These unfunded liabilities are estimated to be in the range of 300% to 400% of GDP, or several times larger than all existing current debt (see “The cupboard is bare”). Our observation is that they are unaffordable and, as such, many of the promises made about funding health care and government pensions will be reduced. The bottom line is: we will work longer and be more directly responsible for our own health care – perhaps a better outcome and one more likely to lead to a healthier and more productive life.
The prolonged effect of the recession – and what some observers are calling The New Normal – will likely cause:
- Unemployment to take longer than normal to recover to pre-recession levels;
- Interest rates to remain below normal for longer than most analysts expect;
- The secular bear market in equities to continue as ongoing personal (and eventually government) deleveraging takes place;
- BRIC countries (Brazil, Russia, India and China) to continue to outperform in relative terms, as do commodity-based countries such as Australia, New Zealand and Canada;
- The U.S. dollar to continue its downward spiral (although recent issues with the Euro may slow that down);
- Sovereign debt to find there are limits to government borrowing. When governments deleverage this will create a drag on economic growth in the short to medium term.
The last decade was, in terms of making positive returns, the most difficult in well over a century. Ten-year returns for 10 different asset classes – a diversified portfolio of 10% in each category – would have netted about 2% per year after fees for the last decade.
While the importance of diversification can’t be stressed enough, our main focus is (and will continue to be) cash flow – through assets that generate a sustainable or growing income stream. That approach has worked very well over the last 10 years, especially when compared to traditional balanced fund approaches (typically 60% equities and 40% fixed income as represented by the Globe Peer Index.
As we look forward to the next 10 years, we are reminded about how difficult it is for anyone to make accurate predictions this far out. How many people would have predicted a Canadian dollar over par in January of 2000 when it was trading at $0.69US, or that the noughties would provide the lowest return for U.S. stocks of any decade ever (including the 1930s) when for the previous two decades it had increased by 1,400%?
Our approach is to develop a strategy based on value principles, cash flow and diversification, and then look for good opportunities within each asset class.
Some of those opportunities could include:
- Life annuities (with or without life insurance) as an alternative to other fixed-income vehicles. Yields are excellent and for non-registered capital, as much as 60-80% of the income is tax-free;
- Preferred shares with adjustable medium-term rates; significant tax benefits on income received for non-registered and corporate accounts; Mortgages on income-producing assets; especially subordinated debt-to-low-loan-to-value first mortgages;
- Distressed debt in publicly traded companies (this we have done through our private equity LP with Maxam);
- Other private equity pools that are able to acquire assets at far better pricing than might exist in public markets;
- Income-producing real estate where the spread between cap rates (income yield) and mortgage rates is at least 2%;
- Diversification out of the Canadian dollar to take advantage of its increasing purchasing power of foreign assets. (Specifically, we are looking at U.S. income-producing real estate and global bonds).
We remain in a challenging environment where the two main factors will be the deleveraging of both consumers and governments, and the political and lifestyle changes society will make as a result of aging populations. This does not mean that good investment opportunities will not exist. As usual it will take significant effort to find value.