvency or bankruptcy. How confident are you in the company completing their capital raise in order to execute their business plan? Some companies like to raise the price of their stock / units in order to reward earlier investors but also allow more conservative investors to invest at the end of the capital raise at a higher premium.

Transparency risk relates to how well you can vet the deal prior to investing as well as tools to continue vetting the business to ensure your investment is safe. Many private companies refuse to provide audits as they believe, as a private company, it’s confidential. That may be an OK attitude when it’s your own business but once you ask people to invest in your company, it’s no longer fully “private”. Stay away from anyone that gives you the “Trust Me” line. If they are not prepared to provide you audited financials on a yearly basis, you should not be prepared to invest.

Liquidity risk describes how and when you can get your money back. Many alternative investments have clauses that don’t allow you to transfer your stocks / units without management approval. They also generally have provisions that can postpone the liquidity event if the company does not have the money, or a return of capital could expose the company to financial risk. Invest money in alternative investments that you can afford to have tied up for an extended period of time (years).

Less regulatory risk is becoming less of a risk as most of the regulators across the country are improving their monitoring of alternative investments. Over the last two years, more money has been raised in the alternative / private markets than the public markets. While most of this money is institutional investors, knowledge slowly trickles down to accredited investors than to retail investors. Investors need to understand the difference between prospectus, Offering Memorandums (OM) and Confidential Information Memorandum (CIM).

The alternative markets are an incredible opportunity to provide additional yield and diversity to your portfolio but probably the most forgotten risk is trying to invest on your own. In some cases, there might not be a big difference from using a broker to conduct public trades to e-trading. In fact, I would argue that with the internet and basic knowledge of valuation of public companies, many sophisticated investors are more knowledgeable than their stock brokers. For example, I was looking to buy Alibaba prior to their IPO but when I spoke to my broker about the largest IPO in history, he knew very little while I’ve been following this company for two years. In fact, I shut down my account the very next day!

I’d be very cautious on buying alternative investments without an advisor as it’s can be very complicated and there is little information on the internet to help you understand if the investment is valued properly. You should obviously investigate your advisor as there are good and bad ones.

Hopefully this has helped you look at the risks of investing in alternative investments. At TriView, we tend to focus on private real estate opportunities as it’s less complicated than hedge funds or some of the morecomplex investment strategies. We feel real estate is something that people can relate to as we’ve all either owned or rented a property. The more educated and comfortable our clients are about an investment sector, the better the investor.

Happy Investing!

Craig

The last month saw a 12% drop in the TSX and volatility has many investors worried about the next 12 months. When you add potential inflation jitters, is the 60/40 equity / bond split still relevant? I would say that investing like it was the 1970s or 80s is like bringing a knife to a gun fight.

But before we finally scare you into cash and low producing GICs, is there another alternative?

There was a great commercial regarding men’s suits and the owner (Sy Syms) would say that “an educated consumer is our best customer”. At TriView, our goal is to educate investors and provide value-added strategies for the Money Talks audience. Over the next four weeks we offer a strategy for retail investors to learn about investing in alternative and private equity investments:

• What are Alternative Investments?
• The Risks of Alternative Investments
• Current trends towards Alternative Investments & Regulatory Changes
• Why and how to add Alternative Investments to your portfolio?

Session #1 WHAT ARE ALTERNATIVE INVESTMENTS?

In last week’s article I explained why I couldn’t invest like my grandfather did in the 1970s or 80s. In this article I want to give you an understanding of what alternative investments are available to reduce public market volatility and inflation concerns. Alternative investments generally have these following characteristics:

–          They tend not to have a correlation to traditional investments like public stocks or bonds which allows them to act as a hedge to public market volatility or inflation.

–          They are rarely traded in the public markets and even rarer to be offered to retail investors due to their complexity and fewer regulatory hurdles compared to traditional investments.

–          They tend to be illiquid securities that tend to have set exits with little ability to sell before the exit term.

–          They tend not to have a secondary market for resale or have restricted sale covenants from the issuer.

–          Most financial advisers do not recommend them to investors due to their own lack of knowledge – which is why they tend to stick to stocks, bonds, mutual funds, ETFs and GICs

There are three main areas to alternative investments that are available to retail investors:

• Real Estate
• Private Equity
• Commodities

Real Estate: More people have made money in real estate than any other kind of investment so why don’t more advisors recommend real estate in their portfolio mix? As most people have owned a home or rented an apartment, investors can generally understand the basics of real estate. It’s interesting that most people would have no problem leveraging a real estate investment with a mortgage. But try to explain a public market strategy of shorting or margining and their eyes glaze over!

Real estate has a low correlation to the stock market, but has a positive correlation to inflation to protect against inflationary erosion. Owning real estate requires significant management and therefore most people prefer to only own their primary residence and perhaps a secondary property. Since most people’s money is in their primary residence, financial advisors may recommend not to add real estate to their portfolio to provide diversity.

If you decide to invest in real estate beyond your home, here are a couple of common scenarios:

Public REITs: these are publicly traded Real Estate Income Trusts (REITs) that invest in specific or multiple sectors like commercial, industrial and residential. They provide some tax efficiencies and the units are normally liquid and generally move with the public markets which generally makes them more volatile than private real estate offerings.

Private REITs: Similar to public REITs except they are not as volatile as their public cousins but are generally not as liquid.

GP/LP Model: This model is generally used for high net worth investors that invest in a specific property and the LP investors (Limited Partners) have limited liability if the development needs more cash and exposure is generally limited to the amount they have invested. This structure has tax efficiencies as well.

MFT: Mutual Fund Trust is set up for investors that would like to invest in real estate through their registered funds. MFTs can invest in single investments or perhaps private REITs

Private Equity: There has become a greater demand for private equity offerings. Traditional investors in private equity were friends and family, angel investors and venture capitalists. Generally these companies were start-ups with huge risks and huge rewards. Most would fail which made it a product for “not the faint of heart”.

Private equity has changed dramatically in the past 15 years as more companies choose to raise capital privately than through public markets. The days of the great “IPO” are over for many entrepreneurs as companies who tend to have market capitalization of less than $500 million tend to be “orphaned stocks” due to lack of volume trading of their stock.

Today they are many quality businesses with strong track records and cash flow that need capital to grow their business and seek private markets for LBOs (leveraged buyouts), MBOs (management buyouts) and mezzanine capital (short term loans) to grow their business and keep themselves private. The negative of private securities is their illiquidity, long term holds of 5 – 10 years and risk of default. That being said, with many baby boomers looking to retire there is an opportunity to buy these highly profitable companies or even invest through your registered funds.

Commodities: For those who like “hard assets” like gold, silver or diamonds, one can invest directly into these assets and hold them in funds or actually take possession of them physically. Most people prefer to buy commodities by owning public securities that are in the mining or resource sector. People who invest in commodities are generally looking for protection against inflation and the volatility of currency fluctuations or buy resources if they feel that the global economy is growing and needs resources to bring products to market (cars, food, etc). Commodities do have a potential flaw as they are volatile to price swings based on the markets’ mood.

I won’t delve into Hedge Funds or Structured Products as they tend to be for institutional investors.

In next week’s article I will cover the risks of Alternative Investments. and remember, before making any investment in public, private or alternative investments, learn the pros and cons – and if it is too good to be true or difficult to understand, DON’T INVEST!

“Who do I call?”

It’s a helpless feeling when things go wrong. Especially when you’re away from home. Unexpected damage to your vacation home. A car accident. Dealing with police in a different country. Or being in a strange hospital.

Suffering a loss is hard enough. Who to call when it comes to your insurance coverage should be easy.

But if you’re like many Canadians who spent significant time in the United States, dealing with an insurance claim away from home can be scary and bewildering.

“The answer? One phone call home.”

So let us suggest an alternative – deal with a home town broker who can take care of ALL your insurance needs – both in Canada and the US. That means one phone call, Deal with someone who knows you and will be there when you get home to make sure everything about your claim is handled right.

HUB International is Canada’s largest cross border insurance broker so we also have a local office near you. Chilliwack to Yellowknife, Winnipeg to Calgary, Saskatoon to Edmonton. And everywhere in between. 105 office in Western Canada alone.

Our local experts can take care of all your home, auto, travel and specialty insurance needs at home and abroad. AND we have HUB offices throughout the United States – which means your home-town broker can help arrange anything you need.

Let us give you a quote the next time you’re looking at insurance coverage for travel or for your US property. We promise to offer you the best coverage at a reasonable price.

AND MORE IMPORTANTLY – we can handle everything on both sides of the border – so you know exactly who to call.

How to contact us

RIGHT NOW

• CLICK HERE for help today
• OR email us at snobird@hubinternational.com
• OR call 1.844.SNO.BIRD or 1.844.766.2473

WHEN IT’S TIME TO COMPARE

• CLICK HERE and let us know when your current coverage expires.
• We guarantee to contact you in plenty of time so you can compare out product and prices.

FIND YOUR LOCAL HUB OFFICE

• Or most importantly – CLICK HERE find out how close our local office is to your home AND where the closest HUB office is to your winter destination.