Skip to main content
portfolio strategy

It's with mixed emotions that I inform you the Two-Minute Portfolio had a tremendous year in 2014.

The 2MP is an ongoing experiment in quick and dirty portfolio building that requires you to do nothing more than invest equal amounts in the two largest dividend-paying stocks in each of the 10 sectors in the Canadian stock market. This strategy produced a return of 23.95 per cent this year, while the S&P/TSX composite index made 10.55 per cent.

This no fluke. The people at Morningstar CPMS have built a database for the 2MP going back to 1986 and the average annual total return – that's dividends plus share price changes – has beat the index 11.19 per cent to 8.45 per cent. The 2MP has a tendency to lag index market in full-on bull markets, but outperform in moderately rising, flat and falling markets. Add it all up and you have gains in 26 of the past 29 years for the 2MP and 21 of the past 29 for the index.

Might this be too much success? I wonder. In close to two decades of writing about investments, I've seen many high-flying funds and strategies eventually revert to ordinary returns or worse. They call this pattern regression to the mean and it's a risk if you start up with the 2MP now.

Frankly, I'd rather see you buy an exchange-traded fund to fill the Canadian equity slot in your portfolio. I'll be updating my ETF Buyer's Guide in the weeks ahead, but for now you might look at the BMO S&P/TSX Capped Composite Index ETF (ZCN), the iShares Core S&P/TSX Capped Composite Index ETF (XIC) and the Vanguard FTSE Canada All Cap Index ETF (VCN). All give you exposure to a wide selection of Canadian stocks and have exceptionally low fees. Best of all, they're easy to buy. One trade at an online brokerage firm is all you need.

Let's deconstruct the 2MP's returns in 2014 and the previous few years. The portfolio includes only large companies, with zero exposure to the medium and smaller companies contained in the indexes tracked by the aforementioned ETFs. Big companies, notably those paying dividends, have been much more popular with investors than smaller, more speculative stocks. Net result: Higher returns for the 2MP than the more broadly diversified indexes used to track the Canadian market.

Also, stocks are equally weighted in the 2MP at 5 per cent for each stock and 10 per cent per sector. The S&P/TSX composite index weights stocks by their market capitalization, or share price multiplied by the number of shares outstanding. The consumer staples sector represents about 3.5 per cent of the index, which means the 2MP benefited much more from this sector's success in 2014. Likewise, the 2MP benefited from less exposure than the index to the weak energy sector.

These are structural issues that affect the 2MP every year. Unique to 2014 was a strange sequence of huge returns from stocks in the portfolio that hardly seems repeatable. Almost half of the 2MP stocks had gains of 20 per cent or more, and eight were up more than 30 per cent. Just two stocks fell on the year and one, Rogers Communications Inc., was down just 2.2 per cent on a total-return basis. Particularly notable is Constellation Software, which has been on a steady, dramatic rise since 2009. How long can this streak last?

Market conditions favourable to the 2MP have helped it outperform the index by 7.2 percentage points over the past five years, much more than the 2.2-point gap over the past 10 years and the slightly larger margin since inception. Here's another reason why caution is called for with the 2MP – it's been playing above its head for the past while.

We should acquaint ourselves with the dark side of the 2MP, such as it is. As noted, it has had far fewer losing years since 1986 than the index. Morningstar CPMS says the worst decline over any 12-month period was 23.6 per cent, versus 38 per cent for the index. In 2008, when the index fell 33 per cent, the 2MP fell 19.1 per cent. In 2002, the index fell 12.4 per cent and the 2MP lost 8.8 per cent.

The most egregious example of the 2MP underperforming was in 2009, the rebound year from the 2008 market crash. The portfolio was up 14.6 per cent, while the index made 35.1 per cent. But even then, the 2MP had better returns over the long term.

The 2MP's success reflects the fact that in the Canadian market, big blue-chip stocks rule. The two-minute strategy of investing in dividend-paying, large-cap stocks was tested in the U.S. market via the S&P 500 index and it failed as a result of its focus on too narrow a slice of the market. Here in Canada, you've succeeded brilliantly with just that approach.

Almost 30 years of history, including multiple stock-market crashes and some powerful bull markets, say the 2MP is a solid all-weather, long-term way to add Canadian stocks to your portfolio (note: you'll want U.S. and international exposure, too). Still, I worry about the kind of bad year that affects all investment strategies at one time or another.

Maybe stronger economic growth and rising interest rates will do it. The 2MP has a lot more exposure to rate-sensitive utilities stocks than the index, and it has a heavier weight of defensive dividend plays in the consumer staples and telecom sectors. Also, the 2MP might lag if energy stocks rebound sharply. The same 10 per cent cap on each sector that protected the 2MP when energy stocks fell in 2014 would be a drag on returns in a turnaround for the sector. The 2MP could also run into plain old bad luck. There's no reason the rampant double-digit returns from the portfolio stocks in 2014 couldn't turn into a series of double-digit losses.

Even an investing strategy that has done pretty much everything right can go wrong at some point. That explains my mixed emotions about the 2MP's great year.

Globe app users click here for a chart showing the Two-Minute Portfolio.

Click on image to enlarge