SmallCapPower (SCP) reporter Grace Pedota caught up with 5i Research CEO and Canadian MoneySaver Editor Peter Hodson at the Toronto World MoneyShow recently, where he shared his investment insights and described what he dislikes most about certain aspects of the industry.
SmallCapPower: Can you summarize your presentation for those who couldn’t attend?
Peter: Sure, so we were talking about everything you need to know in the market, and they gave you 25 minutes to tell you everything you need to know. So it really comes down to avoid reacting, do your homework, avoid fees, don’t listen to brokers, don’t buy mutual funds, be careful on hedge funds, be careful on new issues, and never ever buy leveraged ETFs – they are about the worst thing ever. We then talked about some of the structural problems of the business. So you have a situation where analysts use target prices to create trading target prices. These are evil as far as we are concerned because all they do is cause you to trade and we don’t want you to trade. Another issue is mutual funds. When they are hot the manager gets tons of money in and they have to spend that money and of course what they are doing is they are buying hot things and are paying more for them and then the money disappears and they are selling at the wrong times so there is a structural issue there in many funds in the way they are structured because people chase performance so basically don’t do that. We talked a lot about holding cash the market goes up long term, nobody can predict the bottom, no one rings a bell at the bottom so cash is going to be a drag on your performance, if you are owning cash and the market goes up after 10 percent then you are handcuffed. Nobody wants to buy after a 10 percent move so you remain handcuffed so we just say take your cash and keep it for your emergencies or your new car and invest everything else you can.
SmallCapPower: How do you know when to “pull the weeds” so to speak- and refresh your portfolio?
Peter: Sure, so we like to reward the companies that are doing well and sell the companies that are not doing well. It can be difficult because what we want to look at are the fundamentals and not the stock price. So you can get a situation where a stock goes down and the company is doing fine so you have to segment those two things out. If you have a company that continually disappoints you, they say they are going to make a dollar a share and they make eighty cents a share and they do that quarter after quarter after quarter, and you get a company that keeps issuing new shares and treats their shareholders like an ATM machine, then it’s time to let that one go. That stock in that scenario, that stock’s probably not doing very well anyways so you might have a stock that’s gone down 30 percent but when you look at the fundamentals, maybe there’s no growth maybe they have cut their dividend, maybe they have added debt, just that’s a weed and pull it out of your garden and give the water to another stock.
SmallCapPower: You recommend a maximum of 20 stocks. If something great comes along would you recommend selling one of your stocks?
Peter: Not automatically. So we use the number 20 because mathematically you don’t need any more than 20 if you are properly diversified. Having 25 stocks doesn’t hurt you, it just doesn’t add you any incremental risk/return benefit. So a lot of people have 80 stocks and I can’t follow 80 stocks, nobody can follow 80 stocks properly. But if you have a great idea generally in an ideal world you would just buy it because all of your other 20 are good ideas and you wouldn’t be able to sell any of them because you love them all and so that is a situation you are hardly ever going to be in but that is the ideal situation. So you can buy it and then decide which one of those 21 is the least attractive, but you should have a difficult time with that because if you have chosen properly, you have good stocks in there.
SmallCapPower: What is the appeal of looking for companies with dividends?
Peter: Really, the dividend stream. When a company pays a dividend they are rewarding you as a shareholder. But, more importantly, they have to come up with that cash flow every three months to pay you so they are less likely to go on a big acquisition spree and do something foolish because they have to come up with that money. Cutting a dividend, in our view, is the worst thing a company can do because it just totally destroys investors’ confidence and so they know they have to pay that dividend and so they are more careful with their money. The other thing is, when you are an investor, and you have two stocks, and you are worried about the market or you need the money, one is giving you the money every three months, and one is not. You are far more likely to sell the one that is not paying you, and so from a valuation point of view dividend stocks tend to do better, much better over time.
SmallCapPower: Can you explain what you mean when you said “the investment industry wants all of your money.”
Peter: Ya absolutely! So being a fund manager for a long time I have been in so many situations where the bosses of the company would create products. They would read the newspaper, look at the media, they would talk to investors and they would decide what needed to be sold. So if people were worried about the market, they would come up with a low volatility fund and that would be sold. In the Dot Com days everyone wanted technology stocks, so low and behold 100 technology funds were created. You get these situations where a certain sector becomes hot, and so products are created to sell those sectors because the demand is there. This happened a few years ago when everybody wanted income, so all these income finds were created and the demand is there. They pay the brokers 5 or 6 percent to sell those products, they bring in billions of dollars, and they are not all bad, but they all have fees, and so suddenly you have bought a hot product with fees attached to it and maybe there is so much money going into that hot sector that maybe there is too much money going into that hot sector and it’s not a good sector anymore because everything is overvalued, so the mutual fund industry is designed to keep your money and they want to make sure that your money stays there. And any new money you have they want to have a product that will suit that need to get your money.
SmallCapPower: Would you recommend investing in a mutual fund?
Peter: No, and I have done a lot of work in mutual funds. I was the Chairman of a mutual fund company and they cannot outperform in the long term. There are some very smart people out there managing funds and they can do very well for 5, 6, 7 years, but over a longer period of time the amount of fees that eat into the performance they simply can’t overcome that. Over a 50-year period if you are investing $100,000 at the start and you are paying a 2 percent fee annually, the managers of your funds they take $1.8 million off of you in 50 years and that is enough for anyone to have a nice little retirement. Don’t give that to the manager, you need to keep that money for yourself, and sure there are hot managers, there’s cold managers but over a 15-year period of time there’s no good managers. Not because they are stupid, but because of the fees – they just can’t overcome the fees.
SmallCapPower: Thanks you so much for talking with us today.
Peter: You’re welcome, anytime.
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