Reprinted courtesy of the National Post
by Tom Bradley

They’re all the rage. Even though they haven’t changed in almost 100 years, people of all ages are wearing them.

I’m referring to Converse All Star basketball shoes. I had a pair when I played high school ball (high tops) in the ’70s and bumped around in red, black and blue ones in university. I still take great pride in telling young people in the grocery line that the ones I’m wearing are 40 years old (they mostly look at me like I’ve lost it).

For a fashion item, I can’t think of anything that matches Converse All-stars for longevity. In investing, the equivalent would be a simple portfolio of bonds and stocks. Basic, enduring and as effective today as a century ago.

Like shoes, however, there’s been a steady flow of new investment approaches and features — principal protection; enhanced yield; tax-efficient income; illiquid assets; currency hedging; double-leverage ETFs; notes linked to commodities and indexes; and asset-backed paper.

On this list are some useful tools for building portfolios, but before you stray from the tried and true, here are some things to know about the new and fancy.

More complex equals lower return

Whenever I see a new product being advertised, Bob Hager’s words ring in my ears. Bob was the co-founder of Phillips, Hager & North and a quiet giant in our industry. When investment bankers came to pitch us on new products, he’d invariably say, “No matter how it’s packaged, it always comes down to stocks and bonds. If they don’t do well, the product doesn’t have a chance.” In other words, the bankers haven’t invented a new source of return.

Each additional feature added to an investment product brings more people with it (investment bankers, currency and derivative traders, and marketing executives), and not surprisingly, they don’t come cheap. No matter what bells and whistles there are, the buyer takes all the risk and receives a portion of the return from the assets. The promoters keep the other portion while taking no market risk.

Most structured products are designed to make the ride smoother or convert more of the return into income. Both of these features come with a price — lower total return.

Less transparency means more unexpected outcomes

If you don’t understand how an investment product works, then you can’t be expected to anticipate all the potential outcomes. I learned this from my days as a stock analyst. In the ’80s, I covered a number of conglomerates that offered limited visibility. Understanding what drove Pagurian, Financial Trustco and Hees International (I’m dating myself) was a challenge. More recently, we’ve had big surprises from complicated, opaque companies like Enron, Bombardier and Valeant.

Investment products are the same. If you don’t have perfect clarity as to what’s going on behind the scenes, then be prepared for outcomes not covered in the marketing materials. A decade ago, we had the Asset-backed Commercial Paper (ABCP) debacle. Canadian investors didn’t get what they were owed while lawyers and hedge funds had a field day picking up the pieces.

They’re sold, not bought

A simple bond and stock fund or portfolio doesn’t come with a glossy, 4-page brochure. It doesn’t need one. For products that are more complex and difficult to understand, however, it’s de rigueur.

In the marketing materials and advertising, the terms and language used often make it difficult to compare the product to your other investments. For instance, index-linked notes advertise the best possible “cumulative” return (“Earn up to 9%”) which means that if everything goes right, you’ll earn a 3-year “annualized” return of 2.9%.

There are other tricks to watch for. One of the most common ones is linking a product’s performance to an index return (i.e. S&P/TSX Composite Index). While index levels are reported widely, they don’t represent the return of the market. The total market return includes both the price change of the index and dividends received. This distinction is rarely mentioned in the brochures.

As with athletic shoes, there have been plenty of advances in financial products, some real and some marketing. If you’re moving beyond the Converse All Star portfolio, make sure you know why you’re doing it, what you’re getting and if it has what it takes to last 100 years.