The Globe and Mail, Report on Business
Published January 7, 2011

By Tom Bradley

“Finding the right answers is easy. Asking the right questions is the hard part.”

As we open our calendars on 2011, this old adage has never been more apt. We’re being buffeted with crosswinds and it’s not obvious which ones will affect investment returns the most. I have no special insight on what will dominate in 2011, but do have a few questions to help guide investors’ thought processes.

Can profitable, cash-rich countries thrive while debt-ridden governments and consumers are cutting back?

There is no doubt that a slow or no-growth economy will restrain profits. Economic growth is the number one driver of corporate earnings.

In a subdued environment, however, opportunities will emerge for well-funded companies. Increasingly, public infrastructure will be privatized, and innovative companies can be part of the solution in areas such as power generation and delivery, energy efficiency, health-care management and transportation. Corporations are better capital allocators than governments and can take advantage of low interest rates and labour availability.

There are also parts of the world that aren’t debt and growth challenged. If you’re sitting in Beijing, Bangalore or Sao Paulo, you’re not worrying about lack of opportunity.

Where do I want to be when interest rates are two percentage points higher?

Low interest rates are the economy’s Red Bull. They encourage consumption and risk-taking now, at the cost of lethargy later. The rate tap is flowing because, on balance, there are more segments of the economy that need life support than don’t.

While low rates keep the weak alive, they’re overfeeding the strong. Risk-taking is being encouraged and asset prices are inflating. Investors are buying corporate bonds (credit risk) with the expectation of a 3- to 5-per-cent return. Income-producing real estate is being scooped up based on similar rates. And valuations in some sectors of the stock market are getting stretched.

When the Western world’s economy picks up enough to shift the focus from supporting the needy to discouraging the greedy, and/or a little more inflation creeps into the system, rates will rise. At that point, we don’t want to be only holding rate-sensitive securities like bonds and income-oriented stocks, or trying to sell a condo.

I have strong views on [hot-button issue here], but am I getting the valuation right?

We’re living in a time of extreme views. People either believe passionately in gold or think it’s a bubble. They want to avoid the U.S. and Europe at all costs, or see these recession-ravaged economies as great places to invest. They’re worried about inflation, or deflation.

As investors, however, we’re not here to be proven right on our theories, but rather to generate attractive returns. We therefore need to understand how much of our view is already factored into the price. It’s important to make the right fundamental call, but it’s more important to profit from it by getting the valuation right.

As Howard Marks of Oaktree Capital Management often says, “No asset can be considered a good idea (or a bad idea) without reference to its price.”

Are there compelling reasons to diverge from my long-term asset mix?

An investor’s strategic asset mix is the blend of securities that has the best chance of achieving his/her long-term goals. It’s an educated guess, designed to find a balance between return, volatility and income. Given how unpredictable markets are in the short term, investors need compelling reasons to stray too far from their mix.

Currently, I’m running close to my targets, although I’m holding more cash than usual at the expense of government bonds. To my mind, the reward-versus-risk equation for bonds is tilted the wrong way.

Through my Steadyhand funds, I own a broad range of stocks, including domestic and foreign, and dividend and non-dividend paying. And I’m keeping my speculation on currencies and commodities in check. Some of the cash is in U.S. dollars to fuel my southern property dream, but I don’t own gold, silver or copper.

In a nutshell, I think corporations will do just fine in this economic environment, I can live with higher rates when they come and am not confident enough at this point to make a big bet against my long-term plan.