Wednesday, January 24, 2007

Value Investing - Part 3 - Passive Strategy

In the last two Wednesday instalments I talked about the long-term success of the value investing style. Last weeks post was about the difference between an active or a passive investor and how an active investor might use a simple framework for choosing stock investments. Before that, the first post was about how over the past 40 years the return differential between a value index and the market index has been nearly 2%. That extra 2% rate of return is very substantial over a long period of time, resulting in double the cumulative return over 35 years.

So now lets examine solutions for the passive investor and how he/she might go about constructing a portfolio. First, the passive investor should determine how involved he would like to be regarding the construction of the portfolio. If he is a "Do-It-Yourselfer" then he will be placing the trades and setting the asset allocation himself. If, on the other hand, he has no interest in placing trades then he would prefer a broker, advisor, financial planner, etc to place his trades and determine his asset allocation.

For the Do-It-Yourselfer:
1) Set asset allocation (the split of equities vs. fixed income; the split within equities between Canada, US, and International). For example, we could choose an aggressive portfolio of 20% Fixed Income, 20% Canadian Equity, 30% US Equity, and 30% International Equity.
2) Choose the mutual funds or Exchange Traded Funds that will make up the portfolio
3) Place the trades
4) Rebalance to original asset allocation once per year

For the really passive:
1) Choose a financial planner, broker, advisor. Anyone who will be assisting you with your finances should have the credentials to back up their position. They should have, at a minimum, their Canadian Securities Course, and Professional Financial Planning Course. Preferrably, they will have a more advanced designation like the Certified Fnancial Planner marks.
2) Tell the financial planner that you are only interested in developing a portfolio that follows a value investing style. If your planner is unwilling or doesn't know what this is then get a new planner.
3) Your planner will assist you in developing an asset allocation based on your personal risk tolerance.
4) Your planner will help you pick 'value' mutual funds. Please do some of your own research at this point to make sure your planner is actually picking funds that truly follow the value style.
5) Your planner will rebalance your portfolio for you at an annual review.

Suitable ETFs for a value style:
Canadian Fixed Income: Barclays iShares - XBB (Canadian Bond Index), XCB (Canadian Corporate Bond Index), and XSB (Canadian Short Term Bond Index)
Canadian Equity: Barclays iShares - XCV (Canadian Equity Value Index)
US Equity: Barclay's iShares IWW (Russell 3000 Value Index) but there are others
International Equity: Barclay's iShares EFV (MSCI EAFE Value Index Fund) but there are others as well

Suitable Mutual Fund Managers:

This is by no means an exhaustive list but these are a few of the dominant value investing managers whose products are available in Canada. Any of these managers are suitable as they all follow a disciplined Value Investing strategy.


Uncertain Buyer said...

My long term goals are to get into more affordable RE and start to do some serious investing.

Up until now, I have been mortgage poor and have only contributed small amounts to RRSP Mutual Funds. I am getting an average of 8% on them so they aren't doing to badly.

Could you recommend some good reading for a new investor? I would love to get a good general understanding of how the game is played.


mohican said...

For investing, I recommend the books "The Intelligent Investor" by Benjamin Graham and "Beating the Street" by Peter Lynch, and for Canadian specific financial planning info I recommend "Live Well, Retire Well" by Patricia Lovett-Reid.

Uncertain Buyer said...