Hot Off the Web– February 6, 2011

Personal Finance and Investments

First of all read about what a fiduciary is and why it is important for your wealth in my new blog; a Fiduciary duty requires the fiduciary to place the interests of the client ahead his own.

In WSJ’s “Long-term care: New fixes” M.P. McQueen reports that many insurance companies “have either introduced or expanded offerings of “combo” products—permanent life-insurance policies or annuities with “accelerated” death benefits or “living benefit” riders—which allow owners to draw down cash during their lifetime if they become terminally or chronically ill.” The advantage of such combo policies is that it’s easier to qualify for them, there are typically cheaper, and unlike LTCI policies if you never need LTC the policy beneficiaries still receive the full death benefit. One of the disadvantages is that the maximum living benefit is capped at the death benefit of the policy and the policy premium increases by about 20% on top of the basic premium. (It is something worth investigating, if you are thinking LTCI policy which has its own problems e.g. see LTCI-I Long-Term Care Insurance- An Overview and LTCI-II: A Quantitative View)

In the Globe and Mail’s “Don’t be snowed under by the sequence of returns” Ted Rechtshaffen writes that you should not be scared into high cost guaranteed income stream products like Manulife Income Plus products by so called “sequence of returns” risk as you approach retirement. “…if an investment product has a lot of fancy brochures, charts and binders produced by the manufacturer of the product, it clearly means that this is the product they are pushing. They don’t push products that make them little money. They only push the ones with the big margins. The fancier the package, the faster you should run.” (If interested in the subject you can read my analysis of similar GMWB-like products from insurance companies GMWB I , GMWB II or observations on similar-flavoured bank products e.g. BMO Life Stage retirement Income Portfolios)

Rob Carrick in the Globe and Mail’s “Are you saving enough for retirement?” recommends and provides some links to ‘retirement income calculators. (I haven’t explored them but may be of interest to you.)

In WSJ Smart Money’s “Is your index fund broken?”Jack Hough reviews assorted “indexes” (which may not be considered indexes by all) based on which you may be able to buy available ETFs. He includes the classical capital weighted indexes, as well as the equal weighted and fundamental ones. Also mentioned some more recently developed indexes like the minimum volatility and risk-efficient indexes. Many of the non-cap weighted indexes claim superior performance (at least before fees and transaction costs), but Vanguard challenges the appropriateness of using the ‘index’ descriptor for anything but cap weighted approach. Those on the other side of the fence argue that cap weighting forces you to buy overpriced securities by the very nature of the index.

In the Financial Post’s “Retire early, it’s cheaper” Jonathan Chevreau discusses RRSP “melt down” “before they become highly taxed RRIFs or trigger clawbacks of Old Age Security”. For example “CIBC tax expert Jamie Golombek sees no reason to start a RRIF at 60 but sees a case for doing so at 65. One is to qualify for the pension income credit; a second is to qualify for pension income splitting, which in turn may help keep you and your spouse out of the OAS clawback range.”

In the Globe and Mail’s “Assessing the risk of an ETF ‘blow-up’” John Heinzl discusses reported concerns that heavily shorted ETFs might blow-up. His conclusion is that you should worry about the suitability of the underlying assets in the ETF that you are thinking of investing in, “But don’t waste your energy worrying that the ETF itself will collapse; it won’t.”

In WSJ’s “New Life-Policy fallout: Suits from insured” Leslie Scism reports on new twist in stranger-originated life policies intended to be sold to third parties that “Now, some older people who took out life policies on assurances they could flip them to investors are suing agents, lenders and insurers, claiming they were misled into shelling out premiums on policies that ultimately found no buyers.”

Noreen Rasbach in the Globe and Mail’s “Do your investments fit your retirement plans?” quotes Adrian Mastracci on the need for a “process- to come with the right retirement plan”. (An Investment Policy Statement (IPS) encompasses all the element of the required process. If you are working with an advisor and you don’t have an IPS, you are more than likely not getting all the ‘advice’ that you need.)

In the Globe and Mail’s “How Bay Street can bridge its credibility gap” Tom Bradley reminds reader that the future is unpredictable and Bay Street credibility is at stake for promising 8-10% returns…but the real credibility gap is in promising sustainable better than index returns with active management at 1-3% cost…it’s a pipedream.

Real Estate

Brett Arends in the WSJ’s “Here comes the sunbelt”opines that the previously expected sunbelt boom times predicted due to the coming 80 million  boomer retirees may still materialize, even though the real estate bubble collapsed in the past 3-4 years. Boomers will still be yearning to get out of the cold and prices have fallen about 50% from the 2006 peaks. His argument is based on the return of the “price-gap” between some major northern US cities and the sunbelt prices, may allow again some boomers to sell up north (if they can find buyers) and buy cheaper in the south (no problem finding sellers).

Steve Ladurantaye in the Globe and Mail’s “Home prices could dive if rates rise, analyst says” quotes a Capital Economics report that “house prices in Canada have climbed at the same pace as the United States, but have not fallen at the same rate as in the United States….(and) As the Bank of Canada raises interest rates, mortgages will become more expensive for consumers. Add inflation to the mix, and Capital Economics predicts prices could fall 25 per cent over the “next few years.””

In the Financial Times’ “Long US house price decline predicted”Steve Johnson quotes a residential real estate expert that “It’s probably 40 years, if ever, before [US house prices] get back to their peak,” he says, and that’s in nominal, rather than real terms. “We are going to need a lot of population growth. It’s easily 30-40 years. ..A further 10 per cent fall is not priced in to the market. I think that is going to have repercussions. Housing is in worse shape than it appears and that’s likely to lead to a bumpier, slower economic recovery that is subject to reversals.”

In the WSJ’s “Home prices sink further” Nick Timiraos reports on the ‘WSJ’s latest quarterly survey of housing market conditions and found that in all of the 28 metropolitan areas tracked during the fourth quarter when compared to a year earlier…inventory levels, meanwhile, are rising in many markets as the number of unsold homes piles up…price declines also intensified in several markets that so far have escaped the brunt of the downturn…”


In the Financial Post’s “Bill would protect pensioners”Barry Critchley report on a motion to be tabled in the Canadian House of Commons which would provide priority in case of bankruptcy for DB pension plan shortfalls over unsecured creditors. This compromise proposal, which would not put pensioners ahead of secured creditors, would be a great step forward in getting fairer treatment for Canadian workers whose employers went into bankruptcy (often with the specific intent to shed pension obligations). This is good public policy; giving priority to pension shortfalls (i.e. to deferred wages) over unsecured bondholders, who understood the risk and were rewarded often with junk bond rates for lending to corporations, is the right thing to do socially and economically. This motion needs to be passed ASAP and retroactively to protect Nortel pensioners (of whom, in the interest of full disclosure, I am one. It is also worth mentioning that the Liberal Party White Paper on pension reform recommended the same treatment of pension shortfalls.)

In the Globe and Mail’s “Majority backs Canada Pension Plan, poll finds” Bill Curry reports that “According to the survey, 76 per cent of respondents support increasing CPP benefits and 51 per cent oppose the current federal approach to delay CPP reform in favour of a private pooled pension plan. The survey also found 81 per cent of respondents agreed it is important that retirement security be debated in the next federal election.” (Thanks to BD for recommending article)

In WSJ’s “Nobody is proposing to ‘slash’ Social Security” Charles Blahous writes that “To understand why, we need to start with the basics of the Social Security benefit formula. Since 1977, Social Security has employed a formula that links a retiree’s initial benefit payment to growth in the national average wage index. Since wages tend to grow faster than prices, this formula pays younger cohorts greater benefits (in inflation-adjusted terms) than those paid to earlier retirees“. “The rationale behind this is to provide the same replacement rate (i.e., benefits as a percentage of pre-retirement earnings) for “similarly situated” workers of different generations. In other words, if a typical worker’s benefit today is 50% of his previous wage earnings, then that worker’s grandson, assuming he occupies the same relative position in the national wage distribution, will also get a benefit equal to 50% of his own earnings.”  “Some defenders of the current system argue that Social Security’s benefits should grow with wages because, after all, worker contributions are assessed as a percentage of wages. But since Social Security is an income-transfer program in which current benefits are paid from current workers’ taxes, no such proportional relationship can be preserved as society ages and there are relatively fewer workers to support each beneficiary.”

In the Financial Times’ “JPMorgan strikes important deal for longevity trading”Paul Davies reports that recent deals to insure pension plan sponsors against rising longevity risk of plan beneficiaries is indicative that “Banks and insurers have increased efforts to create a market in longevity risks in recent years as pension schemes and consultants look for more ways to offload all the risks attached to their liabilities.” These deals are fixed term hedging deals on DB plans “to limit exposure of the party taking on the risk”. (I am not convinced that this approach is the future. A better approach, given that individual longevity risk is much greater than cohort longevity risk, is a low-cost mechanism to protect against individual longevity risk and typically leave individuals to absorb the cohort risk.)

John Plender in the Financial Times’ “Following the herd risks capital loss”argues that pension plans are inadequately diversified by heavy weighting in one asset class (stocks) and the recent desire to shift to a liability matching approach (i.e. more heavily fixed income weighted)  would be making the switch at a time when bond yields are at their lowest. “A switch to mechanistic approaches to investment, such as liability matching, entails abandoning such good old-fashioned value rules as “buy low, sell high”. For many investors volatility measured by standard deviation is not the only measure of risk. Loss of capital is their preferred definition. .. There are, of course, ways of diversifying without sacrificing value. Bridgewater’s is the risk parity approach, which involves balancing risk exposures across many sources of return to achieve consistent performance in all weathers… Today the message is that concentration risk can produce lethal capital loss. And that is as fundamental a principle as buy low, sell high.”

In the Financial Times’ “Auto-enrolment the start of a new approach”Jonathan Lipkin discusses how public policy is being influenced by behavioural economics. Examples given include ‘auto-enrolment’ and commitment to ‘save more tomorrow’. Thaler and Sunstein’s book Nudge discusses “libertarian paternalism”. “The libertarian side avoids outright compulsion, while the paternalistic element aims to steer individuals in the direction desired by public policymakers without appearing too draconian. In a consumer-focused age where individuals often wish to have choice, but do not necessarily always exercise it, libertarian paternalism can potentially strike the right balance in a number of areas from finance to health: an “opt out” approach to organ donation.”  “However, in the context of pensions policy, there is also a need for caution” because auto-enrolment is not the whole answer. Governance structures, “innovative and well-targeted approaches to product design and communication”, and “more has to be done to ensure both the simplicity of the long-term savings environment and the ability of individuals to understand the choices available and the potential consequences of not saving. This means a particular focus on the shape of the tax-wrapped product set and on broader financial education.”

Things to Ponder

Inflation potential continues to be a top area of concern in many articles in the past week. In Bloomberg’s “Gross says focus on headline inflation to monitor prices”Cordell Eddings reports that Bill Gross recommends not focusing on the ‘core inflation’ (which excludes food and energy) but instead focusing on headline inflation measure including food and energy.

In the Financial Times’ “Wrong kind of inflation” James Mackintosh writes that “For equity investors the story is rather different. The right sort of inflation – caused by economic growth rather than “stagflation” – should allow corporate profits to keep up with prices, and dividends to rise even after inflation. Yet, it turns out that rising inflation is typically bad for equities, and there is a simple rule of thumb for working out when. Four is the magic number: when inflation hits 4 per cent, equities fall.”

The Financial Times’ Lex in “Inflation: The right kind and wrong kind”argues that “eventually, is tighter monetary, fiscal and regulatory policy, which would take away the monetary fuel that makes price and wage hikes possible. But post-crisis, overleveraged parts of the world have some good reasons for delay. Most important, unexpected inflation detoxifies over-leveraged financial systems by eroding the value of fixed debts – without going through disruptive defaults…below-inflation wage increases are generally more palatable than actual cuts in the pay packet… an increase in the targeted inflation rate would give central bankers more freedom to set negative real policy interest rates… There is a case for allowing higher inflation in the developed world, and an honest admission of this would help the debate. The problem lies in the developing world, where rising commodity prices have created the wrong kind of inflation.”

Paul Vieira in the Financial Post’s “Inflation worries hit factories” reports that “Factories around the world shifted into high gear in January figures released on Tuesday showed, but a surge in raw materials costs has sparked worries advanced economies are about to get whacked with the same inflationary pressures emerging countries are now grappling with.”

In the Financial Times’ “PMI data raise fears on global inflation” Chris Giles writes that “Global industrial production grew at annual rates above 10 per cent for much of 2009 and 2010, putting pressure on oil, energy and water resources. The resulting cost pressures are similar to those in 2008, which squeezed household and corporate incomes and contributed to the subsequent contraction in demand.”

In Bloomberg’s “Taleb advises ‘first’ avoid treasuries and then the dollar” Abelski and O’Brien write that “Nassim Taleb, author of “The Black Swan”, said the “first thing” investors should avoid is U.S. Treasuries and the second is the dollar.”

Jeremy Siegel in the Financial Times’ “Risks abound with inflation-linked bonds” writes that “All this means that Tips investors should beware. Although Tips may compensate holders for future inflation, the interest rate that they offer is far too low to offset the risk of rising rates. Even when these securities yielded 4 per cent, this yield did not compare to the historical return on equities, which has averaged between 6 per cent and 7 per cent in the US and about one percentage point less in the UK. As economic growth recovers and real rates rise, the price of Tips will fall leaving Tips investors with large losses in the face of accelerating inflation…. Dividend-paying stocks, whose payment is well covered by earnings, should be the choice of the conservative investor. These stocks have not only offered inflation protection but have participated in economic growth. This strategy will give investors far better long-term protection against inflation than today’s low-yielding inflation-linked bonds.” (If you decide to focus on dividend paying stocks, just make sure that you don’t get stuck too heavily concentrated in financial stocks.)

In the Financial Times’ “Commodity super-cycle is back in full swing” Roger Jones writes that “This year promises to be a volatile one for commodities, with the hard evidence that the financial crisis only temporarily unseated the super cycle, becoming increasingly apparent. “ He suggests with the exception of gold on which he opines that “if financial market concerns do ease, gold could soon find itself out of favour.”, commodities are ready to party. (Great news for the Canadian market)

And finally, CNBC’s Jeff Cox in “Ready for ‘splash crash’ the ultimate market meltdown?” warns that a repeat of the ‘flash crash’ but with even greater intensity and across multiple asset classes, could result from the “interconnectedness of high-speed trading platforms, and possibly triggered by geopolitical disturbance. (Recommended by CFA Financial Newsbriefs)


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