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Harry Koza

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Cash at work

Harry Koza


Income trusts, oil 'n gas, 'tricity, too
Doin' that Portfolio Tune.
Iron Ore, Timber and Yellow Pages,
Do the fall Portfolio Tune,
Do the fall Portfolio Tune.

Apologies to the Guess Who and "Running Back to Saskatoon"

Now that we're back on the ground, let's look around, and see where we are.

Firesign Theatre, "Don't Crush That Dwarf, Hand Me The Pliers." (1970)

TORONTO (GlobeinvestorGOLD) With the summer doldrums over, the kid back at school, and market activity picking up again, it's a good time to give the old portfolio a fall tune-up. Sort of the investing equivalent of changing the anti-freeze in your car and putting on your snow tires.

My RRSP portfolio is up 7.49 per cent year-to-date, while the TSX is up 5 per cent, so I'm feeling pretty good about that. I figure if I can make something between 9 per cent and 10 per cent for the whole year, I'm a happy guy, and if I can maintain that rate of return from now until I retire, I may not have to get a job as a greeter at Wal-Mart in my golden years after all.

The prospect of saying "Good morning sir, yes, adult incontinence products are on special in aisle seven," is a daunting one, though let's face it, having been a bond salesman for fifteen years, I guess it can't be much harder than the salesman's mantras: "we own and therefore recommend you buy," or "you can trust me, because I'm always right and I never lie," or even the most important one, reassuring the client that "it wasn't your fault that those junior subordinated zero-coupon perpetuals turned out so badly."

My RRSP is my only investment vehicle these days. Outside of the RRSP, my investment vehicle is my mortgage, which should be paid off in another six months or so. Paying down your mortgage is a risk free investment that so far this year pretty much beats the stock market on a pre-tax basis whatever your mortgage rate. That will free up cash flow to either increase my RRSP contributions or invest outside the RRSP.

My main holdings are:

Fixed income:

About 34 per cent of my portfolio. I own some Ontario 4.65 per cent savings bonds that mature in June; some Ford April '05 monthly pay bonds yielding 5.65 per cent; some GMAC monthly pay January '08 medium-term notes yielding 6.40 per cent; some West Coast 8.30 per cent Dec 2012 yielding 6.0 per cent; some Scotiabank bank trust security 6.282 per cent June 2013 yielding 6.02 per cent, and a passel of (formerly) long provincial strips yielding between 8 per cent and 9.5 per cent.

I also own both XGV and XGX i-units, which are respectively, 5 and 10-year Canada bond funds yielding 4 per cent and change. They're very boring, which is what I like most about them.


The bulk of my equity holdings are income trusts, just over 50 per cent of the total portfolio. I own pieces of 35 different trusts. Fifteen are oil/gas, pipeline or well-service trusts. For the oil and gas trusts, I like ones that only pay out around 65 per cent -75 per cent of their cashflows, have good reserve life, decent stability ratings (See the Dominion Bond Rating Service Web site for stability ratings), and are gas-heavy. My best picks have been CCS Income Trust, which I bought at $15 when it was yielding 15 per cent, (it's now around $30), and Canadian Oil Sands Trust, which I bought at $32 (it's now around $50, and it's the kind of thing you buy and hold until you leave it to your grandchildren in your will). Another 10 are electric power trusts either gas-fired co-gen companies like Calpine, TransAlta, and TransCanada Power, or hydro-electricity plays like Great Lakes Hydro, Boralex and Innergex, with some landfill methane, biomass and wind-electric as well. I like the electricity business a lot, and power trusts, with their utility cash flow streams and long-term power contracts, are kind of like bonds that you can trade as stocks.

My best pick was BFI Canada Income Fund, which I bought at $10 (yielding $1.00 a year/unit) when it was first issued, and is now quoted at $21.85 after increasing its payout three times. Should've bought more (The Rule of the Wrong Amount).

In regular equities, I own a chunk of BCE that's down about $1.80 since I bought it, which is somewhat mitigated by the over 4 per cent dividend yield it produces. I also own some Esprit Exploration shares, and that company is about to convert itself into a trust, issuing trust units, shares in a new exploration company and a 22-cent special dividend. It's up about 33 per cent since I bought it, too, and now trades around $3.50. I own small pieces of some closed-end funds: Dundee Precious Metals, United Corporations; and Royce Value Trust, which is up 3 per cent this year but is my only foreign content and still a good exposure to U.S. small cap stocks I hope.

And, of course, I have a handful of dogs:

A couple of junior mining companies that are circling the drain, another that's a good production prospect, and a couple small death-spiral tech stocks, that I hang on to, partly in the doubtless forlorn hope that maybe someday they will emerge from their comas, and partly to remind myself that the market is indeed a harsh mistress. I also own some of a labour-sponsored venture capital fund that serves as a nasty reminder of that old adage about never investing in anything just because it offers a tax credit. Maybe I should just bite the bullet and sell the pig. I hate it because it was up huge a year or two after I bought it but I couldn't sell it until I'd held it for five years (never buy anything you can't sell easily). Now, naturally, it's worth half of what I paid for it (pre-tax credits, at least), but I've hung on to it nonetheless, in the hope that some day the market winds will blow hard enough that the turkey will fly.

I also currently have a little over 2 per cent in cash, but continue to have difficulty finding stocks that I'd really like to buy at current prices. Total size of the portfolio: not nearly enough to retire on. Not yet, anyway.

What to do, what to do?

My Fall Tune-Up task is to put that cash to work somewhere. I am still bullish on oil and gas prices: more geopolitical turmoil will help keep oil prices high. Plus, the other day, OPEC raised it's members' production quotas to 27 million barrels of oil a day, which sounds great, until you remember that they are already cheating on their old quotas and pumping 28 million barrels a day, and have little extra capacity to pump more. There's a lot of talk in the market these days about the "war premium" on oil caused by Iraq, which supposedly adds $8 (U.S.) or $9 to the oil price, but no one seem to be focused on the "China premium." China's consumption of oil increased by 40 per cent in the first five months of this year, and looks set to continue, and they are starting a strategic oil stockpile. As for natural gas, a couple of cold snaps this winter pretty much a sure bet in this country and we'll likely see sharp price spikes there, too.

But, I'm long the energy sector up the proverbial yin-yang already, so I'm not looking too hard to add to my holdings there.

I'm plenty long the electric power sector, too. Over the past few months, as interest rate jitters knocked the price of electric power trusts lower (and yields higher), I've been adding to my holdings. That's worked out pretty well.

Since I started writing this column, I've sold my BCE shares. They've done little for me since I bought them, and, well, it's just a feeling, but, to paraphrase the Buggles' 1979 hit, "VoIP Killed the Telecom Stars."

There's been a few income trusts doing that Chernobyl thing in the past few weeks. Fortunately, they're not ones I ever considered owning. I'm happy to keep milking my herd of income trust cash cows, and continue to add to the power ones on dips. I'm also thinking about taking profits on a few, but would like to be able to replace the yield if I do. That's not so easy. Maybe the fallout from the China Syndrome trusts will cheapen up the sector a bit and create some buying opportunities.

The watch list

I'm happy with my bond holdings, and would like to add more, but interest rates aren't high enough to get too excited about the prospect, and chasing higher yields by taking a walk on the wild side of the credit continuum is something best done on an agency basis, as we used to say on the bond desk.

There are a few stocks I have on my watch list. I've been following Potash Corp of Saskatchewan for a while (I love this company, it's worth a whole column of its own, but just think: 200 years of ore reserves, and about the lowest production costs in the world, for a commodity that everyone needs or they starve, plus, it took a fantastic technological breakthrough one of the great engineering achievements of the 20th Century to figure out a way to mine it). Anyway, I was too greedy: I had a $60 buy target back in July, and it got as low as $60.76. Could-a, should-a, would-a. Now, of course, the darn thing is around $80 a share again. I have also been following Pall Corporation, the filtration and separation giant. Nano-filtration will be a huge industry in the coming years, and the technology is very interesting. It's down 9 per cent from its January highs, and I'm looking for an entry point, hopefully a couple bucks lower than current levels.

I like a little tech company in the U.S., Capstone Turbines. They make micro-turbines for generating electricity. It's a very, very cool technology, (distributed generation is the wave of the future in electricity I just wish someone would explain that to Queen's Park) but a lot of major global players are entering the market (Volvo, ASEA, Toyota, Ingersoll-Rand) and Capstone is burning through cash at a pretty stiff rate. The company has cash resources for another year or two, and trading at only $1.50 (U.S.), might make a good punt. But don't blow the mortgage money. As my proctologist likes to say, watchful waiting is the likely the best thing to do.

Bottom line, so far it's been a pretty good year investment-wise. I'm beating the S&P/TSX composite. I don't see much need to do anything very different from what I've been doing, at least for the remainder of the year. I may tweak my income trust holdings a bit. I'll continue to look for decent-yielding fixed-income instruments. But for the remainder of the year, I think it will be pretty much steady as she goes. 2005 will be more problematic, as I have some chunky bond maturities to deal with, but perhaps bond yields will be higher then. That seems to be the consensus on the street anyway, though I'm not so sure that's right bonds have been good to me this year. I'm thinking stocks may be cheaper next year, too.

I plan to continue to stay away from Nortel, Alcatel, Corel, and, now that I think of it, generally avoiding any stock with a name ending in "el" is probably not a bad idea.

So there we go. Ready for the fall and winter seasons: plenty of oil and gas for when it gets cold, lots of cash flow for when stocks get cheap, a big jolt of electricity for the coming blackouts. All I need now is a couple of cords of firewood and a side of moose in the freezer, and I'll be all set.

Harry Koza is Senior Analyst in Canadian markets for Thomson Financial/IFR. At various times in his career, Mr. Koza has been a prospector, metallurgist, project manager, engineer, as well as an institutional bond salesman for 15 years. His current area of expertise is in high-yield distressed securities and corporate bonds in general.

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