Hot Off the Web- September 5, 2011

Personal Finance and Investments

A must read article for those who still buy mutual funds is the NYT’s “The mutual fund merry-go-round” in which David Swensen  (CIO of Yale University’s endowment fund and author of  “Unconventional Success: A fundamental approach to Personal Investing” writes that high market volatility has driven many investors to sell low after buying high. “The companies that manage for-profit mutual funds face a fundamental conflict between producing profits for their owners and generating superior returns for their investors… For decades, investors suffered below-market returns even as mutual fund management company owners enjoyed market-beating results…(a)  rating system (e.g. Morningstar) merely identifies funds that performed well in the past; it provides no help in finding future winners. Nevertheless, investors respond to industry come-ons and load up on the most “stellar” offerings… (and) investors sell low and buy high… ” Swensen’s recommendations are: “individual investors should take control of their financial destinies, educate themselves, avoid sales pitches and invest in a well-diversified portfolio of low-cost index funds, like those offered by Vanguard, which operates on a not-for-profit basis…the SEC should employ its considerable regulatory and enforcement powers to encourage individual investors to embrace low-cost index funds and shun the broker-driven churning of high-cost, actively managed funds… the S.E.C. should hold the mutual fund industry to a “fiduciary standard,” one that puts clients’ interests first.”  Swensen concludes with “For two decades, laissez-faire attitudes toward financial markets allowed the rich and powerful to take advantage of those less well-off.”(Thanks to Ken Kivenko of the Canadian Fund Watchfor recommending.)

In Barron’s “Where are the customers’ advocates?” Chuck Epstein writes that “Mutual-fund companies need to convince the public that they operate in their clients’ best interests…As former SEC Chairman Manuel Cohen taught, “Wall Street rarely moves toward reform unless it is pushed.”… Appointing shareholder advocates—and listening to them—would be a step in the right direction… While everyone is affected by volatile markets, new regulations, contentious elections, depressed home prices, and sunken portfolios, the fund industry’s very visible public intransigence against any type of industry reform should be considered a remarkable political blunder… They (fund companies) should create a new executive-level position of shareholder advocate. The advocate would examine fund activities involving products, sales materials, sales practices, shareholder communications, key account relationships and lobbying to determine how fund company’s activities are benefitting shareholders—if at all.” (Certainly a fresh idea, striving for change from the inside; but I suspect that mutual fund companies are too late given the level of understanding that exists among the public in the limited extent of value from such funds relative to their cost, especially given the available alternatives.)

In the Globe and Mail’s “A solid return for ETFs even with adviser fees”Rob Carrick compares the best performing Canadian equity mutual funds over the past 10 years with a couple of popular ETFs with 10 year records (XIU the iShares S&P/TSX 60 Index fund and XIC the iShares S&P/TSX Capped Composite Index fund. He points out that even if you have an advisor charging 1% a year in addition to the ETF MERs the ETFs’ performance would still put them at the top end of quartile 2 of the funds.

George Athanassakos in the Globe and Mail’s “The contrarian case for active investing”argues that “the death of active portfolio management is greatly exaggerated”. Specifically he suggests that value managers with concentrated portfolios might be able to outperform the index. (Yes there are funds/investors who outperformed the market after fees, but very few have done so over extended period of time, it is difficult to distinguish those who have done so as a result of skill vs. luck (i.e. repeatability), and even more difficult to identify those who will outperform in the future.)

In WSJ’s “It’s payback time”Ben Levisohn writes that “Slow economic growth. Whipsawing volatility. In an environment like this, it is little wonder investors are piling into stocks with steady dividend payments… But dividend stocks aren’t a panacea—and buying them willy-nilly can lead to disappointment down the road. Dividend stocks are notorious laggards during big rallies, which often start when investors are most averse to risk. And the market is full of “dividend traps”—troubled companies that pay hefty dividends merely to keep investors from bailing out, a risky gambit that usually isn’t sustainable.”

In the Bloomberg’s “BlackRock seeks to start ETFs using proprietary indexes” Miles Weiss reports that “BlackRock Inc. (BLK), the world’s largest money manager, is seeking regulatory clearance for its iShares exchange-traded funds to follow proprietary indexes rather than those developed by third parties such as Standard & Poor’s… The ETF industry is becoming increasingly crowded, prompting managers to cut fees in order to attract and retain assets…(and) Offering funds based on proprietary indexes would help New York’s BlackRock set itself apart from rivals and burnish the company’s brand name… The SEC has limited the ability of ETFs to rely on in-house indexes out of concern that benchmarks run by affiliates might be prone to manipulation…” (Hmmm…not sure that this new initiative is good for the investor?)

In the Globe and Mail’s “Forget the spreadsheet- just start saving” Preet Banerjee writes that you might want stop recording all your spending and stead take a pay-yourself-first approach; using “the trick may simply be to force yourself to adapt. Instead of waiting to see if there is a surplus at the end of the month, have your desired savings taken out of your bank account automatically on the day after you get paid and just focus on not getting into the red before the next payday. You will adapt.  If you are worried you’re already stretching your income, the worst-case scenario is that after a few months you have money in your savings account and an offsetting amount of money owing on credit cards. You can take the cash from the savings and pay down the money owing.” He suggests a minimum of 10% of gross pay (That’s probably too low, 15%+ is a better target) for long-term savings (e.g. retirement), but additionally you must save for short-term goals (e.g. vacations).

Ken Kivenko of Canadian Fund Watch is encouraging all Canadians to “Help create a “new and improved” OBSI. He writes that “SIPA has written Finance Minister Jim Flaherty asking that OBSI be enacted by Federal legislation and be freed from all industry influence. Only a truly independent entity can assure fair restitution for industry wrongdoing. Contact your MP and/or Minister Flaherty and support an independent, legislation empowered, national Ombudsman service for banking, investments and insurance complaints. SAMPLE TEXT We want to express our strong support for the retention of a single national independent complaint handling service, the Ombudsman for Banking and Investments. It is our conviction that this approach is in the public interest . ( sign and date)….Please take a few moments to support investor protection in Canada.”

Real Estate

Eric Lam in the Financial Post’s “Canadian housing prices continue to rise” reports thatCanadian house prices were up 1.7% in June compared with the previous month, the biggest month-on-month jump since August 2009 taking the index to a new all-time high of 144.27, the report said... Prices were up in all six major metropolitan markets surveyed, with Toronto leading the pack at a 2.0% increase. Vancouver and Ottawa came in at +1.7%, while Calgary posted a 1.6% rise, Montreal +1.1% and Halifax +1.0%.” The full June 2011 report is available at  Teranet National Bank House Price Index and it indicates a YoY increase of 4.5% for the composite with individual components increasing as follows: Vancouver 7.2%, Montreal 5.9%, Ottawa 4.6%, Halifax 4.4% and Toronto 4.2%; only Calgary was off -2.7% YoY. …even though “Canadian economy shrinks”

For the U.S. June 2011 S&P Case-Shiller  data released this week shows “This month’s report showed mixed signals for recovery in home prices. No cities made new lows in June 2011, and the majority of cities are seeing improved annual rates. The National Index was up 3.6% from the 2011 first quarter, but down 5.9% compared to a year-ago” Interpretation of the above data is challenged by a combination of “unusually large revisions across the same MSAs” and by it being non-seasonally adjusted data which is not as representative due to seasonal variations. Q2 over Q1 2011 shows a 3.6% increase in prices nationally, however only a 0.1% seasonally adjusted increase. You can read perspectives on the results in the WSJ’s “June home prices below year-earlier level” and Bloomberg’s “Home prices in U.S. showed signs of stabilizing”


In the Globe and Mail’s “Should recent arrivals qualify for Old Age Security?Kevin Milligan asks “How much fiscal benefit should Canadians with only a short history of residence in Canada receive? Earlier this week, the NDP withdrew a Private Members’ Motion originally submitted by Vancouver East MP Libby Davies on this controversial topic. The NDP motion echoed a previous proposal by former Liberal MP Ruby Dhalla in 2009 to make Old Age Security for recent immigrants more accessible…(current rules specify) If residence in Canada over the lifetime is less than 10 years, the person is ineligible. If residence is between 10 and 39 years, a fractional pension is paid. Over 40 years, and the person is eligible for a full pension.” He argues that “I suspect the public mood against these Old Age Security pension extension proposals stems from a sense that the existing fiscal ‘deal’ for short-term residents is already generous enough and needs no improvement. That’s certainly defensible, but (since the OAS is not funded but explicit taxes like the CPP, and is rather funded from general tax revenues) the argument for excluding short-term residents from the benefits received by other Canadian seniors will become harder to make.”

In the Financial Post’s “Get ready to pay billions for hydro pensions”Swift and Tufts write scathing view of the coming costs of public and extended public sector. “In British Columbia, it was revealed that a senior executive at BC Ferries was eligible to receive a lifetime pension valued at $315,000 after only nine years of employment there. In Quebec, Hydro-Québec claimed that its pension costs last year were only $21-million, but its financial reports showed that taxpayers had pumped $646-million into the pension plan… A recent executive compensation report from Ontario Power Generation (OPG) shows it is on track to pay its CEO a lifetime pension of $720,000 annually or $60,000 per month or $2,000 per day starting at age 65. Assuming an average lifespan, the CEO will collect total pension payments valued at about $17.6-million. Various other executives at OPG are shown to be eligible to receive pensions of $490,000, $330,000 and $310,000 per year according to the OPG report… over the past five years alone, taxpayers have pumped $1.3-billion into the plan, while employees have contributed only $368-million… OPG still had an estimated pension deficiency on a wind-up basis of $2.8-billion… Multiply this times so many other arm’s-length government agencies at all levels of government, across all the provinces, and you start to get an idea of the massive obligations that will soon fall on private-sector taxpayers and ratepayers for utilities like hydro.”

Things to Ponder

You might recall that a couple of months ago European regulators have raised concerns about synthetic ETFs much more widely used in Europe than in N.A.; but while they threatened regulatory action, they have not delivered any as yet. In the Financial Times’ “HK regulator outdoes Europe on synthetic ETFs” Joe Morris reports that Hong Kong regulators will start requiring 100% collateralization of swap counterparty exposure associated derivatives used to replicate indexes; if equities are used for collateral the requirement increases to 120% of the exposure.

The Economist’s “A call to arms” reports that at the Jackson Hole meeting of central bankers, the IMF’s new chief Christine Lagarde indicated that the world economy “was entering a “dangerous new phase” driven by a sense that “policymakers do not have the conviction” to take decisions that are needed…(her recommendations included) a forced capital injection into Europe’s banks, aggressive new action to deal with America’s foreclosure crisis, and a broad rebalancing of fiscal priorities…(she) argued (much like US Fed’s Bernanke) that fiscal policy should pivot, putting in place policies to reduce future deficits while supporting growth today.”

You’ll recall that Pimco’s Bill Gross placed a serious bet against U.S. Treasuries earlier this year. In the Globe and Mail’s “Bill Gross admits ‘mistake’ in dumping U.S. debt” Dan McCrum reports that “When the yield on the 10-year Treasury was 3.5 per cent in January, Mr. Gross warned that the risk of rising inflation made government debt a poor investment… However, this month, as turmoil in equity markets caused investors to rush to the safety of government bonds, the 10-year Treasury yield dipped below 2 per cent, a 61-year low… Mr. Gross still argues that on a long-term basis, governments are likely to use financial repression, where the rate of inflation is higher than bond yields, to erode the value of sovereign debt over time. But he also suggested that the “new normal” – Pimco’s view of the global economic outlook in which growth rates for developed countries are slower than in the past – may have to be revised downwards to a “new normal minus”.”

In the Financial Times’ “A sceptic’s solution-a breakaway currency” in a strange twist Hans-Olaf Henkel suggests that rather than some of the so far suggested solutions to the problems of the Euro (like bailout of Greece, and perhaps Ireland, Portugal and Spain, or their exit from exit from the Euro zone with a return to their national currency to permit them to devalue their currency to become more competitive) a better solution might be to have Austria, Germany and Netherland exit the Euro zone while the rest of the Euro zone countries continue with the Euro, and bail out the banks rather than the countries. He concludes with the need “to focus on saving Europe, not the euro”.

In the Financial Times’ “Sovereign spreads challenging cherished notions” Gillian Tett discusses that “At the end of last week, trading in the credit derivatives markets implied that no less than 70 large US companies are now considered a better credit bet than the American government…One way to read this trend is that it presents a verdict on relative levels of corporate governance, and transparency…Sadly, however, many public entities currently lack that sense of transparency; on the contrary, it is painfully hard to disentangle where the liabilities and tangible assets lie…Most of America’s best-run and healthiest companies these days are not really “American” anymore; on the contrary, they draw a growing proportion of their revenues from outside America’s shores, and hold vast pots of cash overseas… (but) irrespective of CDS prices, the US government is still able to borrow money in the bond markets more cheaply”. In a follow-on article a few days latter “Get used to a world without ‘risk-free’ rate” Tett argues that we may need to re-think the concept of ‘risk-free’ rate: what is the appropriate ‘risk-free’ rate (US Treasury yields were the traditional benchmark until now) that can be used for the valuation of risky assets? “is this concept of ‘risk-free’ even  appropriate in today’s world?” and “if the answer to the first two questions is “no”, then what does that mean for portfolio theory and the capital asset pricing model?”

In the Financial Post’s “Chasing Sino-Forest” Peter Foster argues that ability to short fraudulent financial schemes (as was possible to do in the case of Sino-Forest assuming that the “OSC has its facts right, because its action almost certainly destroyed Sino-Forest”) certainly contributed to OSC’s fast action.  He adds that ”the one motivation about which we can be sure is that people will seek personal profit. That’s why we should trust short-sellers much more than regulators. Short-selling has recently come under attack in a number of European countries. That’s because it exposes poor regulation. It’s one of the most effective tools for keeping markets honest.“ He then spends much of the rest of the article discussing the Madoff affair and how the unavailability of mechanisms to short Madoff was a contributor to allowing the fund to continue essentially unchallenged by regulators despite several articles (Barron’s, Rolling Stone) and approaches to the SEC indicating that it was a Ponzi scheme since the performance was not achievable with the claimed mechanisms.. Foster points to OSC’s action against Sino-Forest coming on the same day as the release of a new movie “Chasing Madoff” about investigator Markopolos’s experience in trying to get the unresponsive SEC’s attention to the Madoff scam. “The movie inevitably leaves the critical issue of regulatory competence hanging. Last March, in a lacerating piece in Rolling Stone, Matt Taibbi suggested that lax Wall Street oversight is due not merely to “regulatory capture” but to a revolving door between the SEC, the Department of Justice and Wall Street law firms. This means that big Wall Street firms are essentially licensed to lie and cheat, knowing that they will attract no more than a no-fault fine. The regulatory system, by Mr. Taibbi’s reckoning, has evolved into a “highly effective mechanism for protecting financial criminals.””

In WSJ’s “The Halo Effect: How it polishes Apple’s and Buffett’s image” Jason Zweig explains “If earnings at Apple and Bank of America grow robustly, the stocks could even be cheap at today’s prices. But halos also can lead investors astray. As management professor Phil Rosenzweig points out in his book “The Halo Effect,” a soaring stock price can lead investors to regard the company’s managers as focused, disciplined and passionate—while, in the negative halo of a falling stock price, the same executives will now seem stubborn, unimaginative and resistant to change… The trick, then, is to recognize that halos can be valuable without letting them hijack your determination of value.”

And finally, but still on the topic of behavioral finance, you might be interested in the Bloomberg special report “Behavioral finance studied to improve investing” which discusses how “Financial advisers are relying more heavily on behavioral finance — the study of how unconscious biases affect financial decisions — to coax risk-averse investors out of cash and into the markets. Meanwhile, in academia, researchers are tracking how hormones hurt returns and using brain-imaging technology on scam victims.” There are articles on testosterone being the cause of “irrational exuberance” (Better Trading Through Science), signals indicating that “you’re suffering from Irrational Prudence Syndrome” (Wall Street Wants to Train Your Brain) and a well worth watching short video interview with  behavioural finance expert Meir Statman “about factors that lead to investment mistakes and Wall Street’s interest in behavioral finance” (Losing Money? It Could Be Your Fault).


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: