The Myth of Waiting Until Year End to Invest in Flow-Through Shares

I am not sure where this idea got started with investors. I suspect it started many years ago in the seventies or eighties when there were lots of “Tax Avoidance” structures available to investors. Some of these “schemes” were legal, some were technical loopholes in the tax code and some were outright frauds. Most were not investments, or at least not market-based, so sitting on the sidelines until year end did not affect the ultimate purpose and outcome of these structures. Also, during this period, interest rates were very high so keeping your money in an interest bearing investment until the last possible second made good economic sense.

Then things changed, loopholes were closed, the CRA started cracking down, auditing and reassessing aggressively until now the only legal ways of avoiding taxes in use by the general public are government designed programs such as the RRSP, TFSA and Flow-Through share programs and most recently the FHSA. During this time of government crack down on unapproved tax schemes, interest rates have steadily fallen to near zero for 1 year interest rates essentially eliminating any economic incentive to wait.

Many studies and examples have been created to show investors why contributing early to RRSP plans creates larger plan values over the long haul. We have all seen them. This same logic and compounding math also applies to Flow-Through investing since it is also market based. This all boils down to a time-in-the-market argument; the longer you are invested, the better your expected returns should be.

With Flow-Through investing there are also other reasons related to the logistics of the investment process itself that makes investing early much more likely to produce better long term results. In order to qualify for deduction from an investor’s current year income, Flow-Through investments must be invested before the end of business on December 31st in that year. This applies to the portfolio of the fund itself not just an investment into a Flow‐Through fund. This means the fund must receive the dollars from the investor AND get those dollars invested in Flow-Through shares before year end. This fact creates a challenge for the portfolio manager to invest effectively as the yearend approaches. When you couple this with the next issue you can see how favourable it is to invest earlier rather than later.

I want to discuss now the “Halloween effect” which has been popularized by the saying “Sell in May and go away”. Without turning this into a dissection of this market phenomenon or its potential causes, suffice to say that essentially what has been found in market return data is that virtually all of the returns of the stock market have occurred in the November to May period each year. This does not happen every year of course, but over time this is true. What further exaggerates this effect for Flow-Through investors is that most FT stocks are fairly volatile which means that they move more than the market average both positively and negatively so essentially the fall and winter is much better for producing returns and the summer is much worse. I see this anecdotally all the time in our portfolios and plan for it when calculating tactical timing for stock sales, avoiding selling in the summer as much as we possibly can. However, if late spring/summer is a poor time to sell it generally is a pretty good time to buy. And THAT is the number one reason why waiting until the last minute to invest in flow-through reduces potential returns.

When investors wait until fall to invest in Flow-Through they have done themselves a disservice in two ways. First, they have kept their money on the sidelines reducing the time in the market and second, because an FT fund must be invested by year end, the portfolio manager is forced to buy after the market statistically has rallied in most years, missing the late spring, summer, and early fall buying opportunities.

Do your clients a huge service and encourage them to invest early. As a portfolio manager, having the dollars available earlier to invest definitely gives me the opportunity to invest the portfolio at better prices than if I have them just a few short weeks or days before the end of the year.

At Accilent Capital, in order to encourage investors to do this, we have included a simple feature in our Flow-Through funds which is the ability of the General Partner to accept orders of less than the minimum amount. We only use this power to allow an investor who has previously invested with us during the year to “top-up” their investment later in the year so as to optimize their tax saving based on their expected income as they know more as the year comes to a close. This feature can help eliminate reluctance on a buyer’s part to invest early because they don’t know for example if they want to invest $20,000 or $28,000 in Pavilion Flow-Through based on their income expectations. The solution; invest $20,000 or $25,000 now and later in the year, they can invest the balance, if needed, even though it will be less than the investment minimum. At least in this case the client has made the bulk of their investment early.

As a last point it should always be kept in mind that Accilent Capital’s Pavilion funds do not accept an unlimited amount of investment dollars. In order to preserve the integrity and performance of our investment thesis we will limit new investments when our annual capital raise is into the $25mm area. Clients who wait too long may find that we have reached our maximum for the year and are closed to new money.

Now, as one of my colleagues rightly pointed out “Maybe the reason people wait until the last minute to invest is because they just tend to procrastinate on these things.” This may, unfortunately, be the closest to the mark on why but I hope the points I have included here will help you educate clients of why acting early is statistically and logically better.