Hot Off the Web– April 4, 2011
Personal Finance and Investments
In the Globe and Mail’s “Does your investment adviser put you first?” Rob Carrick looks at mechanisms of finding an advisor who not only answers that question in the affirmative but also means it. Carrick suggest three approaches increase likelihood of finding such an advisor. He suggests that you choose one: (1) with a CFA designation (“trained to higher standard” and must annually sign a code of conduct which includes that they “must act for the benefit of their clients and place their clients’ interests before their employer’s or their own interests.”), (2) who is an Accredited Investment Fiduciary (AIF) (though an expert in financial designations warns that while “ethics is very important for a financial professional”…”the AIF means someone knows how to ethically put clients first. However, it doesn’t speak to an adviser’s ability to build diversified portfolios and other investing basics”) or (3) “fee-only advice, also known as fee-for-service. These advisers don’t sell products, only advice, and they typically charge flat or hourly fees for financial plans. On top of that, they may charge a percentage of the money in your account for continuing investment management.” (This is a very complex topic wroth with many traps, especially when your ‘advisor’ might be wearing many different hats, ranging from broker, planner, insurance salesman, counter-party, etc. If you are interested in the fiduciary topic, you might also wish to read my recent blog Fiduciary. You will also find interesting the Berkshire Hathaway story mentioned in the Things to Ponder section below).
Brett Arends in WSJ’s “The $2,000 iPad” says that the $500 iPad is going to cost him $2,000, given that $500 invested over 30 years (when he expects to retire) in the stock market at 5% real return would grow to the equivalent of today’s $2,000 purchasing power. He also adds that this actually understates the cost as it doesn’t include the tax-benefits if he was investing in a tax-sheltered retirement plan. Arends says: “Yes, I typically do these mental calculations, at least in the back of my mind, for most things. A “$50” lunch at Morton’s really costs $200. A “$5,000” trip to Bali: $20,000. And so on. It tends to cut down on the spending. I typically come back from the mall with no bags, gleefully clutching my future millions.” (Sounds like an interesting mental exercise.)
In Vanguard’s research report (which I mentioned last week and indicated that it sounded interesting and I planned to read) “A more dynamic approach to spending for investors in retirement” Jacconetti and Kinniry write that “In this paper we focus on two of the most common strategies, dollar amount grown by inflation and percentage of portfolio, and we introduce a third—a hybrid of the others that we view as a more dynamic approach. This third method, percentage of portfolio with ceiling and floor, incorporates balance: Spending is relatively consistent while remaining responsive to the financial markets’ performance, thereby helping to sustain the portfolio.” The authors conclude that “In our view, flexibility is the word that best describes a prudent spending strategy. Rigid spending rules cannot eliminate investment volatility; they simply push its consequences into the future. Spending strategies insensitive to returns are risky, inasmuch as they rely on the assumption that the portfolio will recover before a crisis point is reached, at which time much more dramatic reductions in spending would be necessary.” It is also worth noting that in Appendix A of the paper they suggest a sensible set of factors to consider in the process of setting the spending level in retirement: cost of desired lifestyle while factoring in any potential bequest goals, changing lifestyle needs (higher at start of retirement and possibly at end-of-life, and estimated non-discretionary spending requirements. The other interesting piece of information available in Appendix A is that for an 85% success rate over 10, 20 30 and 40 year horizons, with a 5% ceiling and 2.5% floor, you can draw about 11%, 6.75%, 5.25% and 4.5% respectively; by the is no significant difference of these withdrawal rates for conservative (20% stocks), moderate (50% stocks) or aggressive portfolios (80% stocks).
In a report on “The Ombudservice for Life and Health Insurance” Ken Kivenko of CanadianFundWatchwrites that his bottom line is that “We have identified a number of red flags and areas requiring more clarity. OLHI, in our view, is a developing Ombudservice that requires maturing to be fully effective. Nonetheless, OLHI provides a necessary no-charge outlet for insurance industry complaint analysis and possible settlement/restitution. Just make sure you fully understand its boundaries, gaps and limitations before plunging in.” (I am very sceptical of the effectiveness of industry self-regulatory and complaint-resolution/management bodies in handling consumers’ interests.)
In the Financial Post’s “Indexing refined”Jonathan Chevreau discusses other than capitalization weighted indexes that he tables for his readers’ consideration. These include equally weighted indexes, fundamental indexes, value based indexes (So far, I haven’t seen enough compelling evidence to overcome my natural inertia which keeps me invested in ETF implemented cap weighted indexes, because of extra management/rebalancing/tax costs associated with non-cap weighted indexes, the argument that these are not really indexes just value tilted portfolios (and sometimes value and sometimes growth will outperform), and the non-capital weighted indexes don’t scale well.)
In WSJ’s “Five things you should know about funds”Brett Arends says that you shouldn’t pay attention to number of stars the fund has, mutual company’s ‘great’ reputation or recent ‘great’ performance. Instead he suggests you pay attention to: (1) fund’s total fees (loads, management fees, transaction cost, turnover), (2) has manager invested a significant portion of his wealth in his own fund? (3) fundco working in you or their interest (fundco focused on performance or asset gathering), (4) performance figures more often than not mean little or nothing (especially short-term performance is usually pure luck), and (5) is management or marketing in charge? (e.g. is fund doing risk management by dynamic asset allocation or just follows its style box and stays 100% invested in, say, growth stocks)
Andrea Coombes looks at the continuing target-date fund debate which now have >$300B invested in them in the U.S. In WSJ’s “Doubts linger over target-date funds”she discusses changes many of these funds have made or not made after the 2008 market crash. Some of the issues discussed include: (1) the most significant criticism received by target date funds was that some of them had potentially inappropriately high equity allocation at the target date (i.e. retirement); Coombes here explains the difference between funds intended to operate ‘to’ retirement (the objective being 100% of the capital should be ready to be annuitized) vs. ‘through’ retirement (which might assume partial or no annuitization instead), (2) target-date funds come without personalized ‘glide-paths’ (which define how asset mix changes with age or approaching retirement) and there are questions about your fund’s compatibility with your risk profile (and no mention of the challenge of integrating a target date fund into your overall asset allocation), (3) increased attention to risk mitigation using more diversified portfolios (e.g. including TIPS, REITs, commodities, emerging markets) and even tactical asset allocation (perhaps a market-tweaked glide-path). (My take is that target-date funds might make sense for some individuals as they pretty much automatically follow the glide-path without investors having to worry about asset allocation and rebalancing. But they are not the answer for everyone; for example those who do not plan to annuitize but plan on doing a systematic withdrawal strategy, might be uncomfortable with a typical ongoing reduction of equity allocation with age.)
The January 2001 data is now available on Canadian home prices as measured by the Teranet National bank House price index. It shows that “Canadian home prices in January were up 0.4% from the previous month, according to the Teranet-National Bank National Composite House Price Index™. It was the second consecutive monthly rise, following on three consecutive monthly declines. January prices were up from the previous month in four of the six metropolitan markets surveyed: 0.9% in Vancouver, 0.5% in Toronto, 0.4% in Halifax and 0.3% in Montreal. Prices were down 0.6% in Ottawa, a fifth straight monthly decline, and 1.0% in Calgary, a fifth decline in six months.”
Still on Canada’s housing market, in the WSJ’s “Housing booms north of the border” Gutschi and Curren report that “some economists see Canada’s market ripe for correction, with debt rising to worrisome levels”. Downside price risk of 25% is mentioned, given that “House prices have risen to almost 5.5 times disposable income per worker, well above the long-term historical average of 3.5, he says.” But not everyone agrees given Canada’s good GDP growth, strong Chinese immigration to Vancouver and Toronto, still low mortgage rates, government backed mortgages and the “Canadian recourse law makes it harder for buyers to walk away from bad debt.” In the Globe’s “Rosenberg: Canadian housing is okay” Rosenberg argues that Canadian homebuilders have not built recklessly like their American counterparts, and “As such there is no evidence of any meaningful supply-demand imbalance that should undercut real estate valuation” Strong immigration resulting in positive demographics is also helping housing.
The January 2011 show continued decline in US house prices. The 10- and 20-city Composites were off 2.0% and 3.1% respectively since January 2010, and 0.9% and 1.0% since December. Both indices are back to their 2003 levels, but some markets are now below their 2000 levels. David Blitzer is quoted as saying that S&P Case-Shiller Home Price indices“Keeping with the trends set in late 2010, January brings us weakening home prices with no real hope in sight for the near future” “These data confirm what we have seen with recent housing starts and sales reports. The housing market recession is not yet over, and none of the statistics are indicating any form of sustained recovery. At most, we have seen all statistics bounce along their troughs; at worst, the feared double-dip recession may be materializing. A few months ago we defined a double-dip for home prices as seeing the 10- and 20-city Composites set new post-peak lows. The 10-city Composite is still 2.8% above and the 20-City is 1.1% above their respective April 2009 lows…” In WSJ’s “Home prices continue descent”article, reporting on the latest Case-Shiller numbers, they include some graphs showing 2000-2010 prices in various metropolitan areas compared to the 20-city Composite over the same period; it also shows how far prices have fallen from the 2006 peak.
Julie Schmidt in USA Today’s “1.8M ‘distresses’ homes could weigh on home prices for years”reports that even though the January 2010 number was 2 million “The U.S. had 1.8 million distressed homes in January that had yet to be listed for sale, a “shadow inventory” that is expected to weigh on home prices for years…CoreLogic expects all of the shadow inventory to eventually become foreclosed homes. Foreclosed homes sell at a 20% to 30% discount to non-foreclosed homes so they represent an especially “virulent” threat to home prices”.
In WSJ SmartMoney’s “Why new homes don’t sell” AnnaMaria Andriotis writes while existing home sales fell 3% last year, new home sales fell 28%. The reason is simply because “New homes are currently 29% more expensive than existing homes, about double the typical margin, according to the NAR. At the same time, there are some radical discounts in the existing home market, foreclosures and short sales specifically, which accounted for nearly 40% of all sales in February. (In 2010, they accounted for 25% of all sales.)”
William Hanley in the Financial Post’s “One in five Canadians eyeing U.S. housing market”reports that a according to a BMO survey that, the combination of strong loonie and collapsed U.S. real estate prices, one in five Canadians would consider buying a U.S. property. Hanley very wisely writes about the many factors to consider and concludes with “Buying a U.S. property is a big, big step, fraught with risks. Consider that between 1996 and 2006, six million Britons bought homes in Spain, which has now been gripped by a real estate depression. So, most of those Britons have learned a nasty lesson in the harshest of ways. That doesn’t mean that buying a bargain home in Florida or Arizona won’t work out. But, first, a big gut check is in order. And then another. And another.” (If you are one of the one in five, you should heed his words.)
In the Globe and Mail’s “Ignatieff proposes CPP-backed ‘secure retirement option” Jane Taber reports that the Liberal party’s new pension related election proposal Secure Retirement Option (SRO) will “allow Canadians to save an extra 5 to 10 per cent of their pay in a retirement fund “backed by the CPP.”” On the same topic, Jonathan Chevreau’s “Liberals push big CPP as retirement saviour” in the Financial Post also discusses the SRO, with views presented from various experts, but the attributes of the SRO are not clear beyond individuals’ ability of contribute within perhaps the administrative and investment-management framework of the CPP and within current RRSP limits. Beyond that it’s not clear if the voluntary contribution buys specific ‘defined’ benefits (a la CPP), or is just managed by the CPPIB accumulating assets for retirement? If the latter than what are the forms of derived income from these accumulated assets, will these incremental contributions attract/require additional employer contribution? (I have no clue, but at least the proposal makes pensions a significant election issue, as it should be, after years of federal/provincial studies, reports, meetings, decisions to do A then six months later decision to perhaps do B; the end result so far being absolutely no progress on pension reform.)
In Benefits Canada’s “Spending changes little in retirement”Steven Lamb reports that “Looking at spending and income patterns from 1982 and 2008, StatsCan found Canadians in the early 70s spent only 5% less on goods and services than they did in their late 40s. Meanwhile their incomes declined by 16%…While total spending was little changed, what they spent their cash on changed. In 1982, household heads in their late 40s, spent more than one-third on food, clothing, personal care and health care. In their 70s, that percentage fell to 28%…In their 40s, household heads spent just over 30% on residential costs. Among retirees in 2008, that had risen to 43%.” (Just shows you, that retirees needing only 50-70% of their preretirement income makes little sense, and using pre-retirement income, rather than pre-retirement expenses and planned post-retirement lifestyle, as a planning basis for post-retirement spending is also nonsensical.)
Things to Ponder
A clear illustration of “disclosure cures conflict-is nonsense” can be found in this week’s Berkshire Hathaway story in WSJ’s “Insider Trading: Why we can’t help ourselves” Jason Zweig writes, in reference to Warren Buffet’s reaction to his designated successor’s front-running incident, that “If even Mr. Buffett can fail to appreciate a potential conflict of interest under his very nose, then ordinary investors need to realize just how pervasive and insidious conflicts are throughout the financial world.” This particular trading falls under what a securities law expert “calls “an enormously gray area of the law.” It also is a reminder that a basic principle of securities law—disclosure cures conflicts—is nonsense. “Even assuming that [Mr. Sokol] did nothing illegal, [his action] is typical of the kinds of conflicts of interest permitted by our financial system that undermine the integrity of markets,” says Max Bazerman, an ethicist at Harvard Business School and co-author of the new book “Blind Spots.” Most people have what Mr. Bazerman calls an ethical blind spot. Faced with a potential conflict of interest, you automatically conclude that it couldn’t possibly offer any temptation to someone of superior character—like you or those closest to you.” And Zweig concludes his article with “In testimony to Congress in 1991, Mr. Buffett said he expected all his employees “to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper, to be read by their spouses, children and friends, with the reporting done by an informed and critical reporter. If they follow this test, they need not fear my other message to them: Lose money for the firm and I will be understanding; lose a shred of reputation for the firm and I will be ruthless.” Those are words to live by. But living by them isn’t easy for anybody.” In the Financial Post’s “Berkshire ordeal highlights grey area in ethics” Diane Francis discusses the story and concludes that “he (Sokol) should have realized that when you are forced to ask yourself whether something is unethical or questionable, it is”.
Michael Nairne writes in the Globe and Mail’s “Natural catastrophes are inevitable, so are market meltdowns” that people shouldn’t be surprised when a catastrophe strikes; while the proverbial 100 year flood has only a 1% chance to strike in any one year, over a 25 period its probability of occurrence is 22%. The same applies to financial markets. “…financial meltdowns are not only inevitable but occur more frequently than normal probabilities imply. For example, the massive 57% decline in the U.S. stock market from October 2007 through March 2009 was not a once in a lifetime event. It is similar in scope to 49% decline in 2000-2002 as well as the 48% decline that occurred in 1973-1974. The potential for meltdown is there for any asset class, therefore “strategic asset allocation (is) vital. Robust diversification across a broad range of assets will buffer a portfolio from precipitous price declines in any particular asset. Even in 2008, when both equities and real estate were in freefall, government bonds and gold had positive returns.“ (There was no explicit recommendation on the appropriate asset classes to include or how one would go about doing a strategic asset allocation which would provide some level of protection from financial meltdowns.)
There are quite a few interesting articles to look at on the inflation/deflation debate and the measurement of changes in price level. In the Globe and Mail’s “Bond investors should beware of inflation mirage” George Athanassakos questions government CPI figures in light of actual experience when we go shopping. “Although food, fuel, consumer goods and so on have gone up by more than 30 per cent in the past two years, the CPI has barely moved. But the markets for real assets – gold, food, energy and commodities – continue to rise, which suggests inflation.” Canadian and U.S. CPI figures are distorted by: (1) quality adjustment (price increases are reduced if the product/service quality increased), and (2) the CPI basket is no longer fixed (the assumption is that “people substitute cheaper items for those whose prices rise”). The author also warns that that the price pressure will continue to grow in the near future due to: likely increase in money velocity, PPI>CPI, emerging markets manufacturing cost increases driven by food driven labor cost increases and expected shift of China from a source of deflation to one of inflation. (Of course the other questions to consider if the CPI is being manipulated (?) to understate the real inflation then: (1) What do CPI adjustments mean in case of CPP/OAS ( and Social Security) or other pension plans which may have some level of cost of living adjustment? What does this mean to investors who think they are buying inflation protection with Real Return Bonds in Canada or TIPS in the U.S. which have built-in adjustments based on CPI numbers?)
In the Globe and Mail’s “On prices, central bankers are people too” Kevin Carmichael reports on Fed bankers struggle to assess the risk of inflation (vs. deflation), with one arguing the we are only at the point that we can stop worrying about deflation, while another worrying about the apparent underlying strength of the economy driving headline inflation. (I use the availability of $2 scones at the neighbourhood Starbucks before 9 AM on the weekend; this past weekend there was just one left as opposed to about a dozen still typically available at that time. By the scone measure consumers are (maybe) ramping up!?!)
In the Globe and Mail’s “The deflation dilemma: Why falling prices remain a threat” Martin Mittelstaedt discusses how the focus in the past year has radically changed from fears of deflation to fears of inflation. But he writes that some consider this just an “economic version of a head fake”. These inflation naysayers give credible reasons: high debt levels could suppress consumption, deflationary effect of technological advances and the” fading power of labour”. He adds that the deflation prognosticators happen to be individuals with good track records. He then piles on with Robert Shiller’s view that housing could fall another 20%. In a related article the CFA Magazine (Mar-Apr 2011) entitled “The race to zero” there is an interview with demographic consultant Richard Hokenson who argues that as a result of the majority of the world deciding “voluntarily or involuntarily not to replace themselves”, the current estimated 6.9B world population will not reach 8B before it starts shrinking. The result is not just lower population but also older population. This will have serious implications on consumer demand, economic growth and interest rates which will ultimately head toward zero as it did in Japan despite massive build-up of government debt. Lower decreasing or negative population growth and an aging population results in “deflationary shocks”. Hokenson says that he is a “structural disinflationist, and if inflation is going to surprise, it will surprise on the downside.” If he is right he suggests that it is STRIPS instead of TIPS, which will outperform.
In the Financial Post’s “Loonie overvalued, poised to fall: Barclays” David Pett reports that “According to Mr. Robinson’s estimates of purchasing power parity…the Canadian dollar is 17% overvalued relative to the U.S. dollar, while the New Zealand dollar is 26% overvalued and the Australian dollar is 33% too expensive. He thinks all three currencies are likely to start depreciating in the second half of this year and the risks are generally to the downside.” But the WSJ’s reports that “Aussie Dollar takes off amid chaos” and the Financial Post article predicts that “The next step for the loonie is up”(Just shows you how difficult forecasting or at least timing the market, really is!)
In the Financial Times’ “EU battle over CDS ban proposal”Steve Johnson reports on the European debate to possibly ban CDSs (Credit Default Swaps, which are form of an insurance contract to protect bondholder against the default of the issuer). The debate is complicated by the fact that speculators can trade in these CDSs even if the don’t have an insurable interest (i.e. they don’t own the bond).Some blame such ‘naked’ CDS speculators for exacerbating the European debt crisis. Those advocating a ban say “CDS is a form of insurance and in the rest of the insurance market it’s illegal to take out insurance for a risk that you do not face. Taking out insurance on a neighbour’s car or life throws up obvious hazards.” Those against a ban of ‘naked’ CDS buying say that a ban would reduce liquidity for ‘legitimate’ CDS buyers. (It is not obvious that a ban is necessary; in fact how is this different than trading in other derivatives without having an interest in the underlying security? Perhaps a better solution would be to force all derivatives, including CDS, onto an exchange, not just to make trading and holding them transparent, but also to reduce the systemic risk associated with institutions/hedge-funds which, without the discipline of daily settlement, may become overexposed to unhedged derivative risks.)