The following commentary represents the opinions and analysis of Doug Nelson, President, Portfolio Manager, Nelson Portfolio Management Corp. as of October 1, 2018.  Market and index returns noted below are based on the price changes for each quoted item for the period ending September 26, 2018.  Market Statistics:  Source:  https://ca.finance.yahoo.com, https://ycharts.com.

So, what’s the really big news since the last report?  Nelson Portfolio Management Corp. and the NFC Tactical Asset Allocation Pool has celebrated its 5^th year anniversary!  Yes, it was five years ago, on Friday, August 2^nd that Nelson Portfolio Management Corp. (NPMC) was granted its securities registration to provide discretionary portfolio management services in Manitoba, Ontario, Alberta and B.C.  Shortly after, on September 3, 2013, the NFC Tactical Asset Allocation Pool was valued for the first time, representing the core of all client portfolios.  It is exciting for me to share this anniversary with you, thanking you for the trust and confidence you have placed in my team and I over this period of time.  This will be a special edition of our Quarterly Market Commentary, focusing on where we have come from and where we are today.

5 years ago, we took a very big step to set up our own portfolio management firm so that we could have greater control over i) the cost structure of the portfolio, ii) our portfolio management process and iii) to make sure the portfolio had a greater and more personal connection with the goals of our client’s financial plan / retirement plan.

Changes to the Cost Structure of the Portfolio:

• Trading costs were reduced from the $30 to $35 per trade range down to $18 to $25 per trade. This is a 28% to 40% reduction in trading costs.
• For those clients who are 100% invested in the NFC Tactical Asset Allocation Pool (our Bundled clients), overall portfolio management fees were reduced by 40% to 50% (the previous management fees were increasing and close to 3% per year in 2012, the new portfolio management fees are 1.50% per year). Based on the assets of our average Bundled client today ($143,000), this represents an annual estimated annual fee saving of $1700 – $1800.  Over a 20-year investment horizon, this could be a total fee savings exceeding $35,000 to $40,000 per client (Note:  this is not a guarantee but a projection of $1800 per year X 20 years = $36,000.  As a portfolio grows over time this figure is likely to be higher).
• For our Unbundled clients, portfolio management fee costs declined by several hundred to several thousand dollars per year, depending on their circumstances.  Based on the assets of our average Unbundled client today ($860,000), our average portfolio management fee is 1% of the client portfolio value.  By comparison, this would be a 30% savings when compared to an alternative investment with a 1.50% management fee, a 50% savings when compared to an alternative investment with a 2% management fee and a 60% savings when compared to an alternative investment with a 2.5% management fee.  If we put a dollar value on this, this could be an annual fee savings ranging from $4500 per year to as much as $13,000 per year.  Over a 20-year period of time, this could be a total fee savings exceeding $90,000 to $260,000 (20 years X $13,000 = $260,000)!
• These fee savings help to achieve several important portfolio management objectives: i) if the fees are lower, we don’t need to take as much risk to achieve a similar return to a higher fee portfolio and ii) by creating a lower risk portfolio which is less volatile, the returns are typically more consistent.
• Therefore, creating a lower cost structure to the portfolio is definitely one of the keys to longer term portfolio success.

Changes to Our Portfolio Management Process:

• The largest change to our portfolio management process at that time was the creation of the NFC Tactical Asset Allocation pool. The pool was designed to be the core of all client accounts.  Our Bundled clients would be 100% invested into the pool and our Unbundled Clients would have a 60% exposure to the pool.  40% of the portfolio of our Unbundled Client portfolio would then be customized based on the unique circumstances of the client.
• By setting up the portfolios in this way, the pool is then managed based on the changing conditions of the market. When markets are good we tilt the pool to be more aggressive.  When markets are not looking strong, the pool is adjusted to be more conservative.
• By making these changes in the pool, and by the pool representing the same percent allocation across all clients, all Nelson Portfolio Management Corp. clients benefit from these changes at exactly the same time. This allows us to respond to changes in the market environment on a timely basis.
• This also helps us keep transaction costs down over time. By doing most of the active trading within the NFC Tactical Asset Allocation Pool, these transaction costs are shared between all clients.  The total trading costs, as a percent of the average NFC Tactical Pool value in 2017, represented 0.03% (3% of 1% of the average assets under management).  In other words, the trading costs were negligible.  This is the difference between a 7% return and 6.97%.
• There are two components to the fees you pay in the NFC Tactical Asset Allocation Pool: i) the pool expenses and ii) the pool management fees.  The pool expenses are capped at a total 0.25% of the value of the pool.  These expenses include the custody fees, audit, accounting and legal fees.  At this time, due to the growth in the value of the pool and our ability to manage our costs, we estimate the pool expenses to be 0.21%.  This means that over the past 5 years these costs, as a percent of the value of the pool, have declined by approximately 16%.  This is an estimated dollar savings of close to $21,000 (based on 2017 figures) which means that this money is added to the return on the pool each year, and this amount continues to grow.  This is good!

Closer Connection To The Client’s Financial Plan:

• In 2013 a sister corporation called Nelson Financial Planning Corp. was also established. The purpose of this was to clearly establish a difference between the portfolio management process and the financial planning process.  As a result, in the work completed for you by my team and I, project specific financial planning fees are often charged.  This helps my team and I cover our costs for the financial planning work we do, but in turn this also helps to keep the portfolio management fees to a lower level (vs. other potential alternatives).
• Since my team and I are building the financial plan while I am managing the day to day aspects of the portfolio, we feel that there is a closer connection between the client’s financial planning objective and their portfolio management objectives. In other words, we aren’t giving away large portions of your portfolio to other portfolio managers, or mutual fund managers, who aren’t privy to the goals or unique circumstances of our client.
• This is very interesting to us because one of our favorite questions to consider is: do we need to take this risk today for this client?  We believe this creates significant value to the client over time.
• Finally, with this type of portfolio design, and the closer connection to the client’s financial plan, we have also seen a greater level of consistency between clients with similar risk profiles, portfolios and goals. This is a very important outcome.

So, in 2013 we made some very significant enhancements to what we do, how we do it and why we do it that way.  If you haven’t been there recently, please check out our website to see similar descriptions (www.nelsonfinancial.ca).  These were very significant changes that we believed would result in lower cost portfolios and more consistent results.  As you can see above, we have definitely achieved considerable cost savings.  In the next section we will look at the performance results.  But before we do that, I’d also like to say that over the past 5 years we have spent considerable time investing in both people and technology.  To be a successful business today, and to provide effective services and solutions to our clients, I believe that we need to have educated, experienced and capable people who have access to thorough and sophisticated technology.  Our team will continue to grow as the business grows, but when I look at the team we have in place, I am very excited about all that we are doing today and excited about our future.

Thanks again for being a part of this journey over the past 5 years.  I sincerely appreciate your kind support and feedback.

Now let’s take a look at the performance of the NFC Tactical Asset Allocation Pool, as a good representation of our overall portfolio management results.

How Has The NFC Tactical Asset Pool Performed?

At the time of writing, I am very proud to say that we are now managing close to $94 million in assets under management, the core of which is held within the NFC Tactical Asset Allocation Pool ($60 million).  This is close to double our size back in 2013.

With this in mind, the NFC Tactical Asset Allocation Pool is a good representation of our overall portfolio management skill and success.  Here are the 5-year numbers for your consideration.

Table #1:  NFC Tactical Asset Allocation Pool Historical Performance:  1, 2, 3, 4 and 5-year average annualized compound returns of the NFC Tactical Asset Allocation Pool, on a cash basis, net returns based on actual fees and expenses incurred.  Dates:  September 4, 2013 to September 3, 2018.  Source:  Croesus software.  Returns are not guaranteed, and past performance does not predict future performance.

For the 5-year period ending September 3, 2018, the NFC Tactical Asset Allocation Pool has generated an average annual return of 7.31% per year after all fees and expenses have been drawn.

To put these figures into context we can measure them against several market indexes and sample portfolios.  Let’s first look at how some common market indexes performed during this same period of time.

Table #2:  NFC Tactical Asset Allocation Pool vs. Common Indexes:  1, 2, 3, 4 and 5-year average annualized compound returns of the NFC Tactical Asset Allocation Pool compared with the Canadian DEX Bond Index, the TSX Composite Index (Canadian Stocks) and the MSCI Global Index (Global Stocks).  Dates:  September 4, 2013 to September 3, 2018.  Source:  Croesus software.  Returns are not guaranteed, and past performance does not predict future performance.

For the 5-year period ending September 3, 2018, the NFC Tactical Asset Allocation Pool generated an average annual return of 7.31% while during this same period of time the Canadian Bond Index, the TSX Composite Index (Canadian Stocks) and the MSCI World Index (Global Stocks) generated a 5-year average annual return of 3.57%, 5.15% and 7.97% respectively.  This means that the NFC Tactical Asset Allocation Pool as a balanced investment portfolio generated higher returns than the Toronto Stock Exchange composite index during this time, and a slightly lower return than the MSCI World stock market index.

Needless to say, we are pleased with these results.

But let’s continue the evaluation and consider the potential returns of some alternative investment portfolios during this same 5-year period of time.

Table #3:  Possible Comparable Portfolio Outcomes:  1, 2, 3, 4 and 5 year estimated portfolio returns based on the data in table #2, compiled into different portfolio combinations.  September 4, 2013 to September 3, 2018.  Source:  Calculated by Nelson Portfolio Management Corp.  Returns are not guaranteed, and past performance does not predict future performance.

The above table is meant to put the returns of the NFC Tactical Asset Allocation Pool into further context by comparing it to alternative sample Conservative, Balanced and Growth oriented portfolios based on the raw data in Table #2.  We can see that the 1, 2, 3, 4- and 5-year compounded returns of the NFC Tactical Asset Allocation Pool outperformed each of these sample portfolios in all time periods.

The table below shows the degree to which the NFC Tactical Asset Allocation Pool generated higher returns than the comparable, sample portfolios over the past 5 years.

Table #4:  Possible Comparable Portfolio Returns (5 Year Average Annual Compound Returns Are Shown):  5 year calculated returns, compiled into different portfolio combinations, ending September 3, 2018.  Source:  Calculated by Nelson Portfolio Management Corp.  Returns are not guaranteed, and past performance does not predict future performance.

This table shows that the 5-year average annual compound return of the NFC Tactical Asset Allocation Pool is 58% greater than our comparable sample Conservative portfolio, 44% greater than our comparable sample Balanced portfolio and 33% greater than our comparable sample Growth Portfolio.

Another important consideration is the amount of risk that was needed to create these results.  Did the NFC Tactical Asset Allocation Pool take on more risk to generate these higher returns?

Below you will see a Risk & Return Analysis Report of the NFC Tactical Asset Allocation Pool for the 5-year period ending September 3, 2018, generated from the Croesus software.  The 5-year standard deviation of the pool is calculated be 3.78%.  By comparison, the DEX Bond index (Canadian Bonds), TSX Composite Index (Canadian Stocks) and the MSCI World Index (Global Stocks) are shown to have a 5-year standard deviation of 4.46%, 7.43% and 9.54% respectively.

This means that the NFC Tactical Asset Allocation Pool had a lower level of risk and volatility over this 5-year period, compared with these other indexes.

Taking it one step further, the 5-year standard deviation of our sample Conservative, Balanced and Growth portfolios above are as below in Table #5.

Table #5:  Possible Comparable Portfolio Risk (5 Year Standard Deviation Figures Are Shown):  5 year calculated standard deviation based on the data in Image #1, compiled into different portfolio combinations, ending September 3, 2018.  Source:  Calculated by Nelson Portfolio Management Corp.  Returns are not guaranteed, and past performance does not predict future performance.

This table calculates that the NFC Tactical Asset Allocation Pool generated its returns with 35% less risk than the comparable sample Conservative portfolio, 41% less risk than the comparable sample Balanced portfolio and 46% less risk than the comparable sample Growth portfolio.  This is good!

Image #1:  Risk & Return Analysis Report:  NFC Tactical Asset Allocation Pool vs. the DEX Bond Index, TSX Composite Index, MSCI World Index.  Dates:  September 3, 2013 to September 3, 2018.  Source:  Croesus Software.  Returns are not guaranteed, and past performance does not predict future performance.

It is very rewarding to see that the core of our portfolio management process, the NFC Tactical Asset Allocation Pool, has generated investment returns greater than many comparable investments, but at a lower level of risk.

As I have mentioned in many of our quarterly commentaries these past 5 years, we are very pleased with these results.

But perhaps the bigger question is, how did we achieve these results and what can we do in the future?

From our perspective, consistency in everything we do is really important.  For example, over the past 5 years:

• Michael Webster (on my team) and I have consistently met each week;
• Mike and I have reviewed the markets, our portfolios and securities in a consistent manner;
• We have consistently applied a 6-step investment evaluation process so that we can consistently compare securities over time;
• We have consistently entered and exited positions gradually;
• We have equal weighted our strategies so as to help minimize risk; and
• We have employed an active stop loss strategy, that we also feel has helped to protect capital along the way.

Our overall portfolio management process has not deviated much over these past 5 years, so we are going forward with the confidence that our process has been consistent over time in both good markets and bad.  Today we continue to seek out software tools that can help us implement our process more quickly and more thoroughly across a broader range of securities.

On this anniversary I would definitely like to acknowledge and thank Mike Webster for all of his contributions in assisting me with the success of our portfolios during the past 6 years.  Thanks Mike, it is a pleasure working with you.

What Have We Been Up to Over the Past Several Months?

Over the past several months we have been working on five important initiatives:

1. Using technology to help us stay on top of and manage our increasing regulatory requirements. This means to you that from time to time you will receive from us an electronic message asking for your quick feedback on a couple of items.  Answering these questions in a timely manner will help us meet our requirements efficiently.
2. Lynda Perrick is working on her Chartered Investment Manager (CIM) designation. Throughout 2017 and 2018 she has written several exams and expects to complete the program in the coming months.  Lynda’s expanded skillset enables Mike and I to delegate many additional portfolio analysis responsibilities to Lynda.  Thank you to Lynda for expanding her skills in this very important area and filling a key role in Nelson Portfolio Management Corp. today and for many years to come.
3. Enhanced portfolio analysis: As mentioned in previous commentaries, we have made an investment into a new software tool called YCharts (ycharts.com).  This tool gives us access to a great deal of analysis on over 50,000 North American stocks, exchange traded funds and investment fund products.  One of the outcomes is our ability to provide a more thorough and timely analysis of our individual client portfolios.  We feel that this will be a very effective tool and process to help ensure we continue to meet our portfolio management objectives.
4. A new customized version of the Croesus software: Over the past five years the Croesus software we have been using has been part of a shared environment at the National Bank.  This means that we have less control on how to customize the software for our own purposes because it is one software version that is used by hundreds of advisors.  At this time, I am really excited to share that we have entered into a process with the National Bank and Croesus to have a more custom environment established for Nelson Portfolio Management Corp.  This means that we will be making some changes to the look and feel of our statements, which helps to ensure that all securities held in your portfolio are properly categorized.  This has been on my priority list for close to three years now.  I expect that by Christmas you will see the fruits of our labor.
5. Nicole Ross is the newest member of our team, in her role as Administrator and Client Services coordinator for Nelson Portfolio Management Corp. Nicole comes to us with over 15 years of banking experience and plays an integral role in expanding both our use of technology as well as our client contact initiatives.

As you can see, our goal is to have competent and capable people accessing sophisticated technology tools.  These projects are always on-going, and I am very proud of both our team and our systems.

Where Do We Go from Here?

Well, our next big initiative will be our expanded office space.  As of January 1, 2019, we will be occupying both our current space and the space next to us.  This will give us a total of close to 2000 square feet and enough room for 8 full time people.  We have signed a new 7-year lease, which will give us plenty of room to grow over this period of time.  We are very pleased that we could stay in our current location yet expand our office space without having to make significant changes.  The construction starts in December and we expect to be ready to occupy the new space just before Christmas.

Yes, the last 5 years have been very significant.  We had a vision on how to create portfolios of lower risk and lower cost, that would in turn potentially create more consistent returns over time, customized to our client’s personal situation.  Looking at the statistics provided in this Special Edition Commentary, I believe that we have achieved this goal and I am very proud of our results.  It is certainly never easy, nor are things ever as perfect as we’d like them to be.  Yet, with all of the small bumps along the way it is very satisfying to see the higher returns with less risk.

It is also very satisfying to look at the level of sophistication we are using today in the day to day management of our operations and the portfolios.  It takes considerable time and resources to put these things in place, and then to find the people that are just as passionate about our vision as I am.  Looking at both our team and our technology today, we are well positioned for the years ahead.

Finally, looking back over the past 5 years I owe a huge thanks to our clients.  Thank you for believing in this same vision and for the trust and confidence you have had in my team and I to manage your hard-earned savings.  We know how hard you have worked to get to where you are today, and we know that you are looking for an investment partner that treats your hard-earned savings with the respect and accountability it deserves.  We take this responsibility very seriously and we continually strive to do better each and every day.  With great humility, thanks again for the opportunity to do this important work for you.

If you have any questions or concerns about your personal portfolio, please let me know.  I would be happy to meet with you at any time.

All the best!

Doug

Announcements:

• Welcome Aboard Nicole Ross! Nicole is the newest full-time addition to our team, taking over duties from Lorraine Goldring.  Nicole joined our team in mid-May, and is responsible for all portfolio administration and client service initiatives.  Nicole comes to Nelson Portfolio Management Corp. with over 15 years of related banking and customer service experience.  We are very pleased to have Nicole join our team.

With Nicole’s addition to the team, this additional support helps Lynda Perrick, Portfolio Services Specialist, continue to develop her portfolio analysis expertise through Doug’s guidance.  Lynda is studying for her Chartered Investment Manager designation.

Nicole will also help NPMC expand some of its customer service initiatives, helping us to be in contact with you more frequently and addressing your administrative questions in a timelier manner.  Please check out Nicole’s profile on our website.

Nicole is available to help quarterback your administrative requests while also helping you get in touch with the right person on our team.

• Welcome Aboard Henry Letkeman! Henry is also a new addition to our team, taking over duties from Anne Gendzelevich.  Anne joined our team in the fall of 2016 on a part-time basis as our business bookkeeper and to assist with the oversight of several internal policies and procedures.  Anne and her husband are beginning to phase in their retirement plans, which gave us the opportunity to transition this to a full-time role.  Henry is a CPA – CMA who will assist Doug in the day-to-day operations of Nelson Portfolio Management Corp., including areas such as bookkeeping, financial management and compliance.  As Nelson Portfolio Management Corp. continues to grow, we continue to expand many of our core roles and are excited to welcome Henry to the team.  Henry has 30 years of small business advisory experience.
• Secure Quarterly Statements: Version 2.0: We are now sending to you your quarterly portfolio statements in a slightly different manner. We have set up for each client family a secure and encrypted file folder using the Microsoft One Drive. In this folder, all historical portfolio statements will be stored. In this way, should you wish to access previous portfolio statements, you may do so at any time. As a second level of security, your report will now contain a password. The password will be the year of birth of the older spouse. As a third level of security, the report will not be sent as an attachment to your email. Instead, you will be sent a link to your unique folder once your statement is ready for viewing. Finally, as a fourth level of security, we will be able to retain records the extent to which you are viewing your statements. This will help us ensure that we are providing to you the information you wish in the way you most wish to receive it. Our objective is to continually explore ways to provide to you meaningful and timely statements, in a safe and secure manner. Please send us your feedback on this new, enhanced approach.
• Discrepancies between the Nelson portfolio reports and the NBIN (National Bank Independent Network) monthly statements: We see that in some cases there are some small discrepancies between the total portfolio value seen on the Nelson statements and the NBIN monthly statements. In most situations these discrepancies are caused by the timing of when the NBIN statements are produced and when the data concerning the quarterly distribution for the NFC Tactical Asset Allocation Pool is provided to NBIN. This is a timing issue and not an error. Should you have any questions or concerns, or if you identify other discrepancies, please let us know immediately.
• Paper vs. Secure E-Mail Link: It is NPMC’s preference to provide to you this quarterly portfolio package by e-mail. However, if you would like to receive this package in paper format, please let us know and we will accommodate your preference accordingly.