Hot Off the Web- July 1, 2011

Personal Finance and Investments

In “How long will our retirement savings last” Walter Updegrave writes (in regard to the inflation indexed 4% rule) that “Start by recognizing that your ability to engage in more vigorous pursuits can diminish quite a bit with age. Indeed, some financial planners talk about three stages of retirement: the go-go years, up to age 75, when you may travel extensively and volunteer; the slow-go years, 75 to 85, when you scale back on such activities; and the no-go years, when you’re less active due to age and health. To every extent possible, you want to live large during that go-go phase… Ultimately, the key is being flexible and taking your spending cues from the size of your nest egg. If surging markets are boosting its value, you may be able to indulge yourself. If you’ve just come off a market downturn or string of lousy returns, foregoing an inflation increase or scaling back your withdrawals a bit will give your stash a better chance to recover.” (There is evidence that spending in retirement decreases with age as in Ty Bernicke’s “Reality retirement planning: A new paradigm for an old science”; except perhaps the last few years of life usually have a spike in expenses due to cost of medical care associated with illness and required long-term care associated with deteriorating health….so perhaps expenses might be more U-shaped than L-shaped.) (Thank to VP for referring article.)

In the Globe and Mail’s “Distribution rate does not equal yield” Dan Hallett warns that “perhaps the most common misunderstanding I notice among investors emerges when equating monthly distributions with true yield”. E.g. for iShares XSB(DEX Short-term bond index), “the yield-to-maturity (YTM) is the most meaningful piece of data on XSB’s profile page. The YTM was recently listed at 1.89 (2.11 when I checked it today) per cent per year. The fund’s 3.3 per cent distribution rate is real but it’s not the whole picture”. You must factor in fund expenses of 0.26%, leaving you with 1.63%. Of course there is also a (significant) risk to capital (interest rate increase resulting in drop of bond prices especially for mid/long-term bonds, or some of the bonds in the fund default , or risk premia for corporate or high yield bonds increase (most of these risks are unlikely to materialize in a significant manner for this fund. Bottom line: it is easy to get confused or forget about the point being discussed in the article; remember distribution rate is not equal to yield!)

In the Globe and Mail’s “How a trust can lighten the burden of raising a family” Tim Cestnick discusses the approach to and tax advantages of trusts (inter vivos and testamentary). He promises to discuss next week some of the finer points associated with trusts (Hopefully the disadvantages like costs and restrictions will also be covered, so one can understand trade-offs before one commits.) Coincidentally, the Financial Post also has an article on trusts that you might want to read if you are interested in the subject, entitled “Estate planning using a trust”.

In his Q2 report on “Investor Protection in Canada”Ken Kivenko discusses the depressing quarter for investors. He writes that “hundreds of millions of dollars were lost to unsuitable investments, excessive fees and unnecessary leveraging, misleading marketing materials, document adulteration, signature forgery and other wrongdoings by “advisers” and brokers.” His depressing report includes reference to the “threat from 5 investment dealers to dismember OBSI, Canada’s quasi independent Ombudsman service…(specifically) TD Waterhouse Canada Inc., Investors Group Inc., Manulife Financial Corp., Macquarie Group and RBC Capital Markets are out to dismember OBSI… over one thousand financial consumer complaints in a single year, according to OBSI’s 2010 Annual Report. In 2010 OBSI opened 1024 case files, an increase of 3.4% over last year” after a 48% increase in 2009.

In WSJ’s “Hotel’s discount rates can cost you plenty”Scott McCartney warns that you should watch out when booking discounted hotel rooms on Expedia, Travelocity or Orbitz as they often “come with non-refundable restrictions, so travelers who cancel get walloped with full cost of reservation”, and not with a $100-$150 cancellation penalty, as when you cancel a non-refundable flight where the balance of your payment is often available as a credit for a future flight.

In the Globe and Mail’s “How is fund manager performing?” Preet Banerjee discusses the difficulty of differentiating between skill and luck as the source of a fund’s performance. “In a recent newsletter, John West of Research Affiliates LLC indicated that it would take roughly 35 years before you could statistically identify outperformance due to skill as opposed to luck….(and) all funds put together look pretty close to the index, so if there are more fees to pay and higher tax drag due to higher turnover versus an index portfolio, then this naturally translates into lower returns to investors.”

Real Estate

The Canadian housing market is again firing on all cylinders (at least on a sample size of ONE month) according to the Teranet National Bank House price Index which for the just released month of April indicates that “Canadian home prices in April were up 1.1% from the previous month, according to the Teranet-National Bank National Composite House Price Index™. That rise took the index to a record 140.47 (June 2005 = 100). The April increase was the largest of five consecutive monthly rises following three straight monthly declines. For the first time in 10 months, prices rose in all six of the metropolitan markets surveyed. The gain was 1.8% in Vancouver, 1.4% in Ottawa, 1.0% in Montreal, 0.8% in Halifax, 0.7% in Toronto and 0.6% in Calgary.” Over the past 12 months the index was up 4.4%. “The largest 12-month rise was 7.5% in Ottawa, followed by 7.4% in Montreal, 5.8% in Vancouver, 5.3% in Halifax and 4.1% in Toronto.” And Mario Toneguzzi in the Financial Post reports that the research firm Capital Economics (which has been predicting a housing correction at least since start of this year) predicts that “Housing prices could fall 25%, research firm warns”over the next three years.

The just released April U.S. S&P Case-Shiller Home Prices Indices indicated the first increase in both the 10-city and 20-city Composites 0.8% and 0.7% respectively, but both indices were below 2010 levels by 3.1% and 4.0% respectively. “In a welcome shift from recent months, this month is better than last – April’s numbers beat March,” says David M. Blitzer, Chairman of the Index Committee at S&P Indices. “However, the seasonally adjusted numbers show that much of the improvement reflects the beginning of the Spring-Summer home buying season. It is much too early to tell if this is a turning point or simply due to some warmer weather… Existing home sales rose in May, but are still about 15% below last year’s pace and about 35% below their 2005 pace…. As of April 2011, average home prices across the United States are back to the levels where they were in the summer of 2003. Measured from their peaks in June/July 2006 through April 2011, the peak-to-current declines for the 10-City Composite and 20-City Composite are -32.6% and -32.8%, respectively.” (For Florida snowbirds) Miami and Tampa were both down in the month/year, -0.2%/-5.6% and -0.4%/-7.7% respectively.

However in Today MONEY’s “Upward blip in home prices- but don’t relax just yet” John Schoen writes that “spring is traditionally the housing industry’s best season. But a combination of weak consumer finances, falling confidence, tighter mortgage lending requirements and a huge inventory of foreclosed homes has kept a lid on sales and prices. As seasonal demand begins to fade, some economists think home prices will resume their downward trend… Demand is also being held back by an uncertain financial outlook, as wary consumers face the prospect of continuing high unemployment and stagnating wages.” In the WSJ blog “There was never a housing recovery”  reporting on a recent Q&A, Pimco’s Simon, head of MBS and ABS, predicts: another 6-8% decline in US home prices (if government doesn’t break anything in the process of trying to fix things, otherwise could be worse), another 6-7 million foreclosures on top of the 2 million that already occurred, and the continued government role as mortgage insurer is essential to prevent spike in mortgage rates.

In the Globe and Mail Rob Carrick discusses “Why renting can be the right choice for aging boomers”. The pros and cons are discussed. Some pros: capitalize (lock in) today’s value of the house, lower ongoing living costs (by one estimate “renters paying $1,500 a month may find they’re spending only $700 or so more than owners on a net basis”), return on recovered capital from sale of home. Some cons: low after tax “safe” government bond returns, risks associated with a more aggressive portfolio, less choice in rentals.


$4.5B was the final price of the Nortel intellectual property bidding as reported in WSJ’s “Ericsson consortium wins Nortel patents”. The Ericsson led consortium is reported to have been comprised of Apple, Microsoft, RIM, Sony and EMC. That’s wonderful news for Nortel’s creditors, considering that when it entered the CCAA process it apparently had $2.5B in cash and proceeds from asset sales, prior to this $4.5B sale, were about $3B, for a total of $10B. Various legal expenses many months ago have been reported to have been at about $1B at the time. So this might still leave $6-7B available for distribution allowing for other “costs” in the past 2.5 years. Creditor claims have been reported to be in the range of $11-24B (see Bert Hills recent Ottawa Citizen article), and there still are significant jurisdictional issues still outstanding. (This might suggest 25%+ recovery for creditors; if that’s true, it is the first piece of good news in the disaster that has befallen Nortel pensioners and long-term disabled since Nortel has entered creditor protection under CCAA process and then proceeded to sell itself off piece by piece and go out of business entirely, leaving lifetime employees’ pensions, health, life and disability insurance unfunded. Not great, but given current government’s refusal to give priority to underfunded pension trust funds, this is better than nothing. I have no doubt that a future federal government will rectify the gross injustice of not protecting earned trust funded pension obligations, by providing priority of pensions/deferred-wages over unsecured creditors.)

In the Globe and Mail’s “Pension plan funding improving in Canada” Janet McFarland writes that “The survey, scheduled for release Tuesday, found 85 per cent of pension plans reported they are at least 80-per-cent funded as of April, which means they have assets equal to at least 80 per cent of their estimated liabilities for providing pensions to members.” Given the past couple of year’s returns, pension plans’ concerns have shifted away from performance to inflation (if indexed in some way) and interest rates (discount rates for liabilities). For a more in depth look at Canada’s top 100 pension plans, see Benefit Canada’s “Risking it all”. (Is 80% funded level for Canadian pensions a time for celebration, especially if it might be a result of actuarial fantasies, plan administrators’ conflicts of interest, lack of regulatory competence and enforcement rigor, and all under the watchful eyes of the governments and courts? Is this going to end well??? With Nortel pensioners’ outcome we might be watching Act 1-Scene 1)

Things to Ponder

In the Financial Post’s “Negotiating retirement with your spouse”Linda Stern discusses challenges in retirement preparations “You would think that after a few decades of marriage, raising kids and going through the ups and downs of life together, retirement would be a cakewalk for couples. But you’d be wrong.” The suggested foundational elements in the article to a negotiated settlement on what, when, where, how (much to spend), and ifs of retirement according to Stern are : agree on the facts (available assets, who manages, adviser, cost), list of dreams (individual and shared), “learn to switch hit” (if finances are handled by one spouse and that cannot be changed, at least the other spouse must be kept in the loop regularly), “think creatively” and most importantly) compromise (if for no other reason than the quickest way to reduce your standard of living is to split up.)

In Fiscal Times’ “Core inflation rises- Interest rates may follow” James Cooper reports that U.S. core inflation in the month of May was up 0.3%, thought 2011 year-to-date core inflation was 2.4%. May’s is the “largest monthly figure in 5 years”! Autos and airfares increased at annual rates of 8.4% and 13.1% respectively”. (Thanks to CFA institute’s Financial NewsBriefs for recommending.) In Canada, according to the Financial Post’s “What will Bank of Canada do now?” “consumer prices are up 3.7% from year earlier… May marked the third-straight month for which annual inflation has been more than 3%, well above the Bank of Canada’s target rate of 2%… The core inflation rate, which factors out volatile items such as energy and certain foods, was 1.8%. Economists had anticipated 1.%. It was 1.6% in April.”

In the Financial Times’ “Dollar seen losing global reserve status”Jack Farchy reports that according to a survey of central bank managers, unlike in previous years’ surveys, the emerging view is that “The US dollar will lose its status as the global reserve currency over the next 25 years.” The World Bank’s Robert Zoellick “last year proposed a new monetary system involving a number of major global currencies, including the dollar, euro, yen, pound and renminbi. The system should also make use of gold.”

In an interview with WSJ’s Ronald Fink, Gary Gensler head of the CFTC (Commodity Futures Trading Commission) discusses how the “new rules will-and won’t affect how nonfinancial companies use derivatives” in “Keep on hedging”. Mr. Gensler explains that the value of the proposed Dodd-Frank reforms is intended to bring more transparency, democratization of information, “lowering risk of the big financial institutions so that they use on their standard transactions the benefits of what’s called central clearing, nonfinancial companies can continue to use swaps…..or go to clearinghouse???

In the meantime in Bloomberg’s “Investors may lose as Congress saves money on oversight”Leondis and Faux report that “Congress may hand oversight of almost 12,000 investment advisers to Wall Street’s self-funded regulator as a cost-saving measure. The price could be paid by investors. (It will be a sad day)… if brokers’ self-regulatory body FINRA will succeed in replacing the SEC as regulator of registered investment advisors (RIAs).  “They’re supposed to oversee the activity of the industry, but they are industry.”

In the Financial times’ “More pain than gain in funds innovation’Steve Johnson reports that financial innovation brought more pain than gain to pension funds. Innovations like: adding emerging market stock/bond and junk bond asset classes were positive, as were ETF developments. At the other end of the scale: leverage, structured products, currency funds and portable alpha have utterly failed. Leverage and structured products received special mention as having been “relied on to extract value “where there was none”.  The financial “industry is convinced that the greater take-up of commodity funds, hedge funds and ­global tactical asset allocation have been resounding successes, although these are concepts pension funds are more equivocal about…One anonymous respondent to the report said the crisis “will be the mother of introspection, not ­innovation”.

And finally, every day you read about the Greek financial crisis and how it might bring down the world economy (not obvious to me, other than this being a serious threat to the Euro, as countries in trouble could decide that the solution to their problems is default on the Euro debt and return to their old currencies, one by one). You may, have read last October (October 11, 2010 Hot Off the Web ) the  long but fascinating background story to the Greek financial crisis, on how community/individual psychology and behaviour, the life of Greek monks and their business strategy affected Greece’s economy in Vanity Fair’s article “Beware of Greeks bearing bonds” by Michael Lewis. It’s worth a (re-)read.


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