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Slip into something more comfortable and delve into personal finance with Josh Sheluk and Colin White, experienced portfolio managers at Verecan Capital Management. Each episode demystifies complex financial topics, stripping them to their bare essentials. From investment strategies and financial planning to economic headlines and philanthropic giving, delivered with a blend of insight, transparency, and a touch of humour. Perfect for anyone looking to understand and navigate their financial future with confidence. Subscribe now to stay informed, empowered, and entertained.
Verecan Capital Management Inc. is registered as a Portfolio Manager in all provinces in Canada except Manitoba.
Audio:
You are about to get lucky with the Bare Naked Money Podcast, the show that gives you the naked truth about personal finance. With your hosts, Josh Sheluk and Colin White, portfolio managers with WLWP Wealth Planners, iA Private Wealth.
Colin White:
Welcome to the next edition of Bare Naked Money. Call it a Josh hearing. We've decided to spice it up even more. Even more if you can possibly imagine that because just before we began recording, we were discussing two completely different ideas for this podcast and as I'm talking, Josh is flipping back and forth between the two kind of deciding which one it's going to be and I do not know. So I'm going to find out as you find out. Josh, what are we going to talk about today?
John Sheluk:
Something that we should have talked about a long time ago, Colin and when one of our colleagues recommended this to us the other day, we both kind of slapped ourselves in the forehead and said, "Yeah, we should have done this a long time ago." So we're talking about something we talk about all the time, but don't really dive into diversification and what that means.
Colin White:
Yeah, there was a little bit of embarrassment to go around there. It's like as we throw around that word, but we never really truly explained what that is and it's almost like using jargon, I guess. We know exactly what [inaudible 00:01:13] by it, but it's actually a fairly complex or intricate thing and it does deserve its own podcast. So yes, congratulations. Good choice. We're going to go with diversification.
John Sheluk:
Why don't you start with telling us what diversification actually means?
Colin White:
Well, diversification at its base is not betting all on one thing. This is a matter of choosing a number of different strategies all aimed towards a similar goal, but with the intention of approving a percentage chance of achieving what it is your aiming at. And there are situations where diversification is good, there's situations where diversification is less good, there's situations where it's bad and those are all open conversations. But I think we're talking specifically about your investment goal and if we have relearned or it's been reemphasized over the last three to four years exactly how little we know about what's going to happen next, this is why diversification's important in the investment world. I'm not a fan of diversification of diet, for example, because I like certain foods and I don't think I need to diversify that so [inaudible 00:02:22] diversification is indeed bad if I'm allowed to say that.
John Sheluk:
For you it's bad. This is very specific to you as an individual.
Colin White:
Yes.
John Sheluk:
Okay.
Colin White:
However, diversification's... Proper diversification of an investment portfolio is good for everybody. Right, Josh?
John Sheluk:
That's interesting you say that because I'm going to bring something up later once we get through a little bit more about, well, we're going to debate that idea.
Colin White:
Love our debates.
John Sheluk:
Yep. So Colin, I'm just going to throw out an example here just to start, just to get us a little bit further down this concept of diversification. So my portfolio, I have six Canadian banks, three Canadian telecom companies, and two Canadian pipeline companies in it. Diversified enough?
Colin White:
Well, [inaudible 00:03:12] diversified in holding all of the banks. So ceaselessly knowing some people will get the joke. So oh, this is where the intricacies get into it. Yeah, you could take a look and that's what 10, 12 holdings so you could say, yeah, I'm diversified across all these holdings, but are you really? What are the different ways you could diversify rest of portfolio? And that's what you should measure against. What are the various methodologies you could employ and how many of them are you actually put into use? This is something that we study fairly deeply at portfolio venture level and we loosely would call that factors. We take a look at what are the different factors and different types of equity investing for sure. And what is the right mix of those things. So the strength is you've owned more than one thing. The weakness is geographically an industry, they're all concentrated and they would all have historically correlations. We can get with correlation conversation a little bit later because I'll concern [inaudible 00:04:17] on that one a little bit if you like, but they would tend to be either correlated in many respects.
John Sheluk:
Okay. So why don't you explain what correlation is and why is that a good thing or a bad thing?
Colin White:
Well, ideally academically you want to have investments that move differently. You don't want everything moving in the same direction so there's bad news. For example, if volume held were the Canadian banks, so there's bad economic news that was broadly expected to impact the financial sector specific to Canada, that would affect your whole portfolio. So we would take the full brunt of that. So what you're looking for are other investments that would not necessarily be affected at the same time in the same way because it would reduce the impact in bad news or negative information on a given investment or a given category. So you're looking for is something that is going to protect your portfolio so that it moves differently. When you say correlated, there are two things that are expected to move in the same direction at the same time and it's to degree, do they move entirely together? Do they move [inaudible 00:05:17] together? Or do they move opposite?
And we measure these things historically, which has limitations, but can be instructors as to what future expectations should be. So the ideal would be that you have, let's just say, and we've said this on podcast, Canadian banks are great businesses for sure and yeah, they hold a position in everybody's portfolio. Well, you want to balance that. You want to balance that with investments that would move differently because again, you don't want your whole portfolio tied to one particular investment class in one currency, in one country because it's affected by, can be affected by one piece of news. So you want to move past that and the example you gave, you had some utility stocks. Yes, utilities would tend to move or expect to move a little different than the financials. Again, we can come back to [inaudible 00:06:06] at the extremes, maybe they don't but yeah, over time you could expect, again, strong resistance, good rates to return and they would tend to not be affected in the same way by negative news that may affect Canadian bank [inaudible 00:06:19].
John Sheluk:
Yep.
Colin White:
Go ahead.
John Sheluk:
So yeah, really interesting there. So TD Bank and Royal Bank probably affected by mostly the same things so if something economically affects one, it's probably going to affect the other. So we would say that's high correlation, right, Colin?
Colin White:
Yep.
John Sheluk:
Okay. But Canadian banks and the utility company for example. Bank may be a little bit more economically sensitive. Utility may be a little bit less so because even if you're not buying, you still need to put heat into your house so a little bit less so there. And so just to take this example a little bit further, Canadian bank and let's say European utility, maybe even a little bit less correlated, am I right?
Colin White:
Oh absolutely because again, there's stuff that affects Canada. Canada's having a good day or a bad day and the Canadian government will have policies that can affect the business climate and it is expected that countries will move differently [inaudible 00:07:23]. Canada's often characterized as a very commodities-based economy so the countries like Canada and Australia, the overall economy tends to move somewhere in line with the commodities. So when things on the commodities side are doing well, Canada does well, therefore the Canadian banks can be doing well. But if Canada's not doing well, it's more difficult for the financial aspect country to be doing well in negative economic types.
So country that you live in is going to necessarily affect the investments in different categories. So you have situations where you know US banks and we've had this... We've set our portfolio we've had this conversation, let's compare US financials to Canadian financials right now where things are and at the time we made a decision to take a US weighting because again, we like the financial but we like the economic situation in US better at the time. So countries' commonality [inaudible 00:08:22] two so there can be changes or certain characteristics that are common to a geography as well. So that is important to understand.
John Sheluk:
Yeah. Now to take this another step further, Canadian bank stock versus Japanese government bond. Correlated? Uncorrelated?
Colin White:
Well at different periods of time it would absolutely be both of those things. I've been... You keep prodding me, so you really want to go here? So we can go in here. I have yet to see a study, and I've actually been looking for the predictive value of correlations because in extreme [inaudible 00:08:58] correlations go to one and what that means is there are situations where everything goes down and they've all moved in the same direction at the same time. Those tend to be at the extremes, kind of what you're hoping the diversification can protect you from. But there are times that it get so extreme that it just doesn't.
But you would expect and you could reasonably expect that a Canadian utility or Canadian bank is going to perform way differently and be completely unaffected by the same things Japanese treasury is [inaudible 00:09:27] by and that's what you're looking for. So if you look at those two asset classes and you have positive expectations for the long term financial performance and they're going to get there differently, then you've made your portfolio stronger, you want all those things to line up.
John Sheluk:
Yeah. You just said something that's really important there I think. That you're expecting positive financial performance from both of them 'cause you can expect cryptocurrency or SPACs or NFTs to move a lot differently than Canadian bank stocks. Doesn't mean you should own them. Diversification is not the sole purpose of owning an asset. You still have to expect positive returns from something over time for it to be additive for your portfolio.
Colin White:
I think the technical term is diversification.
John Sheluk:
Sure, yeah. We can call it.
Colin White:
But at a certain point, yeah, it's diversification. So anything that you were putting into your portfolio, you should have a thesis, an expectation that it's going to deliver positive economic results. If you don't have that, move on, that you're not diversifying. So if you think, oh there's going to be three horses are going to win the race, bet on all three horses is kind of the way I would determine the people, right? You don't need to, to your point.
John Sheluk:
Bet on the empty horse?
Colin White:
We live in such a rich time for example, do we not Josh? [inaudible 00:10:43].
John Sheluk:
Yeah, sure.
Colin White:
But the Bitcoins and the SPACs and NFTs and all these things that have come along are just so gloriously obviously bad things that we can use as examples and most people will understand them so it is, it's a little easier to have these conversations when these examples are recent and fresh.
John Sheluk:
Yeah, so I'm going to push back on something you mentioned a few sentences ago on correlations go to one. So just for audiences understanding, correlations go to one. One is the highest correlation you can have between two things so correlations go to one is a better way of saying, or a simpler way of saying, or more jargony way of saying the correlations go up and the benefit of diversification goes down in such a scenario. So it's absolutely true that in some severe economic events like call it 2020 with COVID for example, or 2008 with the financial crisis, that a lot of assets, a lot of investments are going to have a very, very high correlation during those times because when people panic, they just sell everything. Doesn't matter if you're a utility, a bank stock, a real estate investment, whatever. Everything is going to go down in value.
But there are some assets that tend to, and, I think, have consistently had a diversifying effect even in extreme events and government bonds, high quality government bonds say from Canada, US, Europe, Japan, these are some of those diversifying assets so you're not going to find a whole lot of diversifying assets during these extreme events, but your savings account is still most likely going to be there. Your government bond is generally going to hold up pretty strongly under some scenarios like that. So there's not a whole lot of investments that are going to provide that level of protection but there are some that again consistently have demonstrated really strong diversifying aspects to a portfolio.
Colin White:
Yeah, and we can get further into it. I mean I think the last year was an example where we saw both bonds and equities to [inaudible 00:12:54] become more correlated than maybe is anticipated.
John Sheluk:
Yeah, sure.
Colin White:
And we're talking a matter of degrees here. Then this is also important then when you start applying correlations, there's geographic correlations, there's asset class correlations, then there's within equities, there's equity correlations too, right? There's all these different things. So my point in bringing that up is we do calculations on them and we try to optimize exposures and I think what you're saying is absolutely true. There's, between asset classes, broadly and most of the time there is this lack of correlation and this is how you build a portfolio. But you need to be aware of, every once in a while even that's not going to work 'cause you don't want to be left with the expectation I built with the optimal portfolio therefore I'll never see you down here. It's not that precise. It's a balance of probabilities that [inaudible 00:13:43] times out of 20 you're going to be fine.
John Sheluk:
Yeah.
Colin White:
But what I'm trying to do is get away just [inaudible 00:13:49] people from the idea it's like it's four digit calculation, once I do that, everything's fine.
John Sheluk:
Right.
Colin White:
No, it's better. And the vast majority of the time it would be better off. But we still live in a very organic world that is teaching us stuff all the time.
John Sheluk:
Yeah. Last year's a great example, I'm glad you brought it up because it was a very challenging year for what we would call a diversified portfolio. Stocks were down, bonds were down, government bonds were down, corporate bonds were down. High yield bonds were down. Most floating rate bonds were down. The US dollar was up. That's one thing.
Colin White:
Yep.
John Sheluk:
Some commodities were up, not all of them. So-
Colin White:
Yeah.
John Sheluk:
... unless you had a portfolio very concentrated in commodities and US dollars, which would be probably unlikely and a little bit crazy, you're going to struggle last year. So you're right.
Colin White:
But I think the hallmark of diversification is the quote, last time I saw the quote was in the Big Short of May that gave credit. I figure they gave credits to the quote for it but it's not that you don't know what's going to hurt you, it's what you think you know for sure that just isn't so and that's kind of what I'm alluding to here [inaudible 00:15:01] diversification like you're going to diversify [inaudible 00:15:06] put yourself in a better spot and what you want to avoid is, hey, there's just one thing I really believe in and the example I've been using with clients because it's starting to save now 'cause it's been three years as of January of 2020, if I said to you, "Hey, we're going to put 40% in portfolio and commercial real estate and 6.4% yield because that's a great guaranteed, I'm air quoting here, guaranteed rate of return, real estate never goes down [inaudible 00:15:28] always pay their bills.
And we say, great, let's take a big allocation to that space in your portfolio. A global pandemic hits. Now was it a necessarily bad idea to make that allocation? Well on its face, it made sense at the time with what you knew, but you unintentionally made your portfolio fragile, unnecessarily made your portfolio fragile by being so specific with your allocations, by over concentrating on something, even though all of the math may have lined up, you still over concentrated [inaudible 00:15:56] turns and then something happens like, well sure I didn't see that coming.
The human history is hung up a whole bunch of things we didn't see happening. That's why diversification helps. Like you don't always know what is around the next corner, but if you have a whole bunch of things in your portfolio with positive expected economic outcomes, the chances of all of them being hit at the same time is way better than the chance of being in one thing that happens to get hit and what that's going to impact, the impact it's going to have in your situation.
John Sheluk:
So I'm going to push back again with a quote from a very, what I call brilliant financial mind. Here so here's a quote. "Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing."
Colin White:
Well, I know the realm this is coming from. So these are the high conviction people. This is the camp that you've gone to, Josh, wait a second, you're going to stand up and [inaudible 00:17:01] the camp of high conviction people? You're going to put that jersey on there?
John Sheluk:
I'm just throwing the quote out there. You can talk about it however you want.
Colin White:
There is, and again, this is largely, I hear this sentiment most often expressed to the hedge fundee space and that kind of is making a little bit of a broader category because you have these investment pieces that people will put forward and if firmly into, in my opinion, end of the realm of speculation, once you cross a certain threshold here, it's like I think that, I got into this conversation with somebody last week that, hey, we're building all this electric cars, so obviously uranium is the only way we're going to have electricity, so make a big uranium investment. I've got high conviction in this, but it's based on a theory of this is, and I'm going to make [inaudible 00:17:49] 80% of my portfolio this like, [inaudible 00:17:52]. They're going to argue that's the only way that you can truly have investing success but it's predicated on the idea that I have to get a home run. In order to be financially successful I have to get a home run. That's the missional. You just need to not lose your money, you need to protect the downside.
It's far more important than trying to capture the upside and I push back on the high conviction people, they make a compelling case because again, this is what's going to win and here are all my reasons why, and I've been right 15 times in a row, so I'm going to be right this time. And if you want to get outsized returns and not just get marked [inaudible 00:18:29], you have to do this. They build a very compelling case. But again, if you don't know what's around the next corner, you don't know when inflation's going to show up again. Interest rates are finally going to move after 20 years of people saying they were going to move. The nuclear bomb goes off somewhere or there's just so many things that can disrupt the timeline that you project it. High conviction, great story and it pugs on that. Here's a shortcut. Here's a way to make more money more quickly than everybody else and looks smarter than everybody else. It's a shortcut and that's kind of how it gets sold. You'd buy it.
Do you have a favorite pie conviction shop Josh? Did you come up trump out and say these guys are like the Ray Dalio's of the world or anything like that and say, oh, this is what we should be [inaudible 00:19:12]?
John Sheluk:
Well, first of all, I don't think Ray Dalio is high conviction. So here's what I have to say about this. I hate this quote. I brought it, I just wanted to get you a little worked out, that's why I brought it to the podcast today but I hate it because it says "Diversification is a protection against ignorance." Yeah, no kidding, we're making predictions about the future. We are ignorant about the future until we come up with a crystal ball or a time machine, we are going to continue to be ignorant about the future. We do not know what's going to happen. And once you admit that to yourself that we're only making as educated best guesses that we can make about the future, we know that some of them are not going to work out. Then yes, the quote is a hundred percent true that diversification is protection against ignorance, but we are all ignorant about the future.
Until something changes there, we're going to continue to be ignorant about the future so that's why it makes so much sense, not very little sense as the, so this is from Buffet. This is from Buffet, which, as much as I love Buffet, and truly do think he is brilliant, this is something that I think 99.9% of people should ignore as investment advice, which I don't think of most of what he says is bang on for most people because-
Colin White:
[inaudible 00:20:31].
John Sheluk:
Go ahead.
Colin White:
Well, if you've got $50 billion and you lose $49 billion, you still have a billion dollars. It's not going to change your life, right?
John Sheluk:
But the thing is with him, I mean we can quibble over how he's made his wealth, but yes, he had all of his wealth in Berkshire Hathaway, which is how he got there but Berkshire Hathaway itself has a very diversified investment portfolio. So he's kind of talking out both sides of his mouth. If he believes that much in high conviction or concentration in a portfolio, then why does he run a diversified portfolio with Berkshire? And so that's where the issue is. Yes, he got to be a multi-billionaire by being very concentrated in one company and that's how every, by the way, how pretty much every billionaire becomes a billionaire is they have a hundred percent of their wealth or very close to it in the business that they run.
But we hear from these people, we see these people on a day-to-day basis or see them in the media. We don't see the millions of other people who had a hundred percent of their wealth in the business that they run and went bust. So there's some truth to the idea that you can't become a multi-billionaire without being very concentrated as an investor and having no diversification but it ignores the fact that you also can blow yourself up and be left for dead if you're very concentrated and have a hundred percent of your wealth in one thing.
Colin White:
Well, yes, it's the halo effect. We take a look at somebody who's successful, we say, "Ooh, that must be the way to do it." But the paths to Everest is littered with the bodies of very [inaudible 00:22:07], determined people. We don't hear their stories. We hear the story that made it to the top of Everest like, "Ooh, I should do that." I was like, "Don't other people die trying that? Really? You think you want to emulate that? Yeah, you're right Josh. There's literally millions and millions of people who have an idea, and honestly, society gets moved forward by the handful of those people who actually are successful and they do make something happen and it is laudable. It's exciting. It's not a howto goal.
It's like how much does Elon Musk sleep? Why would I care? I don't need to recreate Elon Musk's [inaudible 00:22:42]. Just know that people are like that. They aspire, they think they want to aspire to be that, but that is just so not the way to have success in your personal financial life for sure unless you're an adrenaline junkie. If you really, really live for the [inaudible 00:22:58], then how about it?
John Sheluk:
Any departing thoughts Colin?
Colin White:
No, I think that it's... We've covered off, I think all the salient points here. Diversification doesn't mean having everything. Diversification means having a combination of strategies and or investments and or securities that all have positive financial expected outcomes and artfully putting them together in a combination that gives usually the best chance of not suffering unduly on your financial journey because again, and I say it over and over again, the secret to success is not having the right investment, the secret to success is not blowing your shit up. And that's just not a great bumper sticker, but it's yeah, how these things should work.
John Sheluk:
All right. That's it for the pod. Until next time.
Speaker 4:
Based on observation, it seems that the time an investor is most likely to move his or her portfolio to a new advisor is when the old advisor dies. Let us go on record is saying that having a pulse is not a great reason to trust someone with your entire financial future. Stop putting your life in the hands of stillbreathingwealthplanners.com and call us.
Audio:
This information has been prepared by White LeBlanc Wealth Planners who is a portfolio manager for iA Private Wealth. Opinions expressed in this podcast are those of the portfolio manager only and do not necessarily reflect those of iA Private Wealth, Inc. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. Operates.
This should not be construed as legal, tax or accounting advice. This podcast has been prepared for information purposes only. The tax information provided in this podcast is general in nature, and each client should consult with their own tax advisor, accountant, and lawyer before pursuing any strategy described hear in as each client's individual circumstances are unique. We've endeavored to ensure the accuracy of the information provided at the time that it was written. However, should the information in this podcast be incorrect or incomplete or should the law or its interpretation change after the date of this document, the advice provided may be incorrect or inappropriate. There should be no expectation that the information will be updated, supplemented, or revised, whether as a result of new information, changing circumstances, future events, or otherwise. We are not responsible for errors contained in this podcast or to anyone who relies on the information contained in this podcast. Please consult your own legal and tax advisor.