Checking out the ‘noughties’ in the investor’s rear view mirror - Greg Zografos

Let’s give some credit to the BBC for “killing two birds with one stone.” Simultaneously, they have labeled the previous decade and its investment portfolio performance. The word “noughties” is derived from the English word “nought,” meaning zero.

Although this may be true for many financial asset investors, another type of investor prospered this decade — the hard asset investor. A hard asset is defined as having physical properties and is associated with commodities and real estate. Hard assets do not have consistent periodic cash flows unless they are being leased. The market competitor of the hard asset is the financial asset. Financial assets are characterized by consistent periodic cash flows such as dividends and bond interest and are associated with equities and bonds.

With the “noughties” in our rear view mirror, a useful exercise is to analyze what happened and to adjust the portfolio for the coming decade. The chart accompanying this column compares major assets classes and can be analyzed from both Canadian and American perspectives.

When analyzing long-term trends, one notices that hard assets and financial assets usually move in opposite directions of each other. The 80s and 90s were dominated by strong equity and bond returns and poor commodity returns.

Conversely, the last 10 years were dominated by hard asset out-performance, with the CAD/USD exchange rate being the most basic indicator. The Canadian dollar is a commodity currency. When it appreciates versus the USD over a long period of time, it indicates strength in the hard asset market. Hard asset out-performance has been verified with the performance of oil, gold and Canadian real estate.

At this point, some readers may be thinking, “Hey, financial assets also did pretty well except for the United States.”

Correct, however the US equity markets and the rest of the G7 equity markets (except for Canada) all had large negative returns for the decade. A typical balanced portfolio of 50/50 equities to bonds, invested evenly in Canada and US, probably yielded a 0-2 per cent compounded return last decade, after fees. Therefore, real estate was the most important asset last decade for providing respectable performance for the overall portfolio, comprised of both hard and financial assets.

So what lessons can we learn and apply from the last decade? Let’s go through a checklist: 

- Watch commodity currencies to understand whether we are in a hard asset or financial asset investment environment. 
- Watch G7 stock markets and commodity prices to corroborate the point above. 

- Have an investment plan that invests in both hard and financial assets. A balanced approach allows one to survive a nasty correction or crash. 

- Economies, jobs, and house prices in Northern Ontario are correlated to commodity prices; therefore a prudent portfolio would underweight hard assets, regardless of investment cycle. 

- Have a rebalancing plan when the market turns in favour of financial assets again.

Investment management is often compared to racing a car. One needs to understand when to accelerate, when to change gears, when to apply the brakes, and how to optimize balance. Think of your dashboard being made up of the hard asset and financial asset indicators seen in the accompanying chart.

Greg Zografos is a professional investor and president of Zografos Investment Management. Greg grew up in Sudbury and currently lives in Markham. He writes monthly financial columns for Northern Life. Greg can be reached at gzografos@rogers.com.

Correction:
My previous article “Take The Money and Run” had an error with respect to the Vale defined contribution plan. My analysis was incorrectly based on the employee making the eight per cent contribution. I want to thank the individuals who provided me with more accurate information regarding the Vale/Union negotiations.