Hot Off the Web– December 8, 2009

Personal Finance and Investing

Those of you who might have missed Larry MacDonald’s Globe and Mail article “Nortel retiree prefers ETFs” on my personal approach to investing, you might find it interesting to peruse that short article.

Daisy Maxey’s article “What should you do with your money in 2010”in the WSJ reports on some advice from financial advisors. Included in their advice are: broad diversification, innovative financial engineering products with downside protection (don’t bother, usually not worth it), asset allocation focus, reassess risk tolerance, prepare for tax changes (increases)

In WSJ’s “Questions for a financial planner”, Jonathan Burton considers some of the due diligence you should do when looking for a financial planner. He writes that you should “treat him or her as you would any employee: background checks, signed contracts, performance reviews and full disclosure of outside affiliations or other potential conflicts. That’s sound practice when dealing with brokers and investment planners who pledge to act in good faith and work on commission, and with fee-only investment advisers who are legally bound to a fiduciary standard of business and ethics and collect a percentage of assets under management.” He suggests five must ask questions: are you a fiduciary, am I a good fit to your target client list, how do you get paid, who is the custodian of the funds, and what are your conflicts of interest?

Also in the WSJ is Tom Lauricella’s “Retirement planning mishaps” where his list of mishaps includes: overspending, inadequate/lack of up-to-date wills/instructions with explicit beneficiaries (to minimizes taxes), responsible individuals named to attend to their long-term-care/financial/medical needs if they become incapacitated, and/or to explain well in advance of death the reasons for unequal (though not necessarily inequitable) distribution of inheritance.

Anne Tergessen in WSJ’s “Get ready for 2010- the year of the Roth IRA” is quite a detailed look at the new opportunities for more Americans to take advantage of Roth IRAs. She explains advantages over traditional IRAs and how you might go about converting from tradition to a Roth IRA, if it makes financial sense for you (e.g. you have to pay the tax ‘upfront’ on conversion). One key consideration will be your expectations of your future tax rates due higher future earnings and or higher future tax rates.

In the Financial Times’ “In the Vanguard of investor interests” Pauline Skypala discusses the damage that fees inflict on investors’ long-term returns. She quotes from Vanguard’s US website “Investment costs count” reads the headline….Keep more of what you earn,” it continues…On average, other mutual funds cost about six times more than Vanguard’s. The difference can add up over time.” If Vanguard didn’t exist, we’d have to create it. Vanguard recently entered the UK retail market. (Vanguard has been looking at the Canadian market as well, though so far unfortunately has not declared its intentions to enter.) Ms. Skypala concludes with the comment that “The industry has no incentive to manage costs properly or to compete on costs for investors’ business. Who is looking after investors’ interests? Vanguard is the only name I can think of.” (And, Canadians continue to willingly and unnecessarily pay some of the world’s highest mutual fund fees, even though alternatives are readily available.)

WSJ’s Sam Mamudi reports that “index huggers” or “closet indexers” (mutual funds which promise better fund performance by active stock selection, yet in fact just stay close to the index and charge a higher fee) are not good for your financial well being, in “What are you paying for?” (This should be no news for readers of this website.)

Leslie Scism in WSJ’s “Locking in future income” does quite good overview of variable annuities which provide guaranteed minimum payments. She covers most of the angles the opportunity (downside protection of income), the high costs which likely will eat away at the asset base and the upside, and that you might be better off with an immediate annuity. (Ms. Scism is too generous in her assessment; the outcomes are likely to be more often than not much worse than expected due to punishing fees. Those interested in the topic might wish to look at a couple of my related blogs on the subject GMWB I and GMWB II; I would recommend that you handle these products with great care and caution.)

In The Financial Post’s “Don’t mess with your strip bond ladder, Bob Cable advises”Jonathan Chevreau reprints Cable’s advice on fixed income investing: “time and effort trying to decide how to invest fixed-income money is a waste. Use the ladder and then spend time on the equity side of your portfolio where decisions can be made that may lead to better overall portfolio returns. Or take the time to do something with friends and family. “(Well, almost right; you may want think twice about wasting your time on the equity side of your portfolio- just buy the market (index) and spend time on asset allocation, and your family and friends.) His final conclusion is probably closer to being right: “Buy the ladder. Stick to the plan regardless of what anyone thinks. Invest it and forget it and do something else with your time.”

Real Estate

WSJ’s James Hagerty in “House flipping makes a comeback”reports that a new “breed of flipper is proliferating: one who seeks bargains at foreclosure auctions. Unlike the boom-time flippers, the latest generation needs cold cash, lots of local-market knowledge and strong nerves….The bidders often haven’t had a chance to inspect the property or determine whether it’s occupied by tenants, who may be hard to evict….Flippers swoop in at public auctions of foreclosed homes, known as trustee or sheriff sales. In many states, the lender sets the minimum bid, and takes possession of the property only if no one bids more. In the past, the minimum generally was about equal to the mortgage balance due. But in today’s market, in which many home values have dropped far below the loan balance, lenders wouldn’t attract investors if they set the minimum at that level….in downtown Phoenix, trustees, companies that are hired to handle foreclosure auctions, offer as many as 600 or 700 houses every weekday. A typical auction lasts only a few minutes.”

Pensions

Index Funds Advisors reports on results recently published in the Financial Analysts Journal of a study in “From frying pan to fire” that professionals at pension plans and foundations/endowments “are susceptible to the same performance-chasing behavior that plagues individual investors, causing them to lose hundreds of billions of dollars in asset values, while paying dearly to do so.” The study of 80,000 institutional funds concluded that “much like individual investors who seem to switch mutual funds at the wrong time, institutional investors do not appear to create value from their investment decisions. In fact, the study estimates that over $170 billion was lost over the period examined,” and that is before transaction costs and consultant fees are considered!” “The study’s data-rich findings provide further evidence of the random nature of stock prices and the futility of manager selection based on recent strong, but lucky performance.  This study states, “Clearly, plan sponsors could have saved hundreds of billions of dollars in assets if they had simply held course.” “Thanks to Ken Kivenko of Canadian Fund Watch for bringing the article to my attention.

Ken also sent me another interesting story on pensions by Norma Greenaway entitled “Canada’s Medicare story could be model for pension reform”, in which she quotes pension expert Keith Ambachtsheer that just like Canada’s Medicare system which wasn’t invented in Ottawa (but Sakatchewan), neither will Canada’s new pension system replacing the current one in “systemic failure”.  “Whether Ottawa wants to play some role, or not, frankly, it’s not a major issue if all the provinces decide they are going to do it.” (With Ottawa’s feet firmly planted in ideological concrete, reform may in fact have to take place with or without the Fed’s participation. We will get first indication of the direction that Canada’s pensions are heading into, and who is driving, at the December 17^th Yellowknife Federal/Provincial pension conference.)

Blakes Bulletin reports that “Partial Plan Wind Ups in Ontario: FST Decision That Annuitization Not Required”. In case taken to the Ontario Financial ServicesTribunal, Imperial Oil Limited against the FSCO (Ontario’s pension regulator) the decision was that “in the context of a partial wind up under the Pensions Benefits Act Ontario (PBA), a plan administrator could meet its obligations to provide pensions for members affected by a partial plan wind up by providing those pensions through the on-going plan, i.e., not being required to annuitize benefits of affected members who have chosen a deferred pension.” (This is exactly what makes sense to do, in partial or complete windup, and it’s one of the options that (Nortel and other) pensioners have been fighting for, unless of course the pensions can be made whole to 100% of their pre-bankruptcy value.)

In the Financial Times article “Shake-up in Australia’s fee structure” Elizabeth Fry looks at a key flaw in Australia’s, otherwise leading approach to universal pensions introduced in the 90s. The flaw relates to the asset based fee structure charged by the private fund providers without any corresponding “value added”. Changes in approach to fees are advocated, as “huge wealth gathered by many investment managers from a government-mandated growth in superannuation rather than from delivering outperformance.” Investment approaches used by Ontario Teachers’ and Canada Pension Plan are provided as examples to follow. (Just shows you that the best pension system can be developed only by standing on the shoulders of those who have gone before us and learning from their successes and failures.)

Things to Ponder

The WSJ and the Financial Times had a couple of interesting articles which potentially show some changing winds that may be the fallout of the recent economic and financial debacle. In “Japan halts landmark postal sale” Alison Tudor describes changes that “indicates a sharp shift in the country’s approach to economic policy, with a focus more on trying to insulate households from market forces and slow growth than on harnessing deregulation to lift growth.” While in “Berlins’s pious Sabbath decree” Christopher Caldwell reports that “Germany’s federal constitutional court ruled Sunday shopping unconstitutional”; “The driving force behind misgivings about Sunday shopping is worry over globalization, and the sort of capitalism that has landed us in such a mess over the past year or two….(and he concludes with)… If you want different values than the consumerism presently on offer, then at a certain point you have to declare those values openly. Germany is beginning to do that.” (Given that these are from the WSJ and FT, one has to sit up and pay attention as there may in fact be new winds of change; we may understand from where they are blowing from, but I don’t think we know where they are going.)

Jeff Rubin in Globe and Mail’s “Financial crisis or energy shock”argues that the root cause of the financial crisis was not the subprime mortgage fiasco; it all started with doubling of oil prices between 2004 and 2006, which drove up headline inflation (the one that includes energy and food) to 6%, which in turn drove up borrowing costs destroying the ability of millions of homeowners to pay the mortgages “on homes that they couldn’t afford in the first place”

In the Financial Times article “How to take moral hazard out of banking”Ferguson and Kotlikoff argue that governor of Bank of England Mervyn King’s call for “utility banking” “It was a brave and important challenge to a status quo that institutionalizes moral hazard and exposes governments to ruinous losses. True, the enormous bail-outs, loans and guarantees provided to banks helped avert a Great Depression. But they have also sown the seeds of another disaster. The contingent obligations, which…total three-quarters of UK gross domestic product. The US figure is twice GDP”… “were push to come to shove, governments would have to print the money to bail out the banks, leading depositors to walk, trot and, finally, run to get their money to buy something real before prices skyrocketed.”

And finally, the Globe and Mail’s Derek DeCloet article entitled “A climate skeptic’s guide to fun and profit” call for investment bets against global warming with coal, oil sands and railways, and Avner Mandelman’s “Don’t let ‘climategate’ melt down your portfolio” where he asks “why am I going on about this? For two reasons: First, because global warming is an investment theme that a few brokers are pushing; so, if you are a theme investor, be careful. Second, this sort of revelation is a perfect teaching moment of the madness of crowds….If there’s a key lesson here for you, it’s this: learn to resist the lure of popular fads, whether market-related, or ideology-based. If you don’t, you’re likely to find yourself investing in the next Nortel, Bre-X, or Madoff fund, or windmills supported by tax credits.” (More winds of change?)