Hot Off the Web– August 4, 2009

Personal Finance and Investments

In NYT’s “In search for competent (and honest) advisers”Paul Sullivan discusses investors’ questioning their choice of adviser in the wake of the market crash losses and Madoff fraud. One survey of the wealth management industry indicated that 7% of advisers received adequate training, over half indicated some training and 36% felt unqualified for the job. Responsibility for adviser selection rest with investor exclusively and consideration include: is it a reputable firm, are you getting a financial plan, does he have understanding of your risk profile, careful if you are promised much more than probable return of 3% after fees, inflation and taxes, is money at adviser’s firm or third party custodian, do they have reputable lawyers and accountants, what/where is outsourced and associated security safeguards (e.g. encryption). A couple of interesting comments in the article, one obvious  that the wealth management industry’s “ focus on advisers who can bring in clients with lots of assets as opposed to advisers who can actually counsel clients” and one not so obvious “people are dissatisfied with their advisers, but they’re still incredibly loyal to them”

You could do a lot worse than go with Rob Carrick’s “The three-dimensional portfolio”. In the Globe and Mail Carrick basically suggests that three ETFs are sufficient to build a diversified portfolio; the three are: XBB (iShares Canadian bond Index Fund),  XIC (iShares Canadian Composite Index Fund) and  XWD (iShares Canadian MSCI World Index Fund). He then proposes the following asset allocation for three types of investors:

As I said at the beginning, you could do a lot worse than with these portfolios. You might consider the trade-off between XIU (the 60 largest market cap stocks on the TSX) and XIC, with the former having daily turnover of 24M whereas the latter only 300K. As to XWD (daily turnover 8K and expense ratio of 0.45%), I suspect you might be better off with Vanguard’s VT (daily turnover 77K, expense ratio 0.3%). For the very long-term buy-and-hold investor perhaps  the turover volumes would be less of an issue, but with only about $4M in assets, unless assets increase significantly XWD may not have a long-term future.

In the Financial Times’ “Banks fight back with ETF wraps” Ruth Sullivan reports that banks, being threatened by investor interest in ETFs, want to ride the ETF wave. Banks are offering ETF based structured products incorporating: leverage, derivatives for downside protection, diversified portfolios, etc while they add high fees and counterparty risk in the process. “Structured products are never in clients’ interests as they eat vast amounts of fees and deliver disproportionately low returns.”

And speaking of structured products, I can’t resist spilling some extra ink on Tony Martin’s Globe and Mail article “Business adviser keeps investments simple” where he describes the investment approach of a 63 year old businessman who in the name of “simplicity” has invested some funds in variable annuities (like GMWB I , GMWB II) and is about to invest in IA Clarington Target CLICK funds which “in addition to a principal guarantee, the funds lock in the highest month-end value reached…They’re very clean, very conservative and very transparent”. You can buy them with different maturity dates (2010, 2015,…2030) Here is a case of the triumph of marketing over performance, and sizzle over stake. A quick look under the hood gives you a better view of what you are buying in addition to “monthly rebalancing” to protect the fund’s “high-water” mark. Here is my quick read of what you get: (1) government of Canada strip (bought at discount  for $0.50, $0.66, $0.85 or $0.99) maturing on the target date (of 2025, 2020, 2015 or 2010) at $1 providing the “guaranty”, and a “global equity exposure” for the remaining part of each $1 (i.e. $0.50, $0.34, $0.15 or $0.01). Now the corresponding management fees associated with these funds, according to the prospectus are 2.6%, 2.35%, 2.3% 1.9% of the invested funds. Thus, the management fees on the equity only part of the investment are 5.2%, 6.9%, 15.3% and even more for the 2010 (except the manager waives what would no doubt be a confiscatory fees for this fund). There is in addition a front end (load) sales charge of essentially 5%. Why would anyone buy this fund rather than just buy the Canada strips and invest the balance in for example Vanguard’s Total World Stock ETF) VT with a management fee of 0.25% for the balance, beats me. If there was a significant run-up in the equity portion and you really wanted to protect the run-up, you could just sell (some of) the equity gains, after fees and taxes, periodically and move to cash and buy a GIC or strip bond when sufficient cash has accumulated. The principal protection outcome (with the ratchet-up feature) would be the similar, but the expected performance of the equity portion would be 5-15% better then the fund in question, due to the fee differential alone. Oh yes, I almost forgot, you are also bearing the counter-party risk; if the fund guarantor goes bust before the maturity date of your fund, you can line up with other unsecured creditors and fight over the carcass (just like Nortel pensioners except that they didn’t have a choice, pension plan participation was compulsory.) We are living in a complicated world!

Then there is another reminder from Daisy Maxey in WSJ’s “Warning signs up for leveraged ETFs”. She quotes from Schwab’s website: “”while there may be limited occasions where a leveraged or inverse ETF may be useful for some types of investors, it is extremely important to understand that, for holding periods longer than a day, these funds may not give you the returns you may be expecting….Proceed with extreme caution,” it advised. Because the effects of leveraging can compound over time, the funds’ results can deviate widely over time from the intended result.”

In the Globe and Mail’s “It’s a national savings crisis, but provinces are split on solution” Janet McFarland reports on the provincial finance ministers’ get-together in Vancouver on a national pension system based on the proposal tabled by BC and Alberta last year. “The provinces have since suggested the idea should be adopted nationally, but it is not clear yet the federal government or Ontario are willing to commit.” Ontario did not reject proposal but wants first a “broader review of options”. (Sounds like Nero and Rome except here there is fiddling while pensioners burn. What could the Federal and Ontario governments be thinking?)

Tim Cestnick’s weekly Tax Matters column in the Globe and Mail looks at life insurance in  “Decide on coverage that’s right for you” . He discusses two types of coverage: (1) temporary which is term typically for 10 or 20 years; this is the cheapest type of insurance (and the most sensible one to buy since it permits the primary breadwinner of a family to purchase the  required (large) amount of insurance to replace the income should he die, and (2) permanent which can be term to 100, whole life or universal (You can read some of my thoughts on life insurance at How much Life Insurance Do You Need?. and  Universal Life)

Michael Pollock’s WSJ article “The new bond equation” discusses risks associated with bonds and bond funds: inflation risk (protected with TIPS but rates are low), credit risk (watch out for rising junk bond default rates and potentially falling recovery rates), interest rate risk (try to keep short/low bond/fund duration, duration multiplied by the expected interest rate rise predicts corresponding decrease on bond/fund value) and if you are making asset allocation changes don’t try to time the market- make changes gradually.)

A short video by Dimensional’s David Booth on “Retirement, risk and return” discusses why people should not run from stocks to Treasuries. All one is doing by that is exchanging market risk (volatility) for purchasing power risk. At the end of the day the risk that counts is the latter one. Unlike Treasuries, stock deliver real after tax returns.

Something to Ponder

Here are two articles for those who would like to hear the perspectives that argue that a strong US and Asian recovery is imminent or already under way: Tim Bond’s Financial Times “Learn to love the recovery” and the Economist’s “From slump to jump”

In WSJ’s “How to profit from bubble 3.0” James Altucher predicts  that the combination of $600B TARP and $787B stimulus bill will result in “A bubble of unbelievably massive proportions. The bubble to end all bubbles. It may end badly, but if you are a financial adviser the key is to get in front of it fast and early.”  Altucher is not sure where the bubble will occur though he ventures some guesses: non-US currencies, green companies, biotech?

In Financial Post’s “Malcolm Hamilton’s RRSP rescue plan”Hamilton elaborates on the “retroactive TFSA” explaining that to help recoup the losses sustained by people’s RRSPs,  give (to be equitable) every Canadian $5,000 x (age-18) TFSA room  in 2008!?! (That’s $210,000 for a Canadian who is 60 in 2008). “All that the proposal does is put elderly Canadians in the position that younger Canadians will enjoy when they grow old. If we can afford to give today’s 18-year-old $235,000 of TFSA room by the time he or she turns 65, why can’t we afford to give today’s 65-year-old the same opportunity?” (Interesting proposal.)

In Atlantic’s “The quiet coup”Simon Johnson suggests that “The crash has laid bare many unpleasant truths about the United States. One of the most alarming, says a former chief economist of the International Monetary Fund, is that the finance industry has effectively captured our government—a state of affairs that more typically describes emerging markets, and is at the center of many emerging-market crises. If the IMF’s staff could speak freely about the U.S., it would tell us what it tells all countries in this situation: recovery will fail unless we break the financial oligarchy that is blocking essential reform. And if we are to prevent a true depression, we’re running out of time.” (Thanks to MF for pointing out this article.)

And finally…

Here is a slide that describes Emergency Policy Changes Required to Ease Impact of Pension Crisis and Enable Pension Reform The list includes: BIA priority, refundable tax-credit, protection of Nortel’s Canadian estate, $55K pension guaranty (like in the US and UK for example, commuted value (CV) option for pensioners and its 100% transferability to RRSP and let’s not forget a new pension system model.

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