Hot Off the Web– November 1, 2010
Personal Finance and Investments
Eleanor Laise in the WSJ’s “New ways to create a gold-plated pension” discusses a move from a returns chasing approach toward liability-driven investing (LDI), whereby much like pensions are supposed to do (but don’t always do) assets are chosen to mirror (duration of) liabilities. The bottom line is: (1) save more (high returns won’t save you), (2) protect your income requirement for the next 5-10 years with cash and bond/GIC/CD allocations or as Zvi Bodie recommends buy annuities to cover “basic expenses”, (3) watch corrosive effect of investment costs/fees, (4) keep taking 4% of starting retirement assets adjusted for inflation and you could end up in the poor-house after a significant market drop (try instead to make do with <4% of current assets annually), (5) when approaching retirement understand your expenses and develop your plan aiming to maintain your post-retirement expenses in line with pre-retirement ones, (6) hedge against inflation (TIPS, real estate, commodities and equities) and (7) provide feedback tools to measure financial readiness for retirement in terms of projected retirement income rather than assets. (Article at least touches on a lot of what many would argue are good practices that you might consider in your financial planning.)
Jason Zweig in WSJ’s “Have you herd? Your adviser is scared to set you straight” writes that instead of exercising independent judgment advisers are often just following the herd. Pension plans dropped their equity allocation from 69% in 2007 to a recent 45%. Advisors shifted from 26% of bond and cash allocation in October 2007 to 51% by Mach 2009. Market valuations alone do not explain the change. Instead of driving their clients to rebalance their portfolios, advisers allow the clients’ greed and fear to direct allocations. “One danger is that if you (the client) voice a strong opinion, your adviser might not give you a second opinion. He might merely echo your own, making you think he is smart because he agrees with you—and clearing the path of least resistance to his next commission. Sometimes, acting like a sheep just pays better.”
In the WSJ’s “Warning: Retirement disaster ahead” Brett Arends reviews Research Associates’ West and Arnott’s paper “Hope Is Not A Strategy“. They argue that “the return for almost any asset class can be broken down into income, growth (real growth plus expected inflation), plus changing valuation multiples. This leads them to the conclusion that expected returns of stocks and bonds are nominal 5.2% and 2.5% respectively, which for a 60:40 asset mix lead to about 4.5% rather than the assumed 7-8% portfolio return expectations in typical 401(k) and DB pension plans. “Bottom line? Neither pension funds nor private investors seem to have fully absorbed the grim lessons of the past decade. Returns are going to be much lower. People need to save more, much more, for their retirement. If the market rally this year has given them false hope, it will have turned out to be a curse more than a blessing.” (Thanks to SI for recommending the article.)
Inflation/deflation balance shifting? Gongloff and Blumberg in WSJ’s “Yield on TIPS go negative” report that “If negative TIPS yields reflect anxiety about inflation, then that suggests the Fed may be succeeding. Deflation is partly a result of consumers delaying purchases because they think prices are going to fall.” The Financial Times’ “US Treasury sells negative-rate bonds” also mentions that Goldman Sachs is preparing to sell 50 year 6.25% bonds! In the Financial Post’s “Time to get real about returns” Michael Nairne discusses the impact of the current low real interest rates on seniors and the inflation risk that they are carrying. “Today’s rates incorporate an expected annual inflation rate in the order of 1.5%. If actual inflation ends up higher, the real interest return will be further diminished, and may even go negative.”In WSJ’s “Beyond TIPS: Ways to play inflation”Ben Levinsohn writes that TIPS surprisingly have low correlation to the consumer price index and if inflation suddenly takes off, then the Fed will raise interest rates quickly which will drive bond prices down even with inflation protection (as in US TIPS and Canadian RRBs). He suggests commodities and currencies (not US$) are might offer better inflation protection.
Jonathan Chevreau reports that Markopolos author of “No one would listen: Harry Markopolos on Madoff affair” was in Toronto the past week. You might want to read Markopolos’s book. (See my notes on the book at “No one would listen: A true financial thriller”)
In the Financial Post’s “Investors faced with too many complex ETFs” Jonathan Chevreau writes that worldwide ETF assets will pass $2T; in 2011, in U.S. there is a 10% penetration, but only 5% in Canada. He quotes various observers about the proliferation of more and more niche products that often investors don’t even understand what they are buying. Costs also rise with the complexity of the offerings. (Smart investors however stick with broad index low cost, highly liquid ETFs, and will disregard all the noise of the other 95%+ of the products.)
David Berman in the Globe and Mail’s “Long-term investing is not so long” writes that “70 per cent of all trading volume is due to high-frequency trading (HFT) by computers, and the average holding period is 11 seconds.” According to NYSE data mean duration of holding period by U.S. investors was 7 years between 1940-1975, 2 years in 1987, 1 year in 2000, and 7 months in 2007 (these include HFTs)
Real Estate
The August 2010 Canadian Teranet National Bank House Price Indexshows a 10.4% price increase over August 2009 in the six city index but an only 0.2% (2.4% annual rate) increase over July 2010, suggesting a significant deceleration in appreciation. Calgary (-0.5%) and Vancouver (-0.4%) were the only two cities showing a price decrease over July, while Ottawa (+1.4%) showed the largest month on month increase.
The just published August Case-Shiller Home Price Index data “show a deceleration in the annual growth rates in 17 of the 20 MSAs and the 10- and 20-City Composites in August compared to what was reported for July 2010. The 10-City Composite was up 2.6% and the 20-City Composite was up 1.7% from their levels in August 2009. Home prices decreased in 15 of the 20 MSAs and both Composites in August from their July levels”. Only Chicago, Detroit, Las Vegas, New York and Washington among the 20 cities included in the index show increases over July.
In the WSJ’s “Housing gloom deepens”Nick Timiraos reports on NAR’s September data (which does no pair matching of homes like Case-Shiller) that while sales were up 10% over August they were still weak. The article contains a table with inventory change, months of supply, price change, jobless rate and loan repayments overdue for 30 cities/areas.
The Globe and Mail’s Steve Ladurantaye reports in “Realtors ratify deal to give consumers wider choice of services” that the CREA “allows sellers to hire an agent to post their property on the MLS and then conduct the rest of the sale on their own, if they choose”. However in the Financial Post’s “CREA cartel not broken yet”Peter Foster says not so fast. “The system is still arguably rigged….the deal leaves much of CREA’s control intact. Access to the MLS is still restricted. There also remains a two-agent system that leaves the conflicted role of the so-called “buyer’s” or “co-operating” agent unresolved. This agent almost invariably winds up being paid by the seller, which represents an enormous conflict of interest. If she can continue to demand a flat 2.5% from the seller before passing on information to “her” buyer, then the system is still essentially rigged.”
In the Palm Beach Post Kimberly Miller reports that “Palm Beach County home sales up 7 percent”in September, but prices are down 7% from previous year and 1% from previous month.
The Herald Tribune’s “How Bermuda rigs insurance rates in Florida” discusses how unregulated Bermuda based reinsurance companies are legally but opportunistically manipulating Florida’s insurance market creating a temporary shortage of supply driving up insurance rates for their profit.
Pensions
In the Globe and Mail’s “Ontario report calls for boost to pensions” Janet McFarland reports that “Ontario’s recipe for improving Canada’s pension retirement system includes both modest improvements to the Canada Pension Plan and new pension innovations from the private sector…” While the report is encouraging in that it shows a recognition of the serious problems with Canada’s pension system and is a directional statement from the governments thinking on possible solutions, however it is just a first step; the CPP proposals will be phased in over 40 years (not much help for those near or in retirement) and the non-CPP “innovations” are still TBD. (As usual the devil is in the details.) The government is looking for feedback before November 29, 2010. (I plan to do a blog on the report, later on in the coming week.) The Toronto Star tackles the Ontario report in Rob Ferguson’s “Duncan asks Ontarians for pension advice” emphasizing the report’s discussion on the impact of high mutual fund fees on Canadians’ retirement assets. (Thanks to DF for referring the article.)
Sophia Grene’s Financial Times article “Why assets alone won’t help to avoid checkmate” advocates that defined benefit plans “should focus on their funding ratios rather than purely on growing their assets…a combination of demographics, a changing pensions landscape and a new awareness of risk means pension funds are now moving towards a decumulation phase”. “You can’t steer any more with the contribution rate…You will be more or less rudderless if you don’t focus on the liabilities… (it is expected the) debate to lead to changing pension contracts to weaken vested rights both for currently contributing scheme members and even those already in retirement…It’s very difficult not to talk about intergenerational transfers of wealth – younger people should be extremely angry about the amount of money they’re putting in.”
Things to Ponder
Gregory White writes in the Financial Post’s “It’s over: Bill Gross declares the 30-year bond bull run at an end” quoting Pimco’s Gross that “The Fed, in effect, is telling the markets not to worry about our fiscal deficits, it will be the buyer of first and perhaps last resort. There is no need – as with Charles Ponzi – to find an increasing amount of future gullibles, they will just write the check themselves…The impact of this political mess and QE2 is extremely limited returns for investors in the bond market (and the stock market too). That’s because the combination of inflation and negative interest rates is creating a uniquely bad environment for bondholders, according to Gross.”
In Bloomberg’s “Gold will outlive dollar once slaughter comes” John Hathaway writes that “whatever the playbook promises, the capacity of financial markets to overshoot can’t be overestimated…The breakdown of the monetary system will be chaotic. When inflation commences, it will be highly disruptive. The damage to fixed-income assets will seem instantaneous. Foreign-exchange markets will become dysfunctional. The economy will become even more fragile and unpredictable. Gold is an imperfect, but comparatively reliable, market gauge for the extent of current and future monetary destruction. “
Also on the subject of gold, John Authers in the Financial Times’ “Remember 1980: All that glister is not gold” writes that gold’s “intrinsic value is in the eye of the beholder. And the case for and against gold tends to get mixed up with both ideology and emotion.” “For true believers, gold is the ultimate store of value, a constant in a world laid waste by irresponsible central banks, politicians and financial engineers. But it is equally possible to argue that gold is the ultimate speculation. Under the usual definition, “investment” turns into “speculation” when investors no longer look at the underlying value of an investment but rely on the price to rise so that they can sell it to someone else. By this definition, gold is always a speculation. There is no income stream to be derived from gold, in the way that dividends come from stocks, rents from properties and coupons from bonds….Gold could indeed be insurance against runaway inflation, but even its truest believers should also guard against the risk of deflation.” Yet another perspective is expressed by Gillian Tett in the Financial Times’ “Follow the yellow brick road”where she argues that “when faith in banks – and most other forms of modern financial institution – crumbled, the system almost broke down. And now, as western national debt levels spiral, faith in government is also wobbling – or, more accurately, faith in the ability of the state to honour its debts and maintain the value of money. That plays into the Gold Bugs’ hands. After all, the value of gold does not depend on Big Government. It seems tangible; it is readily understood; it appears to have permanent, immutable value. That is attractive, particularly in a world where investors are reeling from the vagaries of excessively complex, disembodied cyber-finance.”
In the Globe and Mail’s “Mark Carney open to changing Bank of Canada’s inflation policy” Bill Curry reports that Bank of Canada governor is considering a shift away from “2% as the target rate of inflation in Canada” to a “price-level targeting…(which) means that if inflation comes in below or above the 2-per-cent target, bank policy should try to make up that difference in the future.” (I.e. lower inflation today means higher inflation in the future.) “The positive aspects would be more predictability as to how prices will rise over time, because the long-term climb will not be thrown off by years with unusually low or high inflation. However the concern is that trying to make up for missed targets would lead to volatile interest rate decisions.” (Are we setting up ourselves for happily accepting higher inflation to make up for recently lower inflation, and have seniors pay for the higher inflation as discussed in Deflation: Impact on retirees? Is it necessarily bad? and Senior Inflation)
Nicholas Pratt in the Financial Times’ “The risk of value at risk” writes that Value at Risk (VaR) measures “of little use in cases of extreme market behaviour because of the lack of historical data and the limitations in backtesting. Therefore the higher the level of volatility, the lower the level of confidence in the VaR figure.” “All models include flawed assumptions so we run fairly basic models and ensure that we understand the limitations. We then use stress tests to assess where the tail risk lies and try to make sure these are extreme yet plausible.” (Yes, portfolio stress testing is essential to measure worst case scenarios.)
The Economist Daily Chart in “The usual suspects” provides an interesting looks at countries around the world measuring public sector corruption. Canada with a sore of 8.9 is 6th on the list of over 170 countries while the U.S. measurement deteriorated to a score of 7.1 which puts it in 22nd position. (Interesting data, though difficult to tell to what degree the measures between various countries are true apples to apples comparisons.)
In the Financial Times’ “Emerging nation a beacon of opportunity”Jerome Booth argues that much of the hand-wringing about possible emerging markets bubble is all wrong. He argues that “cap-weighted indices of publicly listed securities (typically misnamed “investible”) are a very poor representation of global investment opportunities. A better measure of global economic activity – and hence the full universe of investment opportunities – is past income – GDP, and that implies 50 per cent allocations to emerging markets.” (Current emerging market allocations are low even by market cap measures (13%), even lower by GDP based measures (32%) and even lower if the GDP was PPP measured.)
James Mackintosh writes in the Financial Times that “Insuring against equity loss is too dear”. “The question for investors is how much it is worth paying for peace of mind. Fire or theft cover is typically so cheap relative to the value insured that it is worth buying. For equity portfolios, that is not the case. Even alternative insurance methods are fairly expensive, and cheaper cover provides less effective protection. Taking out cover through the derivatives market is so expensive that it becomes an active bet that prices will fall. Just as with any other investment, if that bet does not pay off, the portfolio will suffer…When people are overpaying for insurance, it is time to be an insurer: to sell the protection others are buying.”
And finally, in the NYT’s “To retire in this weak market, the magic word is ‘focus’” Tara Siegel Bernard looks at some necessary considerations for people who are mentally ready to move into retirement but their portfolios haven’t yet recovered. The topics covered are: prioritizing life goals (envision retirement in general? how about if you only had 5 years to live? what about only 24 hours?), reducing investment costs and living expenses (consider musts/wants), understanding pre-retirement expenses (i.e. tracking all expenses by categories for at least a year), creating an emergency (3-6 months of expenses) and a reserve fund (3 years of expenses) with balance going for longer term investments.
RetirementAction.com 