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U.S. portfolio manager Ben Carlson predicts that the three biggest investment trends for the 2020s will be custom indexing, ESG, and defined outcome investing.

Custom, or direct indexing is the one that worries me a bit. Mr. Carson describes how it works, “The difference between direct indexing and simply owning a low-cost index mutual fund or ETF is the ability to customize your indexes to adhere to certain rules, exclusions or tax situations.”

The initial emphasis for custom indexing in the U.S. will be on tax minimization – realizing losses to reduce capital gains tax, and that makes sense.

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My concern is that brokerages aren’t able to stop themselves from building more and more complicated products and portfolios once a trend takes hold. It won’t be long until, for example, custom portfolios will limit weightings of high price to earnings ratio stocks, and this might make them little different from underperforming actively managed value funds.

One of the biggest investing epiphanies I’ve ever had came from famed Legg Mason fund manager Bill Miller. Early in his career, after a period of underperformance, Mr. Miller realized that indexes like the S&P 500 weren’t passive, but actively managed. He then attempted to discover why the criteria underlying the selection of companies for equity benchmarks led to better performance than fund managers.

Mr. Miller observed that a degree of index outperformance resulted from a lack of tinkering with winning stocks. Once a company was added to the index, it was left alone – no trimming for valuation purposes or because it grew to a large percentage of market capitalization.

Related academic studies have shown that the more transactions an investor makes, the lower their expected returns. A 2000 study published by University of California professors was titled Trading Is Hazardous to Your Wealth.

To the extent that custom portfolios just manage tax liabilities, that’s fine, but otherwise they will involve the same risks as over-trading an equity portfolio. Every customization criteria acts as a stock selection transaction, reducing the probability of meeting benchmark returns. For this reason, I think custom portfolios as a trend will have limited success.

-- Scott Barlow, Globe and Mail market strategist

This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.

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Stocks to ponder

Extendicare Inc. (EXE-T) Despite the pandemic and the way that it was ripping through some nursing homes, it was our focus in May. Just over $6 then, it has gone up more than 10 per cent. That does not include the fat dividend that yielded 8 per cent at the time of the article and continues to pay 4 cents a month. It was one of the stocks that panned out for the Contra Guys in a turbulent year. (for subscribers).

The Rundown

What made investors angry in 2020? Bad phone service from online brokers

In 2020, demand for talking to a live agent swamped the capabilities of some firms to provide timely service. I hear that all the time from investors by e-mail and through social media, and it seems to me that the No. 1 complaint in 2020 was long waits in a queue to speak to a live representative at an online brokerage, writes Rob Carrick (for subscribers).

From automation to Bitcoin, Canadian investors see opportunity in 2021

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Canadian fund managers are revamping their portfolios, picking cyclical stocks that could benefit from a return to a more typical economy in the coming year, as COVID-19 vaccines roll out and central banks provide a historic level of stimulus. Fergal Smith and Maiya Keidan of Reuters look at some of the changes (for subscribers).

Investors bet weak U.S. dollar will keep risk rally going in 2021

Investors are counting on a weakening dollar to boost rallies in everything from U.S. stocks to emerging markets and industrial metals in 2021. Record-low U.S. interest rates, massive financial stimulus and a growing appetite for risk are among the catalysts that contributed to the dollar’s 6% drop against a basket of its peers year-to-date, putting it on track for its weakest year since 2017. Reuters’ Saqib Iqbal Ahmed reports (for subscribers)

‘Stay-at-home’ trade still has legs in 2021: top mutual fund managers

The “stay-at-home” trade will not end next year even if the pandemic is defeated, according to managers of the top-performing U.S. mutual fund managers of 2020. They are continuing to bet on those stocks, according to Reuters’ David Randall. (for subscribers).

Others (for subscribers)

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Wednesday’s analyst upgrades and downgrades

Tuesday’s analyst upgrades and downgrades

Tuesday’s Insider Report: Additional selling activity is reported in this bank stock

These 10 TSX cyclical stocks roared back after vaccine news

20 dividend growth stocks that have weathered the storm

Corporate activists return ‘full steam,’ eye 2021, after pandemic muted activity

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Others (for everyone)

Supply squeeze won’t ease on global stocks and bonds in 2021

U.S. approves NYSE listing plan to cut out Wall Street middlemen

Globe Advisor

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Ask Globe Investor

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Question: Do the Canada Revenue Agency’s superficial loss rules, which you discussed in a recent column, apply to transactions in my tax-free savings account? I might want to sell a stock, even at a loss, in my TFSA because I’m sure I can repurchase the same stock a day or two later at a lower price.

Answer: Losses inside a TFSA (or any registered account) cannot be used to offset capital gains in a non-registered account. So, no, the superficial loss rules don’t apply to TFSAs. The CRA doesn’t care if you sell a stock in your TFSA and buy it back a few days later, a few weeks later or a few months later. You can’t use the loss under any circumstances.

-- John Heinzl

What’s up in the days ahead

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Globe Investor Staff

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