Grab the vino, it's year-end portfolio purging time

It's been a tough year, so what are you going to do about it?
Kevin O'Leary writes

By Kevin O'Leary
Globe Investor Magazine Online, December 22, 2008

Kevin O'Leary is the chairman of Gencap Funds LP, the Manager of the O'Leary Global Infrastructure Fund and the O'Leary Global Equity Fund.

No matter how good an investor you are, you made some big mistakes this year.

Why do I know this? Because in this remarkable bear market, almost every asset class has traded down. The question is: What are you going to do about it?

This is not the time to be a wimp; instead, face your mistakes and squeeze the last drop of value out of your portfolio by crystallizing your tax losses.

For me, this is a difficult ritual, and I hate to face the task alone. So I start by visiting my wine cellar to pick a trusty lieutenant that will go into this battle with me.

This year, my pick is a spectacular new world wine, Paul Hobbs 2005 Cabernet Sauvignon from Napa Valley. It's a boutique vintage and difficult to get, but its rich, nutty, cherry aftermath is exactly what you need if you have to look at a trading screen flickering red, full of your year's mistakes. The Hobbs's 14.9-per-cent alcohol content will also help dull the sting you will feel as you pull the trigger on these money-losing trades. It's simple - take a sip, then sell that stock. But before you open the bottle, make sure your selling strategies make sense. This is not my first recession or bear market, and experience has taught me a very valuable lesson about investing in times like these. The moment the market "smells" the end of the economic downturn, it is likely to move up violently.

It is not inconceivable that half the year's gains in the indexes will occur in seven or eight trading days. The problem is that you will never know when the days will come, so you have to stay invested. On the other hand, that does not mean you can't take your year-end tax losses. The key is how you take them.

Many Canadians got slaughtered this year buying bank stocks in the early summer, thinking that the worst was over. Instead, banks continued to punish their investors by pounding out billions of preferred and common shares, even as their stocks continued to trade lower. Manulife, another widely held financial, did the same thing recently. By doing this, they are confirming to their investors that their situations are horrific, because no manager would sell their stock at the low unless they had to . and they have to.

So I'm dumping all my Canadian bank stocks by year-end and taking the tax loss. With the proceeds, I'm buying the iShares S&P/TSX Financial ETF (TSX:XFN). This exchange-traded fund includes all the bank stocks, pays a 5.37-per-cent dividend and is a perfect hiding place for the next 30 days, in case the financials decide to make a move early in the new year. I can sell the XFN in February and re-establish my individual bank positions then.

I've lived through three commodities cycles. Here is the lesson I've learned. When commodities decide to correct, they don't touch the sides on the way down. In this cycle, oil prices have humbled many a commodity bull. Just last summer, many told me "it's different this time" and that oil prices would never go down again.

As always, it's not different this time, as it now seems certain that oil will soon trade below $30 (U.S.) a barrel. It's impossible to pick the top of any market, so I reduced my exposure to energy stocks significantly when oil first traded up and through $100. I watched in disbelief as oil went to more than $140 a barrel, painfully knowing that I left plenty of upside on the table. (Boy, this Paul Hobbs cab tastes good.) But lately, I have been nibbling on energy stocks again. My favourite "perma bull" oil guy is Marcel Coutu, the chief executive officer of Canadian Oil Sands. Marcel and I met at the University of Waterloo in the seventies, where he studied geology and I became the shuffle board champion while enrolled in the liberal arts program.

Later, we did our MBAs together at the University of Western Ontario's Richard Ivey School of Business. I like Marcel because he is cheap. He can't do anything about oil prices, but he is always looking for ways to cut corporate expenses so he can send more distributions to shareholders, and that's all I care about.

I bought some COS.UN at $34 and some more at $19.60. This week, I'll dump the tranche I bought at $34, take the tax loss, and, with the proceeds, buy some Suncor (TSX:SU), keeping my exposure and mining my tax loss.

These are just two positions I must deal with, and I have more work to do, but on the first trading day of 2009, my portfolio will smell like a newborn baby, because I will have whacked all my losers. Tax-loss selling is never fun, but it's a necessary purging every investor must make at year's end - and besides, it's a great excuse to raid the wine cellar.

Happy holidays.

Special to The Globe and Mail