Beyond Funds Market Weekly July 5 Radio Show

Good Morning, and welcome to Beyond Funds Market weekly, for the week of July 5, 2008...I am your host, ScotiaMcLeod Wealth Advisor Jeff Wareham.

It was the first week of quarter 3, 2008, and little change was evident from the first two quarters of 2008. Oil saw another remarkable new high, while all three American markets prepared for the long weekend by straying into bear market territory. Profit taking hit the Toronto market as well, leaving toronto only barely above water for the year...yet Toronto remains the only major global market in positive territory for the year...and the villains this time were the stocks that have added much of the gains in the market year to date.

Over the last few weeks, I have been expressing my concern that a popping of the apparent bubble in commodity prices could lead to a dramatic downturn, and although the commodity prices have remained persistently high, many of the major energy, material, and technology stocks surrendered major pieces of their gains in trading this week.

If oil, or gold, ever lose momentum...look out below...we could easily see Toronto join most of the world's markets in bear territory.

Continuing with the global theme, inflation and unemployment were major themes this week. The European Central Bank raised rates, in response to fears that oil and commodity prices will drive consumer prices higher. Investor's found some solace in the accompanying statement by the ECB, which indicated no bias toward further rate increases. The US jobs and ADP numbers were awful, and it seems clear that the slowdown in the States will continue to hurt their employment picture.

Friday saw broad based downgrades of European financials, and most global banks were sold in response.

Canada saw the approval of the BCE buyout, and it would appear that, for the moment, it will represent the largest leveraged buyout ever...just for disclosure purposes, I hold BCE personally, and it is held in many of my client accounts.

Looking at the numbers, Toronto closed out the week at 14010...over a thousand points from the lofty heights reached two weeks ago, and not that far from correction territory.

New York was closed Friday, but the Dow closed down at 11,288.54, despite a 73 point gain on Thursday. The Nasdaq ended at 2,245, including a 6 point loss on thursday, and the S&P 500 ended at 1,263, with a fairly flat day Thursday. Oil reached 144.18 at the close, surpassing 145 on Thursday, and gold moved well into the 900s, ending at 935.70 ounce. Oil may be interesting to watch, as the exchanges increased margin requirements again this week, with the possible intent of reducing speculation. OPEC leaders added to the story by blaming speculators for oil's rise...and Iran and israel ratchetted up their hostile rhetoric, which led to fears of major supply disruption.

Global markets were uglier, with Europe and Asia marching significantly lower through the week. Particularly noteworthy is Shanghai...closing in on a 60% correction from its peak last year...now that is a bear market.

After the break, i will discuss some of the alternatives that you, as an investor with a growing portfolio, might consider, to protect yourself in such volatile and negative markets.

Just a quick highlight of some upcoming shows...I will continue my series on planned giving, featuring other members of London's charitable community...if you have a charitable cause you would like featured on the show, contact me, ScotiaMcLeod Wealth Advisor Jeff Wareham...and speaking of charity, i mentioned visiting St John's, Newfoundland, and seeing the beginning of the Tour of Hope for the Terry Fox Foundation...ScotiaMcLeod fixed Terry Fox' original camper van, and is taking it across Canada...it is in London July 17...with events at the St Thomas City Hall, The Covent Garden Market, Victoria Park, and the site of the old Wonderland Gardens...for details, email me, or call (519) 660-3260...I will tell you that it was a great emotional experience to see it...and a great history lesson for my kids.

I will also be introducing some regular features, including tax planning ideas, risk management, and financial planning issues for professionals and business owners.

Before the break, I was reviewing another pretty lousy week on the global amrkets...you could certainly be forgiven for wanting to play defense at this point. I have had several investors tell me they want to lose no further money...many recognize that the market will not fall forever, but simply can't or won't accept the risk of losing their principal. This is very reasonable...after all, if you take a 50% loss one year, you need a 100% profit to break even the next. The fact that many investors are considering selling out may be a true sign of a bottom in the stock market, but if you can't bear any further risk to principal, let me share several techniques to protect your principal.

I will start by saying that no true mutual fund solution exists to completely protect your capital...even a money market fund can, in theory, lose money in very low interest rate environments, or if it holds a piece of commercial paper in its portfolio that defaults...many of the top name money market funds in Canada have significant exposure to Asset Backed Commercial Paper...and it is not impossible that we could see negative returns in any of these funds over the next few months...if you are concerned, call me, and we can discuss the holdings of your money market fund.

The first technique is time tested, buying guaranteed investment certificates, or GICS. They are safe, and also a pretty sure fire way to avoid ever earning money beyond the rate of inflation. Further, their complete safety only extends to the level of CDIC insurance, if they are eligible. However, if you truly feel the sky is falling, buy GICs.

Slightly up the risk curve are bonds, and I will lump them in with GICs, as there are many high quality government or near government bonds that offer you the safety of GICs, often with higher yields than a GIC...although this has been untrue at some points during the credit crisis...security concious investors bought canadian and US treasuries with virtually no yield to protect capital, while GICs offered at least some returns.

Moving to all bonds, or all GICS, really is surrendering to achieving no return over the rate of inflation...and ultimatley increases the risk you will not accumulate enough to meet your needs, if, in fact, you are still saving to meet your future goals.

An interesting second alternative is using a strip bond, and some equity, to guarantee your principal....and one version of this strategy is the myriad assortment of structured products that have been created by major fund companies and investment dealers over the last few years. These products generally offer a guaranteed maturity value, and frequently an income coupon, over a period of years...for example, you might invest $100,000, receive a 5% coupon for several years, and be entitled to your principal back down the road. That sounds like a GIC...but it isn't...many have very complicated formulae behind their income calculation, and their maturity value may fluctuate wildly depending on the circumstances of the market...and your early access to the value of the note is generally at the whim of the issuer of the note...at a price they determine. I generally do not use a lot of these products, if only because they are very confusing, and may not be ideal for a truly security oriented client, but, they may offer exposure to the market, without some of the risk...in general, your risk is limited to the opportunity cost of the money you invested, if you hold it to maturity, and everything works against you.

I mentioned that structured products were generally a hybrid of a strip bond and equity...this is the way they are constructed...a portion of your money is put into a strip bond, maturing at the end of the note...the rest is put into a derivative based on whatever the note tracks. these sound complicated and confusing...that is because they are complicated and confusing! Hardly the characteristic you would want if you were seeking a safe place to hide from negative markets...but the fact is that some have merit, if you as the client, and the advisor, understand them and match them to the your need.

The idea of using a strip bond to protect principal actually is a good one...although a quick review of strip bonds may make sense. Strip bonds are literally bonds with the interest coupons stripped from them. You pay less than their face amount, since you do not receive the semi annual interest payment you would get from a bond...but on maturity, you get the face amount. This can allow you to invest in the market, without risk to your principal...let me explain how. You might have 100,000 to invest for several years, but absolutely need that 100000 to be there. You could pay 70,000 for a strip bond that matures for 100,000 at your target date. that leaves 30,000 to invest. if you diversify the 30,000, there is little risk you will lose it all, but even if you do, you are guaranteed to get your principal back on maturity. I really like this strategy...even a few Exchange Traded Funds bought with the difference can give you a very secure, and relatively simple, portfolio that is guaranteed to provide a positive return, unless all the ETFs go to zero value...which is theoretically possible, but almost inconceivable, and even then you get your money back.

The idea of protecting your current portfolio by buying a strip bond with some portion, maturing when you need it, and putting the rest in some form of equity nearly guarantees a positive outcome on your target date. I suggest using ETFs because they track underlying indices, or segments, of the market. The reason I say that you are essentially guaranteed a positive return is this...your bond gets you back to zero. If you have one dollar left in the ETF, that is profit, albeit limited profit. If you bought a bond, and one stock, it is quite conceivable you might get no return...as stocks may go to zero. If you bought the bond and ten stocks...it is much less likely that you would get no return, as all ten stocks would have to go to zero...and that would be surprising. Many ETFs track 100 stocks or more, and to only break even, you would need every single stock tracked by that ETF to go bankrupt. Finally, if you follow the thesis i discussed last week, and buy dividend paying, defensive stocks, you are absolutely guaranteed a positive return the day you receive your first cash dividend...which would generally be in the first quarter after you implemented your strategy. Several ETF issuers are now offering funds that offer double the return of many major indices...these may also fit in well, especially if you do not believe the market is broken forever...as the market recovers, you get double the return of the underlying index on the equity part of your investment...although the portfolio may be a little more volatile than the previous alternatives.

The next strategy I suggest for conserving capital is combining a strip bond with convertible debentures...this also sounds complicated, but if you are an investor with a serious aversion to today's market, this may be a way to protect your down side, and stay exposed to the market. Many Canadian companies offer debentures, which ar simply a private loan between the investor and the company. Convertible debentures offer a right to convert from the debenture to a certain number of shares or units of the company, at a defined price...what a great idea, if you are unsure of market direction, you may buy a debenture in a company you like...if the shares go down, your debenture still pays interest, and you get your principal back at maturity, but if the shares go up, your debenture will rise in value because they may be converted to shares at a fixed price. Once again, if you buy the strip bond, maturing for your initial principal, you may buy debentures with your remaining capital, and collect both interest and potential capital gains...and you get your debenture proceeds back when it matures. Like the dividend paying strategy I mentioned early, your first interest payment guarantees a positive return.

The final strategy i want to revisit if you have no desire to put your principal at risk is the use of segregated funds. I have mentioned these in previous shows...they are essentially mutual funds issued by insurance companies...they feature an insurance benefit, which guarantees both your value at death, and offer a variety of maturity benefits. Manulife has launched a series that offer a guarantee you will get your principal back, and an increasing benefit for every year you do not touch the principal...and if you hold them until you are 65, they actually guarantee a minimum lifetime income from them, as well. the best feature of thes is that the guarantees really allow you, as an investor, to stay in the market if things look rough...in fact, it makes sense to maintain a fairly heavy equity weighting, as equity generally outperforms in the long run, and the guarantees frequently reset to match the market value of the fund...and equity is more likely to get a higher guarantee, only because it grows, and fluctuates, more.

My biggest complaint with these is that they have mutual fund type management fees...but the positives outweigh the negatives to me, especially if they keep an investor in the market when they might otherwise bail out.

Before acting on any of these ideas, consult your advisor.

This program is for information purposes only. Views expressed are those of the author, not Scotia Capital. Fees, amangement fees, and commissions may be associated with mutual fund investing. ScotiaMcLeod is a division of Scotia Capital inc, member CIPF