Hot Off the Web– June 7, 2010

Personal Finance and Investments

In the Financial Post’s “To annuitize or not to annuitize” Jonathan Chevreau suggests annuities as a mechanism to secure longevity insurance (i.e. a lifetime income source). Unfortunately, while annuities may be appropriate for very conservative investors especially if they have no interest in leaving an estate, they are not the best way to tackle longevity insurance. (See my earlier blogs on the annuities at Annuity I, Annuity II, Annuity III, Annuity IV.) Real “longevity insurance” products (not yet available in Canada but available in the U.S. for the last 3-4 years) essentially separate the longevity insurance portion of traditional annuities from the asset management part of the product. Clearly, this is not what insurance companies prefer to do, since they in effect earn their 2-3% annual fees on a much smaller asset base. These real/pure longevity insurance products  for each $1 of single premium at age 65, will pay (a life contingent) $0.8-0.9 annually for life  starting at age 85.Therefore you can buy pure  longevity insurance for about 5-8% of your assets, instead of annuitizing 50-100% of your assets. Here is one of my old blogs on the subject Longevity Insurance- What does it buy you?which compares traditional annuities with a systematic withdrawal approach (from a balanced portfolio) without and with pure longevity insurance; the results indicate that the latter can be expected to lead to superior outcomes for most.

In the Financial Times’ “Doubt rises over regular bond indices” Ruth Sullivan discusses concerns about using bond index based securities in an environment of increasing concerns about sovereign debt. The concern is related to the “indices (being) weighted by market cap because they allocate the greatest weight to the most indebted countries”. Some managers are uncomfortable with this approach, and they prefer a more ‘fundamental’ approach allocation in a global bond fund such as based on GDP or “net foreign asset position”.(This concern with bond indexes is not new, but I suspect it gets a lot more focus in the current environment.)

The Globe and Mail’s Rob Carrick says “if you’re looking for a travel rewards credit card, don’t make a move until you check out this new player” in “Before you book, check out this new travel rewards credit card” (also reviewed in Capital One Aspire World MasterCard Review”). Carrick indicates that the card offers 35,000 welcome bonus points and further 10,000 on the first anniversary, for a total of 45,000 points worth $450 in travel. The card also gives two points for each dollar spent. While it may not be the best in all circumstances, both reviews recommend that readers take a close look into this new card.

Dianne Maley in the Globe and Mail’s “Assets on both sides of the border” looks at things to pay attention to when you straddle the U.S.-Canada border.  Things discussed include: deemed disposition of assets (except RSSP/RRIF/RESPs, real estate) when exiting Canada, 15% or 25% withholding taxes on RRSPs, maximizing RRSP book value before departure,  reporting requirement on RRSPs, no withholding on CPP/OAS, and the requirements for not to be considered Canadian residents.

In the Barron’s article “ETFs get an “F” for May 6 liquidity”Tom Sullivan reports that as a result of the May 6, 2010 20 minute stock drop “some ETFs lost almost all their value and couldn’t be traded at all” and “ETFs represented 70%, or 227, of the 326 securities for which trades were cancelled by the exchanges, owing to a price drop of 60% or more”. “The SEC is…probing the role of market makers, the effect of institutional investors, who often trade rapidly, plus the impact of stop-loss market orders — those placed in advance with a broker to sell a security when it falls to a certain price, limiting an investor’s loss.” Sullivan asks: How bad is the damage to the reputation of exchange-traded funds?” It seems that May’s net inflows into ETFs were still positive.

And for advisors and the more mathematically inclined, in the Journal of Financial Planning’s “The dynamic implications of sequence risk on a distribution portfolio” Frank and Blanchet consider the so called ‘sequence of returns risk’ and suggest practical approach of dealing with the problem. (Insurance company products like variable annuities with guarantees were not included in the suggested solutions. J.) Included in the list were: regular review of probability of exhausting assets factoring in continuously updated life expectancy, regularly measuring and adjusting withdrawal rate as a percent of the updated portfolio size, starting with a lower percent withdrawal rate to minimize impact of significant market declines, adjust asset allocation if necessary to control risk and most of all this is not a “fire and forget” but an ongoing exercise.

Real Estate

In the Globe and Mail’s “Shine comes off housing boom”,  Ladurantaye and McNish report that “Canada’s resale housing boom has run out of steam. After a year of solid gains, monthly sales in major cities took their first step back in May as the threat of higher mortgage rates, tighter qualification rules and a flood of new listings took the pressure off buyers to rush into the market…Mr. Soper (CEO of Royal LePage) said the market likely peaked in December, and the number of sales has been easing off since. Prices in Toronto and Vancouver have gone too high, putting homes out of reach for the average buyer, he said.”

For the U.S. real estate market, the WSJ’s Hagerty and Timiraos in “Drop in home sales in wake of tax credit tops forecasts” report 25-30% sales declines in some markets in May (both new and used homes), following the April expiration of tax credits. “Despite the recent drop in mortgage rates to less than 5%, applications for home-purchase mortgages in late May were down nearly 40% from a month before and have fallen to their lowest level in 13 years, according to the mortgage bankers.” The article also mentions that in the Miami market sales were up 5% due to buying by foreigners attracted by price cuts.

In the WSJ’s “A fresh look at rent vs. buy” Brett Arends reports on’s study of some major real estate markets as to whether it’s cheaper to buy or rent. They used the 15 times annual rent as the crossover point. Manhattan is at 32x, whereas Seattle, Portland and San Francisco are all >20x. Phoenix and Las Vegas are 10x and 11x, respectively. While Arends mentions some caveats why the 15x number may be too low, this type of analysis should be kept in mind as there are significant differences between markets.


In Canada the private member Bill C-501, intended to provide priority to pension plan underfunding in case of sponsor bankruptcy (a la Nortel),which was moved to Committee last week despite Conservative MPs’ large-scale opposition, has some wording problems that need to be addressed. Actuary Jim Murta pointed out the problems with current wording. A careful reading of the Bill indicates that it is addressing “unfunded” (or amounts that were required to be paid by the employer to the fund”) rather than “underfunded”amounts, which is really what’s needed. There still is time to address the issues as it moves to Committee. This wording, in the Nortel pension plan case, addresses the $22/year shortfall payments that Nortel was required to (and did) pay as a result of the December 2006 valuation, rather than the approximately $1B pension plan underfunding that exists today.

In the Financial Post’s “A new pension deal”Frank Swedlove, the president of the Canadian Life and Health Insurance Association of all things,  not surprisingly, wants “a smart evolution, not a revolution.” He thinks that 50-70 bp can deliver a medium sized private sector DC plan; so why are there no such plans readily available to most Canadians today? Besides, even smaller than CPP/OMERS/Ontario Teachers sized plans cost more like 30-40 bp for the actively managed part of pension funds and of the order of 5 bp for the passively managed portions; plans typically are likely >50% passively managed and the trend is to continue increasing the passive component. We won’t even speak of the much higher than the 50-70 bp costs associated with annuities. Mr. Swedlove thinks that “What Canada needs is not the creation of more retirement savings programs, but better access and use of the programs we already have.” That is the last thing that Canadians need. Canada’s insurance industry is trying to create the old FUD (fear, uncertainty and doubt), but hopefully the federal and provincial ministers and their staff studying the matter won’t fall for this campaign. Canada’s citizens won’t, for sure; Canadian deserve better! (Thanks to Dan Braniff for pointing out this article)

Things to Ponder

In the Financial Times’ “Tracing a decline of active managers” Pauline Skypala reports the growing flow of assets to passive managers in the pension industry. “even the consultants now acknowledge that the move to passive is probably permanent, having in the past predicted a swing back to active at some point….There is a long-term trend to indexation, particularly in the most liquid markets.” This coincides with another strong trend he identifies towards asset managers providing asset allocation advice and selling asset allocation products… The other side of the indexation trend is the growing interest in alternative investments… Rightly or wrongly, that is where the active management allocation is increasingly going.” This raises a couple of questions according to Skypala relating to: the implications of lower levels of diligence by passive (index based) institutional managers in their exercise of ownership responsibilities, and risk management since passive approach doesn’t reduce volatility and the related question whether cap-weighted indexation “produces a good risk/return trade-off for investors” (i.e. the shares, and bonds, with largest market caps continue to attract most money, as already discussed above).

William Hanley in the Financial Pot’s “Confessions of a debtophobe” writes that “Despite the lure of cheap-as-dirt money, my friends and I find peace of mind in staying debt-free. We made mortgage payments for almost 30 years, and it did seem like they would never, ever end. But, mercifully, they did. Everything is squared away now. We really don’t wish to go to that particular part of the financial outback again.”

In his third article in a gold-related series (see reference to his first two in last week’s Hot of the Web, Brett Arends in “Playing gold without getting killed” suggests that buying options on GLD ETF might be a way of “making bets they hope will pay off if prices go up, while limiting their losses if the market drops.” “So instead of risking $119 a share on the GLD fund, investors could, for example, pay $16 ($17 today) for $120 call options good until January 2012. That would give them the right to buy the shares at $120 if gold booms, and limit their losses to $16 if gold tanks.”

Jason Zweig in his WSJ article “Hey money managers, stop putting the squeeze on investors” suggests to money managers that in order to prevent middle class America from deserting the capital markets, as they did in the 30s and 70s, they should: “cut fees”, pay attention to after-tax returns, set limits to size of (actively managed) funds, stop acting like sheep and start “measuring managers against growth  rate of national economy adjusted for risk” instead of the S&P 500. His final suggestion may be the best one and it’s based on the investment industry’s premise that “Our actions improve your returns”, so why not compare actual year end returns to the returns if portfolio had been left unchanged from previous year-end.

The Economist’s “The deflation dilemma” discusses the uncertainty as to what to worry more about- inflation or deflation? In a survey of leading economists the sense was that “deflation is the bigger short-term danger in big, rich economies, whereas inflation is an immediate worry in many emerging economies and, potentially, a longer-term danger in rich ones.” The economists indicates that deflation is the one to fear more, as it would result in a “vicious cycle of weak spending and sliding prices” and “increase the burden of consumers’ and governments’ debts. Deflation is also harder to fight than inflation.”

And finally, in the Financial Times’ the “New rules for nations in hock” Alan Beattie argues that with all the experience that both banks and  countries have accumulated over the last half millennium in going bankrupt, then “the new rules for banks should become the new rules for sovereigns”. His tongue-in-cheek proposal includes: break up countries which are “too big to fail”, apply “Volcker” so no country can do both manufacturing and financial services, etc. He also took an opportunity to take a pot shot at “goody-goody” Canada which should be given an exemption from tax levies “to build an Arch of Triumphal Smugness in Toronto”. (Fun reading)


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