Hot Off the Web- February 6, 2012

Personal Finance and Investments

In Vanguard’s “Recessions and balanced portfolio returns” the authors write that “we calculated the historical returns of a balanced 50% equity/50% bond portfolio under two distinct U.S. business-cycle regimes: recessions and expansions. We show that the average real returns of such a portfolio since 1926 have been statistically equivalent regardless of whether the U.S. economy was in or out of recession…While a recession is always unwelcome, our results support the utility of an investment program focused on a diversified, long-term strategic asset allocation, and should give considerable pause to those who recommend a more tactical or reactive approach to investing.”….if you can’t adjust your spending downward then you must save more or increase your risk somewhat (with the attendant downsides). (However once you are retired it’s difficult to do either of these. Thanks to RD for referring article.)

In the Financial Post’s “Don’t give up on ALL your mutual funds” Gordon Pape  writes that you shouldn’t throw out the baby with the bathwater, even if the mutual fund industry has “serious systemic problems” and “offers a lot of products that are at best mediocre and at worst lousy”, but he found five funds that he can recommend. He then mentions that leveraged and some hedged ETFs also had poor outcomes, so don’t assume that ETFs are better than Canadian mutual funds. (The reality is that Canada’s mutual fund industry’s systemic problems affect the vast majority of its investors, whereas only some of the ETF investors and their assets are used inappropriately and investors are mostly very well served (by low cost broad market  physical based index funds) compared to mutual funds. With all due respect to some even skilled rather than just lucky investment managers, it is not clear what the message is. The funds quoted happen to be some with the lowest MERs among Canada’s mutual fund. (So is the message in “don’t give up on ALL mutual funds” means to invest in those that did well (i.e. exceeded peers with even higher fees) the past 10 years is a very low bar to recommend funds. How about sustained performance against an appropriate benchmark? And even so, we don’t know which mutual funds will do better than peers or the market the next ten years. ALL this proves that cheaper and smaller funds may outperform other funds especially when also aided by a fortuitous target asset allocation compared their ‘peers’ in same category. Some managers may have skill but the average investor won’t be able to pick them in advance, and once skill is suspected/recognized, asset under management increase until performance is ground down to average, less fees. By the way to get the fees that Pape quotes (which are still 3-10 times higher than the lowest cost corresponding ETFs) you’d have to put up with the added inconvenience of going directly to the fund companies, rather than being able to buy from your online discount brokers. Don’t be greedy and/or fooled by potential to outperform the market on a sustained basis; stick with low broad market physical based ETFs to implement your strategic asset allocation consistent with your risk tolerance.)

In the Financial Post’s “How Ontario plans to ‘transform’ health care” Tom Blackwell reports on coming changes in Ontario health care: many procedures will be shifted from hospitals to clinics, more family physicians will be available after hours and/or within 24 hours (how?), some of direct funding to hospitals will be shifted to funding the patient using the hospital, province plans to shift funds to home care services from nursing homes to allow the old and infirm to stay in their homes longer.

Real Estate

The November 2011 U.S. Case-Shiller Home Price Indices released the past week indicated that ““Despite continued low interest rates and better real GDP growth in the fourth quarter, home prices continue to fall. Weakness was seen as 19 of 20 cities saw average home prices decline in November over October,” says David M. Blitzer, Chairman of the Index Committee at S&P Indices. “The only positive for the month was Phoenix, one of the hardest hit in recent years. Annual rates were little better as 18 cities and both Composites were negative. Nationally, home prices are lower than a year ago. The 10-City Composite was down 3.6% and the 20-City was down 3.7% compared to November 2010. The trend is down and there are few, if any, signs in the numbers that a turning point is close at hand. “The crisis low for the 10-City Composite was April 2009; for the 20-City Composite the more recent low was March 2011. The 10-City Composite is now about 1.0% above its low, and the 20-City Composite is only 0.6% above its low. From their 2006 peaks, both Composites are down close to 33% through November.” Both Composites were off 1.3% for the month of November.

On the subject of U.S. home sales volume a real estate expert is quoted as suggesting that “for people to start buying in larger volume, they need to see home prices go up a bit…many potential buyers also are waiting to see the jobs picture improve, which will give them confidence in the stability of their own employment” according to Amy Hoak’s WSJ article “Housing remains a buyer’s market”.

On the Canadian house market front in the Financial Post’s “CMHC backing fewer votes” Garry Marr writes that “Canada Mortgage and Housing Corp. is cutting back on mortgages it insures as the Crown corporation edges closer to a $600-billion cap imposed on it by the federal government… Financial institutions are required to have mortgage-default insurance when a consumer has less than 20% equity. However, the banks have been seeking insurance on loans with even high downpayments — something not required by law — so they can securitize those bulk lending loans, thereby getting them off their balance sheets and reducing their capital requirements… The risk to the taxpayer would be a collapse in the market leading to defaults like the U.S. saw. If CMHC couldn’t cover those defaults, Ottawa is on the hook for 100% of any shortfall.“ In a related article in Bloomberg’s “Canada’s subprime crisis seen with U.S.-style loans: mortgages”Andrew Mayeda reports on concerns that suggest that “Canadian lenders are loosening standards, offering mortgages similar to U.S. subprime loans that pose an “emerging risk” to financial institutions, according to the country’s banking regulator. Banks and other lenders are becoming “increasingly liberal” with mortgages and home-equity credit lines that don’t require individuals (especially the self-employed and recent immigrants) to prove their income…”. The concerns are related to “easing of lending standards, which has contributed to the booming housing market” coupled with some estimates of a downside risk of 25% on Canadian housing prices.

Robert Hiltz in the Financial Post’s “Housing bubble is really a balloon: BMO’s Sherry Cooper” reports that Canada’s housing market is no bubble that will pop, but it is more like a balloon which will deflate. (Is this good news?) “Vancouver, the authors say, has had the highest jump in housing prices — up 159% in the last decade — and has seen the price-to-income ratio in the city double to 10. Even though Toronto has seen the relatively modest rise to home prices since 2001, 84%, the city’s price-to-income ratio is now 6.7, up from 4.3 10 years ago.”


Supreme Court (of Canada) is to hear Indalex case on June 5, 2012. According to a Blakes Bulletin “The Supreme Court of Canada…will hear an appeal from the decision of the Court of Appeal for Ontario in Re Indalex, the landmark case dealing with the scope and priority of the deemed trust (a form of statutory security interest) provided for under the Pension Benefits Act (Ontario). For more information on the Indalex appeal, click here.” (This “deemed trust” argument was not attempted (in somewhat different circumstances) on behalf of Nortel pensioners, as it was felt that it had no chance of success.)

In Bloomberg’s “Treasury eases rules on annuities in retirement plans” Collins and Ody report that “The U.S. Treasury Department will help expand the availability of annuities and lifetime income choices in retirement plans… proposed rule would encourage 401(k) and IRA plans to offer participants the option of dedicating part of their savings to a so-called longevity annuity, which may not begin the guaranteed income payouts until age 80 or 85, the Treasury Department said. The agency said it would grant an exception to required minimum distributions from retirement accounts in certain cases where participants choose the insurance product.” (This is a very important change, especially if the longevity insurance is made accessible at a reasonable cost inside the 401(k). This is a revolution in the DC pension world. At least the U.S. is trying to deal with the looming boomer retirement crisis. Sorry, longevity insurance is not in available in Canada within DC plans, RRSPs or even on an individual basis… Here pension reform is spelled PRPP…pity, and pretty sad! Longevity insurance is one of the advocacy topics of this website, but so far I can’t say that we’ve had any visible impact. The subject is a complex one for non-experts, while the financial/insurance industry and its experts have no interest in the subject as they fear a reduction of their universal life, minimal fixed annuity and rapidly growing variable annuity (GMWB/GLIB) business. The NYT’s “New Treasury rules ease 401(k) annuity purchase”also has a good review of the changes.)

Further proof that the U.S. is trying to deal with retirement income issues (unlike Canada) is the WSJ’s “401(k) plans step into the sunshine” where Greene and Tergesen report that “Spurred by the U.S. Labor Department’s effort to force plan administrators and investment companies to disclose the cost of 401(k) retirement plans, companies are looking to reduce fees and offer new investing choices… until now the industry has been opaque, critics say. The new disclosure rules are “going to give employers more control and leverage to negotiate lower fees… The prospect of increased scrutiny on fees is prompting employers to change their investment line-ups to offer more low-fee funds. In a survey last November of 600 employers, 67% had tweaked their investment line-up, compared with about 10% in most years.” In a related story in the Financial Times’ “Auto-enrolment requires low fees” Pauline Skypala writes that “Workplace pension provision should be a non-profit business. Defined benefit pensions are run on that basis; why not defined contribution?” (Do you know the all-in cost of your group RRSP plan? Perhaps you should ask your employer.)

In the Financial Times’ “The OECD gives Asia a pensions warning”Sophia Greene reports that the OECD expressed concerns about Asian pensions as populations age due to their being either too high (China at 78% for men and 51% for women, Philippines at 81%), or paying too long for contributions made (35 years for Sri Lankan women) or too low likely sentencing them to poverty (Indonesia and Singapore at <20% replacement rate). (You might just imagine the chuckles in China, Singapore listening to advice from OECD countries, some essentially bankrupt others responsible for almost bringing the world financial system to its knees. I don’t have the exact statistics handy but unless one looks at public pensions in the economic context of the country, it might not be that meaningful; e.g. are we not told repeatedly that personal savings rates in Singapore and China are of the order of 25-30% , so perhaps we should be looking closer to home to unfunded pension liabilities (Europe) or shamefully low replacement rates (Canada except for the poorest of Canadians), and no legal or pension guarantee funds to protect private sector DB pension beneficiaries whose employer goes into bankruptcy protection. As the old saying goes, people in glass houses, should not throw stones…)

A great deal of ink has been spilled this past week about Prime Minister Harper’s Davos announcement of urgent need for pension reform in Canada. In the Globe and Mail’s “Research belies PM’s warning about OAS” Bill Curry reports that OECD research was done for the government by Edward Whitehouse and “His conclusion: “The analysis suggests that Canada does not face major challenges of financial sustainability with its public pension schemes,” and “there is no pressing financial or fiscal need to increase pension ages in the foreseeable future.” While other OECD countries face big pension problems, the report predicts Canada will do just fine as the baby boomers retire. That’s because, as Canada heads into the boomer crunch, it spends far less than the OECD average on public pensions.” However in the Globe and Mail’s “Raising the retirement age: Consider it a done deal” Frances Woolley writes that “As Kevin Milligan has argued, increasing the age at which people are entitled to receive Old Age Security and Guaranteed Income Supplement won’t produce huge savings. But it’s not the absolute savings that matter, it’s the savings relative to the political cost incurred – and for an increase in the pension age, those political costs will be manageable. That’s why the U.S. is raising its full retirement age, and the U.K. is raising its state pension age. We will raise our pension age because it saves money, and has little political cost.” She also notes that “An increase in the OAS eligibility age might also be accompanied by an increase in the age at which RRSPs must be converted to RRIFs, or an easing of the RRIF withdrawal rules, bolstering support for a change in the pension age.” In Benefit Canada’s “Opposition, experts warn against changing OAS” there is a discussion of the subtleties of delaying OAS to age 67 like knock-on effect of increased costs for the provinces (but Baldwin indicated that there are puts and takes for the provinces) and there would be very serious impact on the poorest of Canadians of that age due to the currently linked start date of OAS/GIS (though the Ottawa could choose to decouple GIS from OAS). You might also want to read Margaret Wente’s different perspective on the (not yet declared) increase of AOS eligibility age to 67 when she writes in the Globe and Mail’s “The war against the young” that “I’m not suggesting we cast the elderly out to sea on ice floes. But we need to think about how we allocate our money. Are we really sure we want to transfer so much wealth from struggling young families to relatively well-off geezers? How smart is it to suck our grandchildren dry? How many schools won’t get built because we’re buying Lipitor for people who can already afford to pay for it?” You can also read “CARP’s response to Wente attack”; debate is good!

Things to Ponder

The Financial Times’ “ETFs: Engine trouble”Lex laments: the decrease in ETF trading volume in January due to lower market volatility and the potential impact of this on liquidity (i.e. might increase bid-ask spread) and the divergence between European regulators focus on synthetic ETFs and US regulator’s focus on leveraged and active ETFs. (Frankly I don’t see a problem with any of these. Synthetic ETFs are a European issue because they are heavily used there, leveraged and active ETFs are important North American issues, securities lending disclosures are relevant to both, and lower trading volume as a result of higher volatility might be related to lower high frequency trading volume, or lower volatility might be the result of less high frequency trading. I haven’t seen any stats on the subject.)

In the Financial Times’ “Low rates: The drug we can all do without” Satyajit Das writes that despite of the positive effect of low interest rates and QE on asset prices, the effect on the economic growth and housing prices has been less encouraging. He argues that low interest rates cause economic distortions like: substitution of capital for labour and debt for equity, discourage reduction of debt, low interest earned on savings discourages spending which reduces economic activity, lower interest rates increased required savings rates for retirement and cause pension fund underfunding (due to low discount rates increase liabilities), cause asset price inflation (especially high dividend stocks and junk bonds),  the longer the low rates are sustained the more difficult it will be to raise rates as high debt levels often caused by low rates become unsustainable at higher rates…and more. He concludes with the comment from a cocaine user that ““Cocaine isn’t habit forming. I should know – I’ve been using it for years.” But reliance on low interest rates, like all addictions, is dangerous.” (Certainly makes you think about the dangers of low rates. Similar sentiments are expressed in the WSJ’s “Bill Gross: Free money ain’t really free” where Tom Lauricella reports on Gross’ view on the “downsides to the economy” associated with “cheap and abundant central bank credit”). By the way the impact of (artificially) low interest rates on seniors/savers is serious as described in the Globe and Mail’s “For savers in Canada, a sinking feeling” where Silcoff and McKenna write that “It’s the saver’s dilemma. Life for these Canadians has become an uncomfortable squeeze between weak returns on their investments, stagnant incomes and the steadily rising cost of everything from food to fuel to housing… Inflation, while low at an annual rate of 2.3 per cent, compares with one-year guaranteed investment certificates (GICs) paying roughly 1 per cent a year. Simply put: A dollar saved today will be worth less a year from now…” (And of course the lower spending constrained by lower income of a growing population of seniors will become a real drag on Canada’s economic growth rate.)

In the Financial Times’ “The pound is a poison pill for an independent Scotland” John Kay has some interesting comments about currency and about how states use other states’ currency (by fixed exchange rate or by actually using another country’s currency with/without explicit permission) and also in the context the Euro and USD. He concludes with “Currency is a confidence trick: its value depends entirely on the belief that it has value.”

In Bloomberg/BusinessWeek’s “Bank of Canada’s Carney says Volker rule might damage markets”  “Carney said. “We and other officials in Canada have looked at the current draft of the Volcker rule and we have some obvious concerns.” The Volcker rule, as currently written, exempts any trades in U.S. government securities from the prohibition. Unless the same exemption is provided to other countries’ government bond markets, it could drain trading activity, he said. “No other government bond market is carved out,” he said. “U.S.-based institutions are significant players in those markets, and so there is a potential for real liquidity change.”” But Michael Mackenzie in the Financial Times’  “Volker downplays risks to bond markets”reports that Mr. Volker argues that there will be plenty of proprietary trading with a half dozen American banks and that trading is and underwriting are permitted, “What is not permitted is a proprietary position.” (This sounds reasonable to me. No proprietary position of non U.S. sovereign debt is just a means of reducing risk taken on by (too big to fail) banks, risk where the upside belongs to the bank management and shareholders and the downside belongs to the taxpayers; doesn’t sound like a great deal for taxpayers.)

In the Financial Times’ “The pros and cons of binning benchmarks” Steve Johnson reports that the recent success of some alternative indices (fundamental and equally weighted) as compared to capitalization weighted ones (and the search to hold the fort against the onslaught of very low cost index based ETFs) is driving some in the industry to declare that they are heading off into “unconstrained” mandates which might produce “superior risk-adjusted returns to the market cap approach over a market cycle, despite higher trading costs.” But then of course, even if on a small scale a skilled/lucky manager might be able to gain some advantage, any mass movement to an unconstrained approach won’t provide superior returns to market cap which is just the aggregate of all investors.

In the Financial Times’ “Forget the big bonuses; a pay squeeze is coming”Gillian Tett writes about a new research report on financial industry pay in the past 150 years. Individual pay was at parity with rest of private sector at the start of the20th century but then increased to 1.7 times the pay of similar jobs by 1929. The report also indicates that the total cost of financial intermediation (wages and profits) increased from 2% in 1870 to 6% in 1930. Pay parity returned by end of WWII and didn’t start increasing again until the late 1970s. Financial intermediation increased in cost from 4% in 1950 to 9% in 2010, while individual comp in the financial sector returned to the 1929 level of 1.7 times rest of private sector for people of similar skills and jobs of similar complexity/responsibility. Report author “reckons at least half of the pay jump represents “rent seeking” (skimming off fees), not innovation. Tett figures that individual pay in the industry may not return to the 1950s parity, but is heading down.

And finally, in IndexUniverse’s “Bogle honoured at the Museum of Finance” you get to read about some of John Bogle’s impact on the financial world in the past 60 years, including indexing, creating Vanguard “…a mutually structured company where fund shareholders are effectively owners of the company. That innovation eliminated a conflict of interest that exists elsewhere in the money management industry between what’s best for fund holders and what’s best for shareholders of the fund company.” We also learn that Bogle hates ETFs because “he considers their intraday tradability to be their fatal flaw, saying the very virtue of buy-and-hold index investing is completely undermined by all the buying and selling that goes on with ETFs.”


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