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Smith Manoeuvre Portfolio – May 2008



Time again for the monthly Smith Manoeuvre Portfolio update, May 2008 edition. I asked during the last update whether or not I should keep these monthly portfolio posts going, or if I should space them out a bit. I think that most of you enjoy these posts, but some may find them boring. So, I have decided that I will keep this post going providing that I have made changes to the portfolio during the month.

For those of you just joining us, The Smith Manoeuvre is a Canadian wealth strategy that utilizes a home equity loan to invest in income producing assets. The result is a tax deductible loan and portfolio that increases as you pay down your mortgage.

Onto the portfolio. It seems that this past month, the Canadian markets have taken off again and have even reached new highs. The new highs made by the index were mostly due to RIMM and POT and would have been even higher if the financials took off.

In terms of trading, there weren’t any new positions initiated, but there have been a few additions to existing holdings RY, PWF, MFC, TRP

Stock Symbol Shares Avg Buy Price Total Div/Share Avg Yield
Royal Bank RY.T 75 $47.62 $3,571.25 $2 4.20%
CIBC CM.T 45 $67.14 $3,021.25 $3.48 5.18%
Power Financial PWF.T 75 $35.68 $2,675.75 $1.25 3.50%
Scotia Bank BNS.T 25 $44.85 $1,121.25 $1.88 4.19%
Manulife Financial MFC.T 50 $39.42 $1,971.00 $0.96 2.44%
Fortis Properties FTS.T 50 $27.30 $1,365.00 $1 3.66%
TransCanada Corp TRP.T 50 $36.87 $1,843.25 $1.44 3.91%

Total Portfolio Cost Base: $15,568.75

Total Dividends / Year: $615.35

As you can see, the portfolio is still heavily concentrated in financials with a sprinkle of utilities. This lack of diversity is inevitable when investing in Canadian dividend paying stocks.

The stock that I currently have my eye on is AGF Management (T-AGF.B) which is a mutual funds management company and sports a current dividend yield of 4.50%. It is currently on the dividend achievers list with a stock price that seems to be beaten up. I’ll have to do more research as to why it “appears” so cheap. Anyone have any ideas?





29 Comments, Comment or Ping

  1. I don’t really follow AGF, but it is likely cheap because the market has been performing so poorly and investors have been redeeming mutual funds and switching into low fee funds like money market funds. There could be further expectation for poor stock market performance which will not help AGF. Have a look at IGM as well as they are the industry leaders along with probably Royal Bank. In my opinion you should be looking at another non-financial instead as you already have loads for wealth mgmt. exposure by holding RY, CM, PWF, BNS, and MFC.

  2. MG, thanks for the tips! Which are your fav non-financial div stocks?

    I’m also looking at diversifying into some foreign market for the long term.

  3. Non-financial dividend payers in Canada are hard to come by and can be hit and miss valuation-wise right now. Off the top of my head Telus (T.A) and Reitmans (RET.A) are on the cheaper side right now.

    Good dividend growers in Canada but more expensive stocks include:

    TRP
    FTS (any other utilities as well)
    TIH
    SAP
    CNR
    HSE
    CP
    Shaw

  4. 4. nobleea

    I have TRP and Shaw. Shaw could be a decent bet for the short term based on what happens with the wireless spectrum auction. I think they are bidding for a fair amount. If you could combine Shaw’s excellent customer service with mobile phones, you’d have a winning combination.

    What would happen if one stock gets bid up 20-30% in a year? Most of the stocks listed here are not growth stocks (Shaw could be considered). If the dividend has no increased correspondingly, does one trade in to another stock that has a better yield and swallow the capital gains?

  5. Congratulations on the dividend raise from BNS today.
    For more on dividend achievers, check:

    http://www.dividendachievers.com/Site/NUS_Canadian%20Dividend%20Achievers/5_methedology.php?id=56&preview=

    Would your strategy work if you bought US dividend companies?

  6. DGI, I would love to diversify into US dividend companies, however, Canadian law taxes dividends received from foreign companies at the full marginal tax rate (for non retirement accounts). Otherwise, I would be all over it.

  7. 7. Millionaireby45

    FT,

    I would appreciate your comments with regards to ETF’s that provide double the exposure (e.g. Horizon Beta Pro ETF’s). There are many people who comment on the Smith Manoeuvre stating that over an extended period of time the market will ALWAYS increase hence there is very little risk involved. They state this as if it were 100% true. If they are that confident, why would you not buy an ETF that offers double the exposure, since you would be doubling your returns. Why settle for 8%, when you can have 16%? I am actually starting the Smith Manoeuvre this week so I am an advocate of it, however I do realize that there is a risk associated with it. Your comments as well as your reader’s comments are appreciated.

  8. 8. Millionaireby45

    FT,

    You may want to look at Rothman’s (ROC). It has a dividend of ~5.5%. Also, Husky offers a very good dividend for a large Oil and Gas Company (~2.5%). These are a couple of stocks that I will be purchasing.

  9. 9. Cannon_fodder

    Millionaireby45,

    Regarding the Horizons ETFs I had exactly the same thinking. In fact, you will see that they don’t track exactly and that there will always be a difference between the underlying index and this ETF. I would imagine this would get larger and larger as time progressed.

    I think it would be possible in extremely volatile situations (especially with large downswings) to see the advantage quite minimized.

    Unfortunately, you don’t get any dividends, let alone 2x dividends! I’ve even thought of investing in dividend producing stocks and then taking the dividends, paying down the mortgage, and then reinvesting the principal into an ETF such as Horizons. Perhaps you take a different approach and that is to invest in the Bear ETFs for some minimal hedging. I haven’t analysed those types of scenarios, just thought about them…

    There is some discussion on the web about the merits and perhaps they are better for short term trading. An example
    http://www.dailyspeculations.com/wordpress/?p=2393

  10. 10. Chuck

    First off, I enjoy reading your monthly updates.

    As to Millionaireby45 though I like the Beta Pro ETFs I’ve only ever used them for short-term investing.

    Since they don’t produce income you may not be able to use them as part of a Smith maneuver since there has to be an expectation of income (not capital gains). I keep all my growth stocks in a separate account from my SM funds to avoid this confusion with the CRA.

    Has anyone looked at the idea of buying a company with low, but consistent dividends and good growth potential? I’ve had a bit of success with this strategy, but have found the higher dividend stocks pretty well cover the interest costs on the HELOC.

  11. Chuck, providing that the investment has the “expectation” to produce income sometime in the future, then it’s still eligible for the SM. Does the HBP funds explicitly state that they will never pay a dividend on HXU?

  12. 12. Cannon_fodder

    Chuck,

    I probably will do as you suggested – buy dividend producing stocks that are a mixture of some lower dividends but good growth potential with those that have higher dividends and lower growth potential.

    Ideally, I’d like to reach a mix of 4% growth + 4% dividends. Having 5% growth and 3% dividends wouldn’t be bad either – it would be a bit more tax efficient.

    I figure that if I invest and really produce income (as opposed to the ‘expectation’ of income) and if it outweighs my interest costs once all taxes are factored in, then the CRA will be more likely to consider me onside with the spirit of the tax laws.

  13. Cannon, I have the same plan of diversifying into growth dividend stocks (ie. O&G). However, they are simply too expensive to buy right now for my comfort level.

  14. 14. Ann Banan

    Could you explain this for novice stock investors like myself. I heard Royal Bank will pay 50 cents a share and above it says $2.00. I read all these articles about dividend high achievers and wonder why I am not getting the same. Is it for preferred shares only? Excuse my ignorance please and would appreciate a simple explanation :)

    Thanks

  15. Hi Ann, the $0.50 represents a quarterly dividend which equates to a $2 annual dividend.

  16. Not sure if it’s worth adding but one column I’d like to see is the current share price.

  17. 17. Sarlock

    What is important is the yield on investment cost, not the growth of the stocks in the portfolio. In this type of strategy, you rarely sell your stocks even when you experience significant capital gains. The concept is that share price growth in most of your dividend yielding stocks should compensate for inflation (and maybe a bit more) while the dividends generate the income.

    Your yield is based off your initial purchase price, what happens after that is largely inconsequential from a cash flow perspective. If you buy stock at $100 per share that yields $4/yr in dividends, you are yielding 4% on your original investment. If that stock then doubles to $200, you are still receiving 4% on your original investment even if subsequent share purchases would only yield 2%. The movement in share price only comes in to play if you actually sell the stock or add to your portfolio. For this portfolio, these are long term holdings. Likely the only scenario which would cause a sale would be if dividend yields weakened significantly (which would also erode share price and likely not yield a higher return if you sold the shares and reinvested them in a higher yielding stock due to the higher premium you’d pay on the better yielding stock).

    There will likely be a continued period of weakness in financial stocks which could last a year, two or even more during which a lot of wonderful buying opportunities will present themselves. Dollar cost averaging your investment over this period of time should build a wonderful portfolio of good dividend yielding stocks and when financial markets finally recover and yields start to increase (we may see very few yields increase over the next while), you should benefit nicely.

  18. 18. Cannon_fodder

    Sarlock,

    I disagree although perhaps I don’t understand what you are saying. So, I apologize if I’ve read your post incorrectly.

    Let’s imagine I buy stock XYZ at $100 and the yield is 4% and this is, historically, where the company has tried to keep it. If, in ten years, it doubles to $200 I’m expecting that the yield will still be 4% whereas you suggested it would actually go down to 2% or, in other words, that the dividend payments would not go up. I, on the other hand, would expect that the dividend payments would also double.

    In fact, most people talk about how stocks they purchased years ago are now yielding double digit percentages compared to their original investment. I owned NA until last year and it was yielding around 4% when I bought it and was still yielding around that range when I sold it – but, compared to my original investment it was yielding almost 12% since I bought it around $20 and sold it around $60.

    I’ll also disagree that the premise that the yield after your initial purchase price is largely inconsequential from a cash flow perspective. If I borrow to invest, then as the stock value increases and my yield stays the same, but my dividend payments increase, I have the option to pay down the principal of my loan so that, at some point in the future, with no additional out of pocket costs, my investment portfolio is free and clear.

  19. 19. Sarlock

    If your predominant strategy is to hold long term then the share price movement after purchase does not matter much as it does not affect the yield off your original investment amount. We’re not buying dividend yielding stocks in order to buy low and sell high, we’re looking for solid dividend histories for future cash flow. In regards to my example of share price doubling, I was referring to a short term spike where dividend yields have not yet moved upwards. If we’re spreading this over several years, then yes, dividend yields would (or at least should) move accordingly… but the short term price spike will matter little to our valuation of our portfolio from a yield/cash flow perspective.

    And you are right about the longer-term picture: As time moves on and yields increase, our return on original investment increases significantly. I am worried, however, that this past period of healthy dividend increases is coming to a close and we may be hitting a period of stagnant dividend growth.

  20. [...]Million Dollar Journey posted updates on his investing in Smith Manoeuvre Portfolio – May 2008[...]

  21. I like the idea of having the dividend pay the interest. however, did you consider what would be the difference if you would reinvest those dividends over a long period of time?

    I think it would be a good idea to compare both situations, isn’t?

  22. That would make an interesting comparison, might be an idea for a post. :) The way I see it is that if I use the dividends to pay down the mortgage, I can reborrow and reinvest the same amount anyways.

  23. 23. ETF Income

    What is the home equity loan interest rate is right now? How much do they usually charge in terms of interest rate?

  24. 24. Josh

    It’s interesting to see your div per year.

    I am also doing this and am holding the following mutual funds:
    DYN1031 5,055.20
    RBF600 5,093.69
    SAX347 5,308.38
    SIC009 5,190.06

    They are generating around $30+ a month each. Conservatively that’s $1,000 a year in dividends. Which I am rolling back into the funds as I really want to take advantage of the compounding.

    My understanding of the SM was that at the end of 25 years you would still owe EXACTLY the price of your house on your mortgage, but you would have invested it all on the other. Compounding it would be worth WAY more than your house. Which doesn’t go with you moving the DIVs back to pay the interest.

    The other thing I understood that we are both doing wrong is that you want to invest in things that DON’T trigger much (if any) interest or dividends. So you are able to write-off your interest payments BUT you only ever trigger capital gains in the end.

    Has anyone seen this: http://www.upvest.com/

    It is basically AIC (which has funds that do what I describe above) trying to push people to leverage, essentially the SM.

    Please call me out if you think I’m full of it…

  25. I thought I would add this site as a resource for further explanation on the Smith Manoeuvre. It has screen shots of example using the Smithman Calculator.

    http://www.toronto-investment.ca

  26. Gee, I wonder how the old Smith Manoeuvre is working these days? Nothing worse than being upside down on BOTH your house value and your borrowed against investment portfolio at the same time. Sweet dreams…………….
    I have to chuckle each time someone comes out with a new way for people to part with their hard earned cash. Well, if we all live to be 150 years old, I guess we’ll be okay.

  27. 27. nobleea

    The Smith Manoeuvre is working just as its supposed to. Why would you think it would be any different these days?
    I think it would be difficult to be upside down on your house value if you had a readvanceable mortgage. You can only get those for up to 80%LTV. Which means, worst case, you’d be breaking even if house prices when down 20% from when you bought.

    So maybe lose the chip on your shoulder.

  28. No chip here. I’ve just heard too much BS through the years to fall for such a “strategy”. I know of people who are using this Smith Manoevre. You know, the ones with the long faces, ’cause they thought the sun was going to shine on their portfolios everyday. I guess its been “cloudy” these past few months…….
    And the readvanceable mortgage you speak of is a big IF with a lot of people on the hook. You’re not breaking even if you’re down 20%! You still had to come up with the 20% in the first place, and if the market has wiped that out, you are down 20% ( a friends house is down 30%!!). That IS real money you know. As well, the above portfolio is down 29% in value as of Friday, and that’s with a recent spike in the markets. Hopefully, some more recovery is on the way over time. That’s why I hope everyone will reach age 150, so they can recover from this horrible market.
    There are many, many better ways to make money in the market. It’s just a huge gamble to me (and this market is proof of that) that one would attempt to use this type of instrument. My guess is many “new” investors have gone with this type of strategy and are quite perplexed by how it is turning out for them.
    I am reminded by some sage advice: “The only way to make money in the market, is to give advice about how to make money in the market”. The SM is just another cheery way to do this.

  29. 29. cannon_fodder

    Market Lessons,

    I think evaluating the SM based on less than 1 year of real life implementation is foolhardy, regardless of whether the market is up/down. If someone extolled the virtue of any investment (rather than speculative) strategy with only 12 months of data, hopefully there would be people out there skeptical enough to evaluate it over at least a 5 year time frame.

    If you don’t have (as opposed to “think” you have) a tolerant for risk, a suitably long time frame and a plan that you commit to, then don’t even consider the SM.

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