Pensions

In Diane Urquhart’s letter to Ted Menzies she tables key reasons for raising priority of pension deficit (and severance, disability payments and health coverage) in bankruptcy over other unsecured creditors. The rationale includes: minimum impact on cost/availability of credit, would encourage restructuring rather than liquidation, other developed countries are already providing preferred status. (Another reason why pension underfunding should have priority over unsecured bondholders is that bondholders are sophisticated investors who negotiated to receive and chose to accept the risk of lending to Nortel in exchange of junk bond (>10%) interest rates; pensioners had no choice, but were involuntary participants/victims whose pensions were their deferred wages and who were prevented or were disadvantaged by the income tax act to make RRSP contributions. Nortel non-negotiated plan pensioners’ average age is 71 and they have an average pension of $24,000 (the negotiated plan’s average pension is about $12,000); pensioners now face 40-50% reductions in their lifetime income and have little or no opportunity to return to work as a means of recovery; on the average 20-25 years younger, severed employees’ loss of 2-10 months of severance income is damaging, but clearly a less of a life-altering event if they get another job in a reasonable time. The pension plan was supposed to have a “trust” to fully fund the plan and every single checkpoint that was supposed to protect the “trust” fund failed as described in Systemic Failure in Canada’s Private Pensions: Who could have prevented it? What could be done now? .)

Mary Williams Walsh in the NYT’s “Retired from GM at 54. Pensionless at 74?” writes how the GM underfunded pension plan is becoming more underfunded. The pension plan is being used to help downsize the company by putting employees into early retirement, while at the same time GM being allowed to take a contribution holiday until 2013. The result is expected to be that the pension funds will be exhausted in about 20 years, unless benefits are cut back now.

Another sign of the times, the Financial Times’ Norma Cohen writes in “BT’s pension scheme to hold less in equities”  that plan’s equity target was cut from 57% to 33%%, with the sudden realization that perhaps “investing for the longer term… in spite of the fact that the scheme is mostly comprised of pensioners or deferred members, equity investments” may not be the appropriate approach. (Not a surprise if fixed payouts (defined benefits) continue in an environment of high market volatility and low employer contributions.)

Inflation/deflation?

In WSJ’s “The time to tame inflation is before it strikes”Jason Zweig warns against complacency about inflation. Just because inflation appears to be low right now, it may be just the calm before the storm. He suggests buying protection now with TIPS whose “principal value increases or decreases (though not if you buy recently issued ones) with the cost of living, TIPS don’t get hammered when inflation rises.” For those who have major future college and healthcare expenses, he suggests going with a prepaid tuition plan and a healthcare ETF, respectively.

In Financial Times’ Martin Feldstein writes that “The Fed must reassure markets on inflation”. He argues that “higher long-term interest rates reflect investors’ concern about future inflation, future fiscal deficits and the future willingness of foreign investors to purchase US bonds. These long-term concerns can have adverse effects on the prospects for recovery during the coming year. The immediate challenge to the US government is to reassure investors about both the risks of inflation and the projected growth of fiscal deficits.” Feldstein uses at least in part the implied changing inflation expectations, as derived from the difference between yield of 10-year Treasury bonds and TIPS; these implied inflation expectation of 0.19% last December and it changed to 2.26% by mid-June. (As you can see, TIPS not only provide protection against inflation, but also are a reflection of inflation expectations.)

Advisers, personal finance and investing

In a sign of the times, Alice Ross writes in the Financial Times of “Commission ban to improve choice for investors” . “The (UK) Financial Services Authority (FSA) said this week that financial advisers would no longer be allowed to receive commission payments from product providers from 2012. Instead, they will agree an upfront fee with the client that will be clearly separate from the charges on the product that they are being sold…(to) ensure that consumers are sold products that are best suited to their needs and not to those of the financial adviser.” In another article, Pauline Skypala in the Financial Times writes that “Commission era is over- ready or not”. She reports hat “In the name of transparency, and to ensure services or products are sold on merit rather than because they pay the highest commission, regulators are demanding that payments for advice must be made by investors to distributors. “ Australia, India and UK investors will be benefiting. “This should create a genuine market for financial advice” and “should create real competition in an industry that has never known it.” (When is this coming to Canada and the USA?)

The Financial Post’s Jonathan Chevreau writes that “Trust is biggest Madoff victim”. He discusses some of the precautionary steps that you could take to prevent becoming a victim: use a fee-only adviser (fewer conflicts of interest), select an adviser who puts “clients’ needs ahead of their own” (fiduciary), and make sure that adviser uses an independent custodian for your securities. (An even better overall approach may be to pay for the advice and then implement it yourself at a discount broker! It will be cheaper and you are in full control.)

Janet Paskin writes in the WSJ’s “Financial planning gets personal” that in the name of generating a better outcome, some planners are digging deeper (perhaps too deep?) into the personal lives of their clients. They argue that they will help them change the way they lead their lives or how to talk to their kids about financial matters. But some argue all this closeness leads perhaps to unearned trust and results in clients dropping their defences. Once they realized that, while they are trained to assess clients’ risk tolerance “many advisers found themselves ill-equipped to handle their clients’ panic and fear after last fall’s crash”, financial planners started attending seminars. The question you must ask is if all this closeness affects the ultimate advice received? “Psychologists say all this sharing creates the appearance of closeness, which breeds trust. Sure, investors want to have confidence in their adviser, but critics say that should come from consistent, ethical performance, not tearful self-disclosure… An adviser typically has complete access to client accounts; if an adviser also has access to a client’s personal weaknesses, Morgan says, “The consumer is just that much more vulnerable.””

Andrew Bary asks in the Barron’s article “The big squeeze”  , if as a result of the significant losses incurred by the Ivy League endowments over the past year, will they move away from their large allocations to alternative asset classes (hedge funds, private equity, commodities, real estate, timber and far land, etc)? The reported 25-30% losses may not even fully reflect the damage given the difficulty in valuing some of the illiquid assets. Inadequate liquidity also has implication their ability to meet commitments on capital calls from private equity investments and ability to fund the ongoing needs of the universities. Average educational institution asset allocations are given as: hedge funds 22%, US equity 22%, bonds 12%, foreign equity 20%, private equity 9% , real assets (real estate and commodities) 14%; so alternatives represent an allocation of 45%, with Yale at 74%! Some are wondering if the big university endowments are heading back to more traditional asset mix bonds and stocks (they are trend setters). Jack Bogle thinks that many “will look at the past year as an aberration” which he considers as fair, however he argues that they “erred in keeping their bond allocations so low”.

The globe and Mail compiled its list of  “The best of the money blogs”as selected by six financial bloggers/writers. Not a lot of consensus, but certainly a lot of variety. You be the judge as to the value. (RetirementAction.com wasn’t listed; perhaps next year!?! J)

An important thing to keep in mind is the incidental message delivered in the Financial Times’ Ruth Sullivan in “Former retail banker faces a mammoth pension task” , that “Maintaining contributions has a bigger impact on the value of the pension pot than investment performance.” (Clearly, maintaining contributions to one’s retirement savings at all times not only adds to one’s asset base which will then grow over time, but in times of crisis, by contributing after market drops, there is an increased likelihood of buying at sale prices.)

Real estate

Grace and Madigan in WSJ’s “Home prices drop at slower rate”  report that the S&P/Case-Shiller Home Price Index.The 10-city index is down 34% from August 2006 peak. During the month of April the steepest drop was in Las Vegas at 3.5%; Miami and Tampa are down 2.0% and 0.7% over the month, 27.3% and 22.3% over the year, and 47.7% and 41.1% from the peak, respectively. San Francisco, Denver, Washington and Dallas were up >1% during April.

Ka Yan Ng in Globe and Mail’s “Real estate recovery is expected to be tepid” reports on status and some forecast on Canadian real estate; and, with the exception of the Canadian Real Estate Associations bullishness, there is little optimism for the balance of 2009. Industry pundits’ and CMHC’s good news is that we are not as bad as the US and we appear to have stabilized, but bad news is that we should not expect an upturn in the second half of the year. (This latter view is not inconsistent with last week’s June 26, 2009 Hot Off the Web comments relating to the latest (April) Teranet-National Bank (Canadian) House Price Index)

Tools

You might want to look at the financial calculators at RetirementAdvisor.ca . Not sure what assumptions were used for some of the calculation (e.g. inflation protected annuities), but they are well worth playing with to get a feel for various tradeoffs (e.g. retirement age, assumed risk/return, etc)

Some things to ponder

In Financial Post’s “Retirement age needs to be 70: think tank” Paul Vieira discusses the just released C.D. Howe Institute report Faster, Younger, Richer? The Fond Hope and Sobering Reality of Immigration’s Impact on Canada’s Demographic and Economic Future: C.D. Howe Institute. Required increases in immigration are unrealistic and current low productivity growth won’t solve problems associated with the growing “old-age dependency rate — or the ratio of Canadians 65 and over to those of working age –(which) will skyrocket from its current 21% level to over 45% by 2058.” The recommendation is “To delay and mute the rise of the dependency rate, policy makers should look to policies that delay the retirement age, to 70, and promote higher fertility rates.”

Rob Arnott discusses in the Financial Times’ “Reversion to the mean, but what mean?” how reversion to the mean works (markets get over- and under- valued but tend to return to some mean), its power in determining future expected returns (when they are valued below long-term mean then future returns can be expected to be higher) and the difficulty in determining what the mean really is. “Stocks today look cheap relative to the “mean” of the last 20 years, but expensive relative to the “mean” of the last 100 years. So, which is right?” Some of the challenges associated with determining “what mean”, relate to when one might expect economic recovery as that would determine advantages of growth vs. value, corporate and high yield bonds relative to Treasuries, TIPS vs. regular Treasuries. Another challenge in determining “what mean” is related to “new political order that is seeking to cushion the more painful aspects of capitalism and contract law”. He concludes with a couple of thoughts: “The main drivers of markets – emotion, changing expectations and mean reversion – remain unaltered. Part of the global crash is mean reversion towards more sensible risk premiums” and “Another result of the debacle of the past year is a global capital market system that is trying to figure out what the new world order means for fair value.”

And finally, something to ponder in the Financial Times’ “Debt is capitalism’s dirty little secret” Ben Funnel argues that escalating debt resulting from “excessive lending was the only way to maintain the living standards of the vast bulk of the population at a time when wealth was being concentrated in the hands of an elite.” “The debt burden has to come down, which means more saving and lower economic growth for many years to come. Along the way inflation is likely to return, probably sooner and more violently than most expect, which will prompt investors to demand a higher return and make it even harder for governments to tackle the debt.” Funnel does not advocate abandoning the capitalist system which he says “is less bad than any other system yet invented.” His solutions include (1) productivity increase through “education, entrepreneurship and innovation”, (2) “live within our means” and (3) careful in redistribution of the inevitable coming tax increases.