Hot Off the Web-September 2, 2009

Personal finance and investments

“Fiduciary duty hits the street-Sort of” “Currently, brokers are held to a more lenient “suitability” standard, which means they can’t put clients in inappropriate investments. Many investment advisers, by contrast, have operated under the fiduciary standard for nearly 70 years.” “Investment advisers want to extend the current standard under the Investment Advisers Act to all financial professionals who give investment advice, while the brokerage industry wants a new, federal standard to apply to any broker-dealer or investment adviser that provides personalized investment advice to clients.” “”For years, they’ve opposed the fiduciary duty,” said Barbara Roper, director of investor protection at the Consumer Federation of America, a consumer-advocacy group.”Now they’ve embraced it in order to gut it.””

In the NYT’s “How retirees can spend enough, but not too much” Ron Lieber looks at withdrawal rates and how one might be able to take out more than 4-4.5% typically suggested for portfolio not to be exhausted in 30 years. He reports on two approaches based on 60% stock and 40% bond portfolio. Kitces’ suggests using “the current price for the Standard & Poor’s 500-stock index divided by the average inflation-adjusted earnings for the past 10 years before the date of withdrawal”; if the ratio was >20 then 4.5% was prudent, between 12 and 20, a 5% withdrawal is safe, but for <12 a rate of 5.5 would work. Guyton, using Kitces’ research for initial withdrawal rate, and then his rules are: (1) after a losing year no inflation adjustment, (2) if proposed withdrawal rate is at least 20% greater than initial value, then take a 10% cut in allowance, (3) after very good year 10% increase was permitted. (Maybe; the point is that there are no/few strategies that you won’t have to adjust over a 30 year retirement. By the way if you are interested in the topic, see my blog this week on Pang and Warshawsky’s excellent paper in Journal of Financial Planning entitled Comparing strategies for retirement wealth management: Mutual funds and annuities)

Barron’s “Small wonders” ranks top 100 US independent investment advisors. Here are comments from some of them. Bachrach on risk: “focusing less on beating an index — or other investors — and more on achieving set objectives.” , Faust: “figures that advisors with fiduciary responsibilities to clients are especially attractive to investors these days” and “places a great deal of emphasis on client education”, Horan: “it wasn’t what I was able to make that was important, but how much of that I was able to keep and what I could do with it.”, Lockshin: “He wanted me to do for him and his family what other firms were doing for institutions; to be systematic about asset allocation, for instance,” he says. “I became his financial concierge, and now that’s pretty much the role I play for all my clients.”, and Mallouk: “It’s concentrating on asset classes, not trying to identify bargain-priced stocks, that leads to long-term outperformance,” (Note the key words: meeting objectives, fiduciary, client education, saving, asset allocation/classes- how refreshing!)

In WSJ’s “Why investors need to see the light and slow down” Jason Zweig writes that with the Dow Industrial Average up 46% “investors need to evaluate their emotions and consider whether their beliefs and actions are justified.”  In August corporate insiders sold nearly 31 times as much stock as they bought” compared to 2 to 1 in the September to March period and the historical average of 7 to 1. “It is well-known that investors chase past performance, buying whatever has just made the most money for other people. What isn’t commonly understood is that investors also chase their own past performance, buying more of whatever they themselves have made the most money on.” “In his classic book “The Intelligent Investor” the great money manager Benjamin Graham wrote that “the investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizable declines nor become excited by sizable advances.” If you can’t exercise that kind of emotional control, then by Graham’s definition you aren’t an investor at all.” Also read Bill Hanley’s “September the cruellest month”in which he writes” That the market could crash twice within a decade should be a reminder that the bigger the potential returns, the bigger the risk. As your teacher might have said all those years ago: “Sit up and pay attention.””

Jonathan Chevreau in the Financial Post’s “Why ETFs are a scam”  has a title that certainly gets your attention (and that was his intent). Just remember that if you remember why ETFs were originally created (low cost, broad index, and trade like stock) and focus on the low(est) cost (most) broadly diversified index ETFs to implement the strategic asset allocation corresponding to your risk tolerance, and rebalance annually, you won’t go wrong. Most investors don’t have the time (or want to spend their time) trying to select actively managed funds, buy individual stocks or for that matter have the resources or skill/ability to consistently predict the winners of tomorrow; those who do more often than not find that the effort/costs don’t justify the results. (Jon doesn’t think they are a scam either.)

In the Globe and Mail’s “Seven of the best deals around” Rob Carrick argues that price is a factor in the decision of what products we buy, but not in investments. He lists seven investment products for your consideration which offer a cost advantage. Among them are two ETFs the unhedged Vanguard Total Stock Market VTI (MER=0.09) and the iShares Canadian LargeCap 60 Index fund XIU (MER=0.17). Also on the topic of cost (mutual fund fees) is John Heinzl’s Globe and Mail article “Shocking fund fees” reports that Canada’s mutual fund fees are the highest among 16 countries. (While this is not news, one can’t repeat this often enough; in fact it should be a weekly feature in the front page of Canada’s papers.) Heinzl lists the problems with the fees: very high (MER=2-2.5%), essentially invisible, trailers (part of MER) paid to advisers (they are “an inducement to steer clients into a particular fund and keep them there…and since the trailer is included in the MER, the result (often) is that assets flow into higher-fee funds… Even funds purchased though a discount broker – where no advice is given – are subject to trailer fees”- Does that make sense?), the fees destroy wealth ($100K invested for 25 years at 2.5% fees increases by $272K instead of $584K with no fees.) You can invest instead in Canadian LargeCap 60 Index ETF (XIU) at 0.17% MER.

Ken Kivenko of www.CanadianFundWatch.comsent out an alert on his OBSI Survival Guide (OBSI is Ombudsman for Banking Services and Investments) warning that if you have been mistreated in the financial services industry be careful with OBSI; OBSI is an industry funded entity, it’s in need for reform, be on guard in direct dealings (don’t go without professional prep or without a witness), watch statute of limitations, and be careful about what documents you are asked to sign as they may limit your future options.

The WSJ has a whole series of articles related to asset allocation. In WSJ’s “Rethinking stock’s starring role” Sam Mamudi reports changes  some manager are making to the traditional 60% stock and 40% bond allocation for a balanced portfolio. Changes are driven by 50% rise in stocks since low this year, perceived need for a more diverse (different asset classes) and more dynamic (tactical) asset allocation. Just about every perspective is covered (more corporate bonds, more TIPS, more commodities, less stocks, emerging markets, more stock for the long term, etc) and no doubt that one of them will work. Shefali Anand in “A plan for retirees” describes one adviser’s push into managed futures (“such funds invest in futures contracts and other derivatives, and seek to profit from rising or falling trends across commodities, foreign currencies and other markets. An index of managed-futures programs, the Barclay CTA Index, gained 14% in 2008”), live off interest and dividend and make up income shortfall by selling some winners. This adviser’s model portfolio has an overall asset allocation of 40% US stocks, 35% bonds (US, global, TIPS), 15% foreign stocks and 10% alternatives (managed futures, hard assets, long-short fund). Karen Hube’s “On second thought…”discusses changes that financial planning firms have made to their portfolios as a result of 2008 experience. Changes range from more tactical asset allocation, more passive implementation (ETFs) of specific asset classes, core-satellite approaches, more asset class granularity, and tactical sector bets to broader index approach. (I am planning to do an in-depth asset allocation blog in the few weeks.

In WSJ’s “Adviser alert”the authors mention that even advisers can get benefits from using an adviser: because they are focused on their customers rather than themselves, “facilitate financial discussions with a spouse and stay on top of the family’s finances if the adviser dies”, another adviser can hold him accountable (e.g. for asset allocation), “Sometimes we need someone to look at us and say, ‘This is what I see.’”

Real estate and Florida property taxes

Jeff Ostrowski in Palm Beach Post’s “Facing realtors, Crist laughs off one error but reiterates another”  reports that “Long-time (homesteaded Florida resident) homeowners are seeing their property taxes rise. A spot check of proposed tax bills for those who have been in the same property for at least six years shows double-digit increases from last year to this year, including 12 percent jumps in West Palm Beach, Delray Beach and unincorporated Palm Beach County and a 14 percent increase in Lake Worth.” (Those who are not homesteaders and have their taxes based on actual market value may find that their taxes will be flat, as rising rates are be cancelled by lower assessed property value. The gap between non-homesteaded out of state property owners and homesteaders has narrowed in the past couple of years, but it is still at an unconscionable level, with non-homesteaders’ taxes often 2-10x those of homesteaders in an identical property.) In another article Palm Beach Post’s Jennifer Sorentrue reports that “Throngs of property owners expected to appeal their 2009 tax bills, Palm Beach County clerk says”.

Mary Shanklin in Sun-Sentinel’s “Orlando condo bargains abound, but watch out for those fees”reports that prices of some Orlando condos dropped 70%; also owners are defaulting in droves on their mortgages and association fees.  Those contemplating buying now, based on low prices must factor in maintenance fees which may be several times the mortgage costs; if only half the owners are paying the fees, and then fees have to double to cover previous expenses. “Desperate condo associations are starting to seek court-appointed receivers”.

Is commercial real estate the next securitized loan crisis? In NYT’s “For commercial real estate, hard times have just begun” Terry Pristin  reports that a  “spate of defaults, foreclosures and bankruptcies that could surpass the devastating real estate crash of the early 1990s” are on the way…and… real estate investors who profited from the ready access to mortgages made possible by securitization now complain that the system is impersonal and rigid. Instead of negotiating directly with a lender sitting across a table (they have) been forced to deal by telephone with “a third party sitting out in the Midwest” who seemed indifferent to his problems.” In fact, the master servicer with whom they would have to start to negotiate the securitized loans “has no authority to restructure it”. This does not bode well for restructuring deals. “Building values have declined by as much as 50 percent around the country, and even more in Manhattan, where prices soared the highest. As many as 65 percent of commercial mortgages maturing over the next few years are unlikely to qualify for refinancing” “Banks…are holding $1.3 trillion in commercial mortgages and $535.8 billion in construction and development loans” with almost $400B scheduled to mature by end of next year. According to WSJ’s “Commercial real estate lurks as the next potential mortgage crisis”  “In light of the complaints, the Treasury is considering guidance that would allow servicers to start talking about ways to avoid defaults and foreclosures sooner”, though many doubt any action given servicers’ contractual obligations.

Some things to ponder

In Financial Times’ “In magic or markets, it is never rational to be wrong”John Kay argues that consistency does not imply rationality. “Consistency is a characteristic to be prized in a world simpler, more predictable and better understood than the one that we live in – the world described by certain kinds of economic model. In the real world, I am consistent but you are stubborn, and each of us has good grounds for thinking we are right.” What might appear as inconsistency may in fact just mean that the facts have changed. “Securities trading usually happens because different people have different, and changing, interpretations of the same facts. That is why prices are uncertain and unstable. It is also why we are not helped by models that tell us there would be a right price for everything if there were consistent underlying beliefs and preferences.”

In the Financial Times’ “Bond yields and equities diverge”Richard Cookson asks: “why on earth have government bond yields been falling recently even as equity markets have been climbing?” and then winds his way through a series of arguments to conclude with “If bond yields have fallen precisely because growth is likely to be more sustainable, that would make sense. But if bond yields have fallen because, as with Japan in the 1990s, bond investors are worried about the sustainability of growth, equity markets themselves look likely to melt.”

Diane Francis in National Post’s “Americans are crybabies II” believes it’s time for Americans to live within their means; Canadian GST-like federal sales would go a long way to fix the problems and fund many of the opportunities (health-care, education). (The discriminatory Florida property tax system is the American tax aversion taken to the extreme, but I guess it’s in the genes; it’s OK to want low taxes, but then expect corresponding level of services.)

In WSJ’s “Loan sharks circle credit-starved consumers”MacDonald and Whalen report from the UK that after an individual ran up an under $3000 bank debt during times of easy credit “banks cut him off and he turned to a loan shark, an illicit credit source that is gaining steam.” Other examples of 60-2400% are listed.


Gretchen van Reisen’s C.D. Howe “The pension tangle: Achieving greater uniformity of pension legislation and regulation in Canada” The problem: “Pan-Canadian organizations are discouraged by the additional administrative burden involved in providing pension coverage in multiple jurisdictions.“  The solution: “a single law and regulator is the most efficient approach to address the uniformity issue, but may also require the resolution of constitutional issues.” The report summarizes very thorough research problems associated with inconsistent/non-uniform pension regulation. Unfortunately, private sector national single-employer pension plans are dead. This report may have helped protect pensioners and/or slow erosion/demise of DB plan system 20-30 years ago, but companies (and employees) have moved way beyond this. DB pension system where employer accepts market and longevity risk for employees, who spent a lifetime with them, is from another age. The author also observes that “Canada is among 11 countries identified, along with the United Kingdom and the United States, whose income replacement rate for an average earner showed a sizable gap (from about 6 to 28 percentage points) between what the mandatory system provides and the OECD average replacement rate of 58.7 percent. For Canada, the gap is about 20 percent. In other words, the average Canadian worker can expect a public pension to replace a far smaller share of income than the average OECD worker.” (This is even worse for above average earners in Canada.) When the CPP was introduced in Canada, we may have been a leader among civilized countries in protecting retirement incomes in Canada. After over 30 years of inaction and neglect of Canada’s pension system, the chickens are coming home to roost. No doubt, finger pointing between federal and provincial governments about who is responsible for the mess will continue to increase. Politicians need to remember that pensioners no longer care who got us here, but will remember in the next election those who were not part of the solution, and just stood by and watched the system disintegrate. Ideology induced paralysis of current government doesn’t exempt it from immediate action to solve the crisis; those in power when the crisis occurs have the responsibility to act now, not continue to hide behind studies.

Even in Dubai and Saudi Arabia employee claims in bankruptcy seem to get preferential treatment, as is described in Bert Hill’s “Not all Nortel victims will be left in the cold” where it appears that Nortel is required to pay employee severances to the tune of $2M or shut down its offices. (Not in Canada or the US; here employee claims are at the back of the line with other unsecured creditors. Amazing!)

And finally, in a believe it or not story Bagnall and Hill report in the Ottawa Citizen that “IRS hits Nortel with a $3B tax claim”. Before this announcement, apparently Nortel bonds with claims against US assets were priced at $0.50 per dollar while those with exclusive claims on Canadian assets were priced at $0.10 (indicating expected recovery levels). If the US judge accepts the (surprising since Nortel hasn’t made money since 2001) IRS claim, the US bondholders who have rights/claims in the Canadian court may  further spill over and dilute the Canadian estate, because taxes owed have priority. Why do I have this strange feeling that Canadian pensioners are about to take another body blow?


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