Hot Off the Web- November 7, 2011

Personal Finance and Investments

In the Financial Times’ “There is no such thing as certainty”  Jane Fuller discusses the pursuit of the Holy Grail of ‘simple’ investment/financial products. Simplicity, she writes, that depending on your perspective, could mean ‘simplicity of outcome’ like annuities or some flavour of other ‘guaranteed’ savings products, which come typically with high cost, access limits to assets and thus the “product becomes complex and opaque even before the saver considers that the guarantee is only as good as the guarantor or “the small print allows it wiggle room”. Or, as Fuller suggests, ‘simplicity’ is when there is clarity of what savings are invested in and correspondingly it would be low cost! She then proceeds to discuss the pursuit of certainty in terms of absence of high volatility, yet when one looks at “what” volatility one fears or disapproves of, the dimensions of the problem grow, and reducing volatility in one dimension may come with not just increased costs but also increased volatility in other dimensions. Her conclusions specifically on pensions are two-fold: need better risk sharing mechanisms between sponsor and member, and “for retail savings product or state benefit there is no such thing as certainty”. (This is a great introduction to a preliminary assessment blog on the new Vanguard GLWB, which I mentioned last week, and plan to release in the next day or so.)

In the Globe and Mail’s “The dangerous rise of an obsession with safety” Tom Bradley opines that “Today every investment discussion and sales pitch is laden with words like caution, capital preservation and downside protection. In the context of recent markets, this is understandable for retirees, but it’s also part of the conversation for investors who have 10, 20 or more years until retirement. As a result, investors own fewer assets with the potential to generate a return in excess of the risk-free rate.” Bradley laments Canadian investors creep to lower equity allocation, lower international diversification and heavy use of currency hedging, and he concludes that “we’ve crept to a place that reflects what happened in the last 10 years, not the next 10. Market volatility has obscured the attractiveness of common stocks and past performance has put Canada on too high a pedestal.” On the same topic, in the WSJ’s “The young and the riskless”Light, Pilon and Silver-Greenberg write that “Risk-taking is for the young—except, it seems, when it comes to investing. The 2008 market panic, last year’s “flash crash” and the latest burst of volatility are proving to be more than many young investors can stomach… Investors who eschew risk at such a young age might be setting themselves up for disappointment. Without the compounding effects that come with investing in equities for a long time, stock-less investors might find it nearly impossible to accumulate a big enough nest egg to retire…” The authors also discuss considerations of one’s human and financial capital and how the nature of one’s job affects the riskiness of human capital.”

Item #7 of InvestmentNews’ “FINRA suffers setbacks on the road to becoming adviser SRO”reports that that FINRA has (thankfully) chosen to abandon its attempt to extend its Self-Regulatory Organization(SRO)power from brokers to advisers, after it was ordered by the SEC to improve its internal compliance procedures after having been caught for the third time doctoring documents intended for the SEC. (So much for the value of SROs. You need the checks-and-balanced that can only come into play with the creative tension between the regulated and regulator; but even that is not a guarantee without skill, knowledge, integrity and toughness on part of the regulator.)

You might find  IndexUniverse’s “Basics of risk, Part I: An ETF primer”an interesting and educational read on ETFs. It discusses total vs. price return, tracking error, premium/discount/NAV, bid/ask spreads and benchmarks.

Real Estate

In the absence of anything more interesting on real estate, I couldn’t resist including the Globe and Mail’s “Cuba allows home sales for the first time in decades” where Paul Haven reports that “Cuba announced Thursday it will allow real estate to be bought and sold for the first time since the early days of the revolution, the most important reform yet in a series of free-market changes under President Raul Castro.” (The ‘good life’ in Cuba will disintegrating…or it might just be the first step for Cubans to start enjoying some of the capitalistic sins… J)


Dorothy Kelly writes in the CFA Magazine’s “Pensions and duty of loyalty” that “In an attempt to eliminate potential confusion, the 10th edition of the (CFA Institute) Standards of Practice Handbook expanded its guidance to include a section on “Identifying the Actual Investment Client”. With regard to “portfolios of pension plans or trusts…the client is not the person or entity who hires the manager but, rather, the beneficiaries of the plan or trust.” “The duty of loyalty is owed to the ultimate beneficiaries”, not to the client who signs the contracts and pays the fees. However, according to a very comprehensive overview of the fiduciary state of affairs in The Rotman International Journal of Pension Management entitled “Reclaiming fiduciary duty Balance”Hawley, Johnson and Waitzer write that “By delegating duties to qualified experts, trustees in many jurisdictions can shift liability risk to the delegates. This can create perverse incentives for trustees to delegate responsibility while the delegates try to avoid liability by providing advice but not making final decisions – or seeking indemnity (Stewart 2009). The result can be a circular system in which no one takes responsibility and the interests of agents trump those of pension beneficiaries.” The article also includes in meantime specific recommendations on dealing with the (obvious) management of service provider conflicts. (It it wonderful that the CFA Institute sets such a high standard of care for its members, but what we now need is that the this also becomes the law of the land as far as all professionals dealing with pension plans: investment managers, actuaries, custodians, etc. Furthermore, clear resolution of the corporate sponsor’s dual fiduciary responsibility to pensioners and shareholders, must explicitly be addressed by the law and resolved in favour of pensioners.)

In the Financial Post’s “The pension Ponzi scheme” and “Canada urged to end ‘pension apartheid’”Jonathan Chevreau reviews a new book and a C.D. Howe Institute report which savage the differences between private and public sector pension systems in Canada. The chasm between the private and public sector retirement systems is represented by the differences between: (A) both the permitted maximum amounts and the actual contributions to retirement savings by Canadians, and (B) the required $2M of savings necessary to cover the pension of a top public sector manager with final salary of $150K/year.

On the US pension scene (and there are commonality of issues with Canada), I received a link from one of my readers (WET) who thought that this Retirement Plan Blog might be of interest to others as well. It covers DC, DB, cash balance, public plans. (At times somewhat technical, but provides a directional view of the evolution of the US retirement system.) And on the same topic in Canada, the CBC New  reports in “Saint John pension reforms could spur legal fight”that “Saint John could face a legal fight if it moves forward with a proposal to stop indexing its employees’ pension plan to the inflation rate, according to a pension law expert… Susan Eng, the vice president of advocacy for the Canadian Association of Retired Persons, said attempts to remove inflation indexing from the pensions of people who are already retired is grossly unfair and probably illegal. Eng said the rules cannot be changed after people have already left the workforce.”

In the Globe and Mail’s “Sun Life’s surprise loss signals stock is more risky than cheap” David Milstead reports that the company has just announced $621M loss in the past quarter due falling stock markets, falling interest rates and changes in actuarial assumptions. The company published previously sensitivity analysis indicating that 10% drop in NA markets translates to losses of $125-175M, while 1% drop in interest rates translates to $200-300M loss. (Changes in actuarial assumptions can result in whatever you would like to achieve. This sounds just like pension plans. Perhaps it’s time to reconsider the shareholder owned model for insurance companies, and return insurance to the mutual or policyholder ownership model again; would be certainly better for policy holders, and likely even shareholders.)

Things to Ponder

Jason Zweig in the WSJ’s “The extraordinary popular delusion of bubble spotting” writes that “Ever since 1841, when a Scottish journalist named Charles Mackay published the book known today as “Extraordinary Popular Delusions and the Madness of Crowds,” the answer has seemed clear. If you watch carefully for signs of euphoria, you can sidestep the damage when markets go mad.” But that was then and still is today a pipedream. “The great value investor Benjamin Graham suggested that investors should never have less than 25% or more than 75% of their money in stocks. He argued for reducing the allocation to stocks “when in the judgment of the investor the market level has become dangerously high.” But, because no one can perfectly predict a bubble, you should never go either to zero or 100%.”

Samuel Brittan in the Financial Times’ “Why I would have voted no in a Greek referendum” he argues that “…those of us who were brought up think of international economics in terms of costs, prices and exchange rates are made to feel like dinosaurs. What is missing from the discussion is the role of adjustment.” Specifically, there is a need for increasing exports, reducing imports, attracting more long-term foreign investment and, if not locked into the “misconceived” eurozone arrangement, devaluation can help with the required retrenchment. The eurozone arrangement left no flexibility points, leaving deflation and potential “downward spiral until the “street” takes over”. Brittan concludes that there is always “a tendency of the financing tail to wag the economic dog” and he quotes a 1925 Winston Churchill comment that what we need is “less finance and more content”! (Plus ca change, plus la meme chose.) On the same subject you can read “What saves the euro will kill the union” and now “Greek vote threatens bailout”which suggests that the just announced referendum in Greece would likely result in $360B debt and its exit from the eurozone.

In the Financial Times’ “Subprime moment looms for ‘risk-free’ sovereign debt” Gillian Tett suggests that we may be approaching a paradigm shift in the way we look at sovereign debt. Some are “now urging regulators to remove the risk-free sovereign tag, not just in relation to reserves (i.e. for any holdings of Greek bonds, say, or loans) but for counterparty risk in trading deals, too.” If the shift takes hold, it will lead to higher cost of sovereign debt, changes in collateral being posted on the $500T derivatives market …exposing an under-collateralization of $1.5-2T. “…if regulatory systems had not encouraged banks and investors to be so complacent about sovereign risk in the past, markets might have done a better job of signalling that structural tensions were rising in the eurozone – and today’s crunch would not be creating such a convulsive shock”.

In a Reuters reprint in the Financial Post of “Retirement crisis closes in on U.S. baby boomers” Tom Brown writes that “Baby boomers are members of the first generation since the 1930s who will be worse off in their older years than their parents… “According to our projections, it looks like most middle-class workers, not just low-income workers but most middle-class workers, will be living at or near the poverty level in their old age,” Ghilarducci said in an interview… Older Americans are already clinging to jobs at the highest rate since before Medicare…was signed into law in 1965.” And commenting on this story in “The baby boom retirement crisis hits home” Jonathan Chevreau writes that “working till you die may not be too tragic if you’re doing something you love and for which you have a passion… Boomers may be leaving the corporate grind but few wish to be put permanently out to pasture. They’re reinventing themselves, turning avocations into vocations, following their bliss, becoming entrepreneurs, business owners, consultants and creative artists.” Bloomberg’s “Economy drives more Americans to extreme poverty” in a related story reports that “The number of Americans living in neighborhoods beset by extreme poverty surged in the last decade, erasing the progress of the 1990s, with the poorest areas growing more than twice as fast in suburbs as in cities.”

In the Financial Times’ “Creditors can huff but they need debtors” Martin Wolf explains that despite complaints by creditor nations like China, Germany and Japan about debtor nations like the U.S. they are in a deadly embrace; those having an ability to produce goods far in excess their own residents will buy but that debtors want, ”are caught between throwing good money after bad or tolerating brutal adjustment, as their markets disappear. In punishing profligate borrowers, they also damage their own citizens.” Wolf argues that both debtors and creditors are at fault; “It would be a good idea to rediscover reciprocal interest….creditors do not sell to Mars. We are on the same planet. Agree to fix its messes, right now.”

John Kay in the Financial Times’ “Capitalism need not be about greed and gambling” writes, in defence of capitalism, that “A semantic confusion leads us to use the word market to describe both the process which puts food on our table and the activity of gambling in credit default swaps(my emphasis). That confusion has enabled people to claim the virtues of the former for the latter… Many of those who preach the doctrine of free enterprise loudest have succeeded by skills more akin to those of backroom politicians than of entrepreneurs.”

The Financial Times’ John Dizard writes that “Low-cost platform is path to the future”for the bond market, and the time has come for disintermediation of the bond dealers. Dizard suggests “Imagine if bond investors got paper or cash by buying or selling from each other rather than from dealers? The dealers would just act as agents, without taking positions against their customers’ orders.” Of course this is just like you can do today for stocks and options, and in any case the current low interest environment undermines the traditional dealer model. (The sooner this change takes place, the better for all.)

In the Financial Times’ “Pendulum swings on American oil independence” Ed Crooks reports the oil rush not just in North Dakota and Alberta, but all the way down to Texas, and then discusses the implications of all this activity on America’s superpower status and its prospect for energy independence resulting from a combination of major new investment, new extraction technology and reduction in demand. The only dark cloud on this picture is the associated environmental concern.

In NPR’s “Why prosecutors don’t go after Wall Street” the reasons given for no prosecutions resulting from the 2008 financial meltdown are the “new guidelines issued by the Justice Department in 2008, which have allowed prosecutors to take a “softer approach” to corporate crimes. The guidelines — known as deferred prosecution agreements — have permitted financial companies to avoid indictments if they agree to investigate and report their own crimes. (Thanks to Breach of Trust’s  Larry Elford for recommending.)

And finally, Ray Dalio in the Financial Times’ “Risks rise as political leaders give in to mob rule”opines that deleveraging in progress is testing our character and social and political systems as it has done in the past. “Rather than trying to resolve disagreements through thoughtful discourse, people are now trying to grab power to beat and suppress their opponents. Politicians who are fighting for power in a political year are fanning the flames and are increasingly willing to do risky things (like shutting down the government) in pursuit of their missions and popular support. In 1933 Germany’s election of Hitler was at least in part enabled by frustrations about perceived “ineffectiveness of government” and expectation that the elected ‘saviour” will clean up the mess. This growing populism will have important implications for monetary, fiscal and trade policies and will significantly increase risks of a markets downturn and a global depression.” He concludes with concerns that if we can’t manage our way rationally through our current problems we could end up with economic, social and political collapse.


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